Front Page Titles (by Subject) PART I: MONEY AND PRICES - Economics, vol. 2: Modern Economic Problems
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PART I: MONEY AND PRICES - Frank A. Fetter, Economics, vol. 2: Modern Economic Problems 
Economics, vol. 2: Modern Economic Problems, 2nd edition, revised (New York: The Century Co., 1923).
Part of: Economics, 2 vols.
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MONEY AND PRICES
NATURE OF ECONOMIC PROBLEMS
§ 1. Increase of economic problems. § 2. Opinions and feelings in economic discussion. § 3. False contrast of theory and practice. § 4. Superficial thinking and popular error. § 5. American economic problems in the past. § 6. Main factors in economic problems. § 7. Range of economic problems treated.
§ 1. Increase of economic problems. The present volume deals with various specific problems in economics, as an earlier volume deals with the general economic principles of value and distribution. The word “problem” is often on our tongues. Life itself is and always has been a problem. In every time and place in the world there have been questions of industrial policy that challenged men for an answer, and new and puzzling social problems that called for a solution. And yet, when institutions, beliefs, and industrial processes were changing slowly from one generation to another and men’s lives were ruled by tradition, authority, and custom, few problems of social organization forced themselves upon attention, and the immediate struggle for existence absorbed the energies and the interests of men. But the present time of rapid change seems to be peculiarly the age of problems. The movement of the world has been more rapid in the last century than ever before—in population, in natural science, in invention, in the changes of political and economic institutions; in intellectual, religious, moral and social opinions and beliefs.
Some human problems are for the individual to solve, as whether it is better to go to school or to go to work, to choose this occupation or that, to emigrate or to stay at home. Other problems of wider bearing concern the whole family group; others, still wider, concern the local community, the state, or the nation. In each of these there are more or less mingled economic, political, and ethical aspects. Economics in the broad sense includes the problems of individual economy, domestic economy, of corporate economy, and of national economy. In this volume, however, we are to approach the subject from the public point of view, to consider primarily the problems of “political economy,” considering the private, domestic, and corporate problems only insomuch as they are connected with those of the nation or of the community as a whole. Our field comprises the problems of national wealth and of communal welfare.
§ 2. Opinions and feelings in economic discussion. The student beginning economics, or the general reader, is likely to think that the study of principles is more difficult than is that of concrete questions. In fact, the difficulty of the latter, though less obvious, is equally great. The study of principles makes demands upon thought that are open and unmistakable; its conclusions, drawn in the cold light of reason, are uncolored by feeling, and are acceptable of all men as long as the precise application that may justly be made of them is not foreseen. But conclusions regarding practical questions of public policy, though they may appear to be simple, usually are biased and complicated by assumptions, prejudices, selfish interests, and feelings, deep-rooted and often unsuspected. When the casual reader declares that he finds the study of practical questions in economics much easier than that of theory, he really means that the one seems to require little or no thought, while the other requires much.
In many questions feeling is nine tenths of reason, and one’s sympathies often dictate one’s conclusions. In the following pages the reader is repeatedly warned when the discussion reaches such a danger point. When, however, in this work, outlooks and sympathies are expressed or tacitly assumed, they are not so much those personal to the author as they are those of our present-day American democratic society, taken at about its center of gravity. When the people generally feel different as to the ends to be attained, a different public policy must be formulated, though the logical analysis of the problems may not need to be greatly changed.
§ 3. False contrast of theory and practice. Still another word of caution should be given to those who find theoretical economic questions hard but who imagine that the understanding of “practical” economic questions is comparatively easy. The very contrasting of theoretical and practical study in this way is erroneous and misleading. The true understanding of every so-called “practical” question requires the understanding of theory, both the general theory (treated in Volume I) that underlies all economic activity, and the special theories that are related to the particular problems (treated in this volume). Indeed, theory as it is here used, and as it ought to be used, is hardly more than a synonym for “understanding”; it is logical analysis, insight, orderly arrangement, in our thought, of the forces, motives, and material conditions that help to bring about certain results. The more clearly the student has thought through the general theories of value, price, time-preference, wages, etc., the better prepared he is to take up the study of such practical problems as money, banking, tariff, labor and capital, etc., every one of which involves more special theories of price levels, fiat money, international trade, the open shop, and minimum wage, respectively.
§ 4. Superficial thinking and popular error. A practical economic problem is always presented as a question: What is the right thing to do or the best course to pursue with respect to some matter that is tied up with many other matters; so that the whole situation is usually very complex. The first answer of the untrained mind is almost certain to be a wrong one—just as to the natural man the earth seems flat, though it is round, the sun seems to circle around us, whereas we revolve on the earth’s axis daily, and at the same time slowly circle around the sun; the echo seems to be a mocking spirit answering us, whereas it is our own voice reflected back. Thousands of erroneous ideas were held by primitive man, and still are held by the savage, the child, and the untrained adult mind, regarding the simplest affairs of every-day life. In a like manner, the first answers to economic problems are usually superficial.
Since almost every economic matter affects various interests, there is the additional difficulty that some groups of persons, often influential and powerful, have something to gain by continuing to think superficially and by getting those who would benefit by the truth to keep on thinking superficially. Indeed, to think clearly, even if one suspects that it would be to his advantage to do so, is even for the ablest minds a difficult task, and for the mass of men, under the conditions, is often impossible. It should not surprise us, therefore, to find that nearly all economic improvements have been opposed not only by the few who would lose but by the many who would gain by the change; and to find, likewise, that the projects of reform that most quickly win the belief and support of the mass of men seeking relief from hard conditions have usually been as superficial and false in their theory as the errors they were meant to displace. Truth, when at last found, is simpler than error, but often it is to be attained only by the hard road of analytic and abstract thought that follows through to the end the workings of each separate force and factor.
§ 5. American economic problems in the past. What, then, are the politico-economic problems in America? They are problems that are economic in nature because they concern the way that wealth shall be used and that citizens are enabled to make a living, but that are likewise political because they can be solved only collectively by political action. With the first settlements of colonists on this continent politico-economic problems appeared. Take, for example, the land policy. Each group of colonists and each proprietary land-holder had to adopt some method of land tenure, whether by free grant or by sale of separate holdings or by leasing to settlers. In one way and another these questions were answered; but rapidly changing conditions soon forced upon men the reconsideration of the problem as the old solution ceased to be satisfactory.
In large part our political history is but the reflection of the economic motives and economic changes in the national life. Thus the American Revolution arose out of resistance to England’s trade regulations, commercial restrictions, and attempted taxation of the colonies. The War of 1812 was brought on by interference with American commerce on the high seas. The Mexican War was the result of the colonization of Texas territory by American settlers and the desire of powerful interests to extend the area of land open to slavery. The Civil War arose more immediately out of a difference of opinion as to the rights of states to be supreme in certain fields of legislation, but back of this political issue was the economic problem of slave labor. Illustrations of this kind, which may be indefinitely multiplied, do not prove that the material, economic changes are the cause of all other changes, political, scientific, and ethical; for in many cases the economic changes themselves appear to be the results of changes of the other kinds. There is a constant action and reaction between economic forces and other forces and interests in human society, and the needs of economic adjustment are constantly changing in nature.
§ 6. Main factors in economic problems. The particular economic problems in America at this time are determined by the whole complex economic and social situation. Two main factors in this may be distinguished: the objective and the subjective, or the material environment and the people composing the nation. The one is what we have, the other is what we are. These factors are closely related: for what we are as a people (our tastes, interests, capacities, achievements) depends largely on what we have, and what we have (our wealth and incomes) depends largely on what we are.
I. The objective factor presents two phases:
(a) The basic material resources, consisting of the materials of the earth’s surface and the natural climatic conditions which together provide the physical conditions necessary for human existence, and which furnish the stuff out of which men can create new forms of wealth.
(b) The industrial equipment, consisting of all those artificial adaptations and improvements of the original resources by which men fit nature better to do their will. These two (a and b) become more and more difficult to distinguish in settled and civilized communities, and become blended into one mass of valuable objects, the wealth of the nation.
II. The subjective factor presents two phases:
(a) The people, considered with reference to their number, race, intelligence, education, and moral, political, and economic capacity.
(b) The social system under which men live together, make use of wealth and of their own services, and exchange economic goods.
The particular economic problems that are presented to each generation of people are the resultant of all these factors taken together. A change in any one of them alters to some extent the nature of the problem. The problems change, for example, (I a) with the discovery or the exhaustion (or the increase or decrease) of any kind of basic material resources; (I b) with the multiplication or the improvement of tools and machinery or the invention of better industrial equipment; (II a) with the increase or decrease of the total number of people, and the consequent shift in the relation of population to resources; (II b) with changes in the ideals, education, and capacities of any portion of the people whether or not due to changes in the race composition of the population. Many examples of these various changes may be found in American history, and some knowledge of them is necessary for an appreciation of the genesis and true relation of our present-day problems.
§ 7. Range of economic problems treated. Of numberless economic problems that are calling for solution in a modern nation like the United States of America, only the more important in relation to present needs can be discussed in their main aspects within the limits of a single volume. The ones here chosen, as may be seen by referring to the table of contents, include a wide range, from the more impersonal financial questions connected with money and the medium of exchange, to the most burning issues of class interests and conflicts; and from those that seem to do merely with the individual (as incomes or wages or taxes) to the most fundamental questions of the form of economic organization and the displacement of private property by communism. In truth, these contrasts are often misleading; for the welfare of individuals is affected in many ways, often remote and unsuspected, on the one hand by impersonal factors such as the production of gold or the invention of machinery, and on the other hand by the form and function of the social organization of which each of us is a part.
Some conceive of the economist’s task narrowly as being merely the study of market prices; others broaden the field to include the study of individual valuations and gratifications; and still others make it include the solution of all problems of economic legislation affecting the general welfare of society. No practical problem in the field of economics can be rightly solved as if it were an economic problem in any narrow sense untouched by political, moral, and social considerations. In this volume the broadest of these conceptions is taken, prices and values being studied because of their bearing upon social welfare. Welfare economics rather than price economics is our ideal.
The titles of the chief encyclopedias of economics and of several good collections of general readings are given in the Manual of references and exercises in economics, for use with the author’s Economic Principles, published by the Century Co., New York. (References to the author’s Source Book in Economics  have been dropped in this edition, as that work is now out of print.) Several American general texts on political economy treat more or less fully the questions taken up in the present volume. Some of the texts are listed here, and are not referred to specifically in connection with the various chapters following.
ORIGIN AND NATURE OF MONEY
§ 1. Origin of money. § 2. Money as a tool. § 3. Money defined. § 4. Qualities of the original money-good. § 5. Industrial changes and forms of money. § 6. The precious metals as money. § 7. Varying extent of the use of money. § 8. Relative importance of money. § 9. Standard-commodity money. § 10. Commodity money without coinage. § 11. The money-material in its commodity uses.
§ 1. Origin of money. Everywhere in the world where the beginnings of regular trade have appeared, some one of the articles of trade soon has come to be taken by many traders who did not expect to keep or use it themselves, but to pass it along in another trade.1 This made it money, for money is whatever comes to be used as a general price-good. The character of a general price-good clearly distinguishes money from goods bought and sold by a particular class of merchants, such as grain, cattle, etc., to be sold again. It is only in so far as a particular good comes to be taken by persons not specially dealing in it, taken for the purpose of using it as a price-good to get something else which they desire, that a thing has the character of money. The thing called money thus is a durative good passing from hand to hand in a community, and completing its use in turn to each possessor of it only as he parts with it in exchange for something else.
The use of money is of such social importance that it would be impossible for modern industrial society to exist without it. The discussion of money touches many interests; it raises many questions of a political and of an ethical nature. There are perhaps more popular errors on this than on any other one subject in economics, but the general principles of money are as fully understood and as firmly established as are any parts of economics.
§ 2. Money as a tool. Money is often, by a figure of speech, called a tool. A tool is a piece of material taken into the hand to apply force to other things, to shape them or move them. Figuratively, this is what money does: it moves things into one’s control. A man takes it, not to get enjoyment out of it directly, but to apply force, to move something, and that which he moves is the thing he buys. Money thus (as money) is always an indirect agent. Adam Smith aptly likened money to the roads and wagons that transport goods, thus gratifying desires by putting goods into more convenient places. The fundamental use that money serves is to apportion one’s income conveniently as it accrues and as it is spent. The use of money increases the value of goods by increasing the ease with which trade can take place. Like any tool or agent, money is valued for what it does or helps to do. It enhances the value of the goods that it buys and sells by dividing them into quantities convenient for use and by making them available at the right times.
It has been said that the service performed by money is to overcome the difficulty in barter of the double coincidence of wants and possessions. For example, a man may possess a horse that he is willing to sell, and he wants in place of it not just one thing, but a group of things, say a cow, a bag of flour, a pair of shoes, and several other small commodities, perhaps preferring not to have them all at once, but distributed over a period of some days or some weeks. Now, it is not likely that these things would exchange at such ratios in the market that the horse would just be of equal value to the group of other goods. Little less than a miracle would be needed to find a man desiring a horse, and who at the same time possessed just that group of goods to exchange for it. So, either no trade at all could take place, or there must be a series of trades in which the man takes some of the things he wants (say a cow) and other things “to boot,” in the hope that later these may be traded for the right things. Evidently, when the “possession” is one large thing and the “wants” are many (or vice versa), the coincidence required is much more than double. In the light of the principles of diminishing gratification and of time-preference, it is clear that the amounts in which and the times at which goods are available have an essential bearing on their values. Money is the most successful device ever discovered for distributing the supplies of a journey along its course and the goods of daily need over a period of time. The use of money as a storehouse of value by hoarding it is merely a more extreme case of keeping income until a time when it will have a greater value to the owner than it has in the present.2
§ 3. Money defined. Money may be defined as a material means of payment and medium of trade, passing from hand to hand and generally accepted as the most usual price-good. The definition contains several ideas. Trade means the taking and giving of things of value. Money passes from hand to hand, is a thing that can be handled and is, or can be, bodily transported. The words “generally accepted” imply that money has a peculiar social character, is not an ordinary good. As a price-good, money itself must be a thing having value; otherwise it could not be accepted.
The application of the definition is not always easy, for money shades off into other things that serve the same purpose and are related in nature. Money is not merely an order for goods, as a card or paper requesting payment; it is itself a thing of value (though this value may be due partly or solely to its possessing the money function). Such things as a telegram when transferring an order for the payment of money, as the spoken word, and as a mere promise to pay, are not money. Even checks and drafts are merely written evidences of credit, and are used as substitutes for money.
In many problems money appears to be at the same time like and unlike other things of value, and just wherein lies the difference it is often difficult to determine. Even special students differ as to the border-line of the concept, but as to the general nature of money there is essential agreement.
§ 4. Qualities of the original money-good. The selection of any money-commodity has not been made by chance, but has been the result of that object being better fitted than others to serve as a medium of exchange. The main qualities that affected the selection of primitive forms of money were as follows:
1. Marketability (or salability); that is, it must be easy to sell. The first forms of money had to be things that every one desired at some time and many people desired at any time. That was the essential quality that made any one ready to take it when he did not wish its direct use himself. Many kinds of food and of clothing are very generally desired goods. But few of these classes of goods have in a high measure certain other important qualities, now to be named.
2. Transportability; that is, the money material must be easy to carry; it must have a large value in small bulk and weight. To carry a bag of wheat on one’s back a few miles requires as great an effort ordinarily as does the raising of the wheat; and the cost of carriage for fifty miles, even by wagon, will often equal the whole value of the wheat. Cattle, while not comparatively very valuable in proportion to weight, and not possessing the other qualities of money in the highest degree, have the advantage that they can be made to carry themselves long distances, and therefore they have been much used as money in simpler economic conditions.
3. Cognizability; that is, the money-good must be easy to know, and to judge as to quality. If expert knowledge or special apparatus is needed to test it in order to avoid counterfeits, few could be ready to take it, and trading would be a costly process.
4. Durability; that is, the money-good must be easy to keep without much loss in amount or in quality, perhaps for long periods, until it can be passed on in trade. Few kinds of food answer very well to this last requirement, being organic and perishable. But all four qualities above named were pretty well embodied in primitive times in rock-salt, in rare flints and bits of copper suitable for tools and weapons, in furs in northern countries, and in many articles of personal adornment, such as beads, feathers, jewels, and metal ornaments.
5. Divisibility; that is, the quality in the monetary material that permits it to be divided easily into smaller amounts and then to be united again into larger masses at little cost and without loss in amount or in quality. This quality is present only when the material is homogeneous throughout the whole mass, a condition fulfilled more completely by the metals than by any other goods. This quality makes it possible to put the governmental stamp upon the money material, and to produce pieces some of which are exact duplicates and some exact multiples, of others. In this manner pieces of money are provided suitable for transactions of different magnitudes, down to small fractional amounts. A monetary system of this kind aids greatly the development of the sense and habit of exact estimation of price.
§ 5. Industrial changes and the forms of money. The money use, as has just been shown, is a resultant of a number of different motives in men. The changing material and industrial conditions of society change the kind of money that is used. Things that have the highest claim to fitness for money with a people at one stage of development have a low claim at another. The final choice of the money-good depends on the resultant of all the advantages. Shells are used for ornament in poor communities, but cease to be so used in a higher state of advancement, and thus their salability ceases. Furs cease to be generally marketable in northern climes when the fur-bearing animals are nearly killed off and the fur trade declines. When tobacco was the great staple of export from Virginia, everybody was willing to take it, and its market price was known by all. It served well then as the chief money; but, as it ceased to be the almost exclusive product of the province, it lost the knowableness and marketability it had before. In agricultural and pastoral communities where every one had a share in the pasture, cattle were a fairly convenient form of money; but in the city trade of to-day their use as money is impossible. Thus, in a sense, different commodities compete, each trying to prove its fitness to be a medium of trade; but only one, or two, or three at the most, can at one time hold such a place.
While industrial changes and conditions affect the choice of money, in turn money reacts upon the other industrial conditions. If a new and more convenient material is found or the value of the money metal changes to a degree that affects the generalness of its use, industry is greatly affected. The discovery of mines in America brought into Europe in the sixteenth century a great supply of the precious metals, and this change in the use of money reacted powerfully upon industry. Money, being itself one of the most important of the industrial conditions, is affected by and in turn affects all others.
§ 6. The precious metals as money. Certain of the metals early began to show their superior fitness to perform the monetary function. The metals first used as money were copper, bronze (an alloy of copper with nickel), and iron. These were truly precious metals in early times, for they were found only in small quantities in a few localities. They, therefore, were widely sought and highly valued as ornaments and for use as tools and weapons. But as the great ancient nations emerged into history, these materials were already being displaced in large measure. Their value fell greatly as a result of greater production due to somewhat regular mining. As wealth grew, as trade increased, as the use of money developed, as commerce extended to more distant lands, the heavier, less precious metals failed to serve the growing monetary need, especially in the larger transactions. Silver and gold, step by step, often making little progress in a century, became the staple and dominant forms of money in the world, while copper and nickel still continued to be used for the smaller monetary pieces. Every community has witnessed some stages of this evolution. In this contest silver had, up to the end of the Middle Ages, proved itself to be, on the whole, the fittest medium of exchange for most purposes, though gold was at the same time in use in larger transactions and in international trade among the leading commercial countries.
Gold discoveries in California in 1848, and in Australia, two years later, caused the production of gold to increase enormously,3 and gold became a relatively larger part of the monetary stocks of western European and North American countries.
In a higher degree than any other one material, gold has the qualities of the main monetary material for rich and industrially developed communities. England was first to give to gold the chief place in its monetary system; the United States did so in 1834, and has continued to keep gold in that place (except for the period of paper money from 1862 to 1879); France did so about 1879, having shifted gradually from silver, after 1855, under the working of the bimetallic law; Germany in 1873; and Japan since the later nineties. Other countries have been moving in the same direction. Since about 1890 some states (including Mexico) and some of the colonial possessions of the great nations (including India and the Philippines) have adopted the plan of the “gold-exchange standard.” By this plan gold is the standard price unit, while silver continues to be used all but exclusively as the material in circulation, its amount being controlled and its value regulated on principles to be explained below under coinage, seigniorage, and foreign exchange.
The most important of the countries in which silver is still the chief form of money is China. There are, however, numerous countries, notably in South America and Central America, in which paper notes have long been almost the only form of money; and in the period of the Great War every one of the belligerent countries excepting the United States approached or reached that condition where neither gold nor silver was actually in circulation.
§ 7. Varying extent of the use of money. Trade by the use of money at no time has become the exclusive method. Barter still lingers to-day.4 The extent to which, on an average, money is used in different parts of the world differs widely. The use of money in Siberia is less than in European Russia, and its use is less there than in western Europe. The use of money as compared with barter is generally much greater in the cities than in the rural districts. In the cities of Mexico not only money but banks and credit agencies are in general use; whereas the rural districts are more backward and make far more use of barter than is the case in the United States. At the ports in the cities of China, India, and South America the use of money may be very like that in European cities; but go a little way into the interior of these countries, and conditions as to the use of money change greatly.
However, the comparative per capita amounts of money (in terms of American dollars) in circulation in different countries is far from being a true index of their industrial development or of their commercial activity. Indeed, beyond a certain point the larger average amount of money in circulation in a country may indicate backwardness in the development of banks and other credit agencies rather than greater amount of wealth or of business. Notice, for example, the medium position of the great commercial countries, Germany and the United Kingdom, as compared with other countries above and below them in the following list.
§ 8. Relative importance of money. Because money is the general expression of purchasing power, and comes to symbolize all other wealth, it often assumes undue and exaggerated importance in men’s eyes. Money is but one of many forms of wealth. It constitutes but a small percentage of the total wealth of a country, and it is far from being the most indispensable to human welfare. Yet its importance, as a whole, in determining the form of industrial organization is enormous. In a society without money industrial processes would be very different, and trade would be hampered in manifold ways.
If a poor community has relatively little money it is because it cannot afford more; it gets along with less money than is convenient, just as it gets along with fewer agents of every other kind than it could use. Pioneers in a poor community where the average wealth is low cannot afford to keep a large number of wagons, plows, good roads, or schoolhouses. If the members of the community were wealthy enough each would have more of these and of other things, and the sum total of money would be greater. Great as is the convenience of money, poorer communities have to do with little of it. It is, therefore, a confusion of cause and effect when poor communities imagine that their poverty is due to the small amount of money in circulation.
Many of the most common errors in economics are the result of confusion as to the real nature and place of money. The word “money” is so often used, in a figurative sense, for any or all of the goods for which it may be exchanged, that men forget that it is often a mere symbol of wealth and not the wealth itself. To give only two illustrations out of many that could be given: In relation to foreign trade, men continually speak of bringing money into the country, or of sending our money abroad, when in neither case, probably, has any money moved in the direction indicated. Again, in reference to the interest rate or to the causes of business crises, men speak of money being more plentiful or less plentiful, when the amount of money has either not changed or has changed in the contrary direction, and what is really meant is that some change has occurred in credit conditions. So persistent is this idea that there is hardly an economic problem in which this characteristic monetary illusion does not serve to mislead popular opinion. The safest course for the student is to assume always that any explanation of processes of production or of trade in terms of money is superficial, and that the real forces and reasons are to be found only by penetrating more deeply into the situation.
§ 9. Standard-commodity money. The actual money in use in almost every country to-day consists of a wide and confusing variety: gold, silver, nickel, copper, paper in various forms, issued by various authorities under various conditions as to amount and as to seigniorage. But, among all the kinds, in each country some one kind is found standing preëminent and in a peculiar position as the standard money to which the value of all the other kinds of money is in some manner adjusted. Usually this standard money is composed of a material (gold or silver) that is a commodity; but there are many examples of paper money being for the time the standard. We mean by standard money that kind, no matter what its form, which serves in any country as the unit in which the value of other kinds of money is expressed. The standard usually is a quantity of metal, of a certain weight and fineness, which, as a commodity, has a value also in industrial uses. Coins of this standard are called full, or real, money by some writers who deny the title of money to everything else. Sometimes the standard may legally be a double one, as in bimetallism, both gold and silver; but in such cases it actually is either gold or silver most of the time.
The difficulties of the money problem must be attacked at the point of standard-commodity money, where it is nearest to ordinary value problems and is less complicated than when the various other kinds of money and the various money substitutes are included.
§ 10. Commodity money without coinage. Let us consider the problem of money and its value as it would present itself if only one kind of commodity money were in use. This doubtless was in large measure, if not entirely, the case for a time in early societies after one material had proved itself to be the best suited for the purpose. The history of many kinds of money may, we have seen, be traced back to a point where they were not money, but commodities with only a direct value-in-use. Such were ornaments, shells, furs, feathers, salt, cattle, fish, game, and tobacco. Each of these materials has, in each situation, a value that is the reflection of its power to appeal to choice. Now, if to the commodity-use is added the monetary use, this increases the demand for that good. No new theory is required to explain the value of a commodity as it gradually acquires the added use of a medium of trade. The money use is one that works no physical or visible change in goods except a slight unavoidable abrasion, and at any time a person receiving a piece of commodity money may retain it for its use-value as food, ornament, tool, or weapon, or may retain it for a time and then spend it as money. This case of value is no more difficult than that of anything else having two or more uses. For example, cattle are used for milk, for meat, and as beasts of burden. Each of these uses is logically independent as a cause of value, yet all are mutually related, the value of cattle to a particular person being determined by the consideration of all the uses united into one scale of varying gratification.
In antiquity the metals were used as money in bulk; that is, the amount was weighed at each transaction and the quality was tested whenever there was doubt.6 In countries industrially backward, payments are still made in this manner. For some time after the discovery of gold in Calfornia, gold dust was roughly measured out on the thumb-nail. In shipments of gold to-day by bankers to settle international balances, metal may be in the form of bars that bear the mark of some well-known banking house. In all of the cases of this kind the gold is money in fact, but not by virtue of any act of government. The metal is simply a valuable good, the receiver of which values it according to its weight and fineness. This is true even when the government mint, for a small charge, tests and stamps the bars at the request of citizens.
§ 11. The money-material in its commodity uses. In the case of a commodity-money, such as gold, the problem of its value as bullion is the same as that of the value of pig iron or of zinc, of meat or of potatoes. The value of gold as bullion and its value as money are kept in equilibrium by choice and by substitution. The several uses of gold are constantly competing for it: its uses for rings, pens, ornaments, championship cups, photography, dentistry, delicate instruments, and as a circulating medium. If the metal becomes worth more in any one use, its amount is increased there and is correspondingly diminished in other uses.7
This adjustment of the value of commodity-money to other things is made also on the side of supply, in the use of labor and material agents to produce the precious metals and to produce other things. Gold-mining, for example, is one among various industries to which men may apply their labor and their available material agents. Some mines are superior, others medium, others marginal which it barely pays to work. There is, therefore, a rise and fall of the margin of gold production, with changes in prices and changes in the cost of production. Large new deposits of gold are discovered from time to time, and new methods of extracting gold are invented. If, when it barely pays to work a mine, such changes occur, gold becomes worth less, and the poorer mines eventually must go out of use. As gold rises in value some abandoned mines again come into use. A similar variation may be noted in the utilization of marginal land, marginal factories, marginal forges, and marginal agents of every kind.8
COMMODITY MONEY AND THE QUANTITY THEORY
§ 1. Coinage and seigniorage. § 2. Technical features of coinage. § 3. Coined commodity money. § 4. Concept of the individual monetary demand. § 5. Factors influencing individual monetary demand. § 6. Concept of the community’s monetary demand. § 7. Quantity of money and prices. § 8. The quantity theory of money. § 9. Interpretation of the quantity theory. § 10. Practical application of the quantity theory.
§ 1. Coinage and seigniorage. Very early it became the practice of governments to shape and stamp pieces of metal to be used as money, so as to indicate their weight and fineness. The act of shaping and marking metal for this purpose is called coinage.1 The coinage by government had notable advantages in giving to the monetary units uniformity of size, fineness, and value, with the stamp that was readily recognized. But in its simplest form coinage in no way changed the value of the money, and any other mark equally plain put upon it would have served equally well, if only it had carried with it equal assurance of the quality and weight of the metal.
Coinage, as practised by early governments and rulers, came to be a function of great importance politically as well as economically. The right to issue money came to be one of the most essential prerogatives of sovereignty. The prince, king, or emperor stamped his own device or portrait upon the coin; hence the term seigniorage from seignior (meaning lord or ruler). Seigniorage meant primarily the right the ruler, or the estate, has to charge for coinage, and hence it has come to mean also the charge made for coinage, and often, in a still broader sense, the profit made by the government in issuing any kind of money with a value higher than that of the materials (whether metal or paper) composing it. Coinage is rarely without charge, and often has been a source of revenue to the ruler. In antiquity and in the Middle Ages this right was frequently exercised by princes for their selfish advantage to the injury and unsettling of trade. This introduced a very great problem of value into the use of money.
The coinage is said to be gratuitous when no charge is made for coinage. Coinage is said to be free if the subject or citizen may take bullion to the mint whenever he pleases, paying the usual seigniorage. Coinage is limited if the government or ruler determines when coinage is to take place. Thus, coinage may be both free and gratuitous, when citizens are allowed to bring bullion whenever they please and have it converted into coins without charge or deduction. But coinage is free without being gratuitous when any citizen may bring metal to the mint, whenever he chooses, to be coined subject to the seigniorage charge.
§ 2. Technical features of coinage. For each kind of metal money there is an established ratio of fineness for the more precious material, which is mixed with baser metals used as alloys. In the United States all gold and silver coins are made nine tenths fine; in Great Britain, eleven twelfths. The established weight of the gold dollar in the United States is 25.8 grains of standard gold which contain 23.22 grains of fine gold. The limit of tolerance is the variation either above or below the standard weight or fineness that a coin is allowed to have when it leaves the mint. This is different for each of the principal coins, being about one fifth of one per cent on a gold eagle. The par of exchange between standard coins of different countries is the expression of the ratio of fine metal in them. Thus the par of exchange between the American dollar and the English sovereign (the “pound”) is 4.866; that is, that number of dollars contains the same amount of fine gold as an English gold sovereign. The embossed design is to make the coins easily recognizable and difficult to counterfeit; and milled or lettered edges are to prevent clipping and otherwise abstracting metal from coins.
§ 3. Coined commodity money. When coinage is free and gratuitous the standard money is a commodity. Such coinage is essentially but the stamp and certificate that the coin contains a certain weight and fineness of metal. Where coinage is free and gratuitous2 each coin will be worth the same as the bullion that is in it, as far as the citizens exercise their choice. They will not long keep uncoined metal in their possession when it is worth more in the form of money, nor will they long keep money from the melting-pot when it is worth more as bullion. Yet there may be a slight disparity between the bullion value and the monetary value before the metal is converted into coin or the coin melted down into metal.
Let us take a case where gold is in general use as money, and where for some time there has been no noticeable change in the amount of business and in methods of trade. What would happen when new gold-mines were found that were much easier to operate, and gold began to be produced at a much more rapid rate than formerly? The amount of gold as compared with other forms of wealth evidently would be increased. If all the increased amount went into the industrial arts, the value of gold in its industrial uses would fall below its value in monetary uses. Then a part of the increased amount must be diverted to monetary uses. When any man, by reason of the increasing gold supplies, gets a larger stock of money than he had before, the proportion formerly existing between his use for money and his monetary stock is altered. He has more money than meets his monetary demand at the existing prices. As he seeks to reduce his stock of money to due proportions by buying more goods, he thereby distributes a part of the excess of money to others. This bids up the price of goods further until the total value of goods exchanged again bears the same ratio as before to the average monetary demand of each individual.
§ 4. Concept of the individual monetary demand. Let us now seek to get in mind the idea of an individual monetary demand, as that amount of money which at any time is required by an individual to make his purchases in expending his income. Every man may be thought of as having an average monetary demand, or his average individual cash reserve, throughout a period. A man with a salary of $50 a month paid monthly has ordinarily a maximum monetary demand of $50. If his expenditures are made in two equal parts, the one on pay-day, the other thirty days later, his average monetary demand during the month is a little over $25. If most of his purchasing is done in the first week of the month, his average monetary demand may be perhaps $10. Many a workman purchases on credit, running accounts at the stores for a month. Then on pay-day he spends his entire month’s wages the day he receives it, and goes without money for the rest of the month. His average monetary demand throughout the month would then be about equal to one day’s wages. Evidently any person’s cash reserve may be expressed as that proportion of his income that is to him of more value retained in money form for any period than if at once expended.
Every moment beyond the average time that any one keeps money increases his monetary demand. If he delays a day, a week, or a month in spending the money, waiting until he can buy in some other market or until a better time to buy, he thus increases insomuch the amount of money needed to make the trade (on that scale of prices). It requires more slow dollars than swift dollars to make a given volume of purchases.
§ 5. Factors influencing individual monetary demand. In this conception of the individual monetary demand must, however, be included not merely the demands of retail purchasers, made by themselves, but also those of all agencies, such as merchants, bankers, and transportation companies, serving the needs of ultimate consumers of goods. The use of money may be necessary several times before a commodity completes its journey from producer to consumer.
Of two persons whose expenditures of money are of the same kind and made at the same rate, the one having the larger amount of purchases to make has the larger monetary demand. But the amount of purchases does not always vary directly with the amount of real income;3 for example, a farmer and a village mechanic may have at their disposal incomes equal in the quantities of goods, such as food, fuel, clothing, and house-uses (worth, let us say, $1000 for each), but the farmer would be getting a larger part of his goods directly from his farm and by his own labor, while the mechanic would be getting first a money income to be expended afterward for food, clothing, and rent. The mechanic would in this case have an average monetary demand much larger than the farmer.
We see thus that the individual monetary demand at any time is that amount of money which rests in his possession as the necessary condition to making his purchases as he desires. Individual monetary demand varies in proportion directly to the delay, and inversely to the rapidity with which the individual passes the money on; and directly to the amount of the person’s income that is received and expended in monetary form.
§ 6. Concept of the community’s monetary demand. The monetary demand of a community at a given time is the sum of the monetary demands of the various individuals and enterprises. It is that stock of money which is necessarily present to effect the exchanges of the community in the prevailing manner at any given level of prices. A single dollar as it circulates helps to supply the monetary demand of many individuals in turn: the more quickly each person spends the piece of money he receives, the greater its rapidity of circulation. Let us suppose that every piece of money passed from one person to another once each day. Then a dollar would, in the course of a business year (about 300 days), serve to buy (and at the same time to sell) $300 worth of goods. If the average purchases of each individual amounted to $1000 a year, the average monetary demand of each would be about $3.33⅓.
The times of maximum monetary demand of the different individuals do not coincide; often they alternate with each other, and the community’s total monetary demand at a given time is a composite of the many individual variations. The amount of money that will remain in circulation in a community depends on several factors, the chief among them being the amount of goods to exchange, the methods of exchange, and the value of the commodity material in other uses. The amount of goods to be exchanged may change even when the amount produced is unaltered (e. g., a change from agricultural to industrial conditions). The methods of exchange may alter so as to require either more money (e. g., cash instead of credit business) or less money (e. g., use of bank checks displacing use of money by individuals). Or, apart from the other factors, the scale of prices may change as the conditions of commodity money production are altered.
§ 7. Quantity of money and prices. Consider the effect of a large and rapid increase in the production of gold in a community where the gold dollar is the standard commodity money. At first some few men, the miners, may have far more dollars than before, while most men have nearly the same number as before. But those nearest the miners and selling to them will get more dollars, which they will pass on to others, and thus, in ever-widening circles, the increased supply of gold will spread until a new equilibrium of the monetary value is attained, when every one will have got his due proportion of the new supplies. If the number of dollars has been doubled, every one will, in the long run, and “other things being equal,” have twice as many dollars as before.
Now, prices of goods cannot remain the same as before; for if they did there would be twice as many pieces of money available to effect the same number of trades at the same prices. There is no reason why each person should tie up twice as large a proportion of his income in the form of money. If, however, there is a concerted movement to spend the surplus money, there results a general bidding down of the value of money, a general bidding up of the prices of goods and of services. At what point will this movement stop? The rational conclusion must be that, other things being equal, the new equilibrium will be established when the ratio between the value of money and the price of the goods that each individual is purchasing becomes the same as before. The money in a community being doubled, prices must be doubled, and proportionally for any other change in the quantity.
§ 8. The quantity theory of money. This explanation of the effect of changes in the quantity of money in a country upon prices (the general scale of prices) is known as the quantity theory of money. This theory has, for a century, been very generally accepted by competent students of the money problem. It may be summed up thus: other things being equal, the value of the monetary unit, expressed in terms of all other commodities, falls as the quantity of money increases, and vice versa. That is, prices rise and fall in direct proportion to changes in the total quantity. This is a simple explanation of a complex and difficult set of conditions. The phrase, “other things being equal,” betokens the statement of a tendency where there are several factors. The quantity theory explains what happens when there is a change in one of the factors—the number of pieces of money. There are three large sets of facts to be brought into relationship with each other in the quantity theory: (1) the amount of business, or the number of trades effected; (2) the rapidity of circulation, depending on the methods by which business is done; (3) the amount of money available. According to the quantity theory, we must expect that, when conditions (1) and (2) remain fixed, prices (the general price level) will vary directly, and the value of money will vary inversely as the quantity of money. This quantity theory may be expressed in the formula P = when P is the symbol for price, or the general price level, N is (1) above, R is (2), and M is (3). P, therefore, changes directly with either M or R, or inversely with N.4
§ 9. Interpretation of the quantity theory. The quantity theory must be carefully interpreted to avoid various misunderstandings of it that have appeared again and again in economic discussion.
(1) It does not mean that the price level changes with the absolute quantity of money, independently of growth of population and of the corresponding growth in the volume of exchanges.
(2) It is not a mere per capita rule to be applied at a certain moment to different countries. For example, Mexico may have $9 per capita and the United States $35, while average prices may not differ in anything like that proportion. But in these two countries not only the amounts of exchanges per capita but the methods of exchange and the rapidity of the circulation of money differ greatly.5
(3) It cannot be applied as a per capita rule to the same country through a series of years, without taking account of the many changing factors. It is estimated that in 1800 the money stock was about $5 per capita in the United States, and in 1914 about $356 but average prices have not necessarily changed in the same ratio. In a period of years a country may change in a multitude of ways, in complexity of industry, modes of exchange, transportation, wealth, and income. These changes require some larger, others smaller, per capita amounts of money to maintain the same level of prices. For example, the substitution of cash payments for book-credit in retail trade is equivalent to increasing N in the formula; whereas an increased use of banks and checking accounts, by economizing the use of money, enables a smaller amount of money to maintain the same level, and may be considered as increasing R in the formula.7
(4) Tho applied originally to standard money, the quantity theory applies to all other kinds of money circulating side by side and at a parity of value, as far as these fulfil the definition of money and are not merely supplementary aids to money. These supplementary forms of money enable each standard dollar to do more work, to circulate more rapidly. If the standard money alone were doubled in quantity, while the various forms of fiduciary money (smaller coins, banknotes, government notes) remained unchanged, the quantity of money as a whole would not be doubled. Indeed, in such a case the method of exchange would be greatly altered. According to the quantity theory, therefore, prices would not be expected to double.
§ 10. Practical application of the quantity theory. Despite the number of changing factors affecting the methods of exchange and the amount of business, the quantity theory is a rule usable at any moment. These various factors change slowly, and the quantity theory answers the question: What general change occurs in prices as a result of the increase or decrease of the money in a given community at a given moment? Like the law of gravitation and the law of projectiles, the theory must be interpreted with relation to actual conditions.
The quantity theory makes intelligible the great and rapid changes in prices which have followed sudden changes in the quantity of money. Inductive demonstration of broadly stated economic principles is usually difficult, but there have been many “monetary experiments” to teach their lessons. Many inflations and contractions of the circulating medium have occurred, now in a single country, again in the whole world; and the local or general results have helped to exemplify richly the working of the quantity principle. With the scanty yield of silver- and gold-mines during the Middle Ages, prices were low. After the discovery of America, especially in the sixteenth century, quantities of silver flowed into Europe. The great rise of prices that occurred was explained by the keenest thinkers of that day along the essential lines of the quantity theory, tho there were many monetary fallacies current at that time. The experience in England during the Napoleonic wars, when the money of England was inflated (by the forced issue of large amounts of banknotes) and prices rose above those of the Continent, led to the modern formulation of the theory of Ricardo and others about 1810. The discovery of gold in California and Australia in 1848-50 greatly increased the gold supply, and gold prices rose throughout the world. Between 1870 and 1890 the production of gold fell off while its use as money increased greatly, and prices fell. A great increase of gold production has occurred in the period since 1890. The wave-like movements of prices since 1897 are explicable as the periodic up and down swings of confidence and credit, but in the main the general trend upward has been due to the stimulus of increasing gold supplies.8 These are but a few of many instances in monetary history, which, taken together, make an argument of probability in favor of the quantity theory so strong as to constitute practically an inductive proof.
FIDUCIARY MONEY, METAL AND PAPER
§ 1. Character of fiduciary money. § 2. Present monetary system of the United States. § 3. Saturation point of fractional money. § 4. Light-weight fractional coins. § 5. Gresham’s law. § 6. Seigniorage on standard money. § 7. Fiduciary coinage on governmental account. § 8. Two stages of coinage debasement. § 9. The gold-exchange standard. § 10. Nature of governmental paper money. § 11. Irredeemable paper money in America. § 12. Irredeemable paper money in Europe. § 13. Theories of political money. § 14. Political money; theory and practice.
§ 1. Character of fiduciary money. The actual moneys in circulation in every modern country consist of a wide variety of pieces, differing in denomination, physical size, shape, and materials, mode of issue, source or authority of issue, and legal character. Among these kinds, one is usually the standard money and usually is a commodity. The exceptions indicated by the word “usually” are (a) that under the plan of bimetallism, two metals may be legally designated as the standard, making in fact an alternative standard, called, however, a double standard; and (b) that an irredeemable paper money may be, for the time, the standard money. The coinage of standard money often is free and gratuitous (or nearly so), and the value of the money is kept close to parity with its value as bullion by changing bullion into coin, or coin back into bullion, whenever there is an appreciable difference between the value in the two uses. This adjustment is brought about by the free action of the people. The government, having declared what is the standard money unit, and having provided a mint to make coins, leaves it to citizens, acting on the ordinary business motives, to decide when they will reduce or increase the number of coins in circulation.
The other kinds of money are not commodity money, and the materials of which they are made, whatever they may be, are not worth as much in any other uses as they are in their present monetary form. Their value is always referred to, and adjusted to, that of the commodity money, as long as any of it is in circulation. In contrast with commodity money, these other kinds may be called fiduciary money. By fiduciary money we mean money that has not a commodity value equal to its money value, but which is generally accepted because each receiver has faith that others in turn will take it in the same way. The faith (fides) is not always that the issuer of the money (whether it be a bank or the government) will redeem the money on demand at any future time; for fiduciary money may circulate while irredeemable, that is, either carrying no promise of redemption in the standard money or in fact not being redeemed. Yet often actual redemption on demand or a good prospect of future redemption is one of the circumstances stimulating the faith and the readiness of each person in turn to receive fiduciary money.
§ 2. Present monetary system of the United States. In the following table is given a summary of the main features marking the monetary system of the United States in 1920.
Not all this variety is essential to an efficient monetary system, and several of the kinds survive as the result of historical accidents (political and legislative). But all are now kept in accord with the value of the gold coin, which, it will be observed, is the only kind the amount of which is not artificially limited. Silver dollars are no longer coined, subsidiary silver and minor coins are issued only in exchange for other money, as are gold and silver certificates in exchange for gold or for silver, which they merely represent while in circulation.
§ 3. Saturation point of fractional money. Fiduciary money is that on which regularly the issuer makes a seigniorage charge.1 Let us consider now the effect of seigniorage on the value of money.
Fractional coins, called also subsidiary coins, are those of smaller denominations than the standard unit of money, as shillings and pence in England, and half dollars, quarter dollars, dimes, nickels, and cents in America. Money to serve well a variety of uses must be of different denominations, and “small change” is necessary to make small purchases and for exact settlement in larger payments that are not multiples of the standard unit. The amount required (or most convenient to use) in each denomination of fractional coins is thus a more or less certain portion of each person’s monetary demand, shaped by experience and fixed by habit. For example, within certain elastic limits of convenience quarters may be used for halves, and dimes for nickles (and vice versa); but each person has a point of preference. The total demand for each kind of change is the sum of the individual demands. This point where the amount of coins of any denomination (in relation to the whole monetary system) is most convenient may be called the saturation point of that kind of small change, up to which point the people prefer a share of their money in that form, and beyond which they will, if free to choose, exchange that kind for other denominations (smaller or larger). Each kind of money, as the cent, nickel, dime, has its own peculiar demand and its saturation point.
§ 4. Light-weight fractional coins. The standard metal is usually too valuable to be suitable for coins of the smaller denominations. Therefore, when gold is the standard, copper, nickel, and silver remain in use for small transactions. But if coins of these metals are issued at weights corresponding with their bullion value, difficulties often arise. Not only are they too heavy for convenience, but with every slight rise in their bullion value as compared with that of the standard metal, they become worth more as bullion than as coin and begin to disappear from circulation. This happened often throughout the Middle Ages and until the nineteenth century. The attempt was frequently made to coin gold and silver at a ratio of weight corresponding exactly to their market values at the time and, every time the market conditions varied, the best full-weight coins of one of the two metals were taken out of circulation; whereas the worn coins might remain in circulation.2 Business thus often suffered for lack of the proper proportion of the various denominations of coins. At length, to remedy this difficulty, fractional silver coins, often called “token coins,” were issued, in limited numbers, of less than full proportionate weight and bullion value, as compared with the standard commodity money.
This plan, having been partially tried, was generally adopted by the United States in 1853 at a time when the silver dollar of 371.25 fine grains was legally rated at the same value as the gold dollar of 23.22 grains, and was freely coined. The fractional coins were made a little more than six per cent lighter per dollar than the dollar coin; two half dollars or four quarters or ten dimes contained 93.52 cents’ worth of silver. Later silver bullion became worth much less in terms of gold, and for years the bullion value of the silver in a dollar of silver small change was between forty and sixty cents. Yet the fact that fractional coinage continued to circulate and exchange freely at parity with standard money showed that it had a monetary value equal to the standard money, dollar for dollar. Why was this?
The answer is, because it is artificially limited in quantity, so that it does not pass the point of saturation in the field of its use. Its value rests on its monetary use; it is fiduciary money, not commodity money. It is limited simply by letting “the needs of the people” determine its amount. This is done by issuing it only in exchange for other money of the larger denominations, and by redeeming it in other money on demand. Mostly, fractional coins are issued by the mints on the request of banks. One needing “change” gets it at the bank; when the bank finds its supply falling short it gets more in exchange for other forms of money, as shown in the table of the monetary system. As business increases in a period of prosperity, the demand for nickels, dimes, and quarters rises, and the mints work night and day to supply the need. If these coins were made in great quantities and forced into circulation by the government through paying them out to creditors and officials, their quantity would become excessive and they would fall in value (be at a discount) compared with standard money. But as this is not done, and as, moreover, they are redeemed on demand at the Treasury (and practically at every bank and post-office) in other money, any slight tendency to depreciation in any locality is at once corrected. The fractional coinage is maintained at a parity with the standard money in accordance with the monopoly principle, expressed in the limitation of the amount. The government makes a seigniorage profit on the fiduciary coinage, as shown in the appended table.3
§ 5. Gresham’s law. Coins may be light weight as the result of another cause—namely, the abrasion (wearing off) of the coins in circulation. Nearly always when this has occurred the worn coins have still been accepted as money, and ordinarily without any depreciation. It makes no difference what may be deemed the cause of their acceptance; whether it be habit, public opinion in business circles, or the act of law making them a legal tender; the essential thing is that they continue to be accepted as money. They have a value as money greater than the value of the bullion that is in them. Yet everybody takes them without hesitation as readily as if they were full weight. If, however, at this point, new full-weight coins are put into circulation, these at once disappear while the old worn coins remain in circulation—a fact that in medieval times was found both mystifying and annoying.
In explanation of this phenomenon was formulated Gresham’s law of the circulation side by side of coins of different bullion value: bad money drives out good money. Sir Thomas Gresham (whose name has but recently been given to this so-called law) explained the principle to Queen Elizabeth when counseling her regarding the recoinage of the debased money of the realm, as was done in 1560. He showed that when old worn coins were in circulation and the mint began putting out full-weight coins, the old lighter ones remained as money, while the new ones, being heavier, were picked out by jewelers and others needing to send money abroad.
Gresham’s law has a paradoxical wording and is frequently misunderstood. “Bad money,” as he used the term, meant, not counterfeit money, but merely worn coins that have a bullion value less than that of some other money then in circulation. But such “bad money” will not always drive out “good money.” The law applies only under certain conditions and within certain limitations. The “good” will be driven out only if the total amount of money in circulation is in excess of what would be needed if all were of full weight and of best quality. Paradoxically speaking, if there is not too much money altogether, the bad money is just as good as the good money. But, even if good money is driven out, it may not leave the country. It may be hoarded, or be picked out by banks and savings institutions to retain as their reserves, or be melted for use in the arts. Gresham’s “law” becomes thus a practical precept. As applied to the plan of recoinage it is: Withdraw worn coins as rapidly (in equal numbers) as you put new coins into circulation.
The continued circulation of “bad” money alongside of “good” money (light-weight alongside of full-weight coins), as long as the total number of coins is not in excess of the money demand for full-weight coins, is explained thus on exactly the same principle as is the circulation at parity of a light-weight fractional coinage, in the preceding section.
§ 6. Seigniorage on standard money. The fiduciary coinage problem presents itself under a somewhat different guise in case a seigniorage charge is made on all coinage, even of that metal used as the standard unit. In this case coinage might be free but not gratuitous. Then no bullion would be brought to the mint unless the coined pieces the owners received had a value equal to the bullion value plus the seigniorage charge. The power to impose a seigniorage charge is a monopoly power, a power of artificial limitation. The number of coins that can be issued without depreciation is limited to that number which would circulate if they were made full weight without a seigniorage charge. With this number of pieces, the money demand of the country is at the saturation point for full-weight metal coins. If more coins could in any way be put into circulation they would be worth less as money than as bullion, and would be melted or exported.
Assume that this full supply of gold money at the saturation point is 100,000 pieces or dollars; then consider the effect of imposing a seigniorage charge of 10 per cent on further coinage. If business or population did not increase, and until through loss, by fire and in other ways, and through use for industrial purposes, the quantity of money had been reduced below this point, the seigniorage charge would have no effect, and there would be no desire to change gold from bullion form into coin. But when any or all of these suggested changes take place, the value of the monetary unit relative to the bullion value will begin to rise. It will take on a monopoly value due to the limitation of coinage. When it has risen until the coin will buy any more than one ninth more bullion than was in it, the citizens will begin to take metal to the mint. After the 10 per cent charge is taken out they will receive a coin which, though containing one tenth less bullion, will be worth very nearly the same as the metal taken to the mint. No depreciation could take place unless the volume of business fell off so that less money was needed than before. In that case there would be no outlet for the excess of coins until they fell to their bullion value, i. e., till they lost the entire value of the seigniorage, the monopoly element in them. Melting or exporting them before that point was reached would cause to the owner the loss of whatever element of seigniorage value they contained.
We thus have arrived at the general principle of seigniorage: when coins are not issued beyond the saturation point, a seigniorage charge raises the monetary value of the money-material above its bullion, that is, its commodity, value. And this holds good of a large seigniorage charge as well as of a small one, even up to the extreme limit of a charge of 100 per cent. In this last case the government would retain the whole of the bullion brought to it and would give in return a piece of money made of material (metal or paper) with a negligible value.
§ 7. Fiduciary coinage on governmental account. The fiduciary coinage problem may be presented also when coinage is not free, and the times and amount of coinage are determined by law or by legally authorized officials. In this case the bullion must be obtained by purchase in the open market (and paid for by some form of legal money, or by bonds). Coinage is then said to be “on governmental account.”
Now, assuming that the normal money demand (the volume of business or sum of exchanges) remains unchanged, let us consider what will result if the government begins to issue money in this way when, as in the preceding case, 100,000 units of full-weight money are in circulation. This action might be taken most simply by recoining all the full-weight pieces that came into the treasury, making them contain one tenth less precious metal, and paying out 1111 pieces for every 1000 received. Every time this was done there would be an excess of 111 pieces above the normal money demand, and 111 full-weight pieces would be exported or melted (Gresham’s law). The process (in strict theory) may be repeated 90 times, at which point 90,000 full-weight coins have been received, 100,000 light-weight coins have been issued to take their place, and 10,000 full-weight coins have gone out of circulation. The total seigniorage profit would be one-tenth of 90,000, or 9,000 units of bullion. No depreciation has taken place,4 the pieces, by reason of their limitation, bear a money value in excess of the bullion that is in them.
Now the government, with the next 1000 pieces collected by taxation, could buy enough bullion (in the open market) to make another 1111. The excess of 111 pieces could not now be promptly removed by the melting down or exporting of 111 coins, for all those remaining in circulation have a bullion value one tenth below their money value. As this process is repeated the number of coins must continue to grow from 100,000 to 111,111, and the value of the money piece in terms of bullion continue to fall from ten to nine. At this point the 111,111 pieces would contain just the same amount of bullion and have just the same value as the 100,000 pieces did before. Thereafter no further profit would accrue to the government from issuing coins of that weight. To make a further profit it must again reduce the amount of pure metal in the coin.
§ 8. Two stages of coinage debasement. It will be seen that, taking the number of full-weight coins at the saturation point as parity (when price is 100), then (a) price rises directly as the number of units of money; (b) the value of the monetary unit is the reciprocal of price (changes inversely with the number of units of money).
When a new seigniorage charge is imposed, the change in the physical content of the coin is called debasement. Two stages of this change may be distinguished (as is shown in the preceding description). The first stage is debasement without depreciation of the monetary unit; the second stage is debasement with depreciation. In the first stage the monetary unit, as a result of limitation, has an artificial value in excess of its bullion value; in the second stage its monetary value falls toward its bullion value, but may (depending on limitation) rest anywhere between the former full-weight bullion value and the new bullion-content value.
The process illustrated above was often repeated in the Middle Ages. A ruler, either by making a higher seigniorage charge or by coining on his own account, debased the quality or reduced the weight of the money of his realm. For a time the new coins, having the same monetary use, circulated at par with the old coins. The ruler, pleased with this almost magical power of getting a revenue with little trouble, continued to issue coins, until suddenly the heavier coins began to be exported or melted, and the value of the other money fell, to the mystification alike of the prince and of his people. The reason is now perfectly plain: the number of coins was not kept within the proper limits and they went down to their bullion value. The only way a further profit could be made in this way was to debase the coin again. By successive steps the coinage came to consist almost entirely of cheaper alloy.
§ 9. The gold-exchange standard. In a number of silver-using countries and colonial dependencies near the end of the nineteenth century, the fluctuations of the value of silver in terms of gold was a constant source of difficulty in the payment of foreign obligations to gold standard countries. Yet there were strong reasons in the habits of the people and in the industrial conditions of the country to prevent the adoption of gold and the disuse of silver as the actual money in circulation. The method adopted, that of the gold-exchange standard, in operation in India since 1893, in the Philippines since 1903, and in Mexico since 1904, involves these features:
(1) Closing the mints of the country to the free coinage of silver.
(2) Adoption of a fixed ratio of exchange between the silver coins in circulation and a gold coin which is made the standard of value in all transactions (as the dollar or the pound sterling), the money in circulation thus being all or nearly all of a fiduciary nature.
(3) Regulation and limitation of the amount of silver money in circulation, so that a fixed parity between it and gold may be maintained, (a) by issuing coins in limited number and only on governmental account; (b) by the sale, at a fixed rate, of foreign exchange bills payable abroad in the standard unit, the money paid for the bills being withheld in a special reserve, thus reducing the total volume of money in circulation; (c) by the purchase of foreign bills of exchange at a fixed rate, thus paying out and putting again into circulation some of the fiduciary money in the special reserve.
These monetary changes furnish numerous illustrations and demonstrations of the quantity theory of money as applied to the entire circulating medium of the country.5 The silver coins which alone are in actual circulation become fiduciary by reason of the artificial limitation of their number, and their monetary value is made to conform to the value of gold6 as used in international trade.
§ 10. Nature of governmental paper money. The problem of seigniorage presents itself in its most extreme form when money is made of paper. Paper money is issued either by a government or by a bank. We will consider governmental notes here, reserving until later the case of bank notes.
The issue of paper money in some cases grew out of the practice of debasing metal. However this may have been, governmental paper money may be looked upon as money for which a seigniorage of 100 per cent is charged. The gain of seigniorage from paper money is greater and is just as easily secured as that from coinage of metals. Governmental paper money is called “political money,” in contrast to commodity money. However, all coins that contain an element of seigniorage, or monopoly value, are to that degree “political money.” The typical paper money is irredeemable; that is, it cannot be turned into bullion money on demand. It is simply put into circulation, usually with the “legal-tender” quality. Money has the legal tender quality (as the term is used in the United States) when, according to law, it must be accepted by citizens as a legal discharge for debts due them, unless otherwise provided in the contract. The prime purpose of making money legal tender is to reduce the danger of dispute as to payments; but another purpose often has been to force people to use a depreciated money whether they would or not. The purpose of the issue of political money is usually to gain the profit of seigniorage for the public treasury, and often it has been the desperate expedient of nearly bankrupt governments. Governmental paper money differs from bank-notes in that its value does not necessarily depend on the promise of redemption by the issuer. It differs from promissory notes and bonds in that its value is not based on the interest it yields, but mainly on its monetary uses. The issue of paper money may save the government the payment of interest on an equal amount of bonds. The promise to receive paper in payment for taxes or for public lands may help to maintain its value by reducing its quantity, but nothing short of its prompt redemption in standard coins makes it truly redeemable.
§ 11. Irredeemable paper money in America. The most notable examples of paper money in the eighteenth century were the American colonial currencies, the continental notes, and the French assignats. In all the American colonies before the Revolution, notes or bills of credit were issued which were in most cases legal tender. Parliament forbade the issues, but to no effect. Without exception they were issued in large amounts, and without exception they depreciated. The continental notes were issued by the Continental Congress in the first year of the war (1775), and for the next five years. The object at first was to anticipate taxes, and it was expected that the states would redeem and destroy the notes; but this was not done. The notes passed at par for a time, but depreciated rapidly as their number increased. It has been estimated that the country had less than $10,000,000 of coin before the war, and when, in 1780, more than $200,000,000 of notes were in circulation they were completely discredited: hence the phrase “not worth a continental.” Specie then quickly came back into use.
The United States, under the Constitution, did not try legal-tender paper money till 1862, when paper notes (called greenbacks, because of the color of ink with which the reverse side was printed) were first issued, later increased to a total of about $450,000,000. Other interest-bearing notes were issued with the legal-tender quality and circulated as money to some extent. Greenbacks depreciated in terms of gold, and gold rose in price in terms of greenbacks until, in June, 1864, it sold at 280 a hundred. Fourteen years elapsed after the war before these notes rose to par in terms of gold (in December, 1878), and they became legally redeemable in gold January 1, 1879. This was called the “resumption of specie payments.” Ever since that time the United States has maintained the gold standard.
§ 12. Irredeemable paper money in Europe. The leaders of the French Revolution, failing to learn the lesson of the American revolutionary experience, issued, on the security of land, notes called assignats in such enormous quantities that they became worth no more than the paper on which they were printed. The paper money issued by the Bank of England under the restriction act of 1797-1820 is especially notable because it gave rise to the controversy which did much to develop the modern theory of the subject. Parliament forbade the Bank of England to redeem its notes in coin because the government wished to borrow the coin the bank held. The result was the issue of a large amount of bank money not subject to the ordinary rule of redemption on demand. It was virtually governmental paper money. The notes depreciated and drove gold out of circulation, and it was not until 1821 that specie payments were definitely resumed. Essentially the method of the restriction act was applied by each of the belligerent nations to its state bank in the period of the World War.
Almost every nation has at some time issued political money. During the Franco-Prussian War in 1870, France, through the medium of its great state bank, made forced issues of notes of a political nature, which only slightly depreciated. Many countries—Russia, Austria, Portugal, Italy, and most of the South and Central American republics—have had or still have depreciated paper currencies.
At once, at the outbreak of the Great War in 1914, the governments of the warring nations began to exercise a strict control over the issue of paper money, sought in every way possible to gather into the public treasury all the precious metals in the form of coins or ornaments, and to give paper (either governmental notes or bank-notes) a forced circulation, making it the sole circulating medium. In such cases the money partakes somewhat of the characters both of bank-notes and of political money. Even in Great Britain the paper money (governmental and Bank of England notes) depreciated 20 per cent or more, compared with gold; in France and in Belgium, at the worst, nearly 60 per cent; whereas in many of the other continental countries (notably Germany and Austria) it fell nearly 99 per cent. In Russia the paper seems to have become quite worthless. The return to the gold standard is one of the most difficult tasks these countries have to perform.
§ 13. Theories of political money. There are two extreme views regarding the nature of paper money, and a third which endeavors to find the truth between these two. First is that of the cost-of-production theorists, who declare that government is powerless to influence value or to impart value to paper by law. They deny that there is any other basis for the value of money than the cost of the material that is in it. Money made of paper, on a printing-press, has a cost almost negligibly small, and therefore, they say, it can have no value. The facts that it does circulate and that it is treated as if it had value are explained by the cost-of-production theorists as follows: while the paper note is a mere promise to pay, with no value in itself, it is accepted because of the hope of its redemption, just as is any private note. Depreciation, according to this view, is due to loss of confidence; the rise toward par measures the hope of repayment.
Taking a very different view, the extreme fiat theorists assert that the government has unlimited power to maintain the value of paper money by conferring upon it the legal-tender quality. The meaning of fiat is “let there be,” and the fiat-money advocates believe that the government has but to say, “Let it be money” to impart value to a piece of paper. The typical fiat-money advocates in the United States were the “Greenbackers,” who wished to retain the greenbacks issued in the Civil War and to increase the amount greatly. They saw in paper money an unlimited source of income to the government. They proposed the payment of the national debt, the support of the government without taxes, and the loan of money without interest to citizens. All might live in luxury if the extreme fiat-money theorists could realize their dream. The depreciation that has taken place in nearly every case where government notes have been issued, the fiat theorists declare to be due to a mild enforcement of the law of legal tender. To them the fact that paper money may circulate for a time at par appears a reason why it always should. They do not recognize that there is a saturation point in the use of money.
The almost universally accepted opinion among economists rejects both of these views, while recognizing in each a certain limited aspect of the truth. The cost-of-production view overlooks the features in which paper money differs from ordinary credit paper. The value of a man’s promises to pay depends on his reputation and his resources; the resources constitute the basis of value. Bonds have value because they yield interest and are payable at a definite time in standard money. But paper money, lacking this basis for its value, has another basis in its money use, in its power to buy goods.
§ 14. Political money; theory and practice. The theory of paper money here outlined explains the value of paper money as a special case of political monopoly. As the power of any private monopoly over price is relative, not absolute, so is that of the government over the value of political money. The money use is the source of value of the paper notes. It is this that gives the economic condition for value in paper money and strictly limits the power of the government—a fact overlooked by the fiat theorists. Business conditions remaining unchanged, the limit of possible issue without depreciation is the number of units in circulation before the paper money was issued, the saturation point of full-weight and full-value coins. Under wise and honest control and regulation, political paper money might serve the monetary function very effectively. Since the end of the World War, from various quarters has been advanced the plan of an international paper money, to be issued by some organization like a world federal reserve bank. The amount and value of the notes would be regulated in conformity with the gold standard. To monetary students this plan is not new and is theoretically sound except for the political difficulties likely to arise.
Resorted to in desperate extremities, political money has usually proved to be a costly experiment. Once the issue of political money begins to be excessive, its further limitation proves to be most difficult. A result usually unintended is the derangement of business and of the existing distribution of incomes. The rapid and unpredictable changes in prices give opportunity for speculative profits, but injure legitimate business. This incidental effect on debts and industry offers the main motive to some citizens for advocating the issue of paper money. It is peculiarly liable to be the subject of political intrigue and of popular misunderstanding. It is this danger, more than anything else, that makes political money in general a poor kind of money.
PRICE LEVELS AND THE GOLD STANDARD
§ 1. Concept of the general price level. § 2. Index numbers. § 3. Definition of the standard of deferred payments. § 4. Increasing importance of the standard. § 5. Defectiveness of the gold standard. § 6. Relative values of gold and silver. § 7. Gold production, 1800-1850. § 8. Gold production and price changes, 1850-1873. § 9. The great fall of prices, 1873-1896. § 10. Nature and object of bimetalism. § 11. The free-silver movement.
§ 1. Concept of the general price level. The price of any good is some other good or group of goods given for it in trade.1 The standard unit of money coming to be the most convenient expression for price (whether or not money be actually passed from hand to hand in any particular trade), prices usually are monetary prices, and more specifically are prices in gold, or in silver, or in whatever constitutes the standard money unit. But the price of each good is a definite, separate fact, which expresses the ratio at which that commodity is sold. The price of any particular kind of goods may fluctuate in either direction as compared with the prices of other goods at the same time. For example, iron and many other goods may rise while wheat and many other goods fall in price. There is, therefore, no such thing as an actual general change in the prices of goods in terms of money, but it may be seen that the prices of large classes of goods, often of nearly all goods, change upward or downward at the same time and in the same general direction. We thus have need to distinguish between changes in the valuations of particular kinds of goods in terms of each other and general changes in the valuation of a number of different goods in terms of the monetary unit.
To get some idea of whether such a general trend occurs, the algebraic sum of all the changes in the particular prices of a selected group of goods may be taken, and for convenience this may be reduced to an average price (by dividing the sum by the number of articles). Such an average is called a general price, and, when comparing it with the general price of another time, we speak of changes up or down in general prices, or in the general scale of prices, or in the price level.
When gold is the standard unit, its value is the converse of general prices; as prices go up the value of gold goes down, and gold is said to depreciate. As prices go down the value of gold goes up, and gold is said to appreciate. Rising prices mean falling value of gold (and at the same time falling purchasing power), and vice versa.
§ 2. Index numbers. The process of calculating general prices and changes in them has in it, inevitably, something of arbitrariness and incompleteness. For not all prices can be included, but only those of articles of somewhat standardized grades and those that are pretty regularly sold in markets where prices are publicly quoted. No list of articles that can be selected is of equal importance to different persons and classes of persons, at different places, at different times, and for different purposes. And yet the study of general prices as shown by any broadly selected list reveals changes that in some measure affect the interests of every member of the community.
General prices are conveniently compared from one time to another through the use of index numbers. An index number of any article is the per cent that its price at any certain date is of its price at another date (or of the average for a series of prices) taken as a base or standard. Thus if the average price of cotton in the base year were 10 cents (taken as 100) and the price rose to 12 cents, the index number would be 120. A tabular index number is the per cent that the price of a selected group of articles at any certain date is of the price of the same group of articles at a date that has been taken as the base. Numerous tabular index numbers have been worked out for different countries and periods.
A chart of the principal index numbers of the leading countries is shown in Figure 1. The fact that from 1862 to 1879 inclusive prices in the United States were expressed in an irredeemable paper standard makes comparisons for that period misleading. A better idea is obtained by using as the base for each of the several series the average of prices in each country for the years 1890 to 1899.
§ 3. Definition of the standard of deferred payments. As a medium of exchange, money comes to be the unit in which most prices are expressed and compared; in other words, it becomes the common denominator of prices.2 This makes it also the most convenient unit in which to express the amount of credit transactions and of existing debts.3 A credit transaction is a trade lengthened in time; one party fulfils his part of the contract by delivering the goods or money, the other party promises to give an equivalent at a later date. The equivalent may be in any kind of goods; for example, in barter one may part with a horse on the promise of a cow to be received later; or a small horse on the promise of a large one; or a flock of sheep on the promise of its return at the end of the year with a part of the increase of the flock. A simple standard in which to express the debt is the thing borrowed, as horse, sheep, wheat, house. Again, the thing to which the value of debts is referred may be a thing quite different from the goods borrowed, and, with the growth of the monetary economy and the use of the interest contract, money comes more and more to be used as the standard. At length the law declares that in the absence of any other agreement, the amount of a debt is to be payable in terms of the unit of standard money, which thus is made legal tender as well as the customary standard of deferred payments. A standard of deferred payments is the thing of value in which, by the law or by contract, the amount of a debt is expressed and payable.
§ 4. Increasing importance of the standard. Until the use of money develops, the use of credit is difficult and limited; it becomes easy when the value of all things is expressed in terms of a common circulating medium. It therefore generally is true that the importance of money as the standard of deferred payments increases with the use of money as a medium of trade. The volume of outstanding debts expressed in terms of money now very greatly exceeds the total value of the circulating medium. Changes in the general level of prices have, therefore, great effect upon all existing debts. The value of all debts changes in the same proportion as does that of the standard unit of money; when this rises or falls in value, it means increase or reduction, in the same ratio, of the purchasing power of every creditor. It is as if he had in his possession metal dollars equal in amount to the face of the debt, and they had changed by so much in purchasing power. The debtor’s interests in such changes are, of course, just the reverse of the creditor’s interests.
Outstanding contract debts may be roughly divided into two classes: short-time loans, running less than a year; and long-time loans, running for a year or more.4 Fluctuations are rarely rapid and great enough to affect appreciably the debtors and creditors in the case of short-time loans. The results are appreciable in the case of loans running from one to five years, and may be very great in the case of loans made for still longer periods, such as the bonded indebtedness of nations, states, municipalities, and business corporations, and as mortgages given by farmers on their land or by owners of city real estate. A multitude of interests are thus affected by a change in the value of money. When money rises in purchasing power, receivers of fixed incomes are gainers. When it falls in purchasing power, they lose. Receivers of fixed incomes from loans include not merely private investors, but also many educational and charitable institutions which dispense their incomes for public purposes. Wages and salaries of many kinds go up and down less rapidly than do other prices, and thus to some extent wage-earners are in the position of passive capitalists5 as regards changes in the monetary standard. In a capitalistic age, therefore, almost every individual is affected in some way by a change in the value of money.
§ 5. Defectiveness of the gold standard. Money is, in general, for both borrowers and lenders the most convenient standard of deferred payments. But from the usage of speaking of all things in terms of gold arises the popular notion that the value of gold is always the same, while the value of other things changes. In truth, a fixed objective standard of value is not possible of attainment. Although the value of gold is stable as compared with most things, it rests on the estimates made by men and is constantly changing with conditions. The current new supplies of gold are comparatively regular. For centuries at a time there was little change in the methods of mining gold and there were no radical changes in its output. The nature of the use of gold, likewise, is such as to make changes in the amount of it needed, under ordinary conditions, more stable than is that of most other goods. Moreover, the stock of gold in monetary uses is but slowly worn out; it is, therefore, a large reservoir into which flows a comparatively small stream of annual production; the existing stock is twenty or thirty times the annual output. The existing stock of precious metals, gold and silver, more than other products of mine and field, is at any time the accumulation of many years’ production, and is changed very little, proportionally, by a large change of output in any year or short period. It changes in volume as does a glacier fed by the snows of many years, not as does a river, filled by a single rainfall.
Yet the value of gold expressed in other things is never quite stable, and sometimes several influences combine to affect it greatly. At various times the discovery of gold deposits, and recently the invention of chemical and mechanical processes, have suddenly altered the conditions of gold production, causing revolutionary results in the field of prices and deferred payments. A brief survey of these changes will be helpful to an understanding of the problem involved.
§ 6. Relative values of gold and silver. Both gold and silver were used as moneys in Greece and Rome, and continued to be used in Europe in the Middle Ages, though silver was much the more common. The two metals continued in the seventeenth and eighteenth centuries to be used side by side in Europe and in the new settlements in America, silver for the smaller and gold for many of the larger transactions. Both were legal forms of money in units of specified weights and fineness, the weights bearing a certain ratio to each other. Thus it was possible for a debtor to discharge his obligations with that one of the two metals which at the moment was the cheaper at the legal ratio. Fluctuations in the prices of gold in terms of silver were at times such as to cause a large part of the full-weight coins of one or the other metal to leave circulation (in accordance with Gresham’s law). So from time to time the ratio was slightly changed by law in the various countries to permit the circulation or to bring back the kind of money that had been undervalued in terms of the other.
It is a remarkable fact that from the time of Xenophon until the discovery of America (a period of nearly two thousand years) the market ratio of silver to gold bullion in Europe had remained pretty close to ten to one, being only temporarily altered by sudden and unusual occurrences. From 1492 to 1660 the ratio changed to fifteen to one, where it remained with remarkable stability until about the year 1800. At the establishment of the mint of the United States in 1792 that ratio was found to exist. Men had come to look upon the ratio of fifteen to one as the natural order, determined (it was sometimes said) providentially by the deposit of the two metals in due proportion in the earth’s surface. But, as we now see it, this in part was mere chance and in part was due to the equalizing effect of the wide use of both metals, so that the one could be easily substituted for the other in case of a divergence of the market ratio from the legal ratio as money. From the year 1500 until 1800 the western hemisphere was the main source of the precious metals, the alluvial deposits were widely scattered, were gradually discovered, were usually found in small quantities, and were extracted in primitive ways. For a short time after the discovery of America (from 1493 to about 1544) the average coining value6 of the world’s production of gold, nearly all found in America, was about one and one-half times as great as that of silver; but thereafter for three centuries from about 1545, the annual value of silver produced was between one and one-half to four times as great as that of gold, averaging about twice as great. Silver was the money chiefly in use in the ordinary transactions in all of the principal countries of the world.
§ 7. Gold production, 1800-1850. The legal ratio of 15 to 1 in the United States, at which by the law of 1792 both metals were to be freely coined at the mint, proved to be an undervaluation of gold. The market ratio of the two metals had been gradually changing before 1792, and continued to change, gold becoming more valuable in terms of silver. Gold largely left circulation, and by 1818 silver and bank-notes formed nearly the whole of the circulating medium. Then the production of gold began to increase absolutely and relatively somewhat more than that of silver, and when the market ratio had become about 15½ to 1 in 1834, the legal ratio of the United States was changed to 16 to 1. This overvalued gold and brought a good deal of it back into circulation, gradually driving out most of the silver (the heavier coins disappearing first).
In the decade 1841-50 the average annual value of the gold production, for the first time since the early sixteenth century, exceeded that of silver. Then, from 1848 to 1850, came the great gold discoveries in California and in Australia. The value of gold produced in the world in 1851 was one and one half times that of silver, in 1852 three times, and in 1853 four times as great; and then slowly declined, but continued every year as late as 1870 to more than twice as great. Let us observe the effect on prices that was brought about by the discoveries of 1848-49.
§ 8. Gold production and price changes, 1850-1873. The unprecedented increase in gold production between 1849 and 1853, and the continuance of production in volume about fourfold as great as that of the decade 1840-49, caused the displacement of silver by gold in the United States and drove out a large proportion of the silver coins of smaller denominations. To make possible their retention the law of 1853 was passed, authorizing subsidiary coinage (on government account only) of lighter weight.7 Gold became then the one standard money actually in circulation in the United States, and the increased gold production was reflected at once in a rise of prices. This was the most revolutionary price change that had occurred since the sixteenth century. A period of prosperity in business culminated in the crisis of 1857, felt more or less in all the leading countries. This prosperity accelerated the effect of increasing quantities of the standard money. Credit was stimulated and the rate of circulation and the efficiency of money were increased. Prices rose to a temporary maximum in 1857, and then fell, as a great international financial crisis occurred.
Then the substitution of gold for silver in monetary uses made an additional market for gold, and at the same time the rapid growth of population, commerce, and industry in Europe and America began to take up (“absorb”) the new supplies of gold. The price movements in the United States between 1860 and 1879 are passed over here, for the excessive issues of greenbacks drove gold out of circulation and made greenbacks the standard money (except in California and elsewhere on the Pacific Coast, where, by public opinion, gold was retained as the circulating medium). In the European countries prices in terms of gold, though fluctuating somewhat, kept at about the same level from 1860 to 1870. The years 1871 and 1872 were very prosperous and showed rapidly rising prices, which reached a maximum in 1873, when a financial panic occurred.
§ 9. The great fall of prices, 1873-1896. In the year, 1873, notable in monetary history, just as the gold production for the first time since 1851 had fallen below $100,000,000, several notable changes in monetary legislation were effected which made gold more important in the circulation of a number of countries. In 1873 Germany made gold the standard throughout the new German Empire (having prepared the way by legislation in 1871 which made gold a legal tender alongside of silver), and provided that silver was thenceforth to be used only in the subsidiary coinage. The same year Belgium, and the next year the other countries of the Latin Union (France, Switzerland, and Italy) took steps that resulted in demonetizing silver, that is, in limiting its coinage to governmental account, and in making gold their one standard money.
In the United States at that time, and until 1879, greenbacks were standard money, and neither gold nor silver was regularly in circulation (except in California). There was a long-continued discussion of a “return to specie payments,” which meant the return to a metallic standard, and the redemption of greenbacks on demand. Meantime in 1873 a law was passed making the gold dollar “the unit of value” and dropping out the standard silver dollar from the list of coins authorized to be issued at the mint.8 From 1873 until 1879 prices (in greenbacks) were falling in this country very rapidly because the country, with the increase in population, wealth, and business, was “growing up to” its unchanging currency supply. For a like reason, at the same time gold prices throughout the world were falling. While this country was lowering its level of prices from an inflated paper money to a gold commodity basis, the gold basis itself was sinking to a lower level.9 Between 1864 and 1876 our own gold product had been nearly all exported; but, beginning in 1878 and continuing till 1888, the demand of our Treasury and banks for gold caused the retention of our own gold product in this country (nearly $400,000,000 worth, coining value, in the period of eleven years), and required an enormous net importation, amounting (in the same period) to $225,000,000 worth of gold. The combined effect of these causes is seen in the great fall of prices in all gold-standard countries in the period of 1873-1896.
The general price level fluctuated but on the whole tended downward between 1884 and 1893 (the year of panic), and reached a minimum in the year 1895 in Germany, 1896 in England, and 1897 in America. The resulting increase in the burden of outstanding debts was felt by all debtors, but particularly by great numbers of the agricultural classes both in Europe and in America. Their tribulations were aggravated by the fact that at that time (especially from about 1873 to 1896) the prices of their products were falling much more rapidly than were general prices, as a result of the very rapid extension of the agricultural land supply.10 There was complaint, agitation, and demand for relief on the part of many interests in France, Germany, England, and the United States. As a result, the money question became in this country a leading political issue and continued to be such between 1873 and 1900.
§ 10. Nature and object of bimetallism. First came the “greenback movement,” which lasted until after 1880.11 This then gave way to an agitation for bimetallism. Bimetallism is the plan of using two metals as standard moneys. Bimetallism is legally authorized when both metals are admitted to the mints for free coinage at an established ratio of weight. Bimetallism may be legally authorized, but not actually working; for if the market value long continues to vary appreciably from the legal ratio, only one of the metals may in fact be left in circulation. This situation is called limping bimetallism (or halting double standard), though this is a contradiction of terms. National bimetallism is confined to a single country, as was the case in the United States before the Civil War, and in France before 1867. International bimetallism is that resulting from an agreement among several nations to use two metals on the same terms.
The theory of bimetallism is that the government can act on the value of the two metals through the principle of substitution. The metal tending to become dearer will not be coined, the other will be coined in greater quantities. The degree of influence that can thus be exerted on the value of the two metals depends on the size of the reservoir of the metal that is rising in value. When it all leaves circulation, the law on the statute book permitting it to be coined becomes a mere phrase. In such a case there is bimetallism de jure, but monometallism de facto. The greater the league of states, the greater is the likelihood that the plan will continue to work. The only notable historical instance of international bimetallism is that of the Latin Union which united France, Belgium, Italy, and Switzerland in an agreement remaining actually in force from 1866 to 1874. A strong movement developed between 1878 and 1892 in favor of forming a great international bimetallic union of states.
One object of bimetallism was to put an end to the great fluctuations in the rates of exchange of money between the silver-using and gold-using countries, fluctuations that occasioned much uncertainty and loss to individuals engaged in foreign trade. The rise in the price of gold exchange in the silver-using countries (notably India) meant also an increase in their burden of taxation. These countries collected their revenues in silver, but they had to pay their debts, principal and interest, in gold. Another object of this movement was to prevent the burden of individual debts from increasing by reason of the rise in the value of the single standard, gold. It was, indeed, hoped that by bringing silver much more into use the value of gold would be reduced, thus bringing relief to the debtor classes. Still another object of the bimetallic movement was to aid the silver-miners and silver-producing districts by creating a larger market for silver.
Several international conferences were held, which were taken part in by some of the leading financiers of the world, representing their respective governments. The United States was foremost in advocating the policy; France at first favored it, as did in large measure the British Indian administration; though England was in the main opposed. The movement came to nothing.
§ 11. The free-silver movement. When all hope of international bimetallism failed, the efforts of many of its advocates were turned to the plan of legalizing national bimetallism in the United States at a ratio of 16 to 1. This was very different from the market ratio. Gold had become before 1860, in fact, the standard of our money system, and after 1873 it was the only metal admitted to free coinage. Silver, little by little, had been losing purchasing power in terms of gold, until from being worth in 1873 one sixteenth as much, ounce for ounce, it became in 1896 worth but one thirtieth as much as gold. The power of silver to purchase general commodities fell much less than the change in its ratio to gold would indicate, gold having risen in terms of most other goods as well as of silver. However, the “free-silver movement” to open the mints to the free coinage of silver at the ratio of 16 to 1, supported by one of the leading political parties in the year 1896, threatened a sudden and marked cheapening of money. Probably gold would have been entirely driven out as money for the time and silver would have taken its place as the standard. It is not impossible, however, that the substitution of silver for gold in the United States would have brought the two metals to parity at a level of prices much less than 100 per cent higher than the existing one, possibly not more than 20 or 30 per cent higher. In any event, “free silver” would have accomplished the purpose of making the standard of deferred payments cheaper. It was at first a debtors’ movement, but to succeed it had to enlist the support of other large classes of voters. And thus it developed into the more sweeping theory that wages, welfare, and prosperity were favored by a larger supply of money quite apart from the effect it would have upon debts.
In its extreme form the free-silver plan was a fiat scheme; for some of its supporters believed that by the mere passage of the law the two metals could be made to bear to each other any ratio desired. But its most intelligent advocates recognized that the force of the law was limited by economic conditions. The victory of the gold standard in the campaign of 1896 was, it would seem, due more to the well-founded fear that a sudden change of the money standard would cause a panic than to a popular understanding of the question.
RISING PRICES AND THE STANDARD
§ 1. Rising prices, 1896-1913. § 2. Rising prices in Europe, 1914-1920. § 3. Causes of European inflation. § 4. Gold stocks of belligerents. § 5. Redistribution of European gold stocks. § 6. The flood of gold to America, 1915-1917. § 7. The gold embargo in the United States. § 8. Gold depreciation and gold production. § 9. The high cost of living, 1919-1920. § 10. Various ideal standards suggested. § 11. The tabular or multiple standard. § 12. Fluctuating standard and the interest rate.
§ 1. Rising prices, 1896-1913. The free-silver advocates got what they desired, a reversal of the movement of general prices, through an occurrence for which no political party could justly claim the credit. In 1883 the gold production of the world was less than $100,000,000. From that date, with the opening of new gold-yielding territory in South Africa and in the Klondike, the annual output of gold had been increasing rapidly and almost steadily. The methods of extracting gold theretofore had still been in large part of a primitive sort. But intricate machinery was taking the place of crude tools, chemical processes had been introduced (notably the cyanide process), and the principal product began to come from the regular and certain working of deep mines rather than from chance surface discoveries. In many parts of the world there were enormous deposits of low-grade ores, before useless, that could be worked economically by the new methods. It is noteworthy that the very year 1896, which marked the height of the political agitation to abandon the gold standard for silver, saw the gold production for the first time in all history surpass the $200,000,000 mark. The gold output had not only caught up with, but had begun to surpass, the normal monetary demands of the world, meaning by that phrase the amount of gold needed to maintain a stationary level of prices.
A study of Figure 1, chapter 6, will help to an appreciation of the enormous increase in the world’s production of gold after 1850. The production of gold from the discovery of America to 1850 doubtless was much greater than it had ever been in any equal period. But this amount was duplicated in the next quarter of a century, again duplicated in the next twenty-five years, and more than doubled in the following eighteen years. The annual average output in the 357 years ending 1850 was $8,700,000, in the quarter century following 1850 was $124,000,000, from 1876 to 1900 was $140,000,000, and from 1901-1918 was $405,000,000.
The whole character of the monetary problem was changed. A period of rising prices set in, as is shown graphically in Figure 2, chapter 6. By 1913 prices had risen just about 50 per cent above the low level of 1896. The rise was at the average rate of nearly 3 per cent each year. This caused a reversal of the former positions of advantage and disadvantage on the part of debtor and creditor respectively. The burden of the average debt began relatively to decrease. A wide field for enterprisers’ profits was opened up by the rapid displacement of prevailing prices in all quarters of the industrial world. The price of manufacturers’ products rose in advance of the rise of costs of many raw materials and especially of the labor costs of manufacture. The average enterpriser’s gain was the average wage-worker’s loss. Wages (and salaries), as nearly always in the case of a change of price levels, moved more slowly than did the prices of most of the commodities that are bought with wages, thus causing great hardship to large classes living on comparatively slowly moving incomes.1 Extremes meet, and these classes include both those living on passive investments and those dependent on their daily labor for a livelihood.
§ 2. Rising prices in Europe, 1914-1920. The year 1913, the last before the outbreak of the World War, marks a new era in price history, and is now usually taken as the base from which are measured in the various countries the remarkable series of price changes that followed. The year 1914 was one in which the political outlook was disquieting, and the European state banks and treasuries were quietly building up their gold reserves to meet possible emergencies, thus contracting the circulation. The annual average index numbers in all the leading countries were nearly the same in 1914 as in 1913.
In the warring countries, however, wholesale prices began at once in August to rise rapidly, attaining in the last quarter of 1914 the figure of 107 in France and 108 in Great Britain. Retail price changes in every country lagged behind the wholesale, not infrequently being retarded a year or more. This rise of prices continued, with hardly an interruption, in all countries, reaching the maximum about the middle of 1920.
In the United States prices fell quickly to 98 in the last quarter of 1914, as gold was clamorously (and foolishly) demanded by European bankers, and a brief financial panic occurred. But the average of prices continued in the United States almost stationary until the last quarter of 1915 (that is, about one year after the war began in Europe), when they began to rise sharply, for reasons that will be indicated in the next section. The changes are shown graphically in Figures 3 and 4, Chapter 6.
§ 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.
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 régime, 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.
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.
§ 7. The gold embargo in the United States. Moved by mistaken fear, the Federal Reserve Board imposed an embargo on the export of gold (made its export illegal). This policy of gold-fetichism, which remained in force from September, 1917, to June, 1919, involved a deplorable lapse from sound monetary principles. The gold embargo had the evil effect of introducing into conditions already bad, a new and artificial element of inflation. However, trade conditions were such that the general world balance of gold payments would, on the whole, have been little away from America, otherwise the embargo would have been still more difficult to enforce. As far as it was enforceable (which it was probably, for the time, in large part), the embargo could have only the evil effects of disrupting the exchange rates (as it did) with countries to which we had international balances, notably Argentine, Spain, and Japan. Indeed, in principle, it is suspension of specie payments in international trade, and this is an abandonment of the international gold standard. Our exchanges with a few foreign countries that were selling us largely were thrown into disorder. In the twenty-month period of the embargo, our net loss of gold was only $5,000,000. Just as the embargo was removed these conditions were already changing. In the next ten months (June 1, 1919, to April 1, 1920) our net exports of gold were more than $400,000,000, which served to restore the value of the dollar in those countries where it had depreciated. Then, again, after a few months of fluctuating balances, began, in September, 1920, a new flood of gold to the United States, which by the end of May, 1921, amounted to more than $480,000,000. The exports of gold from the United States between November, 1918, and August, 1920, have gone largely to Japan, China, British India, Hongkong, Spain, Argentine, and Mexico. Imports since September, 1920, however, have been largely sent by England, France, Sweden, and Canada, not merely to pay their trade balances, but because the United States has become the most important free gold market in the world, and “dollar exchange,” the best international currency, is eagerly desired by producers and owners of gold everywhere.
§ 8. Gold depreciation and gold production. In explanation of the changes in price levels in the various countries, a distinction should be made between gold depreciation and paper depreciation—or, otherwise expressed, between gold inflation and paper-money inflation. The one expression refers to the value of gold in terms of goods, the other to paper prices expressed in gold. In the United States (except during the embargo, to a slight degree) and several other countries gold has continued to be the standard money in international trade, and the rising index number has reflected a real fall in the purchasing power of gold. The main reasons for this are: (1) the transfer of large amounts of gold from the countries where for the time being it has been in fact demonetized, to the countries still maintaining the gold standard; our own gold stock in two years increased by the amount of the world’s total production for three years; (2) the increased use of banking credit under the Federal Reserve system has enabled an equal amount of gold to perform more monetary services; and (3) the world’s production of gold, which reached its highest peak in 1915, continued, relative to the narrowed field of its monetary uses, to be larger until 1920 than it had ever before been in history. This is shown in Figure 6, chapter 6.
Higher prices in terms of gold mean higher wages, higher costs for machinery and supplies, in short, higher costs of every kind in gold-mining. Many mines formerly profitable must be abandoned, one after the other, until the costs of mining on the marginal mines are brought into accord with the value of the gold produced. The folly, at such a time, of proposals for governmental subsidies and bonuses to gold-mining to keep up the quantity of gold ought to be apparent to any one with the most elemetary understanding of monetary principles. Yet such a proposal was presented in a bill in Congress, and strongly supported, as it was said, “to aid us to maintain the gold standard.”
The increase of index numbers in countries with paper currencies is in every case greater than that in gold-standard countries. The difference measures, pretty exactly, reciprocally the depreciation of the paper in terms of gold, and the abnormal rise of foreign exchange rates.
§ 9. The high cost of living, 1919-1920. The curve of general wholesale prices that began to rise in the United States about July, 1915, reached its peak in May, 1920, at a point 172 per cent above the level maintained from 1913 to June, 1915. Retail prices (estimated as “cost of living” on a standard family budget) followed on the up-swing, but, as usual, lagged behind, reaching a maximum in the middle of 1920, a little more than 100 per cent above the 1913-15 level. A very large part of this increase both of wholesale and of retail prices occurred in the post-war period of great speculation between March, 1919, and May, 1920. This movement was world-wide, as the result partly of great increases of paper money and bank credits, in the European countries, necessary because of the desperate state of their finances, and needlessly assisted in America by those having ultimate authority in the Federal Reserve system. Prices ran the usual course as a financial crisis approached, goods being bought and contracts made with borrowed funds in the hope of a further rise of prices. It was for many a veritable financial joy-ride.
Such a rapid rise affected different classes of persons in business and different classes of goods very unequally. Cases of extravagant expenditures (relative to former standards) were conspicuous in working class circles, where wages rose faster than the cost of living, and among the newly-rich employers who had “profiteered” in the war and the post-war period of speculation. Less conspicuously, great numbers of wage-earners and salaried and professional workers felt keenly and suffered greatly from the higher cost of living (popularly denominated the H. C. L.). The different elements in the cost of living moved at various rates, as is shown in Figure 8, chapter 6.
Among the industries that profiteered most for the time were those engaged in producing clothing, furniture, and food, including nearly all agricultural products. Among those that were losers in the purchasing power of their incomes were many active enterprisers whose products rose in price more slowly than the average (or than their wage bills and other costs) and all public utilities fixed by charter or controlled by price-fixing commissions. Many railroads, trolley lines, gas and electric companies were brought to the verge of bankruptcy or beyond.
§ 10. Various ideal standards suggested. Price history since 1873, however varied, teaches one lesson clearly: that our “standard” unit of price has in fact been subject to great fluctuations in its value. We escape the evils of a rising standard of deferred payments (falling prices) only to meet those of a falling standard (rising prices). And as long as we have so fluctuating a standard these difficulties must arise again and again, continually repeated, causing unmerited gains and undeserved losses to individuals. But what standard would be better than that of gold? It may, perhaps, be agreed that the ideal standard of deferred payments is one that would insure justice between borrower and lender. Yet different views may be and have been taken as to what constitutes justice in this matter. The suggestion is attractive that repayment should involve the return of enjoyment equal to that which could be purchased with the sum at the time of the loan. Such a standard is impossible of perfect realization in any general way, for men’s circumstances are constantly changing. To insure even to the average man the same amount of enjoyment is only roughly possible. The same goods do not afford the same enjoyment when conditions, either subjective or objective, have changed. Another suggestion is that the goods returned should represent the same sacrifice as those lent. Here again the difficulty is in the lack of a standard applicable to all men. Whose sacrifice? That of the lender, who may be rich, or that of the borrower, who may be poor? Some have supposed that the condition of equal sacrifices was met by the labor standard, according to which the sum returned should purchase the same number of days of labor as when borrowed. But what kind of labor is to be taken, that of the lender, or that of the borrower, or that of some one else? Labor is of many different qualities, which can be exactly compared only through their objective value in terms of some one good.3
It must be recognized that any possible concrete standard of deferred payments will sometimes work hardship in individual cases. The best average results for justice and social welfare will be secured by measuring debts in some standard that will change least often, and least rapidly, in relation to the great majority of people of all classes in the community.
§ 11. The tabular or multiple standard. Gold is the best standard yet devised and put into actual practice, but it is very imperfect. A standard better than a single metal, more stable than a single commodity, is desirable if it can be found. Apart from the difficulties of its practical operation, such a standard would be a tabular standard, consisting of a number of leading commodities in fixed proportions, such as is used in calculating index numbers expressing the general scale of prices. This averages the fluctuations of particular goods and would give a fair approximation in practice to the ideals of equal sacrifice and equal enjoyment (on the average, though not in individual cases). While some natural materials are growing more scarce and call for more sacrifice, other products are by industrial progress becoming more plentiful. This kind of standard has been viewed with favor by many monetary authorities, and, despite the administrative difficulties, ways may yet be found for putting it into practice.
After choosing the components of the multiple standard, the actual regulation of the quantity of money to make prices conform to the standard might be accomplished in one of several ways. It might be done by letting the value of the gold dollar fluctuate as it does now, while requiring a greater or less number of dollars to be given in fulfillment of all outstanding contracts. For example, if prices by the multiple standard fell from 100 to 95 in the time between the origin of a debt of $100 and its payment, the debt would be discharged by paying $95; if prices rose to $110, the debt would be discharged only by the payment of $110.
Another plan is that of a “compensated gold dollar.” By this plan the legal weight of gold coins would be increased or decreased from time to time to conform with the changing index numbers. Still a third method would be to regulate the issue of standard paper money, contracting and expanding its amount by issue and redemption, by deposit in and withdrawal from depository banks, at regular intervals to bring prices into conformity with the tabular standard. These are as yet but distant possibilities, and for some time to come gold will continue to serve as the standard money in the same manner as in the past.
§ 12. Fluctuating standard and the interest rate. In connection with the standard of deferred payments there is presented a problem of the effect that fluctuations of the standard may have upon the interest rate.4 As the general price level falls or rises, the monetary standard conversely appreciates or depreciates.5 If these changes are slight in amount and imperceptible in their direction they may not affect considerably the motives of borrowers and lenders. Therefore, the rate of interest this year in long-time loans would be just that resulting from the expectation, on all hands, of a stationary level of general prices. Suppose that rate to be 5 per cent on the standard investment (such as real-estate loans and good bonds). Then the lender of $1000 will receive each year a $50 income and at the end of the investment period $1000 principal, each dollar of which will purchase the same composite quantum of goods that a dollar would have purchased at the time the loan was made. Likewise, the borrower would pay interest and principal in a standard that reflected an unchanging general level of prices. But, now, if the general level of prices unexpectedly falls 1 per cent within the year, the creditor of a loan maturing at the end of the year would receive (principal and interest) $1050, which will purchase 1 per cent more goods per dollar than the sum he lent, or (approximately) $1060 worth of goods. Hence, he has received, in quantum of goods, a yield of 6 per cent on his investment. If this change continues for five years, the lender of a five-year loan would receive each year $50, having a purchasing power successively 1, 2, 3, 4, and 5 per cent greater than the same sum had at the making of the loan; and at the end of the five years would collect the principal, having a purchasing power 5 per cent greater. The borrower, on his part, would have to pay interest and repay the principal in a money that is to be obtained only in exchange for a larger sum of goods than that which could be bought with each dollar that he borrowed. This means that, with individual exceptions, creditors generally gain and debtors lose by falling prices.
But this is fully true only in respect to loans already made. For, just to the extent that such a movement of prices comes to be more or less regularly in the same direction, both borrowers and lenders are able to take it into account, and, as experience shows, do take it into account.6 When prices fall men become more eager to sell wealth, to lend the proceeds, and more reluctant to borrow for investment at the prevailing rate of interest and at the prevailing prices. There is an incentive to divest one’s self of ownership (e.g., by selling stocks) and to become a lender (e.g., by buying bonds). This whole situation is reversed in a period of rising prices. The result is that the rate of interest in any long-continued period of falling prices (such as from 1873 to 1896) has a trend downward and in a period of rising prices (such as from 1897 to 1915) has a trend upward. This movement of readjustment would not go on indefinitely, even if the same trend of prices continued; for in the strict theory of the case the adjustment would be complete when the interest rate had changed by just the amount of the annual change in the level of prices. For example, if 5 per cent is the static normal rate of interest, then when prices are falling 1 per cent each year, the adjusted rate of interest would be 4 per cent; and when prices were rising 1 per cent each year, the adjusted rate of interest would be 6 per cent. Such adjustments serve to some extent to neutralize the effects of changes in the standard of deferred payments as far as concerns new loans made in view of just such a change and in expectation of its continuance. But no one can foresee exactly, and most persons take little account of, such a change until it has continued for several years in the same direction. The adjustment is therefore never very prompt or very exact. In some years the general level of prices has risen more than 5 per cent, or more than enough to offset the entire interest received by most lenders. The principal and interest combined have no greater purchasing power at the end of the period than the principal alone had at the beginning of it. It is the same as if the dollars had been buried during a period of stationary prices.7
[1 ]See Vol. 1, pp. 15-16, 50-53, and 262-264, for an introductory statement of the origin and functions of money.
[2 ]The old-fashioned miser, however, withdraws his hoarded gold for the time from its usual monetary function as an indirect agent, and treats it as a direct good yielding to him psychic income by its mere possession.
[3 ]See chart of gold production, ch 5, Fig. 2.
[4 ]See Vol, I, p. 43, on the decline of barter.
[6 ]“I will . . . refine them as silver is refined, and will try them as gold is tried.” (Zech. xiii, 9.) “I bought the field, . . . and weighed him the money, even seventeen shekels of silver. And I . . . weighed him the money in the balances.” (Jer. xxxii, 9, 10.) A shekel was 224 grains, troy weight, which is about equal to six tenths of the pure metal in a silver dollar to-day, and worth in recent years from twenty to sixty cents in gold. At that time, however, the purchasing power of silver was many times greater than it now is.
[7 ]See § 1 and § 2 of this chapter; also Vol. I, especially pp. 31-38 and 353-355.
[8 ]See Vol. I, pp. 138 ff. and 361 ff.
[1 ]From the French coin, in turn from Latin cuneus, wedge, suggestive either of an earlier wedge-shaped piece, or of a wedge-shaped mark on the piece. The German word Münze is from the Latin moneta (as is the English mint, the place where coins are made), which meant money, that name being taken from the temple Juno, called Moneta, where coins are made.
[2 ]This means actually gratuitous, for any real difficulty in getting metal to or from the mint operates as a cost in the conversion of bullion into money, or vice versa; e.g., the gold may be in Australia and the mint in London.
[3 ]See on kinds of income, Vol. I, p. 26 ff.
[4 ]This formula is presented by E. W. Kemmerer in “Money and Prices” (2d ed., 1909), p. 15 ff.
[5 ]See table in ch. 2, § 7.
[7 ]On the function of deposits see ch. 7, § 11.
[8 ]Consult Figures 1 and 2 in chapter 5 for the graphic presentation of these and related facts.
[1 ]In the broad sense as before defined, ch. 3, § 1.
[2 ]See next section on worn coins in connection with Gresham’s law.
[3 ]Receipts and Expenditures of Mint Service in 1920.
[4 ]In this and following numerical examples no account is taken of the possibility that the standard metal may depreciate in the world market in terms of all other goods as a result of its diminished use as money in one or more countries. This properly belongs in a more complete theoretical treatment of the subject.
[5 ]See “Modern Currency Reforms” (1916), by E. W. Kemmerer, professor of Economics and Finance in Princeton University, for a detailed treatment of this remarkable series of monetary changes, probably unequaled in instructiveness to the student of monetary theory.
[6 ]That is, it is made to conform as closely as do the values of gold in two different countries, fluctuating within the upper and lower limits of the gold-shipping points, as explained more fully under international trade in ch. 15. § 10.
[1 ]See Vol. I, p. 45 ff.
[2 ]See Vol. I, p. 262.
[3 ]See Vol. I, p. 263, on credit transactions, and p. 302, on interest contract.
[4 ]See Vol. I, p. 304.
[5 ]See Vol. I, p. 319.
[6 ]The amount of silver is here expressed at its coining value; this is not the commercial value, but rather the number of silver dollars 371.25 fine grains weight that could be made out of the silver produced. Silver and gold of equal coining value are, therefore, as to weight always in ratio of 16 to 1.
[7 ]See ch. 4, § 4.
[8 ]This change was what later was referred to in political discussions as “the crime of ’73.” The dollar referred to was the standard silver dollar; at the same time the coinage of a trade dollar was authorized (intended to be used only in foreign trade), which, after 1876, was not legal tender in the United States.
[9 ]See ch. 4, § 4.
[10 ]See Vol. I, on agricultural leases, p. 159, wheat prices, p. 436, and changes in the land supply, p. 442.
[11 ]See ch. 4, § 13.
[1 ]This happened to coincide with a relative increase of the prices of food-products and of other necessities of daily life at a greater rate than general prices. This aspect of the much-discussed rising cost of living must be carefully distinguished from that of the change of the general price level, and also from that of the relatively slower change of wages. See Vol. I, pp. 437, 445-446 on population and food supply.
[2 ]These figures are from a different source; the relatively small discrepancy in the total does not necessarily indicate an error, but a slight difference in the data, or the inclusion of some minor countries in the figures.
[3 ]See on the labor theory of value, Vol. I, pp. 210, 228-229, 502.
[4 ]This could not be treated in connection with the interest rate in Vol. I, Part IV, for the reason that even its elementary treatment must presuppose the fuller study of the nature of money and the study of changes in the level of prices, that has just been given in this and the three preceding chapters. The theory of interest in Vol. I, therefore, is a static theory in respect to the standard of deferred payments, and requires adjustment to apply to a condition of a changing price level.
[5 ]See ch. 5, § 1.
[6 ]Mention was made in Vol. I, of the prospect of profit as affecting the motives of commercial borrowers; e.g., pp. 298, 335, 348, 495.
[7 ]The modern explanation of this phenomenon was worked out in the period of falling prices before 1896, and hence was referred to as the theory of “appreciation and interest” (meaning the relation of the appreciating dollar to a falling rate of interest). More generally the theory is that of the relation of a changing standard of deferred payments and the rate of interest.