Front Page Titles (by Subject) Sect. II.—: Circumstances which Regulate the Exchangeable Value of Money. - Treatises and Essays on Subjects connected with Economic Policy with Biographical Sketches of Quesnay, Adam Smith & Ricardo
Return to Title Page for Treatises and Essays on Subjects connected with Economic Policy with Biographical Sketches of Quesnay, Adam Smith & Ricardo
The Online Library of Liberty
A project of Liberty Fund, Inc.
Sect. II.—: Circumstances which Regulate the Exchangeable Value of Money. - John Ramsay McCulloch, Treatises and Essays on Subjects connected with Economic Policy with Biographical Sketches of Quesnay, Adam Smith & Ricardo 
Treatises and Essays on Subjects connected with Economic Policy with Biographical Sketches of Quesnay, Adam Smith & Ricardo (Edinburgh: Adam and Charles Black, 1853).
About Liberty Fund:
Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.
The text is in the public domain.
Fair use statement:
This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.
Circumstances which Regulate the Exchangeable Value of Money.
This branch of our subject naturally divides itself into two parts: 1st, an inquiry into the principles which regulate the exchangeable value of money when the power to supply it is free or unfettered; and, 2d, an inquiry how far these principles are liable to be affected by the operation of monopoly.
I. There does not now seem to be much room for difference of opinion respecting the circumstances which regulate the value of the precious metals, and their distribution throughout the various countries of the globe. Bullion is a commodity, on the production of which competition operates without restraint. It is not subjected to any species of monopoly, and its value in exchange must, therefore, depend on the cost of its production, that is, on the quantity of labour required to produce it and bring it to market.
If it always required the same quantity of labour to produce the same quantity of bullion, its value would be invariable; and it would constitute a standard by which the variations in the exchangeable value of other commodities might be correctly ascertained. But this is not the case with bullion or anything else. Its value fluctuates like that of other articles, not only according to the greater or less productiveness of the mines from which it is extracted, but also according to the skill of the miners, the improvement of machinery, and other circumstances.
In his treatise on Political Economy, M. Say has a chapter entitled “De la valeur que la qualité d’être monnoie ajoute à une marchandise.” But a little reflection will convince us, that Say is mistaken, and that the circumstance of the precious metals being used as money does not affect their value. Say reasons on the vulgar hypothesis, that an increase of demand is always productive of an increase of value, an assumption which is totally at variance with principle and fact. Value depends upon the cost of production; and it is obvious that the cost of a commodity may be diminished, while the demand for it is increasing. This is so plain a proposition, as hardly to require to be substantiated by argument. And a reference to the case of cotton goods, the price of which, notwithstanding the vast increase of demand, has been constantly on the decline during nearly a century past, is enough to convince the most sceptical of the extreme erroneousness of Say’s conclusion. But, with regard to the particular case of the precious metals, it is clear that under ordinary circumstances, or when mining is prosecuted under nearly the same conditions as other businesses, the capital devoted to the production of gold and silver must yield the common and ordinary rate of profit; for, if it yielded more than that rate, there would be an influx of capital to the mining business; and, if it yielded less, it would be withdrawn, and vested in some more lucrative employment. And hence, though the demand for gold and silver should, from the adoption of some other commodity as an instrument of exchange, gradually become less, the value of the precious metals would not, on that account, be reduced. A smaller supply would, indeed, be annually brought to market, and a portion of the capital formerly engaged in the mining, refining, and preparing of the metals, would be disengaged. But as the whole stock thus employed yielded only the average rate of profit, the portion which is not withdrawn must continue to do so; or, which is the same thing, gold and silver must continue to sell for the same price. It is true that where mines are, as they almost always are, of different degrees of productiveness, any great falling off in the demand for bullion might, by rendering it unnecessary to work the inferior mines, enable the proprietors of the richer mines to continue their work, and to obtain the ordinary rate of profit on their capitals, by selling bullion at a reduced price. In this case the value of bullion would be really diminished; but this diminution would not be occasioned by a falling off in the demand, but by a greater facility of production. On the other hand, an increased demand for bullion, whether it arose from the suppression of paper money, or from a greater consumption of gold and silver in the arts, or from any other cause, would not be accompanied by any rise of price, unless it were necessary, in order to procure the increased supply, to have recourse to less productive mines. If the mines from which the additional supplies were drawn were poorer than those already wrought, more labour would be necessary to procure the same quantity of bullion, and, of course, its price would rise. But if no such increase of labour were needed, its price would remain stationary, though ten times the quantity formerly required should be demanded.
But these conclusions, though true under the circumstances supposed, are often much modified in practice. The production of the precious metals frequently, indeed, partakes very largely of the nature of a gambling speculation. When gold or silver is found in any particular locality, its abundance, and the facility which it affords to adventurers of enriching themselves, are uniformly exaggerated, and an excess of hands is attracted to the pursuit of the metal. In such cases, it commonly happens that, while a few individuals engaged in the business make fortunes, the great mass make little or nothing. But most people being sanguine enough to think that they will be found in the fortunate class, the supply of bullion may be largely increased, and its value reduced, even though the majority of those engaged in its production should be really carrying on a losing employment.
When the gold and silver mines of America first began to be wrought, the most extravagant ideas were entertained of their productiveness; so much so, that they were supposed to be able to bear a duty of half the produce. But it was soon found that the exaction of such a duty would occasion their total abandonment. It was consequently lowered, by successive reductions, to a tenth; and even this was felt to be oppressive, so that, in the end, the duty was fixed at a twentieth part, or five per cent. And, despite this reduction, the trade of mining, speaking generally, was unprofitable. Ulloa says, that in Peru, an individual who embarked in a mining speculation used to be considered as a ruined man, or as having adventured in a lottery, in which, though there were many great prizes, the blanks had a decided preponderance;1 and, according to Humboldt, nearly the same thing was experienced in Mexico; the search after mines, and the working of them, being there looked upon as a sort of gambling adventure, in which many were ruined, while a few only attained to great wealth.2
It remains to be seen whether the result of the late extraordinary discoveries in California and Australia will be different. We suspect, however, that it will not; and that in the lottery of these countries, as in that of Mexico and Peru, the blanks will greatly exceed the prizes. It is understood that, last year (1851), there were in California above 100,000 persons engaged in the raising of gold, or in the employments subordinate to and immediately connected therewith. And if we estimate the value of the labour of these parties at £100 a-year each, at an average, we shall not probably be beyond, but within, the mark; and, on this hypothesis, it would require a sum of £10,000,000 to defray their mere wages. Now, it would appear from the accounts most worthy of credit, that the produce of the gold diggings, etc., of California in 1851, amounted to from £12,000,000 to £14,000,000; and, taking it at the latter amount, which is perhaps exaggerated, still it would only yield £4,000,000 of surplus, which, were it equally divided among the parties employed in raising it, would give £40 to each. But instead of being equally, it is most unequally, divided; and, while a few have perhaps realised from £1000 to £5000, or upwards, it is plain that very many can have made little or nothing, not even ordinary wages. And this, no doubt, will also be the case in Australia. But the brilliant prizes, and the stories of cobblers and ditchers whom a fortunate chance has suddenly raised to opulence, will not fail to attract crowds of competitors. And the probability is, that the business of gold-raising will be zealously prosecuted, even though it should make a most inadequate return to the aggregate hands engaged in it. Under such circumstances, the supply of bullion may become, to a considerable extent, independent of the cost of its production; and the value of gold in the market may, for lengthened periods, depend chiefly on its quantity compared with the demand.
Although, therefore, it be true that, under ordinary circumstances, commodities are but seldom brought to market unless they sell at a price sufficient to repay the cost of their production, including therein a reasonable profit to the producers, yet many things occur to disturb the equilibrium between cost and price. And though, in the great majority of instances, such disturbances, when they do occur, are rarely of any very considerable permanency, such is not the case with gold and silver. The circumstances connected with their production are so very peculiar, that they may be furnished for indefinite periods, and in large quantities, even when they do not really indemnify the great body of their producers.
After gold and silver have been brought to market, their conversion into coin, or manufactured articles, depends on a comparison of the profits which may be derived from each operation. Bullion would not be taken to the mint if it would yield a greater profit by sending it to a silversmith; and the latter would not work up bullion into plate, if he could turn it to better account by converting it into coin. Hence the values of bullion and coin, in countries where the expenses of coinage are defrayed by the state, nearly correspond. When there is any unusual demand for bullion in the arts, coin is melted down; and when, on the contrary, there is any unusual demand for coin, plate is sent to the mint, and the equilibrium of value maintained by its fusion.
It appears, therefore, that while competition operates without restraint on the production of gold and silver, their value will vary, as above stated. And, while they constitute the currency of the commercial world, the price of commodities, or their value rated in gold or silver, will vary, not only according to the variations in the exchangeable value of the commodities themselves, but also according to the variations in the value of the gold or silver with which they are compared.
II. But if competition were not allowed to operate in the production of the precious metals—if they were monopolised, and limited in their quantity—their exchangeable value would no longer be regulated by these principles. If, after the limitation, they still continued to be used as money, and if, in consequence of improved methods of production, raw and manufactured commodities, and valuable products of all sorts, were very much multiplied, the exchanges which the limited amount of money would have to perform, would be proportionally increased. A smaller sum would, therefore, have to be appropriated to each transaction, or, which is the same thing, money prices would be diminished. When the supply of money is fixed, the amount of it given in exchange for commodities, varies inversely as the demand, and can be affected by nothing else.
We have assumed in this statement, for the sake of simplifying and elucidating the subject, that the substitutes which may be used for money, and the methods of economising the latter, are the same at both periods. Nothing, however, is easier than to allow for any change in the one or the other. And, supposing this allowance to have been made, it follows, if double the usual supply of commodities be brought to market in a country with a limited currency, that their money price will be reduced a half; and that, if only half the usual supply be brought to market, it will be doubled; and this, whether the cost of their production be increased or diminished. Products are not then exchanged for money, because it is a commodity capable of being advantageously used in the arts, and which has cost a certain quantity of labour, but because it is the universal equivalent used by the society, and will, as such, be willingly received by every one. The remark of Anacharsis, the Scythian, that gold and silver coins seemed to be of no use but to assist in numeration and arithmetic,1 would, if confined to a limited currency, be as just as it is ingenious. Sovereigns, livres, dollars, etc., would then really constitute mere tickets or counters for computing the value of property, and transferring it from one individual to another. And as small tickets or counters would serve for this purpose quite as well as large ones, it is unquestionably true that a debased currency may, by limiting its quantity, be made to circulate at the value it would bear if the power to supply it were unrestricted, and it were possessed of the legal weight and fineness: and, by still further limiting its quantity, it may be made to pass at any higher value.
Thus it appears, that whatever may be the material of the money of any country, whether it consist of gold or silver, or of copper, iron, leather, salt, cowries, or paper, and however destitute it may be of all intrinsic value, it is yet possible, by sufficiently limiting its quantity, to raise its value in exchange to any conceivable extent.
Suppose the existing money of Great Britain to consist of 50,000,000 or 60,000,000 of one pound notes, and that we are prevented from increasing or diminishing this sum, either by issuing additional notes or coins, or by withdrawing the notes in circulation: It is obvious that the quantity of commodities for which such notes would continue to exchange, would increase or diminish with the increase or diminution of the commodities brought to market. If we suppose that three times the amount of products now offered for sale, are offered ten or twenty years hence, and that the economy of circulation has continued the same, prices will fall to one-third part of their present amount; or, which is the same thing, the exchangeable value of the paper money will increase in a threefold proportion: and, on the other hand, if the products brought to market diminish in the same proportion, the exchangeable value of the paper money will be equally reduced.
The principles we have now stated are of the greatest importance to a right understanding of the real nature of money. Its value depends, at any given moment, on the quantity of it in circulation, compared with the demand. If it consist partly of coin, and partly of paper immediately convertible into coin, the value of the paper will obviously depend upon, and be, in fact, identical with, that of the coin. But if it consist of paper notes, not convertible into coin, and which, nevertheless, are legal tender, then it is plain that the value of such notes must be wholly determined by the number of them in circulation. Such a currency having little or no intrinsic worth, its value, in exchange, depends on the extent to which it has been issued, and on the fact of its being legal tender. By restricting its issue, its value may be raised to any extent.
Speaking generally, the value in exchange of a currency, consisting of the precious metals, is coincident with the cost of their production. If a sovereign commonly exchange for two or three bushels of wheat, or a hat, it is because the same labour is commonly required for its production as for that of either of these commodities; while, if with a limited and inconvertible paper money, they exchange for a one pound note, it is because such is the proportion which, as a part of the mass of commodities offered for sale, they bear, taking the cost of each into account, to the supply of paper in the market. This proportion would, it is evident, be not only immediately, but permanently, affected by an increase or diminution either of paper or commodities. But the relation which commodities bear to a freely supplied metallic currency could not be permanently changed, except by a change in their cost, or in that of the metals.
We have already seen in how far these conclusions are liable to be affected by the peculiar circumstances under which gold and silver are frequently produced. But how much soever their value in exchange may diverge for a while from the cost of their production, its uniform tendency is to coincide with that cost; and though the value of bullion, as compared with other articles, may differ very widely at different periods, these differences are usually manifested only by slow degrees. The vast extent of the surface over which the precious metals are spread, and the many purposes to which they may be applied, prevents even the largest additional supplies from suddenly reducing their value; while, on the other hand, their great durability prevents any sudden diminution of their quantity, and the influence of a falling off in the supply from being speedily visible.
It may, therefore, be laid down generally, that the value of money depends on the quantity of it in circulation compared with the exchanges to be effected by its means, or with the business it has to perform. When, however, money consists of coins, their value is most commonly limited by, and proportioned to, the cost of their production; whereas, when it consists of paper, not convertible into coin, its value is exclusively determined by the magnitude of its issues, and has nothing to do with the cost of its production. That cost may, indeed, in its case, be regarded as zero.
Such seem to be the circumstances which regulate the value of money, both when the power to supply it is not subjected to any species of monopoly, and when it is monopolised and limited. In the former case, its value generally depends, like that of the greater number of other commodities, on the cost of its production; while, in the latter case, its value is unaffected by that circumstance, and depends entirely on the extent to which it has been issued, compared with the demand.
The conclusions deducible from these principles are most important. A metallic currency, on the coinage of which a high seignorage or duty was charged, and a paper currency, not convertible into the precious metals, were occasionally seen to circulate at the same value with a metallic currency of full weight, and which had been coined at the expense of the state. But no rational or consistent explanation of these apparently anomalous results could be given until the effects produced by limiting the supply of money had been appreciated. Now, however, that this has been done, these difficulties have disappeared. The theory of money has been perfected, and we may estimate, a priori, what, under any given circumstances, would be the effect of imposing a seignorage, or of issuing inconvertible paper.
[1 ] Ulloa, Voyage de l’Amerique, i. 379, Amsterdam, 1752.
[2 ] Nouvelle Espagne, liv. ii. cap. 7, edit. 1825.
[1 ] Hume’s Essay on Money.