Front Page Titles (by Subject) Chapter VIII: The Principles of Circulation - Money and the Mechanism of Exchange
The Online Library of Liberty
A project of Liberty Fund, Inc.
Chapter VIII: The Principles of Circulation - William Stanley Jevons, Money and the Mechanism of Exchange 
Money and the Mechanism of Exchange (New York: D. Appleton and Co. 1876).
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.
The Principles of Circulation
Before proceeding to consider the actual monetary systems adopted by modern or ancient nations, it is desirable to dwell for a short time upon the different meanings which may be attributed to the word money, and upon the natural principles which govern the use and circulation of coins. We must, in the first place, distinguish three things which, in the practical working of a currency system, are often separate, namely, the actual coins employed, the numbers by which they are expressed, and the relation of those numbers to the assumed unit of value. We must further distinguish coins according as their values depend upon the metal they contain, the metal for which they can be exchanged, or the other coins for which they are the legal equivalent.
The Standard Unit of Value.
It is essential, in the first place, to decide clearly what we mean by a standard unit of value. This must consist of a fixed quantity of some concrete substance, defined by reference to the units of weight or space. Value may seem to some people to be a purely mental phenomenon, and a pound would then have to be defined, as Lord Castlereagh asserted, by a sense of value. But we might as well define a yard by a sense of length, or a grain by a sense of weight. Just as every quantity in physical science is defined by reference to some concrete standard specimen, so, if we are to measure and express value at all, we must fix upon definite quantities of one or more definite and unchangeable commodities for the purpose.
The expression standard unit of value, will indeed be almost inevitably misunderstood as implying the existence of something of fixed value. As we have seen, however (p. 11), value merely expresses the essentially variable ratio in which two commodities exchange, so that there is no reason to suppose that any substance does for two days together retain the same value. All that a standard of value means is, that some uniform unchangeable substance is chosen, in terms of which all ratios of exchange may be expressed and calculated, without any regard whatever to the feelings or mental phenomena which the commodities produce in men. For reasons already stated, one or other of the metals, gold, silver, or copper, has usually been considered most suitable for constituting the standard substance.
The absolute weight or magnitude of the unit of money is a matter of little or no importance, provided that all people agree upon the same unit, and that it be permanently and exactly defined, and afterwards adhered to. Before the English yard was fixed, it would not have mattered whether it was a few inches longer or shorter; it does not matter, indeed, whether the inch, the foot, the furlong, or the mile is the unit, provided that one of them is definitely fixed, and the others referred to it by known ratios. So, it is really indifferent whether we regard the pound troy of standard gold, or the ounce, or the fixed number of grains in the sovereign, as our standard. It is only requisite that every contract expressed in money shall enable us to ascertain exactly how much standard gold is due from one person to another.
M. Chevalier and some other continental economists have argued elaborately in favour of a universal standard unit of value, coinciding with the metric system of weights. They wish the unit of value to be ten grams of gold exactly, and seem to think that there is some magical efficacy in the correspondence of money and weights. This correspondence might perhaps be a slight convenience to those bullion dealers who have to calculate the metallic value of coins before melting or exporting them, or to those mint officials who have to adjust and test the weights of coins; to all other persons it would be a matter of complete indifference. Those who use coins in ordinary business need never inquire how much metal they contain. Probably not one person in ten thousand in this kingdom knows, or need know, that a sovereign should contain 123.27447 grains of standard gold. Besides, if we agree to accept a precise metrical quantity of one metal as our standard, the weights of the coins composed of other metals will be complicated fractional amounts, to be determined with reference to the accidental market values of the metals.
All we can say, then, is that the standard unit of value is some entirely arbitrary weight of the standard metal, the exact amount of which, being a matter of indifference on general grounds, should be fixed as seems most convenient in reference to the habits of nations or other accidental circumstances.
Coin, Money of Account, and Unit of Value.
It is desirable to distinguish clearly between three things which, although definitely related to each other, need not be identical. The unit of value, or standard weight of the selected metal, is not necessarily made into a coin. It may be a quantity too great or too small for coining. All that is requisite is that the current coins shall be multiples or submultiples of the unit, or easily expressible in terms of the unit. Nor is it even requisite that the numbers in which we express value should be numbers of coins, or number of units of value. The money of account, as it is called, may differ both from the current money and the standard money. This is well illustrated in the Anglo-Saxon system of currency. The unit of value was the Saxon pound of standard silver, which was far too large to be coined. The only coins issued in any considerable quantity by the Anglo-Saxon kings, were silver pennies and a few halfpennies; yet the usual money of account was the shilling, which, after varying from four to five pence, was fixed by William I. at twelve pence, as it has ever since continued. No coin called a shilling was issued before the reign of Henry VII. Though the shilling has survived, other moneys of account have been forgotten, as, for instance, the mancus, which was equal to thirty pennies, or six shillings of five pence each. The mark, the ora, and the thrimsa were other moneys of account used by the Anglo-Saxons.
In our present English system the three moneys happen to coincide, which is doubtless a matter of some convenience. The sovereign is at once the principal coin, the unit of value, and the money of account in all the larger transactions, although in the expression of smaller sums the shilling is yet preferred. In France at the present time the money of account and the unit of value is the franc in gold; but as this weighs only 0.3226 gram, or about five grains, it is coined only in five, ten, and twenty-franc gold pieces, with subsidiary silver coins. In Russia, before the time of Peter the Great, the rouble was an imaginary money of account, consisting of one hundred copper copecks.
When Montesquieu affirmed that the negroes on the West Coast of Africa had a purely ideal sign of value called a macute, he misunderstood the nature of money of account. The macute served with the negroes as the name for a definite, though probably a variable, number of cowry shells, the number being at one time 2000. The macute has also been coined in silver pieces of eight, six, and four macutes, struck by the Portuguese for use in their colonies, the macute being worth 2¾d.
When the currency of a country undergoes a change, the units of coinage, account, and value are likely to become separated. Sometimes a new system of accounts is applied to an old coinage, as in Norway at the present time. The Stockholm government is endeavouring to introduce the Swedish decimal system of currency, and some merchants are said already to keep their accounts in kroner and öre, although the money in circulation consists almost wholly of the old skillings and the paper specie-dalers. On the other hand, the coinage is sometimes changed, and yet the old methods of accounts retained, especially as regards foreign transactions. Thus the rates of foreign exchange between the United States and England were, until last year, quoted in terms of a dollar valued at 4s. 6d., in accordance with a law of 1789. This rate seems to have been the traditional par of exchange of the Mexican dollar, and it was still retained even when the American dollar had been coined so as to be worth only 49.316 English pence.
There are two causes which have often led to a difference between coinage and money of account. The coins may, by legitimate abrasion, or by fraudulent clipping and sweating, become much reduced below their proper weights, yet an agio, or allowance, being made for the average depreciation, the old standard of value and money of account may be retained, as was the case in Amsterdam, Hamburg, and other towns. When a depreciated currency is issued in a country, the money of account may either change with it or remain as before; and it is an exceedingly difficult, if not insoluble problem, to decide whether, in particular periods of English history, prices were expressed in the new depreciated or the old good money. Professor J. E. T. Rogers has pointed out, in his admirable "History of Agriculture and Prices in England," printed by the Clarendon Press (vol. i. p. 175), that, in the fourteenth century, the coinage, though apparently passed by tale, was often weighed. In the ancient college accounts which he has investigated, he finds charges entered both for the cost of scales to make the weighings, and for the deficiency of weight of the coins.
In many countries, even at the present day, the circulating medium consists not of any one simple and well-connected series of coins, but of a miscellaneous collection of coins of various sizes and values, imported from foreign states. In such cases the money of account must necessarily differ from the mass of the coins, of which the value is usually estimated by a tariff expressed in terms of the money of account. In the German states, a few years ago, French and English gold was freely accepted in this manner. In Canada there is an intricate confusion of monetary systems. There being no national mint, the circulation consists of many species of foreign coins, chiefly varieties of the dollar. The monetary unit is a dollar, taken as equal to fifty English pence; but this is represented by bank notes, and not by any coin. At the same time there are two different moneys of account: the Halifax Currency Pound divided into twenty shillings of twenty pence each, and defined by the fact that sixty such pence are equal to one dollar; and, secondly, the Halifax Sterling Currency, which perpetuates, for the purpose of expressing the rates of foreign exchange, the old valuation which makes a dollar equal to 4s. 6d.
Standard and Token Money.
We must distinguish between coins according as they serve for standard money or for token money. A standard coin is one of which the value in exchange depends solely upon the value of the material contained in it. The stamp serves as a mere indication and guarantee of the quantity of fine metal. We may treat such coins as bullion, and melt them up or export them to countries where they are not legally current; yet the value of the metal being independent of legislation will everywhere be recognised.
Token coins, on the contrary, are defined in value by the fact that they can, by force of law or custom, be exchanged in a certain fixed ratio for standard coins. The metal contained in a token coin has of course a certain value; but it may be less than the legal value in almost any degree. In our English silver coinage the difference is from 9 to 12 per cent., according to the market price of silver; in our bronze coinage the difference is 75 per cent. The metal contained in the French bronze coins is in like manner equal in value to little more than one quarter of the current value. In many cases the difference has been far greater, as for instance in some of the old kreutzer pieces lately current in the German states. Woods's halfpence, which at one time created so much discontent in Ireland, or the small money previously issued by Charles II. in Ireland, are extreme instances of depreciated token money.
Metallic and Nominal Values of Coins.
It has been usual to call the value of the metal contained in a coin the intrinsic value of the coin; but this use of the word intrinsic is likely to give rise to fallacious notions concerning the nature of value, which is never an intrinsic property, or existence, but merely a circumstance, or external relation (see p. 9). To avoid any chance of ambiguity, I shall substitute the expression, metallic value, and I shall distinguish this from the nominal, customary, or legal value, at which a coin actually does, or is by law required, to exchange for other coins.
There are two ways in which the metallic value of a coin may be reduced below its nominal value, namely, by reducing either the weight or the fineness of the metal. English silver coin is still maintained at the "ancient right standard "of 11 oz. 2 dwts. in the troy pound, which has existed from time immemorial. By the Act of 1816 the silver coins which had previously been, in theory at least, standard money, were reduced in weight by 6 per cent., and thus rendered token money, which they still continue to be. In France and other countries belonging to the Monetary Convention, the smaller silver coins of two francs, one franc, and fifty centimes, have been converted into tokens by reducing the fineness of the silver from 900 to 835 parts in 1000. It does not seem to be a matter of any importance which mode is adopted; but the English mode, so long as it does not render the coins inconveniently small, is perhaps slightly the better, because some persons can satisfy themselves as to the weight of a coin, but none are able to test its fineness, unless they are professional assayers.
It need hardly be stated that coins which circulate by law in one country as tokens may be accepted in other countries at their metallic value.
Money must further be distinguished, according as it is or is not legal tender, or has or has not what the French call cours forcé. By legal tender is denoted such money as a creditor is obliged to receive in requital of a debt expressed in terms of money of the realm. One great object of legislation is to prevent uncertainty in the interpretation of contracts, and accordingly the Coinage Act defines precisely what will constitute a legal offer of payment on the part of a debtor, as regards a money debt. If a debtor tender to his creditor the amount of a debt due in legal tender money, and it be refused, the creditor may indeed apply for it, or sue for it afterwards, but the costs of the action will be thrown upon him.
But there seems to be no legal necessity that exchanges or contracts shall be made in money of the realm. At common law, contracts for the direct barter of two commodities, or for purchase and sale in terms of any kind of money, will be valid, provided it is clear what the terms of the contract mean. Accordingly, the sixth section of the Coinage Act (33 Vict. c. 10), while enacting that every contract, sale, payment, bill, note, transaction, or matter relating to money, shall be made or done according to the coins which are current and legal tender in pursuance of this Act, yet adds, "unless the same be made, executed, entered into, done or had, according to the currency of some British possession or, some foreign state."
If I understand the matter aright, then, every person is at liberty to buy, sell, or exchange in terms of any money or commodity whatsoever which he prefers; and the fact that certain coins, up to certain limits, are legal tender, only means that the state provides a definite medium of exchange and defines precisely what that is. The Act requires that English money shall be the money issued by the mint, in accordance with the terms of the Act. Of course it remains quite open to a creditor to receive payment in coins which are not legal tender, if he like to do so, and I presume there would be nothing to prevent him entering into a contract to that effect. If a man contracted to sell goods to the extent of £100, and to receive payment in bronze pence and halfpence, it would no doubt be a valid contract, although no single quantity of pence exceeding twelve pence is a legal tender.
The exact meaning of the term, legal tender, may of course vary from country to country, and the above remarks apply only to countries under the English law.
The Force of Habit in the Circulation of Money.
No one can possibly understand many social phenomena unless he constantly bears in mind the force of habit and social convention. This is strikingly true in our subject of money. Over and over again in the course of history, powerful rulers have endeavoured to put new coins into circulation or to withdraw old ones; but the instincts of self-interest or habit in the people have been too strong for laws and penalties. Though in particular instances it may be difficult to explain occurrences which happen in the circulation of coins, yet a close analysis of the character of those who handle money, and their motives for holding or paying it away, will throw much light upon the subject.
We must notice, in the first place, that the great mass of the population who hold coins have no theories, or general information whatever, upon the subject of money. They are guided entirely by popular report and tradition. The sole question with them on receiving a coin is whether similar coins have been readily accepted by other people. Thus in the remote parts of Norway at the present time, the old paper daler notes are preferred to the beautiful new twenty-kroner gold pieces. By far the greater number of the people possess no means of learning the metallic, or even the legal, value of an unfamiliar coin. Few people have scales and weights suitable for weighing a coin, and no one but an assayer or analytical chemist can decide upon its fineness. Many a traveller who has carried good new coin into a country where it happened to be strange, has had to suffer a loss in paying it away. When our bronze pence were quite a novelty, I happened to take some with me into a remote part of North Wales, and they were rejected.
People in general accept coin simply on the ground of its familiar appearance. So entirely is this the case among very ignorant populations, that it has often been found desirable to maintain unchanged the impress on successive issues of coins. In many cases coins have been struck for this purpose with the date of a long past year, or even the effigy of a dead sovereign. The Maria Theresa dollar is still coined by the Austrian mint, with exactly the same design and date as when first issued in 1780, because it is the favourite coin in some of the states of North Africa, and various parts of the Levant. The British Government, when undertaking the Abyssinian expedition, procured a large stock of these coins for paying the natives. In the same way Mexican dollars are usually worth rather more than silver bullion, because of their easy currency in the East.
To the supremacy of habit, and the absence of means of estimating the real value of coin, is obviously due the depreciation which currencies have undergone. False coiners and kings alike find that, if they can only make new coins look and feel exactly like old coins, the people will accept depreciated money without question.
The annals of coinage, in this and all other countries, are little more than a monotonous repetition of depreciated issues both public and private, varied by occasional meritorious, but often unsuccessful, efforts to restore the standard of the currency. A curious instance of successive attempts to beguile a people are found in certain Roman denarii of the Consular times. False coiners having issued plated denarii among the subject Germans, the people appeared to have notched them with files to test their genuineness. The Germans having thus become accustomed to see genuine notched coins, the Roman government found it desirable to issue new coins notched in a similar manner. But the forgers were not to be beaten. They issued plated denarii with the notches all complete, apparently displaying good metal within; and notched false coins of this kind exist to the present day in numismatic cabinets.
Though the public generally do not discriminate between coins and coins, provided there is an apparent similarity, a small class of money-changers, bullion-dealers, bankers, or goldsmiths make it their business to be acquainted with such differences, and know how to derive a profit from them. These are the people who frequently uncoin money, either by melting it, or by exporting it to countries where it is sooner or later melted. Some coins are sunk in the sea or lost, and some are carried abroad by emigrants and travellers who do not look closely to the metallic value of the money. But by far the greatest part of the standard coinage is removed from circulation by people who know that they shall gain by choosing for this purpose the new heavy coins most recently issued from the mint. Hence arises the practice, extensively carried on in the present day in England, of picking and culling, or, as another technical expression is, garbling the coinage, devoting the good new coins to the melting-pot, and passing the old worn coins into circulation again on every suitable opportunity.
From these considerations we readily learn the truth and importance of a general law or principle concerning the circulation of money, which Mr. Macleod has very appropriately named the Law or Theorem of Gresham, after Sir Thomas Gresham, who clearly perceived its truth three centuries ago. This law, briefly expressed, is that bad money drives out good money, but that good money cannot drive out bad money. At first sight there may seem to be something paradoxical in the fact, that when beautiful new coins of full weight are issued from the mint, the people still continue to circulate, in preference, the old depreciated ones. Many well-intentioned efforts to reform a currency have thus been frustrated, to the great cost of states, and the perplexity of statesmen who had not studied the principles of monetary science.
In all other matters everybody is led by self-interest to choose the better and reject the worse; but in the case of money, it would seem as if they paradoxically retain the worse and get rid of the better. The explanation is very simple. The people, as a general rule, do not reject the better, but pass from hand to hand indifferently the heavy and the light coins, because their only use for the coin is as a medium of exchange. It is those who are going to melt, export, hoard, or dissolve the coins of the realm, or convert them into jewellery and gold leaf, who carefully select for their purposes the new heavy coins.
Gresham's law alone furnishes a sufficient refutation of Mr. Herbert Spencer's doctrine, already noticed (p. 64) that money ought to be provided by private manufacturers. People who want furniture, or books, or clothes, may be trusted to select the best which they can afford, because they are going to keep and use these articles; but with money it is just the opposite. Money is made to go. They want coin, not to keep it in their own pockets, but to pass it off into their neighbour's pockets; and the worse the money which they can get their neighbours to accept, the greater the profit to themselves. Thus there is a natural tendency to the depreciation of the metallic currency, which can only be prevented by the constant supervision of the state.
From Gresham's law we may infer the necessity of two precautions in the regulation of the currency. In the first place, the standard coins, as issued from the mint, should be as nearly as possible of the standard weight, otherwise the difference will form a profit for the bullion-broker and exporter. In the second place, adequate measures must be taken for withdrawing from circulation all coins which are worn below the least legal weight, otherwise they will continue to circulate as token coins for an indefinite length of time. All commerce consists in the exchange of commodities of equal value, and the principal money should consist of pieces of metal so nearly equal in metallic contents, that all persons, including bullion dealers, bankers, and other professed dealers in money, will indifferently substitute one coin for another. But it is obvious that these remarks do not apply to coins intended to serve as tokens, since the current value of tokens exceeds their metallic value, and every one who uses them otherwise than in ordinary circulation will lose the difference. Hence the weight of a token coin is comparatively a matter of indifference, so long as people will receive them, and the deficiency of weight is not too great a temptation to the false coiner.
In England at the present day the force of habit, and the absence of means of discrimination, lead to the depreciation of our gold standard coinage by abrasion. Only while a sovereign exceeds 122.5 grains in weight is it legally a sovereign; but people go on paying and receiving indifferently, in ordinary trade, sovereigns of which the metallic values differ 2d. or 4d., and sometimes even 6d. or 8d. Every standard coin thus tends to degenerate into a token coin, and such a coin can only be withdrawn from circulation by the state.
Extension of Gresham's Law.
Gresham's remarks concerning the inability of good money to drive out bad money, only referred to moneys of one kind of metal, but the same principle applies to the relations of all kinds of money, in the same circulation. Gold compared with silver, or silver with copper, or paper compared with gold, are subject to the same law that the relatively cheaper medium of exchange will be retained in circulation and the relatively dearer will disappear. The most extreme instance which has ever occurred was in the case of the Japanese currency. At the time of the treaty of 1858, between Great Britain, the United States, and Japan, which partially opened up the last country to European traders, a very curious system of currency existed in Japan. The most valuable Japanese coin was the kobang, consisting of a thin oval disc of gold about 2 inches long, and 1¼ inch wide, weighing 200 grains, and ornamented in a very primitive manner. It was passing current in the towns of Japan for four silver itzebus, but was worth in English money about 18s. 5d., whereas the silver itzebu was equal only to about 1s. 4d. Thus the Japanese were estimating their gold money at only about one-third of its value, as estimated according to the relative values of the metals in other parts of the world. The earliest European traders enjoyed a rare opportunity for making profit. By buying up the kobangs at the native rating they trebled their money, until the natives, perceiving what was being done, withdrew from circulation the remainder of the gold. A complete reform of the Japanese currency is now being carried out, the English mint at Hong Kong having been purchased by the Japanese government.
What happened in an extreme degree in Japan has often happened in England and other European countries, in a less degree. If the ratio of gold and silver in the coinage, as legally current, differs only one or two per cent. from the commercial ratio, it may become profitable to export the one metal rather than the other, and in this way, as we shall see, the main part of the currency of France was changed from silver into gold between 1849 and 1869. In fact the character of the coinage of most nations has been determined in a similar manner, and England and the United States were thus led to adopt a principal gold currency. There is every reason to believe that in ancient Rome, both in the time of the Republic and of the Empire, great difficulties were encountered in regulating the currency of silver alongside of copper, and the perplexity became worse when gold coin was introduced.