The War and America


By W. H. SCHUBART, Vice-President of Bank of the Manhattan Company New York,

March 5, 1941

Vital Speeches of the Day, Vol. VII, pp. 368-375.

A YEAR ago I had the pleasure of presenting to you a paper entitled "The War and America." In that paper I discussed the British war economy as it was developing under the influence of such men as Keynes, Salter d Stamp and then proceeded to a comparison of their economy with ours and a projection of the expenditures that would be required of us if we were to become what is now ailed the arsenal of democracy, if only for defense purposes.

Since that occasion a great deal of history has been made and it is now becoming increasingly obvious that, irrespective of the degree of our participation in the war, we will be greatly affected, and that our company is even now undergoing important revolutionary changes.

Tonight I propose to discuss very briefly the present German economy, then to touch upon similar developments in Great Britain and finally, with a background of what is happening abroad, to discuss with you the effect of war upon our own American economic scene.

Because my own sympathies, like those of the great majority of our citizens, are so deeply engaged, it is not easy for me to maintain a dispassionate attitude toward these subjects. But I conceive that lessons from the proving grounds overseas can be evaluated only by a dispassionate approach, whether they relate to economics or warplane design or tactics of mechanized armies. Accordingly, I shall try tonight to confine my discussion to facts.

Examined from a purely clinical standpoint, the only difference between the German, British and American economies is that the Germans established a war economy first. The British are in the process and we are heading in that general direction. As we are the most fortunate in terms of natural wealth and in point of time, it is our privilege to derive from the experiences of England and Germany much essential information that can help us to avoid unfortunate mistakes.

It is wrong to assume that Germany is operating under a novel and unusual Nazi economy. On the contrary, thorough study shows that she has evolved a typical war economy, now in an advanced stage, with production for war as the focal point. Her men of finance think and operate in a sphere of their own, using the tools provided by the authoritarian state to prod the economic machine where it might not functionsatisfactorily if it were left to depend upon normal motivation. A "suggestion" here and there from the state is useful in bringing private individuals and corporate entities to do things that might not be done in a free country. In short, the Nazi state is not particularly concerned as to the wishes of the people. Failure to invest in government securities would have unfortunate consequences and everyone knows that. However, as government financing has been reduced from a cost of 4 1/2 per cent to about 3 1/2 per cent at the present time, it is evident that so far there has been no great need for coercion in this field. In considering the German picture it is important always to bear this psychological factor in mind. In a country where blind obedience to the state is obligatory, where no one dares to question why, certain factors operate differently than in a country where individual liberty is prized above all else.

In short, it is an economy in which war, and not Nazi ideology, is the dominating factor. From 1933 to 1936 the German state worked at designing an Imperialist-Totalitarian cartel economy described as a "new order for Europe" with regulated labor, agriculture, public works and government planning, but from 1936, and more particularly from September, 1939, war and war production became the dominating factors and, as a result, the present Wehrwirtschaft is not unlike the concept of a war economy as developed by British economists as long as ten years ago and as described in my last year's address.

We are pretty well informed as to how Germany manages her raw material problem. We know that she classifies her own products in three essential categories; those needed for the maintenance of life, those essential for building her war machine, those best suited for barter with other countries in exchange for goods of the foregoing categories. We know that she fosters the production of "Ersatz" materials, substitutes made from more readily available and less necessary raw materials, thus releasing from general consumption many items needed in other categories.

We know that to accomplish her barter objectives before the war she subsidized her exports, directly and by manipulation of the rate of exchange, subsequently recovering such expenditures by taxation and by taking advantage of currency depreciation elsewhere, as well as of the discount of her own foreign obligations. In time of war these subsidies are largely unnecessary.

With raw materials acquired in this and other ways and with labor under rigid control, subject to long hours, moderate wages, no right to strike, but at work all year round, she accomplished the construction of a military machine sufficient to invade and occupy Poland, Denmark and Norway, the low countries and, finally, France. Thus she secured considerable food and material and access to the mines of Alsace-Lorraine, the factories of Belgium and France, the dairy products of Holland and Denmark and assured herself of continued supplies of Swedish iron ore. Since that time she has been adjusting her economy to absorb and control the new production factors now in her possession and from all data available it may be assumed that she has sufficient supplies to last an indefinite period.

Incidentally, to maintain the legal fiction of acquiring assets in France and elsewhere by purchase, Germany has developed the following simple technique: All she does is to charge in the currency of the invaded country far in excess of the actual cost of maintaining her armies of occupation. These credits to German account on the ledgers of the respective countries are then used to pay for the army and the remaining balances are available to pay for all desired purchases, be they newspapers, factories or other assets. In the meantime German personnel, trained for occupation duties, picks up the threads of trade and threads them into the needle at Berlin.

We know that, because of their economic problem in finding markets for their goods, she was able to force trade treaties upon her neighbors to the east, building up in this way clearing agreements by virtue of which she draws their agricultural and other basic products in return for her manufactures, thus engulfing these neighbors in the German economy. This development has been fostered by the blockade, for Central Europe has lost all export markets except Germany.

Wages are maintained at levels deemed by government to be the precise points at which life can be moderately maintained while curtailing spending that would otherwise create a demand for consumption goods in excess of present capacity. You are aware of the German system of limiting purchases by the "point" system, thus enabling the government to know exactly the proportions of consumer demand. Certain psychological devices are resorted to from time to time to make up for deficiencies in purchasing power. These include vacations, railroad trips and, in the alternative, political pressure. No worker can afford to be dropped from the Labor Front.

The balancing of purchasing power against available production—avoiding up or down wage and price spirals—is more easily accomplished under the German system because the Fuehrer and a hierarchy of lesser Fuehrers take the position that the right to work and earn wages has been given to the German people by Hitler and is therefore his to modify as he sees fit. And there is plenty of trouble for any worker who does not accept this theory. No wonder then that intelligent workmen in other countries dread the German brand of socialism and it is equally clear why many industrialists, harassed by labor problems, see much that is attractive to them in the German economy. What these businessmen too often do not clearly see is that, in a totalitarian economy, their own freedom of action would be no less circumscribed than would be that of their own workmen.

The methods by which Germany is taking over control of the invaded territories are peculiarly thorough. In certain cases, such as in Poland, there are forced inward movements of population and outward transfers of labor useful to German industry. Similar attempts were made to move the population in France but these proved troublesome and have been halted. As far as we know, little of this nature has been done in Belgium and Holland, except that some 80,000 workmen have been removed to Germany from these states. Nevertheless, Germany is moving rapidly to consolidate her economic control of all conquered areas. The three Axis powers think in terms of spheres of influence and each seeks to map out its own area in concentric circles with its ruling class in the center, secondary vassals in the middle and the subject inferiors in the outer fringes. As far as we are able to judge, it is the German military plan that the territory west of Berlin will be the center, and it is apparently the intention of the German government to draw into an area within a radius of several hundred miles all heavy productive machinery and those key industries without which no resistance can be implemented. The control of financial wealth is to remain at the center. Passing beyond this to the next ring, the lighter consumption industries are to be set up, and proceeding still further from the central point will be dairying and agriculture. If one were to take a train from Berlin to Warsaw, Prague or Copenhagen, he would passfrom the center of power and wealth inhabited by the "elite" through areas of constantly diminishing economic importance until in the fringes one might find what may best be called "serfdom." This plan does not follow a perfect geometrical design but the objectives are the complete concentration of the power to wage war and control of the economy in Berlin, and the elimination from vast areas of surrounding territories of those tools that might be used to achieve any degree of military or economic independence. Incidentally, the same type of thinking has been passed along to the Japanese end of the Axis, and you will have noted that there is a similar plan which the Japanese are now proclaiming. These ideas originate in military circles and may be difficult to execute.

Trained servants of the Reich are now in all the invaded countries organizing the economy and trade of each area so that it may be directed from a central bureau in Berlin. We have had examples of German efficiency in the management of their export and import trade, and we may expect that not a single crate of eggs will move from Prague to Vienna without a corresponding ledger entry in the central control.

The German fiscal problem is simpler than the English one because Germany no longer depends upon foreign exchange. The countries in Germany's sphere of influence prefer payment in goods such as coal and manufactures in exchange for their products so that barter is both easy and customary. With the countries invaded, plus those in the bartering sphere, she is practically self-sufficient except for oil, coffee and rubber for which synthetic, but none too satisfactory, substitutes are available.

German economy is based on maximum production. All other factors are subordinated to this end. The total volume of production is the national income. Prices are controlled by balancing purchasing power with available production to avoid inflation. Reasonable profits are permitted to assure a growing backlog of savings. Savings are put to work on new enterprise either directly or by the government. Curiously enough, banking has a wider field than in the United States for German banks combine all the functions of an American commercial bank, an investment banker and a stock broker, with considerable advantage to the state because of integration of all financing operations. Thus the income of the banks is preserved and through cooperation with the government there is possible nice discrimination in investing bank deposits in both government and private securities. All security issues require government approval. For all practical purposes, the banks are an instrument of government and are useful in bringing about investment in government securities of idle corporate funds.

This all sounds very simple but it deserves some further explanation. One should never forget that under a totalitarian state a great many things can be done by introducing psychological factors distasteful to us. In the final analysis, the German banking system is government controlled and does not exercise any right of decision except in comparatively minor matters, and then only in line with general government policy.

The expansion of plant facilities is under control and is regulated to the needs of the country. While there is no written evidence to prove the point, it is becoming increasingly obvious that the German government contemplates the need for permanent maintenance of her defensive and military equipment, for that portion of German production facilities is being set up permanently and very evidently with a long-range plan in mind.

Control of the money market is entirely in government hands. Treasury bills are discounted with the Reichsbank and find their way in great part into the hands of the privatebanks. Thus spending power is created and when the cash balances reach certain proportions the holders of deposits are "asked" to buy government obligations, thus reducing bank deposits which might otherwise be used for spending beyond the limits of production. Long term government bonds pay 3 1/2 per cent, thus attracting the funds of private owners of savings to a greater degree than is currently the case in the United States.

In this connection it is interesting to note that Germany entered the war with high interest rates on government securities, paying per cent in 1939 as against 3 1/2 per cent at present. In the United States we entered the war period with unnaturally low rates, due to a plethora of funds arising from huge gold imports.

There has been a very considerable rise in the value of German equity securities, common shares having risen from 25 per cent to 75 per cent in value, in spite of limited dividends and the natural effects of corporate taxes, "gifts" to the party, "voluntary" contributions to labor, tag days and like burdens that have been imposed. Speculation is discouraged from time to time by government just as in this country, but it is not punished by special taxes. Rising quotations have reduced equity yields from 7 per cent in 1933 to about 4 per cent at present—and that this has not been due to fear of fixed income obligations is evidenced by a reduction in the yield of mortgage bonds from 6.8 per cent in 1933 to about 4.4 per cent at present.

This development is not easy to explain. Perhaps the attraction of equity investments is due to the fact that investors foresee an eventual liquidation of the war cost by a new inflation, although there is no immediate indication of such a development. They remember that in the postwar currency inflation gilt edge equities were the best vehicles for preserving wealth. It may be due to the slow increase in equity capital. Perhaps it is due to the gradual substitution of government for private ownership of inventories. This releases corporate funds for plant extension and other capital improvements that might otherwise have to be financed in the equity market.

Under present German practice, when bank deposits and savings move naturally into private enterprise, government direct expenditures recede and when for various reasons such funds are not turned into productive usefulness, the government steps in to fill the gap by creating work projects of one kind or another.

The test of the German financial system, or any war economy, is whether the total budgetary cost of war and subsistence can be met by taxation and borrowing without exhausting savings and those who are expected to produce them.

In Germany the accumulation of savings can be explained by the fact that in an advanced war economy the ownership of essential raw materials eventually rests in the government, thus releasing corporate cash formerly required to carry such inventory assets. The money so released now goes largely into government bonds so that, broadly speaking, it is merely a transposition of financing and not an addition thereto. Some theorists believe that, due to a shortage of materials, German economy is in a naturally advantageous position because her people have no supplies. They are able to buy only modest amounts of food and clothing and because the goods are not for sale in the shops they have neither automobiles nor a normal supply of woolens, linen, refrigerators and a thousand and one other items. This builds up a tremendous accumulated demand for goods which, if implemented by accumulated savings, may substantially ease the eventual transition from war to peace.

Savings have been preserved to a certain extent by limiting all taxation to 65 per cent of individual income. There is no 100 per cent excess profits tax, as in England, which tends to take away the incentive to produce economically. Apart from patriotic motives, what does a manufacturer care if his profits are predetermined by previous performance or by a fixed return on invested capital? Whatever his costs are, his net results will be the same. But with a moderate tax there is an incentive to cut costs and material supplies for in that way the remainder is larger. In German economic circles there is a feeling that taxation has reached its limit—and this is psychologically valuable in stabilizing government and investment markets. Investors feel that they can safely estimate the value of securities once tax factors are more or less constant.

The picture would not be complete without a glance at the German revenue and expenditure figures.

The present German national debt, already $32,000,000,000, is increasing at the rate of between $1,250,000,000 and $1,500,000,000 per month. Government expenditures are financed 35 per cent to 40 per cent out of taxation, the remaining 60 per cent to 65 per cent being raised to the extent of 2/3rds by treasury bills and 1/3rd by long term financing. Special 27 year non-negotiable bonds are designed for life insurance companies and savings institutions. These bonds carry a 3 1/2 per cent interest rate. The insurance companies can resell to the government in case of need but the bonds have no general market. Other bonds, of 10 to 15 years maturity and negotiable, are sold to the general public.

German national income is currently estimated at $40,000,000,000. In September, 1939 her national debt was $15,000,000,000. At the end of 1940 it was $32,000,000,000, an increase in sixteen months of about 113 per cent. At present it is growing approximately $1,400,000,000 a month.

Revenue from taxes is calculated currently at $12,000,000,000 per annum and is increasing pro-rata with government expenditures. Forty per cent is used for civil purposes; sixty per cent for war. Combining revenue applied to war and new borrowings for the same purpose, one may roughly estimate German war expenditures for 1941 at $24,000,000,000 or $2,000,000,000 a month. As her war effort is stepped up this figure will increase rapidly.

I have heard that unification of currency for all of Continental Europe is one of the plans of the leaders. This will not be difficult to accomplish as a fixed rate of exchange has been set up in terms of "marks" for each European country. It is relatively simple to unify currencies, but no such step has yet been taken.

To conclude this sketch of the German Wehrwirtschaft, it is important to make certain qualifications.

It is not right to assume that Germany has discovered the philosopher's stone of money management or that she has achieved perpetual motion in financing war. Nor is it safe to rely too much on the figures that are presented to us. There has been so much rigging of her books through her foreign exchange transactions, through retirement of her external debt at heavy discounts, through legalized and systematic robbery of the invaded territories that it is best to take all figures with more than a grain of salt.

At this point it is important to digress from purely economic considerations to emphasize that the efficiency of the German economy has been accomplished only by the most ruthless indifference to human and spiritual values while, in sharp contrast, the English economy, faced with much greater difficulties and with little compulsion, has produced the most amazing results and has brought into play all that is finest in the British character.

As Germany was the first country to set up a war economy she is in the most advanced stage. England started three years later. Our defense economy is in its initial stages. Curiously enough financial mechanisms follow generally in the same pattern; that is why the German picture deserves our careful attention. There are essential differences constantly to be remembered. From the standpoint of economic possibilities, German Europe is a well consolidated geographic unit. The British Empire is far flung. Both Germany and England suffer from raw material shortages, aggravated by shipping difficulties. We are a geographic unit and, what is more, we have a surplus economy.

A careful study of the British war financing leads one to the conclusion that there is as yet no definite economic plan. Money is being raised, taxes imposed and consumption goods rationed from time to time as necessity dictates. This is not intended as criticism of the English war program for it is still in its early stages and is enormously complicated by political considerations and by the geographic position of other parts of the Empire. England must maintain the integrity of the internal economies of her dominions while endeavoring to secure from them a major effort for war. Her shipping losses constitute a problem of the first magnitude. For the second time in recent history her fate will depend upon whether her navy is sufficient to protect the vital shipping routes that are the arteries of her Empire.

Her position differs from that of Germany in that her productive capacity is not as self-contained. She must rely on her dominions and in an ever increasing degree on the United States for food and war supplies. On the other hand she has upwards of $10,000,000,000 of external assets while Germany has none. Again it is dangerous to oversimplify for these external assets are the life-blood of her island economy and cannot be used for payment purposes without destroying the overseas investments which in normal times have provided the income to offset her food and raw material purchases. If the volume of her overseas investments is materially diminished in the present crisis it cannot fail to reduce her goods imports after the war and in consequence either the standard of living of her people or even the population which the island can sustain.

British exports for 1940 have not increased as planned. Her total exports and reexports will approximate about $1,750,000,000 or about $150,000,000 less than in 1939. Her adverse balance of trade was considerably larger. For the year 1939 her negative balance was $1,600,000,000 while for eleven months of 1940 it increased to over $2,400,000,000. These results increased her shortage of foreign exchange and have forced her to block sterling balances standing on her books to the credit of other nations. Her declining purchasing power abroad, plus the heavy drain on the savings of her people to finance her war effort, makes it necessary to reduce constantly the supply of consumption goods available to her own people. As a result, England is seriously considering the use of the German "point" system. This will involve the use of purchase cards fixing the number of "points" or units of various commodities that may be bought. In this way she soon may have to ration rich and poor alike.

The British national debt rose nearly $9,000,000,000 in 1940. In 1941 the increase will be about $12,000,000,000. The debt now stands at $44,000,000,000, roughly $1,000 per capita. In Germany the equivalent figure is $375—but she wrote off her old war debt by currency inflation. England did not, although she defaulted on her war debt payments to us. Again I must point out that statistics are dangerous and that the per capita debt comparison is subject to manyadjustments including local borrowings which differ in each case.

Up to this point England's debt reflects her entire war effort. If the Lend-Lease Bill becomes law, it is unlikely that her national debt figures will be expanded to include the cost of aid forthcoming from us. Such costs would show on our books unless we were to receive useful merchandise in exchange which could be credited to her. Judging from the current rate of expenditure, I think it is safe to say that she is spending more now than at any time in the first World War. British revenues are currently being collected at about $5,400,000,000, roughly half of which goes to civil government expenses, leaving half or $2,700,000,000 as a contribution to the war effort. New loans are raised by sixty and ninety day treasury bills and by 15 to 19 year bonds issued at 3 per cent and more recently by seven year notes at 2 1/2 per cent.

The British national annual income is currently about $32,000,000,000. War expenditure may be estimated at $15,000,000,000 per annum or about 47 per cent of national income, while government expenditures for civil purposes approximate $2,700,000,000 or 9 per cent of national income. This compares with 60 per cent of Germany's national income going for war and 12 per cent for the normal operation of government. Comparison is difficult, if not impossible, for England's figures should not be considered without measuring the similar efforts of other parts of her Empire, while Germany has expropriated valuable material from her conquered or dominated neighbors. Nevertheless it is probable that England's war cost will advance to the equivalent of the German figures—i.e., 60 per cent of her national income or about $20,000,000,000 per year.

It is important to remember that national income usually rises with every increase in government expenditure so that current totals mean very little and current expenditures are not a safe basis on which to compare annual results. Only the ratios are of real interest.

The linking of the American economy to the British effort by means of the Lend-Lease Bill adds a complicating factor to the calculation of both. If we are to be the arsenal of democracy, and therefore a large supplier of goods for British use and of the money to finance production of such goods, then the picture so far presented is somewhat altered. Assuming that we will finance a substantial part of England's war effort, and that part, if not all, is to be in the nature of a gift, we are merging British production and financing with ours. To the extent to which we supply goods without payment, by so much will the British avoid an increase in their national indebtedness. If we charge her ledger account in U. S. dollars for materials delivered, her external debt will be increased; if we ask her to repay in kind at a later date, the reduction of her internal debt may be retarded. The $1,300,000,000 limit is meaningless for it depends on the values to be assigned to the goods loaned or leased. In this way the two economies will become more closely linked as the war progresses. I am not discussing the propriety of this action but I am pointing out that, in our own interest, we are taking the first step in voluntarily supporting part of the British economy and the British defense.

The Lend-Lease Bill contains the germs of important possibilities for future economic collaboration between England and America. What will England do after the war? Will she make Ottawa agreements, compete with us the world over and lock us out of her Colonial possessions? I don't think so. Britain will surely recognize that while we are acting primarily in our own interest, incidentally we are working hard to preserve her very existence. If Britainwins the war, it is hoped that she will cooperate with us in eliminating tariff and quota restrictions and in setting up a trading system that will permit better and freer distribution of the world's goods.

While the British national debt stands at $44,000,000,000, ours stands at about $51,000,000,000 if guaranteed securities are included. Our population is three times that of the British. Proper comparison cannot be made without including the state and municipal indebtedness of both countries. As national debts rise to astronomical figures, it becomes increasingly obvious that a constantly larger portion of national income is being turned over to government in the form of taxes and the investment of savings in government obligations. This process transfers national spending power from private hands to government agencies and tends to lead away from free enterprise. It parallels the path of the German transition from the Second to the Third Reich, and it makes it necessary for those of us who wish to preserve our economic liberties to give the most serious consideration to the problem of attaining maximum production without incurring compulsory regulations. If the war continues abroad and especially if we become belligerents, it is not unfair to assume that a much larger part of our national income must go for military purposes, that is through the hands of government departments and agencies. This might mean government control of the resources of the banks, of production capacity, of the investment of private savings, of food consumption, of foreign exchange and of every other item that enters into the economy of the United States. That is what has long since happened in the Axis countries. England has been forced to take many steps in this direction. We are on the threshold. The road back from central to decentralized control is extremely difficult. The attitude of the people towards their government might be very different in a strictly managed economy than under free or normal conditions, and it is difficult to determine whether there could again be a wave of decentralization as after other wars when there were still new territories to be opened up and underproduction still existed at home.

Similar conditions were produced in the last war and still we returned to a relatively free economy. That is true enough—but there is at least one important qualification. England and America are still carrying the cost of the last war in the form of debt and taxes and the cost of this one is being superimposed thereon. At the end of this war period our national debt will include the cost of two wars and the "emergency" spending of the depression era, a heavy burden to carry.

Emergency is an overworked word. We have been treating the ills of our domestic economy as emergencies for more than ten years. We have built up a huge national deficit greater than that left behind by the first World War (which is still unpaid for) and now we are confronted by what is already or may soon be a real emergency and in terms of our financial position we are in bad shape to meet it.

In the last war productive capacity in this country was substantially increased. In this war there is a similar development and there may be an even larger expansion than last time. In England and here, government rather than corporations may own excess plant capacity after the war and while this, together with present-day amortization privileges may mitigate the financial difficulties of the private corporations when the war ends, the more serious problems arising unemployment will not be relieved. Instead of excess plant facilities having to be charged off by corporations and their stockholders, such new plants will probably belong to the taxpayers. This will happen unless the corporationsfind use for such facilities because of continued demand for old or new products which would justify purchase of the plants. To avoid having idle plants after the war, Keynes (in England) proposes that the people lend their savings to the government for war purposes on the assurance of the gradual return of these savings by the government after the war is over, thus providing purchasing power at that time for consumption articles. The difficulty with this scheme is that the money to be returned after the war will have to be raised by new taxes or new loans, for, in the meantime, such savings will have disappeared in the bottomless well of war expenditure.

This brings up another point. In Germany there is a serious shortage of all items of civilian consumption and the same situation is developing rapidly in England. German economists and now English economists are claiming that this may prove to be an advantage in terms of postwar economy. When peace is restored, so this theory runs, there should be a tremendous demand on the Continent and in England for goods of all kinds from heavy plant machinery to food, clothing and shelter. They argue that this accumulated demand should support postwar manufacturing, thus continuing employment on a considerable scale during the period of readjustment.

In the United States our people have as yet felt no pinch in the supply of consumption goods. As new employees are taken into the factories, they will have early access to our instalment finance system and will be able to stock up on all kinds of personal inventory. Instead of developing an accumulated demand, it is likely that there will be heavy personal inventories. It is true that our government is giving thought to the preparation of public projects that will occupy some of our workmen when it is no longer necessary to manufacture arms. Even these palliatives will not be sufficient to avert a very serious postwar problem.

Study of the German economy is apt to lead to the false conclusion that the only danger of a large national debt is the cost of carrying it. In this country in some quarters the theory is held that the interest rate on government obligations should be brought down and held at the vanishing point. Obviously, this is a false conclusion for, without strong motivation, there is no incentive to take government securities with an insignificant yield when there are other more fruitful avenues for investment or when cash balances appear safer. So far, German experience has shown that a nice balance can be maintained, for the time being, by paying a moderate return for such funds, recapturing the interest cost through taxation. In revamping our somewhat muddled tax system, it will be important to bear in mind that the English have probably blundered in levying a 100 per cent excess profits tax. To provide an incentive to the manufacturer to produce economically, it is important that he should have a proper share in the net earnings. He should not profiteer—no one wants that. But his enlarged profits help to increase the national income, stimulate investment interest and improve the whole economy. I say this because there are some here who are beginning to ask for 100 per cent excess profits tax, not realizing the full implications of such action.

Our tax system should be stabilized as rapidly as possible. It is better to know the worst—and then plan accordingly—rather than to have to guess at the probabilities of every next year's tax bill.

There are many who fear inflation cannot be avoided and there are others who just as strongly believe the opposite. If we proceed wisely and learn from what is going on abroad, there need be no inflation in our country. This may involvegradual reduction of normal consumption, particularly in luxury goods, unpopular as this may be. It will also require strictest economy in cost of government. We shall have a credit expansion and, of course, an enormous increase in our national debt if the need for maximum defense continues or if we become more deeply involved. How far can we increase our debt? Some believe there is no limit as long as national income increases accordingly. Others believe national debt can be pumped into banks, insurance companies and the like ad infinitum. I do not share this view. If that is done, payment of the accumulated debt eventually will be evaded no matter how long such action is postponed.

It is important always to bear in mind that inflation does not result from the mere accumulation of deposits or cash, as long as such assets are not used. If, due to a fear psychosis, the idle funds are suddenly used for the purchase of goods, and there is an insufficiency of the latter to supply the demand, then prices rise, money value depreciates, finally wages go up and chaos results.

It is increasingly clear that when order is reestablished in the world, we shall have to play a leading role in maintaining peace or face the risk of having to come to Britain's aid again if she is threatened by Continental powers. I do not see how we can avoid this responsibility in the future. If Germany wins, she will most certainly extend her clearing system. She will not repeat her former mistake of borrowing heavily abroad. She will exchange merchandise at prices set by her to fit the exigencies of the situation. In such a barter economy we shall not fit and much of the world trade will be denied us. Present-day German thinking completely eliminates foreign exchange as we have known it in the past—and her methods circumvent tariff and quota restrictions. If Germany loses the war and the small nations are restored as economic units, they will trade with us to the extent that we will accept their goods and services in payment for their purchases.

Eventually we shall be faced with the necessity of giving careful consideration to the disposition of our gold in such a way that it will serve the purposes of conducting international trade and for settling payment differences. It would have been better, at the time when much gold was moving here for safekeeping, if our authorities had segregated it from our monetary system by the simple expedient of offering storage facilities in the Federal Reserve Bank of New York; in effect, placing gold in bonded warehouse for a monthly storage fee. This would have obviated sale of government obligations to effect sterilization and would have transferred the cost of the storage operation from the taxpayer to the owners of the gold. Then when the owner of gold needed U. S. dollars, he could have exchanged the metal for cash. It would have extended the ear-marking privilege, presently only available to foreign governments and central banks, to foreign nationals as well. Of the $14,000,000,000 of gold that have moved to this country during the last seven or eight years, a large part was owned by foreign nationals who would have preferred to store their gold here instead of taking dollars.

Once peace is reestablished abroad, we may expect an outward flow of goods. Repatriation of capital may require the movement of substantial amounts of gold. As the inward movement of gold has expanded our bank deposits and created excess reserves, so the outward movement will contract them. This leads to the conclusion that we ought to prepare now by setting aside a portion of our present gold holdings for eventual foreign use. In itself, this action, is properly publicised, would remind Europe that muchof her capital is here ready to go to work abroad when peace returns.

There is a further advantage in setting aside such a block of our presently useless gold hoard. If the Treasury were to agree to authorize the Federal Reserve Banks to sell part or all of $5,000,000,000 of gold certificates to the banking system, then excess reserves would be decreased by an equivalent amount, thus removing one of the dangers of credit inflation without the necessity of new legislation to increase required reserves; i.e., to reduce excess reserves. With such gold in the banks, it would be ready to move into trade at the right moment. Such action would restore control of the money market to the central monetary authorities and would serve to correct the present unnatural situation. It would not seriously affect the ability of the banks to absorb new issues of government securities when that becomes necessary, although interest rates might be firmer. The purchase of such securities creates new deposits as the government spends the money thus borrowed and under present conditions there would still remain sufficient excess reserves to care for the increased deposit liability.

This picture sets us a nice problem. History has shown both lender and borrower the fallacy of international loans that carry no provision for liquidation in terms of goods and services. The time has come to adjust our ideas on tariffs and quotas unless we intend to isolate ourselves completely from world trade. If we decide upon the latter course, we shall have to substantially readjust our internal economy, but I do not believe for one moment that in a closely integrated world the latter course is humanly possible.

As labor grows in experience and political importance, the underlying implications of our former trade policies will come to be understood and it will be found that much readjustment is needed to fit present day world conditions. We shall have to go in for multi-lateral exchange of goods or continue to pour money down the drain in the form of foreign loans if our agricultural surpluses are to be absorbed and our factories kept going. It is not a question of "isms," it is a cold question of employment. It is clear now that high tariffs lead to barter and barter drives out gold as an instrument of international trade. It is high time for government to establish an authoritative commission to study these problems and to make recommendations to Congress for legislation that will meet these difficult postwar questions.

The United States operates under a capitalistic system. The distinguishing features of this system are private property, a free market and individual enterprise. It is a money economy in which the price of goods and the rate of wages normally are determined by market conditions, expressed in money terms. Theoretically, the ultimate goal of a free economy is an equilibrium in which there is sufficient productive capacity to absorb all available labor, gradual expansion in such capacity to offset savings of labor resulting from technological improvements, distribution of spendable income to assure consumption demand sufficient to buy and pay for the productive output, stimulation of the profit motive by limiting taxation so as to permit savings for productive investment. Government spending does not reestablish equilibrium although it affords relief. If government spending competes with private business and is accompanied by legislation interfering with properly managed private enterprises and weakening to the profit motive, it subtracts from private production with one hand while it adds with the other.

We started to regulate our economy and interfere with free markets long ago when Alexander Hamilton invented the protective tariff to protect our infant industries. What infants they are today! Over the years we have done much regulating. More recently we interfered again in the free play of our profit system. The government stepped in to prevent liquidation and bankruptcy; in a word, to protect debtors, large and small. Witness the railroad, banking and real estate legislation of those days. In addition, money was spent for all kinds of relief, for projects to create employment, for agricultural price stabilization schemes, restriction of production and in a great many other ways. So our free economy is not so free and we have been planning to relieve—but not to avoid the need for relief. We are moving rapidly from a free to a managed economy.

There is a growing conviction that many old axioms and definitions of economic theory are open to considerable doubt We have seen that the totalitarian, Germany, Italy and Japan, adjudged bankrupt ten years ago, have built up huge war machines, the largest in history, while thus far maintaining the appearance of solvency and avoiding inflation, We have seen an era of cheap money in the United States and an accumulation of idle deposits never equalled before, without substantial and lasting business recovery or inflationary results. We have seen national currency management carried to extremes and the complete disappearance of free foreign exchange. In Germany we have seen bad money that did not drive out good money. It is true that all these manifestations may still prove to have been temporary but the orthodox consequences certainly have been efficiently postponed.

Perhaps an explanation lies in the following factors: As we have just stated, the world over debtors have been protected against creditors, thus avoiding the normal readjustment of the capitalist or profit system, and in this country in particular we have definitely moved from over-consumption (under-production) to unde-rconsumption (over-production). We have not known how to put to use everything we could make or grow including the labor capable of making and growing. This, in itself, is our major economic and social problem. The government has tried to solve this problem but in the attempt it has been only partially successful.

The present war will require us to modify our economic conceptions and to do a considerable degree of thinking ahead. There is so great a need for speed in defense that we may overlook the postwar economic repercussions and involve ourselves eventually in serious social complications, threatening to our democratic way of life. As long as the people can choose the men to run our government and are given a chance to understand what is being done, we should he safe. It is our good fortune that we have all the means to keep us in daily touch with the problems at hand, and it is to be hoped that the authorities will see fit to keep us thoroughly and accurately informed. It is our duty to pay strict attention, to get a clear conception of the objectives and to make ourselves heard when we approve as well as when we disapprove unless we wish to be governed by active minorities. As it is conceived, our government policy is controlled by public opinion. Sometimes government will be ahead of public opinion; often the reverse will be true. Out natural interest in government will be stimulated, I fancy, by rapidly increasing tax bills. The American people are intelligent and will make the right decision quickly when the issues are promptly and clearly stated, but they must make their judgment known if majority opinion is to prevail. Intelligence and promptness are necessary if democracy is to produce results as quickly as is done in one mangovernments.

Now has come the time when, as a nation, we face a whole world at war. This war is born of economic causes. It will test whether the advances towards individual liberty

over a thousand years are to be discarded because of politico-economic failure. Whether we fight or look on, this country will be profoundly affected by the outcome. Our success in creating the kind of world we want for our children will be measured only by our intelligence and high courage.