§ 3. Causes of European inflation. Changes in index numbers reflect changes in the relation of the quantity of goods to be exchanged, expressed in their prices, and the quantity of money used in exchanging them. Therefore the explanation of any particular rise in the price level may be found in the factor of goods, (a) in a reduction of their amount or (b) a lessened need to exchange them by means of money; or may be found in the factor of money, (x) in an increase in the amount of money or (y) in an increased use of substitutes for money, such as banking credit. At the outbreak of the war the popular explanation of rising prices is the lack of goods—that is, (a). Attention is drawn dramatically to the number of men taken out of industry to go into war service, at the front or behind the lines. But these comprise only a small percentage of the total population; their places are in large part taken by women and by older men, inspired by patriotic motives, and the exercise of war-time economies largely reduces the demand for many kinds of goods.

Fig. 4. Prices in Four Leading Countries, 1915-1921.

Factor (b) doubtless has some validity: withdrawing men from ordinary industry, where they receive wages in money and spend it in retail purchases, and putting them into the army, where their food, clothing, and other wants, are supplied by the government, reduces the monetary demand of the community. At the same time, the use by the government, factor (y), of the facilities of the banks in its war purchases reduces the field within which money is required in war-time as compared with ordinary peace-time business.

Much the larger part of the explanation sought is to be found in (x). Immediately on the outbreak of war all the warring countries began to issue paper money, usually through the agency of their central state banks. They continued to issue it in larger and larger amounts not only until the armistice in November, 1918, but, under the pressure of financial need, after the armistice. Even England and France, whose prices were already up to 235 and 330, respectively, at the armistice (on the basis of 1913 prices), each increased their note issues about 130 per cent between the armistice and the middle of 1920. The effect is seen in the mounting price curves. Though it is impossible to estimate exactly the amount of paper money issued, because of different agencies, governmental and banking, through which it was done, the rise in prices probably fell short of the paper money inflation; but it must be considered that this was in part offset by the complete withdrawal of gold and silver from circulation.

§ 4. Gold stocks of belligerents. The depreciation of the paper currency was not due to the absence of gold in these countries. They all alike made strenuous efforts to impound in their central treasuries all the gold that was in the countries. A strong patriotic appeal was made to all citizens. Some gold that had been in circulation was exchanged for paper issued by the banks; in many cases old coins that had been hoarded for generations (as is not uncommon in Europe), and therefore having no more effect on prices than so much gold in the earth, were brought out of hiding and into the banks. Family plate, ornaments, and jewelry were brought to the mints, were melted and assayed, the owners not only being paid in bank-notes, but receiving certificates of patriotic service, and often, besides, some valued privilege, such as that of driving a nail into the Hindenburg wooden statue in Berlin. This process of getting gold has been called "mining it out of the pockets of the people."

The total gold held by all European banks and state treasuries between 1914 and 1919 increased every year (excepting in 1916). Most of this increase took place in the neutral countries, notably Spain, Holland, and the Scandinavian countries, to which it was shipped to pay for war supplies. But France and Italy nearly held their own, and England and Germany each largely increased their gold stocks. Russia and Austria, however, lost a large part of their gold stocks, Russia by export to buy goods under the Bolshevik regime, and Austria by forced deposit with Germany as a condition of financial assistance.

§ 5. Redistribution of European gold stocks. The net gain of gold, expressed in terms of American dollars, in leading European banks and central treasuries was approximately as follows (not including Russia, the data for which are uncertain):

Classified by groups of countries,2 it appears that in the war period the Central Empires gained net about 6 per cent (Austria losing nearly all and Germany more than doubling its stock), the Allies (England, France, and Italy) gained net 28 per cent (France and Italy, which had large stocks at the beginning, losing little, and England, which had a small stock, more than trebling), and European neutrals gained net 66 per cent, of which Spain got $338,000,000, Holland $216,000,000, the Scandinavian countries $102,000,000, and Switzerland $47,000,000 value.

It is apparent that the gold that was collected by the belligerents did not, as it is often assumed, serve " to support" the value of the paper money which had been issued in excess. Indeed, it may be said that it did not in the least so serve. What it did do was to give to these countries a valuable exportable commodity to exchange with neutrals for much-needed supplies of goods, and to afford the readiest of assets for post-war financing. Error will be avoided by clearly recognizing that these European stocks of gold had ceased to be money for domestic purposes, and that their essential use was to be found only in international trade as long as specie payments were suspended.

§ 6. The flood of gold to America 1915-1917. The United States lost some gold to Europe in the first months of the war; but thereafter, while it remained neutral, it received large quantities of gold from Europe. In the first month of the war, August, 1914, and increasingly in the following months, contracts for food and supplies of all kinds were placed in America by European countries, and soon a large and steadily swelling stream of exports was moving toward Europe. The Central Empires were prevented by the Allied blockade from getting many of these goods directly, but large amounts got into Germany and Austria through bordering neutral countries, which profited greatly by this trade. As England and France accumulated rapidly large debits in America, they not only floated loans of various kinds to satisfy these for the time, but also shipped here gold in unprecedented amounts. For two years our gold stock had been almost unchanging; but between July 1, 1915, and the end of June, 1917, the net increase of gold stocks in the United States was about one and a quarter billion dollars—a veritable "flood of gold" borne upon which prices rapidly rose.

2 These figures are from a different source; the relatively small discrepancy in the total does not necessarily indicate an error, hut a slight difference in the data, or the inclusion of some minor countries in the figures,

This inflow continued until after our entry into the war (in April, 1917), when our large loans to the Allies reduced their need of sending us gold, and at the same time our increasing purchases from Spain, South America, and Asiatic countries made some net exports of gold necessary, first in May, and then after June in increasing amount. The movement of gold by years is shown graphically in Figure 5, chapter 6.