/ '/ >7 -ej THE CITIZEN'S LIBRARY OF ECONOMICS, POLITICS, AND SOCIOLOGY EDITED BY RICHARD T. ELY, PH.D., LL.D. PROFESSOR OF POLITICAL ECONOMY UNIVERSITY OF WISCONSIN MONEY A STUDY OF THE THEORY OF THE MEDIUM OF EXCHANGE THE CITIZEN'S LIBRARY OF ECONOMICS, POLITICS, AND SOCIOLOGY. I2mo. Half leather. $1.25 net each. MONOPOLIES AND TRUSTS. By RICHARD T. ELY, PH.D., LL.D. THE ECONOMICS OF DISTRIBUTION. By JOHN A. HOBSON. WORLD POLITICS. By PAUL S. REINSCH, PH.D., LL.B. ECONOMIC CRISES. By EDWARD D. JONES, PH.D. OUTLINES OF ECONOMICS. By RICHARD T. ELY. GOVERNMENT IN SWITZERLAND. By JOHN MARTIN VINCENT, PH.D. ESSAYS IN THE MONETARY HISTORY OF THE UNITED STATES. By CHARLES J. BULLOCK, PH.D. SOCIAL CONTROL. By EDWARD A. Ross, PH.D. HISTORY OF POLITICAL PARTIES IN THE UNITED STATES. By JESSE MACY, LL.D, MUNICIPAL ENGINEERING AND SANITATION. By M. N. BAKER, Pn.B. DEMOCRACY AND SOCIAL ETHICS. By JANE ADDAMS. COLONIAL GOVERNMENT. By PAUL S. REINSCH, PH.D., LL.B. AMERICAN MUNICIPAL PROGRESS. By CHARLES ZUEBLIN. IRRIGATION INSTITUTIONS. By ELWOOD MEAD, C.E., M.S. RAILWAY LEGISLATION IN THE UNITED STATES. By B. H. MEYER, PH.D. THE EVOLUTION OF INDUSTRIAL SOCIETY. By RICHARD T. ELY. THE AMERICAN CITY: A PROBLEM IN DEMOCRACY. By DELOS F. WILCOX, PH.D. MONEY. By DAVID KINLEY, PH.D. IN PREPARATION. LABOR PROBLEMS. By THOMAS S. ADAMS, PH.D. NEWER IDEALS OF PEACE. By JANE ADDAMS. CUSTOM AND COMPETITION. By RICHARD T. ELY, PH.D., LL.D. SOME ETHICAL GAINS THROUGH LEGISLATION. By MRS. FLORENCE KELLEY. ;|B ( ftITISH CITIES ANP THEIR PROBLEMS. By MILO ROY .IALTBIE, PH.D.' ' ,' ^COLONIAL ADMINISTRATION. By PAUL S. REINSCH, PH.D., LL.B. '.IKE ECONOMICS OF AGRICULTURE. By HENRY C. TAYLOR, PH.D. INTRODUCTION TC SOCIAL THEORY. By GEORGE E. VINCENT, PH.D., and RALPH G. KI'MBLE, PH.D. THE MACMILLAN COMPANY, 66 FIFTH AVENUE. PREFACE THE present book is an attempt to present a systematic exposition of the theory, or scientific principles, of money. The historical and descrip- tive literature of the subject is already so volumi- nous and rich that I have not thought it best to enter that field, excepting where necessary for purposes of illustration, and in those cases I have made my references as brief as possible. I began the work at the time when Walker's " Money " and Jevons's " Money *and the Mechan- ism of Exchange" were the only books we had in English which purported to do what I had in mind, and I expected to have my task completed long ago. Many things have postponed this com- pletion until now. The field which I attempt to cover has recently been occupied by Professor Laughlin's " Principles of Money " and, in part, by Professor Scott's "Money and Banking." If my own book had not been practically all written at the time of the appearance of these works, I might not have written it at all; but as so much of it was already done, it seemed best to me to finish it. It is my hope that some new points will be found in the work, although I am painfully aware vi PREFACE of the likelihood that what is new may not be important, and what is important may not be new. As Jevons once wrote, " I am far from supposing that the exact relations in regard to prices, com- modities, gold, and capital have been hit upon. I do not believe that any of our economists have yet untied this Gordian knot of economic sci- ence, although some cut it in a very unhesitating manner." 1 It will be seen that neither in my view of the influence of credit, nor of the relation of the quan- tity of money to its value, am I in accord with Professor Laughlin or Professor Scott. I take occasion, however, to express my appreciation of the high quality of both works and of the help they have both given me. The authorities to whom I am indebted are too numerous to mention specifically. The references at the beginning of each chapter will indicate in a general way where I have found my inspiration and my help. I am indebted to several friends for help in carrying out my work. In the first place, I wish to express my warm appreciation of the kindly patience and inspiring helpfulness of my friend, the editor. Without his encouragement I doubt very much whether I would have had patience to finish the work, owing to the harassing incidents of my administrative work. Next, I am deeply indebted to my colleague, Professor N. A. Weston, who has read a large part of the manuscript and 1 " Investigations in Currency and Finance," p. 32. PREFACE vii criticised it, I am glad to say, somewhat severely. His criticisms of the new points, however, were from the standpoint of accepted doctrines, and, after considering them carefully, I decided that I must let my innovations stand. To Professor Weston also belongs the credit of preparing the bibliography at the end of the book. It is design- edly confined mainly to Money, to the exclusion of Credit and Banking. Professor M. B. Ham- mond, Professor M. H. Robinson, and Mr. L. W. Zartman, Fellow in Economics, have also given me assistance, which I am glad to acknowledge. I hope soon to supplement this book with one on Credit and Banking. DAVID KINLEY. UNIVERSITY OF ILLINOIS, March 16, 1904. CONTENTS CHAPTER I THE SOCIAL IMPORTANCE OF MONEY ?E riON PAGE 1. The Intimate Connection of the System of Exchange with Social Progress I 2. Adaptation of the Monetary System to the Prevailing Stage of Economic Life 3 3. Relation of the Monetary System to the Scale of In- comes .......... 4 4. Division of Labor and the Monetary System ... 5 5. The Monetary System and Political and Economic Freedom ......... 6 6. The Monetary System and Nationality .... 8 7. The Monetary System and Economic Prosperity . . 9 8. The Monetary System and the Distribution of Wealth . 1 1 9. The Socialistic View of the Monetary System . . 13 CHAPTER II THE EVOLUTION OF MONEY 1. The Conjectural Character of Early Monetary History . 14 2. The Character of Monetary Evolution . . . .17 3. The First Service of the Money Article .... 19 4. The Selection of the Money Commodity ... 20 5. Kind of Article Selected 22 6. Subdivision of the Money Article 23 7. Influence of the Market on the Evolution of Money . 24 8. The Complex Character of the Mechanism of Ex- change 25 ix x CONTENTS CHAPTER III COINAGE SECTION , PAGE 1. Natural Objects as Monetary Units 27 2. The Nature and Purpose of Coinage .... 28 3. The Evolution of Coinage 29 4. The Requisites of Good Coinage 31 5. Government versus Private Coinage 33 6. The Charge for Coinage; Seigniorage .... 34 7. The Arguments for and against a Charge for Coinage . 35 CHAPTER IV THE CURRENCY AND THE PRINCIPLES OF ITS CIRCULATION 1. Classification of Media of Exchange .... 39 2. Adaptation of the Medium of Exchange to the Scale of Incomes and Prices 41 3. The Credit Portion of the Medium of Exchange . . 43 4. Securities as a Part of the Medium of Exchange . . 45 5. Standard Money, Money of Account, and Medium of Exchange 46 6. Legal Tender Money 47 7. Systems of Metallic Currency 47 8. Systems of Paper Currency ...... 49 9. Fundamental Causes of Circulation of Media of Exchange 50 10. Gresham's Law; its Operation and Limitations . . 52 CHAPTER V SERVICES AND NATURE OF MONEY 1. Definition of Money determined by its Services . 59 ^ 2. Essential Services of Money 60 3. The Derived Functions of Money 63 4. Contingent Functions of Money 65 5. Money the Embodiment of Generic Value . . .67 6. Definitions of Money . , , . . . 68 / CONTENTS xi , .ION PAGE The Fundamental Gauss of Superiority of Commodity Money 71 8. Characteristics of Good Commodity Money ... 72 CHAPTER VI THE MOVEMENT AND DISTRIBUTION OF METALLIC MONEY 1. Emphasis laid upon the Supply of Money ... 78 2. The Division of the Precious Metals depends upon the Relative Demand of Different Countries ... 79 3. The Value of the Precious Metals not everywhere the Same 80 4. Changes in Prices, and the Movement of the Precious Metals 81 5. Price Changes not necessarily followed by a Movement of Specie ......... 82 6. The Ricardian Theory modified by Economic Friction . 86 7. Influence of the Credit Mechanism on the Distribution of the Precious Metals ...... 89 8. The Effect of the Use of Bills of Exchange on the Move- ment of the Metals 90 9. Other Causes which render Export of the Precious Metals Unnecessary 93 10. The Usual Causes of the Movement of Specie . . 95 n. The Amount of Money needed by a Country . . 97* " CHAPTER VII THE STATIC DISTRIBUTION OF THE PRECIOUS METALS 1. Distribution of Money in the Sense of Apportionment . 99 2. Conditions of the Apportionment 100 3. An Increased Volume of Exchanges requires Larger or More Efficient Medium of Exchange, but not neces- sarily More Money 101 4. The Amount of Metallic Money in a Country tends to a Minimum . . . . . . . 104 xii CONTENTS SECTION PAGE 5. Readjustments in the Exchange System caused by a Demand for More Medium of Exchange . . . 105 6. The Extension of Credit Exchange Slower as the Volume of Exchanges Increases ...... 108 7. Other Conditions which retard the Growth of Credit Exchanges 112 8. Periodic Character of the Growth of Money and Credit Payments 114 9. Relation of the Theory of this Chapter to the Amount of Money needed by a Country . . . . .119 10. Artificial Increase of the Money Supply Inexpedient . 121 CHAPTER VIII THE VALUE OF MONEY 1. Difficulty of the Subject 123 2. The Price Level distinguished from Relative Prices . 124 3. Conditions assumed to simplify the Problem . . .125 4. The Value of Money a Social Fact 125 5. Advantage of replacing Barter with Money Exchange . 126 6. The Maximum Value of the Money Supply which a Society can afford to Have . . . . . .127 7. The Minimum Value of the Money Supply to a Society . 129 8. The Unreality of the above Conditions and the Actual Limits of the Money Supply 130 9. Limitation upon the Freedom of Choice between Barter and Money Exchange 133 10. The Relation of the Quantity of Goods to their Marginal Utilities 134 n. The Value of Money at any Moment, determined by Demand and Supply . . . . . . .135 12. The Quantity of Money and its Value . . . .139 13. The Relation of Quantity and Value in the Case of Com- modity Money ........ 141 14. The Establishment of Equilibrium among the Various Demands for the Money Commodity . . .144 15. The Volume of Business and the Value of Money . . 146 CONTENTS xv 6. The Kind of Average used in computing Index Numbers 231 7. The Number of Articles necessary to furnish Proper Averages 233 8. Relative Proportions, or Weights, of Articles Used . 234 9. Influence of New Commodities 236 10. Whether Wholesale or Retail Prices furnish the Better Comparison ........ 237 11. The Different Purposes of Tables of Prices determine their Character 237 12. The Services of Tables of Prices 239 13. The Best Kind of Table for General Purposes . . 242 14. The Similarity of Results in Different Tables . . . 244 15. The Table of the London Economist .... 245 1 6. The Work of Jevons on Index Numbers . . . 247 17. Soetbeer's Tables 247 1 8. Sauerbeck's Tables 250 19. Falkner's Tables 253 20. Other Tables of Prices . . . . . . .256 21. Other Methods of measuring Price Changes . . . 256 22. Professor Edgeworth's Presentation of the Solutions of the Problem of measuring Price Changes . . .258 CHAPTER XIII THE STANDARD OF DEFERRED PAYMENTS 1. Definition of the Standard 260 2. Steadiness of the Standard Important for Deferred Pay- ments .......... 261 3. Assignment of the Gain or Loss due to a Change in Prices 262 4. Apportionment of Gain or Loss due to Change in Prices between Creditor and Debtor 264 5. The Standard of Deferred Payments a Social Concept, not a Corrective of Individual Fluctuations . . . 266 6. An Invariable Standard Undesirable and Impossible . 268 7. The Incompatibility of Returns of Equal Value, Equal Utility, etc . 269 8. Classification of Standards of Deferred Payments . . 272" 9. The Single Commodity Standard 273 xvi CONTENTS SECTION PAGE 10. The Nature of the Tabular, or Multiple Commodity, Standard 275 11. The Equity of the Multiple Standard .... 277 12. Theoretical and Practical Objections to the Multiple Standard 279 13. The Labor-time Standard 281 14. The Labor-cost Standard 281 15. The Disutility of Labor Standard 283 1 6. The Marginal Utility Standard 284 17. The Total Utility Standard 285 1 8. The Purchaser's Surplus Standard 287 CHAPTER XIV BIMETALLISM 1. The Nature of Bimetallism 292 2. The Advantages claimed for Bimetallism . . . 294 3. The Maintenance of the Chosen Ratio of Exchange between Gold and Silver ...... 296 4. Some Factors adverse to the Maintenance of the Ratio . 299 5. Bimetallism and Fluctuations of the Price Level . . 301 6. Bimetallism as a Relief from the Burden of Debts . . 304 7. Bimetallism would not provide a Slowly Depreciating Currency . . 306 8. Obstacles to International Bimetallism .... 307 9. The Increase in Gold and the Bimetallic Agitation . . 309 10. Symmetallism . . . . . . . . .311 11. Neo-bimetallism 312 12. Commissions to regulate the Price Level . . . 313 CHAPTER XV SOME FACTORS WHICH MODIFY THE INFLUENCE OF PRICE CHANGES 1. Cause of the Demand for Steadiness of the Price Level . 317 2. Industrial Improvements diminish the Burden of Debts of Producers 3 l % 3. The Debtor Class also a Creditor Class .... 319 CONTENTS xvii 4. Debts contracted for Profit 320 5. Effect of shortening the Period of Debts . . . 320 6. The Influence of the Speculator in diminishing the Effect of Price Changes ....... 322 7. The Influence of the Rate of Interest on the Burden of Debts 322 8. Difficulty of doing Justice by Artificial Corrections of Price Changes 326 9. Gold Monometallism probably does Substantial Justice in the Long Run 327 CHAPTER XVI INCONVERTIBLE PAPER MONEY 1. Kinds of Paper Money 329 2. Meaning of Convertibility 330 3. Characteristics of Irredeemable Paper . . . . 331 4. Benefits and Dangers of Irredeemable Paper . . . 333 5. Influence of the Issue of Irredeemable Paper on Specie 335 6. Signs of Excessive Issue 337 7. The Relation of the Quantity of Inconvertible Paper to its Value ......... 339 8. The Effect of an Issue of Paper Money on the Price Level 341 9. The Premium on Gold and the Depreciation of Paper in Commodities ........ 344 10. Special Provisions for maintaining the Value of Irre- deemable Paper 347 11. The Evils of Irredeemable Paper 349 12. The Fiscal Advantage of Irredeemable Paper . . 350 13. Motives to the Issue of Irredeemable Paper . . .351 14. Some Noted Historical Examples of Irredeemable Paper 352 15. Regulation of Irredeemable Paper 353 CHAPTER XVII CONVERTIBLE PAPER CURRENCY 1. By whom Convertible Paper Notes are Issued . . . 355 2. The Advantages of Government Convertible Currency . 356 xviii CONTENTS 3. Convertible Bank Paper 358 4. The Meaning of the Term "Elasticity" as applied to Convertible Paper Currency 359 5. On the Desirability of Elasticity 361 6. The Banking Theory and the Currency Theory of Note Issue 363 7. The Power of a Bank to force its Paper into Circulation 365 8. Some Practical Considerations which modify the Above Conclusions 369 9. Provision of Proper Safeguards for Note Issue . . 372 10. Regulation of Note Issues by limiting their Volume . 373 n. Regulation of Note Issues by controlling Reserve . 374 12. The Minimum Reserve Method 375 13. Proportional Reserve Method 476 14. Simple Deposit Method ....... 376 15. The Partial Deposit Method 377 16. The Bond-deposit Method 378 17. The Safety-fund Method 381 1 8. Notes issued on General Assets 382 19. The Advantages of combining Several Methods . . 383 20. Comparative Advantages and Disadvantages of Govern- ment and Bank Issues 385 MONEY -J >F THE UNIVERSITY MONEY CHAPTER I THE SOCIAL IMPORTANCE OF MONEY REFERENCES : Buckle, H. T., History of Civilization in Eng- land, Vol. II., p. 318; Del Mar, Alex., Money and Civilization; Harper, J. W., Money and Social Problems, Ch. 3; Jevons, W. S., Money and the Mechanism of Exchange, Chs. I, 15; Nicholson, J. S., Money and Monetary Problems, 5th ed., pp. 16-17, 107-110; Tucker, George, Theory of Money and Banks, Ch. 3. 1. The Intimate Connection of the System of Exchange with Social Progress. We are so accus- tomed to the conveniences of the modern system of exchange that we seldom reflect on its historical significance or its present importance. 'Yet that system is, in a way, an epitome of the history of civilization. There is no phase of life which the system of exchange, or the monetary system, has not affected ; there is no byway of the life of the individual, or of society, into which its influence does not reach. Some writers minimize the importance of the monetary system of exchange as a factor in prog- ress and prosperity. Some, ethically inclined, and influenced by the evils which spring from the bad use of money and credit, insist that these means B I MONEY of exchange are not necessary to industry, and think to purify society by abolishing them. Others, with Mill, look at money as a third wheel, and tell us that " there cannot ... be intrinsically a more insignificant thing, in the economy of society/' l It is a little difficult to get the point of view from which a writer of Mill's logical sense could make a remark so wide of the truth. Far from playing an unimportant r61e, money is now, more than ever before, a social necessity ; as necessary to the easy exchange of material goods as is writing or printing to the interchange of ideas. So inter- woven with all phases of the life of society is the modern system of exchange that were it suddenly destroyed, much that is best in civilized life would be swept away ; many of its noblest influences, which are commonly thought of as far removed from contact with thoughts of money, would van- ish ; much of the breadth of view and the tolera- tion of spirit that comes from contact, even indirect and remote, with other peoples, workers in other fields, would be lost. The mojaetary jysjemuof a country reflects its eco*tomia-p*ogress. The system of exchange is at once a cause and a consequence of the stage of economic development. With every change in the form of industrial life has come a change in the system of exchange. " Corresponding to the changes in productive methods under mechanical machinery we should find the rapid growth of a 1 " Principles of Political Economy," III., vii., 3. 2 THE SOCIAL IMPORTANCE OF MONEY complex monetary system reflecting in its inter- national and national character, in its elaborate structure of credit, the leading characteristics which we find in modern productive and distribu- ' tive industry. The whole industrial movement might be regarded from the financial or monetary point of view." l 2. Adaptation of the Monetary System to the Prevailing Stage of Economic Life. The forms of money and the whole mechanism of exchange at any time are adapted to the stage of industry and trade, and to the scale of incomes which prevails at the time. Where trade is limited, industry primitive, and market values low, we expect to find a simple and inexpensive money and a simple mechanism of exchange, with the credit system but little developed. Where industry and trade are highly organized, where business is relatively complex and expensive, and the scale of market values and of incomes high, we expect to find money of a high cost of production, and the mech- anism of exchange correspondingly complex and costly. His arrow-heads, his bow, and the skins of the beasts he kills, are the natural features of the system of exchange in the simple economic life of the huntsman. Gold, in the form of a highly finished tool, representative paper money, and the manifold forms of a credit system, widely extended and intricately ramified, are the equally natural features of the system of exchange necessary to 1 Hobson, " Evolution of Modern Capitalism," p. 7. 3 MONEY the complex relations of the modern business world. The people of a country with little capital endeavor to economize that little by stretching their credit. Unable or unwilling to sink labor and goods in the production of a jnaterial money, they seek to carry on their exchanges by means of its paper representatives. A rich commercial country, with abundance of capital to spare for use as money, provides itself with a plentiful supply of metallic money and rests easily and without strain, upon the basis so provided, a complex system of credit exchanges that reaches every market of the world. In short, the stage of development of their system of exchange is a measure of the industrial development of a people. 3. Relation of the Monetary System to the Scale of Incomes. More particularly, the standard of living of a community is disclosed, more or less accurately, by the kind and denominations of the money it uses. Since expenditures depend on the scale of incomes, small incomes imply small pur- chases ; small purchases require small denomina- tions and a cheap money material. If goods to the value of ten cents a day represent the pur- chases necessary to the daily living of the larger number of the people of a country, the unit of money commonly in their thoughts is the cent. If, on the contrary, the usual expenditure of a majority of the people is a dollar and a half or two dollars a day, they think in dollars rather than in cents. To millions of Chinamen, cash, representing a 4 THE SOCIAL IMPORTANCE OF MONEY fraction of a cent, is the unit of purchases for a day. To an American the dollar is the familiar unit of account. The difference in the value of the two units indicates, at least roughly, the differ- ence in the scale of expenditure, and, therefore, of the standards of consumption, of the two peoples. 4. Division of Labor and the Monetary System. Further, it is a commonplace remark that the modern system of production depends upon the extent to which the division of labor can be car- ried; but the extent to which this division can^'be carried is greatly increased by an easily working system of exchange, since the size of the market depends largely on the facility of exchange of products. The remark holds as well for the divi- sion of labor between different countries as be- tween different localities within a country. In other words, money is necessary to large interna- tional trade. Without some system of exchange each country would have to provide for itself all that it needed to consume. I If the mechanism of exchange, especially the credit portion of it, were to break down, the trade between countries would be so deranged that the different nations of the world would be thrown back into positions of relative economic isolation, such as characterized them before the era of modern civilization began. While it is very far from being true that Rome fell, as Sir Archibald Allison has said, because of a growing dearth of money, yet that lack un- doubtedly had an influence in checking trade, 5 MONEY lowering the standard of living, and retarding that free intercourse necessary to produce the com- munity of interest, without which no country of extended territory can long remain intact. 5. The Monetary System and Political and Eco- nomic Freedom. Money has undoubtedly been the means of promoting freedom, both political and industrial. Sir Henry Maine has pointed out that social progress is quickened by the substitution of contract for custom in the dealings of men. Cus- tom has made way for competition and status for contract in the domain of economic exchange as the money economy has extended, and has left the payer of taxes and tithes and rents, as well as the seller of goods, freer because of its extension. For contracts are more readily discharged, and there- fore more widely extended, with a medium of pay- ment that is general in character and acceptability. One of the most striking historical illustrations of the impulse which a money exchange gives to social and political improvement is found in the betterment of the condition of the serfs in the Middle Ages by the commutation of the services due their overlords into money payments. " So far from being an evil, during this period at any rate, the extension of the use of money as a medium of exchange was the means of effecting great social reforms, and there can be little doubt that progress was retarded largely by a deficiency of the precious metals, especially the dearth of silver." 1 1 Nicholson, "Money and Monetary Problems," 5th ed., p. 17. 6 THE SOCIAL IMPORTANCE OF MONEY It is true, too, that in the later Middle Ages the growing use of money to replace exchange by barter made it easier to raise revenue for purposes of defence, and thus strengthened the cities and kings in their struggles with the feudal aristocracy. As the revenue needed grew larger, and increased taxes were in consequence imposed, the demand for greater freedom and for a larger voice in the control of the government became stronger, so that a better system of exchange indirectly in- creased personal freedom. Somewhat similar is the influence of money wages and rent on the con- dition of the negro in the South. Of the economic classes among the negroes, Mr. Du Bois paints darkly the life of the " cropper " and the " metayer," and remarks that " a degree above these we may place those laborers who receive money wages for their work," while "the renters for fixed money rentals are the first of the emerging classes." 1 A later instance of the good influence of the extended use of money in promoting economic freedom is found in laws abolishing the truck system and requiring that wages be paid in money. Great abuses grew up in England and in certain parts of this country under the truck system. It was not only that those who lived under it suffered loss from having to pay unreasonably high prices, but, worse, that they were not free to buy where and as they pleased, and had not the power, which ready money gives, of seeking an economic escape 1 W. E. B. DuBois, "The Souls of Black Folk," p. 159. 7 MONEY from their hard conditions. Under such a system the man who is politically free may be economically enslaved ; and the person who is economically a serf cannot long effectively exercise the rights of political freedom. 6. The Monetary System and Nationality. The modern mechanism of exchange exercises an influence, too, for the promotion of national unity. Money, and the division of labor and exchange which the wide use of money implies, destroyed the self-sufficing villages of English economic history, and taught their people the advantages of mutual dependence and community of interests. The industrial and commercial unity so developed laid the foundation for an intenser common na- tional feeling. In a similar way international comity is promoted. Like the system of trans- portation, the mechanism of exchange brings thej people in different parts of the world into closer touch with one another. The interests of the people of different countries are united, and the facility with which the transfer of capital is made in these days is doing much to break down the industrial isolation that custom and national prejudice have fostered so long. The influence which the system of exchange exerts in bringing different countries closer together would be greatly increased by the adoption of a uniform coinage ^ system throughout the civilized world, or at least by the great commercial countries. The adoption of a common monetary system by 8 THE SOCIAL IMPORTANCE OF MONEY the great nations of the earth has been prevented partly by national prejudice, and partly by the in- convenience involved in making the change. Each nation is unwilling to give up its own system, and is ready to consent to the adoption of a common coinage only if its monetary unit be made the com- mon one. }Moreover, each country is anxious to get whatever advantage in trade is brought by the use of its coins in other countries. There is a feeling that German or English trade, for example, will be promoted in the Orient by the use of the German or the English coins. While there is some force in these contentions, the benefits that would accrue from a unification of the world's monetary system would far outweigh any detriment that .might come to particular countries. 7. The Monetary System and Economic Prosper- ity. The modern system of exchange promotes industry and trade by making the aggregation of capital easier. It enables people to turn their savings into money and, by depositing it in savings institutions, or by purchasing the shares of corpora- tions, to concentrate under the direction of com- petent men the large capital necessary to the great enterprises of the present day. Still more, the modern monetary system facilitates the transfer as well as the aggregation of capital. Money is the most general form of capital, capital in the fluid state, so that it can be immediately turned to new enterprises and transferred for investment to dis- tant places. Without this fluidity, investments 9 N MONEY would necessarily be more local in their character, and the industrial possibilities of distant places in need of capital could not be so readily developed. The monetary system indirectly increases the total utilities available for consumption by the com- munity. If a community effects its exchanges by barter alone, it does so at a certain cost. The in- troduction of money exchange, under proper con- ditions, will lessen that cost and thereby increase the volume of goods available for consumption. The same effect is produced in a community which already makes its exchanges with money, if by an increase in the amount of money exchanges can be effected which could not be effected before. Not only may the introduction or extension of monetary exchange increase the net consumption of a community, by decreasing the cost of making its exchanges, but either may add directly to the available utilities. For in a regime of barter, for example, many people possess things which have no direct use to them, but have to others. As soon as this is found out, the things acquire an indirect importance to their owners, and an exchange value. From the point of view of society money has, of - course, no superiority over other kinds of goods. The belief was once common, and is still held by a good many people, that because an individual is richer the more money he has, the same is true of a country as a whole. But this is not so. The money can be used by the country, regarded as a whole, only to do its domestic business or to buy 10 THE SOCIAL IMPORTANCE OF MONEY foreign goods. If any country could arbitrarily in- crease her amount of gold, the larger quantity, generally speaking, would simply effect the same amount of exchanges as the smaller did, but on a different price level. As a matter of fact, how- ever, an excess of money would flow abroad for goods. The only case in which a country is richer by the possession of gold beyond her need for it for purposes of payment is when she possesses her own mines. For then she can send her surplus gold abroad in exchange for other goods, and she becomes richer, not by keeping her gold, but by parting with it. A country is no better off from having a surplus of money than is a railroad company with more locomotives than it can use economically. ->/ 8. The Monetary System and the Distribution of Wealth. On the other hand, the monetary system of exchange involves disadvantages which appear to some minds so serious as to offset the good it does. Some people believe, for example, that money produces inequality of wealth. There is a certain plausibility in this opinion. For the pos- sessor of money has a certain advantage over holders of other forms of wealth, because his goods are in general demand ; while the owner of other forms of wealth, if he wishes to exchange, must search for a purchaser who has what he wants to buy and is willing to take what he has to offer. This fact gives the owner of money a pecul- iar industrial and social power, a kind of monopo- listic advantage. It may be said in opposition to ii MONEY this view, that the same advantage lies with any one who happens to have an article for which there is a strong demand. There are occasions on which the possessor of wheat, for example, has an advan- tage in trade over the man who has money, that is, when the demand for wheat is strong and its supply limited. This, however, is not a sufficient answer, for any one will take money for his goods, but not every one cares to take wheat beyond a very limited quantity, if at all. If a man owns a house for which he paid $5000, he can buy other things with it only as opportunity offers. If he has $5000 in money, he can buy other things as he pleases. iThe market for other things is more or less local ; jthat for money is universal. There is always a ktarket somewhere, in some measure, for any eco- nomic goods, but the individual who has any kind of goods but money must find this somewhere and some measure. The owner of money needs not do so. Nevertheless, inequality of wealth really de- pends very little on the existence of money. Such inequalities were never greater than in pastoral and agricultural states, where wealth consisted of cattle and land. The rich are not rich because they have large quantities of money, for they do not keep their wealth in that form ; but because they have acquired a legal title to a large share of the goods in the community. Another disadvantage of the monetary system lies in the disturbance which changes in the value of money cause in the distribution of incomes. 12 THE SOCIAL IMPORTANCE OF MONEY Money is the vehicle of the distribution of product, and variations in its value between the times of re- ceiving income and spending it, may change the relation of the distribution. The owner of money gains or loses, when he purchases, with every change in its value. It is true that fluctuations in the value of money may, in the long run, offset one another, so that the loss of to-day becomes the gain of to-morrow. The trouble is that the gain is not always or perhaps seldom made by the same persons who experience the loss. 9. The Socialistic View of the Monetary Sys- tem. Notwithstanding the evils which the use of money entails, and the impossibility of removing all of them, we may not conclude, with the socialist, that money and the monetary system could be dis- pensed with. Even if the socialist's dream could be realized, and all producers should turn their products into a common fund on which each would draw with equal right, it would still be necessary to have some evidence of these rights and claims, if only checks issued by the government. If the owners of these checks accepted them from one another, instead of always presenting them directly to the government warehouse, they would be, to all intents and purposes, paper money. That they would thus pass current in the absence of any other medium of exchange would be inevitable, since their currency would be necessary in order to enable each person to sell his own product for other things in such quantities and at such times as he needed them. CHAPTER II THE EVOLUTION OF MONEY REFERENCES : Babelon, Les Origines de la Monnaie ; Biicher, K., Industrial Evolution, pp. 67 ff . ; Carlile, W. W., Evolution of Modern Money ; Del Mar, A., History of the World's Monetary Systems ; Jevons, W. S., Money and the Mechanism of Exchange, Ch. 4 ; Laveleye, E. de, La Monnaie et le Bimetallisme International, Ch. I ; Lenormant, P., La Monnaie dans antiquite ; Menger, K., On the Origin of Money, Econ. Journ., 1892, pp. 239-255; White, H., Money and Banking, pp. 12-14. 1. The Conjectural Character of Early Monetary History. There is a perennial interest in the life of early man. His habits, the instruments he used r and his ways of doing things have always been subjects of curious inquiry on the part of the anti- quarian and historian. We rake over the refuse heaps of past generations to find the kind of tools with which they worked; and use the known re- mains of a lost language to reconstruct the religious beliefs and social customs of the people who spoke it. While many of the conclusions resulting from these inquiries rest upon a substantial basis of fact, there are some that can be classed only as conjec- tures. But when these conjectures are plausible, they are likely to be accepted as correct explank- tions of the conditions they attempt to describe long 14 THE EVOLUTION OF MONEY after their origin and character has been forgotten, and by people to whom it was never known. There is no phase of the history of early institu- tions to which these remarks are more applicable than to money. The generally accepted explana- tion of the origin and development of the system of exchange is largely conjectural. It found its beginning in the a priori conceptions of Aristotle. It seems evident enough that the writer who would attempt to give the correct explanation of the early history of money should have at hand considerable information about life in primitive communities; but neither Aristotle nor his contemporaries had sufficient information on this subject to justify us in thinking that he or they could frame an expla- nation of money that we could accept as historically correct. It savors, doubtless, of economic heresy to say it, yet nothing can be clearer than that Aristotle's explanation of the origin of money is pure conjecture, and is a corollary of his_ distinc- tion between what he calls the natural and the conventional modes of acquiring property. Speak- ing of buying and selling, he says : " The other or more complex form of exchange grew out of the simpler [or barter]. When the inhabitants of one country became more dependent on those of another, and they imported what they needed and exported the surplus, money necessarily came into use. . . . Hence men agreed to employ, in their dealings with each other, something which was intrinsically useful and easily applicable to the MONEY purposes of life, for example, iron, silver, and the like." l In this passage, especially in the last sentence, we have clearly set forth the theory which has been accepted throughout the centuries as describ- ing an actual historical evolution, but is nothing more than Aristotle's guess of what probably oc- curred. Being plausible and at the same time Aristotelian, it has come down to us through gen- erations of writers, with scarcely any modification. We find Paulus, for example, saying that " a sub- stance was chosen which, from its permanent and universal value, might become the medium of ex- change, and obviate the difficulties constantly aris- ing in the system of barter." 2 It is clear that for this passage the Roman lawyer is the debtor of the Greek philosopher. Not only is the common theory of the origin of money conjectural, but so, too, are some of the explanations of the development of the system of exchange. Hildebrand and others have told us, for example, that the regime of barter was dis- placed with one of money, and that this in turn will in time give place to a system of exchange by means of credit. We are told that the extent of the use of credit in a given country may be looked upon as a test of its civilization ; that as a country becomes more highly civilized it discards barter and diminishes its use of money. The pertinacity 1 " Politics," I., 9, 7. Jowett's ed. 2 Digest XVIII., p. I. Quoted by Lenormant in Cont. Rev., p. 34. 16 THE EVOLUTION OF MONEY of this theory, which has been held by not a few, is probably due in part to its simplicity, and by its show of conformity to what is called evolution. It is too great a strain on one's credulity to believe that primitive man had as much knowledge of trade as is imputed to him in Gossen's theory that money and exchange presuppose a knowledge of the advantage of exchange in reducing cost of pro- duction. But such explanations of the origin and development of the system of exchange assume too much knowledge of trade and too accurate foresight on the part of primitive man, and a course of development that is too simple and too clean-cut. The explanation of our social progress would be beautifully easy if we could assume that every old habit and institution was to be consigned to the limbo of the forgotten and unused as soon as some new means of performing its work were discovered ; and that we could always select in ad- vance an improved means of accomplishing our purpose. 2. The Character of Monetary Evolution. Yet criticism of such theories must not be severe, for the temptation to interpret the past by the present and to attribute to other people motives and knowl- edge that are our own, is a pitfall that few writers succeed in escaping. The first use of money did not arise frcm any agreement among men, nor has the evolution of our system of exchange been one of successive displacements of one means of ex- change by another. Like other institutions, both c 17 MONEY are slow and unconscious growths from conditions and actions which existed, in germ at least, in very early times. For all three methods of trading known to the modern world barter, money, and credit were present in societies of more or less primitive civilization. Some early peoples traded only by means of barter, while others used barter and money, or barter and credit, or all three means ; and no society has abandoned one means of ex- change because it resorted to another. Illustrations of these facts may be found in some of the data col- lected by Herbert Spencer. 1 Among the ancient Mexicans, for example, trade was carried on by both barter and money. The money system in use was what may be called a poly-commodity system, and comprised five articles : cocoa beans, small cotton cloths, gold dust in goose quills, copper, and tin. The Shillooks, a Nigritian tribe on the White Nile, are said to have made contracts valid for one month. 2 Among the inhabitants of Yucatan there was an active trade by means of a similar money system, and goods were sold on credit, without interest ; while among another South American people, the Chibchaws, interest was charged. Among the Bondas, a tribe of lower Guinea, strings of beads and cowry shells were the media of exchange, while the ordinary media of the Fuegians consisted of small pieces of damoor cloth, tin rings, 1 " Data of Sociology." 2 Featherman, " Social History of the Races of Mankind," Vol. I., pp. 66, 410, 424, 731, 735 ; Vol. V., p. 601. 18 THE EVOLUTION OF MONEY slaves, and glass beads. Such cases show clearly - that the evolution of the system of exchange has / not been everywhere along a single line. In some \ cases it was from barter to money, or money and credit ; but in others, credit seems to be found as early as barter, and not infrequently more than one kind of money was used by primitive peoples. If, now, it be true that all the phases of the existing mechanism of exchange were recognized in more primitive societies, in what sense can we properly say that there has been an evolution in the system of exchange ? In this sense : barter, the use of money in each single exchange, deferred money payments, and cancellation of indebtedness by credit paper, while used in all stages of social development, are used in different combinations, with different emphasis on the different members of the series among different peoples at the various stages of their civilization. It is a case of evolution in which all the organs are present, even in the most rudimentary form of the organism ; but dif- ferent organs and different groups of organs have been developed by different descendants of the original organism because they have lived under different conditions. The conditions of their in- ' dustrial life have determined whether, among a given people, barter, or money, or credit, should be the most prominent feature of their system of exchange. 3. The First Service of the Money Article. The use of an article, or articles, as intermediate 19 MONEY goods implies that it performs the two services of promoting exchange and expressing value. There has been a good deal of discussion of the question which of these services was first recognized. Was the first use of an article as money due to the need for a means of exchange, or to that for a common measure of value ? Each view has its advocates, but the question is not of much importance, and has but little interest for the economist. Some insist that the idea of facilitating exchange must have followed the use of the money commodity for comparing values; others, that the concep- tion of a measure of value is necessarily in- volved in that of a medium of exchange. As Professor Bonamy Price puts the matter: "The savages who first took to cowry shells would hardly be up to such a thought as comparing goods with one another. The given measure was the consequence, not the motive, of the use of money." This hardly seems the reasonable view, for we cannot believe that a comparison of values did not take place, even in the earliest use of a medium of exchange. Rational beings, even though savages, would hardly exchange their goods without reference to their value. The fact that the money was itself an article of consump- tion is sufficient proof of this view. 4. The Selection of the Money Commodity. Of more importance than the question which service, of money was first recognized, is the inquiry : What causes led to the gradual narrowing of the 20 THE EVOLUTION OF MONEY circle of things used as money and the final set- tling upon one or two ? In other words, what were the characteristics of the things most suitable for the purpose ? Here again we are tempted to im- pute conscious choice to early man. We write or speak of his choosing this or that article as the exchange medium. But this cannot be the correct description of* the facts. The result was reached unpurposively. The thing which was fittest at the time to serve as a medium of exchange, became the medium ; but fittest can mean only that which caused less inconvenience than other things which were used for the same purpose. The reduction of the number of things used as money came from noticing the wider acceptance of some as compared with others. That commodity for which the demand was most general established itself, without previous reasoning, on the part of its users. Among the multitude of things which men exchanged there must always have been some which, from whatever cause, were more readily or more generally sought than others. It was doubtless soon seen that these articles were the best ones for a person to get if he sold his goods at a time when he did not want things for immediate consumption. For the articles in most general demand would be most easily exchanged later on for others, and therefore came to be .looked on more or less as intermediate goods. In time this circle of articles became narrower by a process of ^nconscious selection as experience 21 MONEY showed which of them best served the purpose of a commodity go-between in trade. Their character as consumption goods became relatively less important, and their character as intermediate goods more so. If this process of selection could be carried to its logical conclusion, it would result in finding for use as money an article which could not serve any purpose of direct consumption. The nearest approach to such a money is bank or government paper money. Moreover, that article which by its natural divisions was best suited to the prevailing range of values, was doubtless found to be more convenient than any other. It is very likely that these two attributes, general acceptability and convenient subdivision, were the qualities that had most to do with the final deter- mination of the medium of exchange. 5. Kind of Article Selected. The article which, in early times, was generally acceptable was not always the same. Sometimes it was a necessary of life, sometimes an ornament. Articles which served the latter purpose were likely to be ac- cepted over a wider area, but the generalness of the acceptability of a particular thing depended mainly on the stage of economic life a community had reached. Skins and furs were always in demand in a community of hunters, cattle in one of shepherds, dates in a date country, and wam- pum beads, or cowry shells, or gold, where these were highly valued for personal adornment. As soon as it was recognized by all tb<^ people in a 22 THE EVOLUTION OF MONEY community that a certain article could be sold at any time, it became the medium of exchange, the money of that community. The article thus took on a new function. Instead of being simply a thing for direct consumption, it became in addi- tion an instrumental good, a means of facilitating exchanges and measuring values. There was an added demand for it, and it therefore took on a higher exchange power. 6. Subdivision of the Money Article. But money, chosen from such commodities as men in a low industrial society had at their disposal, had incon- veniences of its own. Some people probably could not get an article which was at the same time in general demand and capable of convenient division. This difficulty seems to have been met by the early use of what may be called represen- tative money. We know that the early Greek coins were stamped with the figure of an ox, and the early Chinese with that of a shirt* 1 One form of early Russian money consisted of small pieces of definite shapes cut from the skins of animals and passed from hand to hand as tokens of owner- ship of the whole skins. The ox, the shirt, the skin, were each too heavy or too large to pass about. A piece of metal shaped like the horse or the shirt, or a disk with pictures of these stamped on it, or a piece of skin shaped so that it would fit a hole in a certain complete skin, all obviously 1 Dean, " History of Civilization," Vol. II., p. 76 ; Nineteenth Cent. Mag., Vol. VI., p. 789. 23 MONEY mean that they entitled the receiver to expect goods of a value equivalent to that of the horse, or the ox, or the shirt. The value of the metal itself was, perhaps, not prominent in the minds of the exchangers at first, so that the money was representative. Not for some time was the value of the money thing taken for the measure of the value of the goods it bought. Experience taught men in time that the metals, of one kind or another, served as a medium of exchange better than anything else that had been tried. For the metals, as Menger says, possess in higher degree than any other article the attri- bute of universal salableness. As the standard of life rose and the range of prices became higher, a more valuable unit was needed, and this need gradually led to the use of the most valuable metal available. Curiously enough, when the stage was reached where the most valuable came into use, it was found necessary to return to what has been called the poly-commodity system. The most valuable metal was not divisible into convenient units of small enough value to suit the scale of prices and the range of incomes. So modern man uses gold for his larger payments and more valuable exchanges, and one or two, or more, other articles for payments of value too small to admit of the use of the dearest metal. 7. Influence of the Market on the Evolution of Money. The principal influence in the evolution of the money commodity was, of course, the growth 24 THE EVOLUTION OF MONEY of trade in volume and complexity. Indeed, it may be said that the development of the money I system depended entirely on the development of the market. Barter was the earliest form of trade, because it is the form peculiarly suited to that stage of trade in which exchanges were few, local, and between individuals who wanted articles for direct personal use. In time, trade between indi- viduals gave place to local markets on the border- land between tribes, and these markets, in some cases, became regular established fairs, in which the traders found profit by bringing the products of different localities to these centres of trade. This class it was whose experiences of the incon- veniences of barter, and of the use of several things as money at the same time, gradually led to the various steps of progress that have been briefly described. So long as there was no sepa- rate trading class and no market in the commu- nity, individuals could as well as not use any one of a variety of goods to pay for their purchases. In local markets the adaptation of the single money medium would be a matter of great convenience, and in trade between different communities it would be almost a necessity. 8. The Complex Character of the Mechanism of Exchange. We have seen that barter and credit, as well as money, are found as means of exchange in communities of a low degree of civilization, so that we cannot accept Hildebrand's cut-and-dried theory of simple steps from one to another of the 25 MONEY three means. Of course the credit methods used lr in undeveloped communities were of a very simple character. We cannot in any case speak correctly of the existence of a credit system in such cases. So far as credit was used at all, it assumed the form of debt between individuals with direct per- sonal payment by debtor to creditor. Cancellation of indebtedness was unknown, for the clearing sys- tem, even in its simplest form, belongs to a com- paratively higher stage of civilization. The sphere of barter in the modern world is still somewhat ex- tensive. In the country districts of even the most highly civilized countries the farmer still brings his produce to the country storekeeper to exchange it for what he needs, and the world is far from hav- ing abandoned the payment of labor in kind. But as the different countries become more thickly set- tled, and society becomes more integrated, we may look for still greater restrictions of the sphere of direct barter. Perhaps in the far future barter will cease to be important as compared with the total trade of the world. But here, as in many other cases, the simple method discovered by the world in its infancy will always prove serviceable, and perhaps necessary, to the world in its maturity. It is the simple which is universal. 26 CHAPTER III COINAGE REFERENCES : Evans, G. G., History of the United States Mint and Coinage ; Hepburn, A. B., History of Coinage and Currency in the United States, Pt. I., Chs. I, 2, 3 ; Jevons, W. S., Money and the Mechanism of Exchange, Ch. 7 ; Knies, K., Das Geld, 2d ed., pp. 192-210 ; Laughlin, J. L., Principles of Money, Ch. 2 ; Liver- pool, Lord, Treatise of the Coins of the Realm ; Muhleman, M., Monetary Systems of the World ; Nicholson, J. S., Money and Monetary Problems, Pt. I., Ch. 3 ; Norman, J. H., The World's Metal Monetary Systems, pp. 8, 12, 45 ; Ridgeway, W., Origin of Metallic Currency and Weight Standards ; Scott, W. A., Money and Banking, Ch. 5 ; Watson, D. K., History of American Coinage ; White, H., Money and Banking, 2d ed., Ch. 2. 1. Natural Objects as Monetary Units. Man naturally turned for his first money to something ready to his hand. The earliest forms of the medium of exchange were, therefore, natural ob- jects, and the diversity of the things used for the purpose by different peoples is almost as great as that of the portable natural objects available. It was necessary, however, to find articles whose units were of as nearly equal purchasing power as possible, and also capable of subdivision to make purchases of different amounts. The first of these needs gradually led to the selection of natural 27 MONEY objects which were approximately uniform in size, shape, and color. The need for money units of dif- ferent purchasing power led sometimes to the use of different articles to furnish the necessary de- nominations. An ox, a cow, a sheep, would, for instance, be one gradation ; and a buffalo skin, a beaver skin, a wolfs skin, another. For it was impossible to divide, for example, a beaver's skin, or an ox, or a shell, into parts to suit the amounts of different transactions. The division would have destroyed their value and their availability as money altogether. Sometimes, however, the diffi- culty was met by using an article, different grades of which were available. For instance, different sizes or colors of cowry shells, or of wampum beads, formed a scale of related values and served roughly the purpose of coins of denominations. In colo- nial times, in New England, the black wampum beads had a higher purchasing power than the white ones. 2. The Nature and Purpose of Coinage. In time, of course, men undertook to meet the need for uniform and graded pieces of money by artifi- cial methods. When they came to use a money substance capable of such manipulation, they made it into pieces to suit their purpose. This process of giving uniformity and thereby at the same time recognizability to money constitutes coinage in the widest sense of that word. According to Walker, the word may be defined as any method " of de- termining, for easy popular recognition, the quantity 28 COINAGE and quality of individual portions of that which has been adopted into use as money." l But this definition is too broad. As it stands, it would include all kinds of money, of whatever material, whose character was indicated by a de- vice of any kind, whether stamped, printed, or en- graved. By the word " coinage " is now commonly meant the stamping of a piece of the metal for use as money so as to make known its denomination and value directly, or by indicating its weight and fineness. 3. The Evolution of Coinage. It is not difficult to trace in a general way the steps in the evolution of coinage. The first effort was to give definite shape or size or weight to articles which were by nature uniform in their physical character. The cowry shells of the African negro, the wampum beads or shells of the North American Indian, the Abyssinians' cubes of salt, the Mexicans' quills, full of gold dust, square pieces of leather, and similar articles, all illustrate this effort. Nature furnished the homogeneity and cognizability which were necessary to make convenient money, and man gave shape to the articles. The trick once learned was applied, in various ways, to all articles that successively came into use. When metal became the medium, it was made into wedges, " spikes, or small obelisks." Indeed, the word " coin " is derived from the Latin ctmeus, a wedge, and originally meant a piece of metal so 1K Money," p. 164. 29 MONEY shaped. The modern representative of these spikes or obelisks is the bars which are used in making international money payments. Bars, it has been found, lose less by abrasion than coin, and hence are preferred for shipment. It is not clear how ring money came unto use ; but it may be that the easy bending of a thin spike into the handier form of a ring led to the change. In time the ring form suggested the plan of mak- ing metal disks with holes punched in them, prob- ably for ease in carrying. The Chinese cash are of this form. The transition from plain bars or disks, to bars or disks marked for recognition or guarantee, must have come early in monetary history ; but the manu- facture of stamped disks of the modern sort was a comparatively late development. 1 In the early days of the stamped coin only one side of the disk was marked ; but the presence of an unmarked face caused loss because it tempted dishonest people to rub off or file off a portion of the metal. To pre- vent this, in time both sides were stamped, and at last, in order to check the dishonesty wholly, the edges were milled, and thus we come to the coin of our own days, the mechanical technique of which leaves little to be desired. Coins have been made at different times of nearly all the commonly occurring metals. Iron, copper, lead, tin, platinum, silver, gold, and others, alone 1 The first coins of this kind were attributed to Pheidon, King of Argos. See Grote, " History of Greece," Vol. III., 318. 3 I COINAGE or in composition, have all been used for the pur- pose. The choice of the metal depends mainly on the range of incomes and prices in a community. The higher these range, the more valuable the metal needed. It is for this reason that the coins in most common use in China are of copper ; while in the advanced countries of Europe and America they are silver. In a highly developed country, however, coins of several metals are needed to meet the demands of various classes with different scales of incomes and of purchases. 4. The Requisites of Good Coinage. The req- uisites of good coinage are accuracy in composi- tion and weight; convenience of shape, size, and weight ; difficulty of counterfeiting ; durability and cognizability. Great care is taken to produce coins as nearly perfect as possible in chemical com- position and mechanical form. Gold and silver make more durable coins if they contain a definite proportion of copper in alloy, and accordingly are always so manufactured. But it is important that the proportions of the money metal and of the alloy shall be exactly the same in all coins of the same denomination. Otherwise some would be more valuable than others. This inequality of value owing to varying composition occurred not infre- quently before the art of coinage was well devel- oped. Equally important, for the same reason, is uniformity of weight in coins of the same kind. So difficult is it to attain this uniformity that all gov- 3 1 MONEY ernments which coin money allow a slight variation from the exact weight prescribed for their coins. This variation is known as tolerance of the mint. In the coinage of the United States, for exam- ple, eagles and double eagles may vary one-half grain from the weight set by law. In practice, of course, this maximum variation does not often occur. If coins always passed by tale, slight differences in weight would be of little consequence. But they pass this way only in the country in which they are coined. In the payment of foreign debts they pass only by weight. It follows that if the coins of the same denomination differ much in weight, the heavier are picked out for melting or for ex- port. For the owner of the coins can either sell them as bullion or pass them by tale. If they .contain so much bullion that they are more valuable in that form than for payment by tale, they will be melted or sent abroad. Either operation depletes the circulation of the country. The best shape for coins is that which allows for the least loss from use and from fraudulent altera- tion, and at the same time affords most convenience in handling. Most coins nowadays are circular, but square, octagonal, oblong, and cubical coins are not unknown. The circular is the most convenient. A good coin should not be too large nor too small for convenient handling. A five-dollar piece of silver would be clumsy, and our old one-dollar gold piece was too slight. 3 2 COINAGE In order to prevent counterfeiting, the device on a coin should be difficult to imitate, but in spite of the high state of the art of coinage this result is hard to reach. The coin should be hard and tough enough to reduce loss by abrasion to a minimum, and yet malleable enough to take sharply the impression of the die. The durabil- ity of the coin is generally promoted by putting a rim around it somewhat above the face so that when the coin is laid down it rests on this rim. Finally, the shape, color, and device should show at once what the coin is and what its value. The device should be simple and legible. 5. Government Versus Private Coinage. Coin- age is now everywhere regarded as an attribute of sovereignty and is done by the government, al- though, historically, it did not originate with govern- ments. Doubtless the fact that coinage could be so easily made a source of revenue had much to do with the early claim of governments to its monop- oly ; but there are better reasons for the monop- oly than a custom derived from the claims of kings and overlords to exact tribute from trade. Since coins circulate among people who have no means of verifying the accuracy of the device upon them for certifying their weight and fineness, it is desirable that the devices shall be the same on all, and shall be made by an authority in which every one has confidence. The sovereign power is the only one that fulfils this condition. Moreover, if coinage were left to private enterprise, the diffi- D 33 MONEY culty of verification would make fraud easy. Light weight and spurious coins would be put into cir- culation, to the damage especially of the poor and ignorant. With competitive coinage more, per- haps, than in any other business would it be true that the character of competition sinks to the level of the most unscrupulous competitor. Finally, if a profit is to be made from coinage, this profit in equity belongs to the people. 6. The Charge for Coinage ; Seigniorage. Bull- ion may be turned into coin by governments either for their own account or for individuals ; and they may do this free of charge or at a price which exactly covers the expense of coinage or which exceeds it. If the coinage is on government ac- count, it is said to be limited ; if it is done for any individual who offers bullion for the purpose, it is. called free coinage. If the work is done without charge to those who offer bullion, the coinage is gratuitous. If a fee is exacted equal to the expense incurred, the charge is called brassage ; 1 if in ex- cess of this expense, it is called seigniorage. How- ever, the name " seigniorage " is commonly used for both charges, and not infrequently describes simply the government profit on coinage whether the work is done for individuals or not. The practice of charging for coinage varies. Most nations exact such a charge, but those most 1 In compliment to Sir Thomas Brassey. Seigniorage derives its name from the old feudal exaction by the " seignieur " of a tribute from trade. 34 COINAGE advanced try to keep the charge equal to the actual expense of the work. To charge more than this is wrong to the owner of the bullion, deceives the public, and leads to the evils of a debased currency. England is the most conspicuous, perhaps the only important, country in which no charge of any kind is made for the coinage of the standard metal. 7. The Arguments for and against a Charge for Coinage. Several arguments are advanced in favor of brassage. In the first place, it is urged that a coin is a manufactured article, and that to charge for its making "puts the cost of coinage where it belongs/' It is questionable, however, whether this is strictly true. The convenience to the public at large, and to traders and producers other than the bullion owners, which comes from the existence of coin is very great. It is a fair question whether they should not pay part at least of the cost of manufacturing the coin. A second argument advanced by the advocates of brassage is that if there is a charge for coinage, coins are less likely to be exported than bullion to discharge a foreign indebtedness, because with brassage the metal would be more expensive as coin than as bullion. Closely allied with this argu- ment is a third point, that brassage prevents the melting down of coin by jewellers because they will not submit to the loss of the brassage charge. Those who take the contrary view, however, and insist that coinage of the standard metal should be gratuitous, point out, in the first place, 35 MONEY that if a charge is made, the principal measure of value will not be perfect. Inasmuch as cost of coinage will vary in different places, the same amount of gold will be embodied in coins of differ- ent values. In the second place, it is urged that if gold in the form of coin has the same value, weight for weight, as in the form of bullion, when prices change so that less money is needed, the coinage will adapt itself much more rapidly and with a nicer adjustment to the new level of prices. It is further urged that a coin of the country which makes no brassage charge is far more likely to be used by the people of other countries. That this has happened with the English sovereign is undeniable. The use of its coins in foreign countries may help the trade of a country by mak- ing people familiar with its money. " Such circu- lation, it is claimed, will amount to a demand for the trade of the country conducting the coinage, which it can very well afford to pay for, as truly as a merchant can afford to pay for advertise- ments in a newspaper, or a circus manager for hav- ing his fearful and wonderful pictures displayed along the street/* l A fourth argument used by advocates of gratuitous coinage is, that if merchants should find it necessary to export coin, on account of the difficulty of getting bullion, they would add the loss of the amount charged to the price of their imported goods and so transfer the loss to consumers. 1 Walker, " Money," 185. 36 COINAGE Finally, the advocates of gratuitous coinage insist that the loss by export is less than may be supposed, for the reason that a great many of the exported coins are eventually returned. This is certainly true in the case of English sovereigns and American eagles. It has become a practice in various countries to hold imported coins for export when the tide of trade turns. What has been said thus far about coinage and seigniorage applies to the principal coins of a country. Besides these, which comprise the stand- ard unit and its multiples, every country needs coins of smaller denominations, submultiples of the standard unit. These are called subsidiary coins, and may or may not be made of the stand- ard metal. Usually, even in gold standard sys- tems, the subsidiary coins are of silver, because coins of the small value required would be incon- veniently small and light in weight. Coins of the smallest denomination are usually copper. The number of standard coins, as dollars, which may be minted from an ounce of gold, is fixed by law, and is the mint price of gold. This mint price has no relation to the purchasing power of gold. It depends entirely on the amount of gold put into the unit of money. When coinage is gratuitous, the owner of bullion is entitled, in theory, to take this .bullion to the mint and get back its full value in coin. He may have to wait, however, until his metal is coined ; and if so, he loses interest on it in the interval. To avoid 37 MONEY this delay the English law requires the Bank of England to buy all gold offered at ,3, i ?s. yd. per ounce, which is \\d. less than the bullion owner would get if he waited for his gold to be coined. This i \d. is to cover the expense to the bank for interest and the labor of weighing and assaying the metal. When the bank is in need of gold, it sometimes foregoes part of this fee and pays more per ounce than $, 17 s. <)d. The bank is then said to pay a premium on gold. The expression is not technically correct, since one gold sovereign is not worth more than another. It simply means that the bank's need for gold is so great that it is willing to forego part of the profit on its purchases. In the United States the owner of bullion does not have to wait for his coin, but he must pay for the alloy. CHAPTER IV THE CURRENCY AND THE PRINCIPLES OF ITS CIRCULATION REFERENCES : Farrer, Sir T. H., What do we pay With ? Ch. 4; Giffen, R., Gresham's Law, Econ. Journ., Vol. I., p. 304 ; Jevons, W. S., Money and the Mechanism of Exchange, Ch. 8 ; Laughlin, J. L., History of Bimetallism in the United States, pp. 26-30, 65-69, and elsewhere; The Principles of Money, Chs. 5, 12, 15; Moses, B., Legal Tender Notes in California, Quar. Journ. Econ., October, 1892 ; Nicholson, J. S., Money and Monetary Problems, Pt. L, Ch. 4; Report of the Comptroller of the Currency, 1896, Vol. L, pp. 57~97 ; Report of the Indianapolis Monetary Commission, 1898, pp. 113-130 ; Scott, W. A., Money and Banking, Ch. 2 ; Walker, F. A., Money, pp. I 93~ I 95 > White, H., Money and Banking, 2d ed., p. 25. 1. Classification of Media of Exchange. The medium of exchange, or the circulating medium, comprises all the instrumental goods used for pay- ing debts or purchasing commodities. Payment may be made, indeed, with an article which to the receiver is a direct consumption good rather than an instrumental good, or one which he uses by passing it on for his payments in turn. In that case the article is not part of the medium of exchange. Some of the articles which enter into the me- dium of exchange are generally current, or com- monly accepted in payment, without any reference 39 MONEY to any characteristic except their passableness. These articles constitute the currency. Other portions of the medium of exchange do not have a circulation which can properly be called general ; they are accepted primarily because of the credit of the issuer, and are not currency. Accord- ingly, we may classify the media of exchange as follows : (a) The medium of general circulation, or the currency, including (i) metallic money; (2) incon- vertible paper money ; (3) certificates of deposit of metallic money ; (4) credit paper which has a gen- eral circulation, as convertible notes. (#) The medium of restricted circulation, or non- currency, including (i) credit paper which does not circulate generally, as checks and drafts, rep- resenting bank deposits ; and bills of exchange, representing goods ; (2) securities representing goods or property. It is obvious, then, that the currency is not sim- ple and homogeneous, but complex and -heteroge- neous. In most countries we find coins of different metals and of different denominations passing side by side with paper money, and with credit paper of private, public, or semi-public origin. There are, indeed, occasional historical instances in which the currency of a community or country has con- sisted of a single article. This was probably the case in ancient Lacedaemon, where iron money was for a long time used alone, while in some other ancient states copper wa.- used by itself. Ordi- 40 THE CURRENCY narily, however, the only cases among modern nations in which we find a single thing used as money are those in which the currency consists of very depreciated paper money. For example, during our Civil War practically the only circulat- ing medium in the United States was government and bank notes. The copper cents, and perhaps some silver, remained in use; but the fact that notes were issued for sums as small as five cents is the best evidence that coins of that denomination were out of circulation. 2. Adaptation of the Medium of Exchange to the Scale of Incomes and Prices. It is not an accident, of course, that the medium of exchange is generally composite. It is due principally to the need of adapting the currency to a variety of grades of incomes and payments. A minor cause is the necessity for having coins convenient to handle. One kind of currency would not be con- venient for payments of all amounts. A cheap metal would be inconvenient for making large pay- ments ; a dear one, for making those of small amount. The Chinese use " cash/' each of which is equal in value to a fraction of an American cent, because the scale of ordinary purchases in China makes coins of that small purchasing power suitable for daily use. If we with our higher range of incomes and prices should attempt in this coun- try to use coins of so low a denomination, we would experience great inconvenience from having to carry about large amounts of them to make ordi- MONEY nary payments. On the other hand, it would be impracticable for the Chinese to use gold for their small purchases. The best medium of exchange, therefore, pro- Ivides instruments of exchange of different kinds, each kind adapted, on the whole, to different scales of payments. To be sure, if paper money alone is used, it can be issued in any denomination with equal convenience ; but, as we shall see, such a system involves dangers which make it extremely inadvisable. ^Accordingly, the circulating medium of most countries comprises metal money, paper money, and private credit instruments. J As a rule, the metallic money consists, first, of the principal, or standard, money, usually gold or silver ; second, of subsidiary coins, which are usually of a different metal from the standard and dependent on the standard for their nominal purchasing power. Where gold is the standard money, the smallest gold coin is usually of a denomination such as the majority of people will be able to use in their larger ordinary payments. In the United States the smallest coin of gold is the two-and-one-half dollar piece. Gold dollars were formerly coined, but were found too small for easy handling and were easily lost. In England, the smallest gold coin is the half-sovereign ; in Germany, the five-mark piece; and in France, the five-franc piece. The subsidiary coins are subdivisions of the stand- ard coin and are generally silver and copper. The 42 THE CURRENCY smallest denominations are sometimes called minor coins. In the United States, subsidiary coins, like the half-dollars, quarter-dollars, and dimes, are of silver ; the five-cent piece is nickel, and the cents are copper. Other countries, as England, Ger- many, and France, use silver and copper for their smaller coins. Paper money is used both by itself and in com- bination with coins. The technical advantages of paper money are its convenience to handle, its easy and cheap manufacture, and the possibility of mak- ing it of any denomination. It may be issued by the government, by banks, or by other corporations. In the United States paper money is issued both by the government and the banks. The same is true in Canada ; but in England, Germany, and France the paper money is all bank money. JL > 3. The Credit Portion of the Medium of Ex- change. Besides the kinds of medium of exchange thus far mentioned, there are certain private credit instruments which are used to effect exchanges. Broadly speaking, these include bank deposits rep- resented by checks, bank drafts, whether written or telegraphic, bills of exchange, and negotiable se- curities. In so far as the last mentioned are used in making exchanges and effecting payments, they may be properly regarded as part of the medium of ex . <^n & c. Deposit currency, consisting of credits of deposi- tors in banks, and represented in circulation by checks and drafts and similar paper, has come to 43 MONEY play a part of immense importance in modern busi- ness, far exceeding that played by notes. Some idea of this importance may be had from the fact that, as shown by the clearing-house returns of the United States, transactions aggregating $114,068,837,569 were performed by means of this kind of currency in 1903. At various times, in England and in our own country, efforts have been made to determine the proportion of payments made by this part of the medium of exchange, by determining in what proportion it enters into the receipts of banks. All these examinations have shown that the receipts of the banks are over 90 per cent, in credit paper and less than 10 per cent, in all kinds of money. The most extensive exami- nation into the matter was made in the United States in 1896, and secured separate returns of the deposits of people engaged in retail trade, wholesale trade, and all other businesses. It ap- peared from the figures that at that time about half the volume of retail payments were made with private credit currency, and more than nine-tenths of the wholesale business. After making allowances for errors and omissions it seemed from that ex- amination that perhaps 70 or 75 per cent, of the payments in settlement of mercantile business in the United States at that time were made with checks and other similar paper. 1 Of a total vol- ume of clearings of the New York clearing house, 1 See Report of the Comptroller of the Currency, 1896, and The Journal of Political Economy -, March, 1897. 44 THE CURRENCY of $70,833,655,940, in 1903, only 4.68 per cent, were settled with money. 4. Securities as a Part of the Medium of Ex- change. Another important part of the modern medium of exchange consists of negotiable secu- rities, especially the bonds and stocks of corpora- tions and the bonds of cities and states. When used as currency, these have a certain resemblance to paper money. Paper money represents or gives command over goods in general ; securities represent or give command over certain general classes^ of goods. In other words, they avoid, al- though far less completely, the lack of coincidence in barter. Their use for the settlement of debts is confined, of course, to a special field, their service being mainly in the settlement of transactions in such paper itself, and, indirectly, in the settlement of the balances of international trade. We shall examine in another chapter the part they play in this latter matter. In the settlement of stock exchange transactions the sales of stock by the brokers are set off against their purchases, in the stock exchange clearing house, and the balance is paid in money or checks. Thus in New York "on the single day of January 23, 1899, there were sold 5,006,900 shares of stock valued at $35o>900,ooo by the transfer of only 735,000 shares and the payment of balances amounting to $724, 500." i 1 Charles A. Conant in The Annals of the American Academy, September, 1899, p. 44. 45 MONEY 5. Standard Money, Money of Account, and Medium of Exchange. A distinction must be made between standard money, money of account, and current money. The standard may be gold,, the money of account may be silver, and the cur- rent medium of exchange may be paper. The standard money is that to whose value the value of the other kinds of money is referred for deter- mination, but it may not be coined. The money of account is that in which prices are usually ex- pressed, and the current money is that in which actual payments are made. In the United States, for example, the standard is the gold dollar, 25.8 grains of gold nine-tenths fine, which is no longer issued. In some parts of the country payments were formerly reckoned in a money of account spoken of as bits and shillings. 1 The public ac- counts of New York State were kept in pounds, shillings, and pence 2 until 1796, although the standard from 1792 was the dollar. Payments were made in various kinds of paper and foreign coins. In England the standard is the gold sovereign, equivalent at par to $4.86%. Accounts, however, are sometimes reckoned in guineas, 3 sometimes in pounds, and sometimes in shillings, while the money actually used in payment may be 1 A bit and a shilling were each I2j cents. 2 First Annual Report of the Comptroller, New York Assembly Journal, Vol. XVI., p. 20. The New York pound was $2.50, eight shillings to the dollar. 8 Twenty-one shillings. 46 THE CURRENCY either gold, silver, or paper. The Old English, or Anglo-Saxon, unit of payment was a pound of silver. The money of account was the shilling, and the current coins were silver pence and half- pence. Similar instances can be found in other countries. 6. Legal Tender Money. The currency may in- clude legal tender money and money that is net legal tender. Legal tender money is money the offer or tender of which in payment of a debt con- stitutes, under the law, a sufficient discharge of the obligation. The declaration that such and such a thing shall be legal tender is not necessary to its use as a medium of payment, although it doubtless facilitates that use. A legal tender law prevents uncertainty in contracts, and in a measure protects ignorant and weak creditors from being imposed on with spurious money. It does not, however, prevent people from making contracts to be settled by other means of payment. Under a legal tender law, the standard money is usually made unlimited legal tender, while the sub- sidiary money is limited to payments of certain amounts. In the United States, for example, gold coins and silver dollars are unlimited legal tender. The subsidiary coins, half and quarter dollars and dimes, are legal tender to the amount of ten dollars, while the five-cent piece and the copper cent are legal tender for twenty-five cents. 7. Systems of Metallic Currency. The system of metallic currency in use at any time depends on 47 MONEY the development of coinage and on the scale of in- comes and prices. Uncoined metal and crudely fashioned coins pass by weight ; those more accurately made, by tale. A legal tender system by tale could not well be used until coinage was perfected. A single metal would serve a com- munity with a uniform scale of incomes and prices, while more than one would best answer the purpose where considerable differences exist in the economic conditions of different social classes. Accordingly, the possible systems of metallic currency fall into five classes. Jevons l describes them as currency by weight, unrestricted currency by tale, the single legal tender system, the multiple legal tender system, and the composite legal tender system. Under the first of these the government simply provides a system of weights and measures, and people who have payments to make use these in weighing out, or measuring out, the metal used as money. This is undoubtedly the oldest method of payment with money. Some of our monetary terms, like the English pound, the French livre, the Hebrew shekel, the Greek and Roman talent, and others, were originally names of units of weight. In the system of unrestricted currency by tale, the metal is coined into pieces of uniform weight and fineness, their value, or their weight and fine- ness, being stamped upon them, and they are passed from hand to hand on the basis of this 1 " Money and the Mechanism of Exchange," Ch. ix. 48 THE CURRENCY certification. The nearest approach to this system to-day is in the use, for international payments, of gold bars made at the government mints. Under the single legal tender system only one metal is coined as legal tender. The iron money of Sparta is an example. Such a system is suitable for a community of simple economic life. Under the legal multiple tender system, coins of differ- ent metals are used at a fixed ratio and each is an unlimited legal tender. Bimetallism is the most familiar example. Under the composite legal tender system one coin is unlimited legal tender, while others are so only to a limited extent. This is the system of advanced countries to-day. 8. Systems of Paper Currency. There are three systems of paper money, representative paper money, fiduciary paper money, and fiat paper money. The first is made up of notes which are receipts for metal deposited with the issuer of the paper, either in the form of coined or of un- coined metal. Credit paper money consists of notes promising to pay, with or without conditions, speci- fied sums of metallic money. Fiat paper money consists of printed statements that the notes are of such and such denominations, or represent such and such sums of metallic money. They are always in the form of promises to pay, but are not intended to be paid. Any one of these kinds of paper money may be legal tender, and any one of them may be issued either by governments or by banks. Not infrequently both metallic and paper E 49 MONEY money are legal tender at the same time. This is the case in the United States, where gold and silver are legal tender equally with greenbacks, or government notes issued during the Civil War, and the treasury notes issued against the de- posits of silver bullion under the Sherman law of iSgo. 1 9. Fundamental Causes of Circulation of Media of Exchange. The underlying cause of the circu- rfiation of any and all of the kinds of media of II exchange is confidence in their acceptability. L The bases, or the causes of this confidence, are four : (a) belief in social stability, or the persist- ence of social habit ; (b) law, or the authority of a particular government ; (c) the credit of the issuer, whether a public body or a private person or cor- poration ; and, finally, (d) direct agreement among individuals. Each of these forces promotes the circulation of a different kind of money. The persistence of social habit is the primary cause of the circulation of commodity money. As usually put, a commodity money, like gold, is more widely acceptable than any other kind because it has value independent of that which arises from its use as money. But this value can be present only so long as the demand for the article continues. To accept it in payment is, therefore, to show one's belief that the general desire to own this particular commodity is permanent; that men will continue 1 By the currency law of 1900 these notes are being replaced with silver dollars. 50 THE CURRENCY to act in the future as they have acted in the past ; that social habit is persistent. The second basis of confidence which may lead one to accept a certain thing in payment of debts due him, or of sales made by him, is the stability of the particular government which issues it as money. People believe that the provisions made to create a demand for this kind of money, by way of receiving it for taxes, making it legal tender, and so on, will lead to its acceptance, although it has no direct utility and no specific value. Or else they think the law can enforce its acceptance. In the next place, an article may be accepted in payment of debt or sales because of confidence in the integrity and stability of an individual or a corporation. The receiver believes that the issuer will redeem the article ; in other words, guarantees that it will be accepted by himself, if not by some one else, in exchange for articles of direct utility. The cause of circulation here is commercial credit. Examples of such media of exchanges are checks and bank notes. In the fourth place, the confidence which leads one to accept a given article in payment may be the direct agreement of the individuals of a certain social or industrial group so to accept it. There is hardly to be found any historical illustration of such an agreement. Some writers have written on the origin of money in a way to imply the exist- ence of such a convention or agreement, but there is no evidence that this has ever been made. The MONEY nearest approach to it is, perhaps, the use of checks by gamblers in settling their gambling claims. A case resembling such an agreement is found, also, in the action of the nations that composed the Latin Union. If international bimetallism is ever estab- lished, we shall have another remote analogy. The cause of circulation in this case will be international agreement, enforced in each country by its own laws. It is not a matter of concern to us at present to consider which one of these causes of circu- lation may fairly be considered the best on which to rest the medium of exchange. If any one of them is present, the article for which it causes a demand will serve as a medium of exchange. The first and most general principle of circulation, then, is this : The primary cause of the circulation off money is the receiver's belief that others will take it from him in turn. The area of circulation de- pends on the basis of this confidence which induces acceptability, and may vary from the small group, in which the cause of acceptability is the personal integrity of the issuer, to the larger group influ- enced by political and legal authority, or to the largest group which takes in payment only articles whose acceptability is the result of social habit. 10. Gresham's Law; its Operation and Limita- tions. Although an article may be generally acceptable as money, different portions of it may have different degrees of acceptability. ^ If coins of the same denomination differ in weight or fine- 52 THE CURRENCY ness, the better ones will serve not only for ordi- nary payments, as do the inferior coins, but also for foreign payments or for making more valuable articles in the arts. They are likely, therefore, to be treated as bullion and used for export or in the arts. Not every one, of course, who handles coins lays aside the better ones in order to make a profit from their greater value. This is done by money dealers who handle large amounts, so that a small profit on each coin yields a large aggregate gain. Their work of selecting and withdrawing from circulation the more valuable coins is known as picking and culling the coin. So likely is the elimination of the more valuable coins from circu- lation to occur, if there is much variation in coinage, that it is commonly said that " bad money drives out This Statement of th^ non is knowii^LsGreshanilsJjaw, from Sir Thomas GreshamTwho called the attention of modern stu- dents anew to the occurrence more sharply than any writer up to his time had done. The phenomenon was known, however, long before Gresham's time, although perhaps not scientifically formulated. 1 1 That it was known as early as the time of Aristophanes, at least, is shown by the following passage in the " Frogs " (lines 717 ft.):- " Oftentimes we have reflected on a similar abuse In the choice of men for office and of coins for common use ; For your old and standard pieces, valued and approved and tried, Recognized in every realm for trusty stamp and pure assay, Are rejected and abandoned for the trash of yesterday ; For the vile, adulterate issue, drossy, counterfeit, and base, Which the traffic of the city passes current in their place." 53 MONEY The second principle of circulation is, then : If a money of one material is in use, the less valu- able portions of it tend to remain in circulation, and the more valuable to disappear. There is an apparent paradox in the operation of Gresham's law. Ordinarily, people are led by their self-interest to choose the commodity which is better and reject the one which is worse. In the case of money, however, they seem to keep the bad and reject the good. The apparent paradox is easily explained if we regard the owner of money as a seller rather than as a buyer. He keeps the inferior money because it will serve his purpose for payment ; he sells the better goods because he can get more for them in that way. But it is not always the case that two articles which differ some- what in quality, yet are so nearly alike that either serves fairly well the purpose of the other, will command different prices. They will sell at the same price if the demand is strong enough to need all of both, provided the price is high enough to offset the superior cost of production of the one which is more expensive. This is the case with coins of unequal bullion value. If the demand is not large enough to use all of both, part or all of the better coins will be withheld from circulation by tale, and held at a higher price as bullion. We thus find, as a limitation of Gresham's law, the condition that the aggregate of good and bad coins must be in excess of the country's need for cir- culating medium. To put the matter in another 54 THE CURRENCY way, we may say that if business is so large and brisk that it needs all of both kinds of coin to per- form exchanges, the demand for them for mone- tary purposes raises the value of the inferior coins to equality with the bullion value of the full weight coins. This cannot be exceeded because the heavier coins will not be taken anywhere for more than their bullion value. If there is any further increase in the purchasing power of coin, foreign coins or bullion will be imported, as we shall see later, and the value of the home coin will not be able to rise above the high-water mark of the value of the bullion in the full weight coins. Again, an inferior money will not circulate in opposition to custom or public opinion. Perhaps the most notable historical instance of this fact was found in California during the Civil War. The people of California would have none of the greenbacks issued by the government; public opinion was against their use. In consequence, gold continued to be the money of California while the rest of the country was using paper. Sometimes, too, a law which requires the use of a specified kind of money may prevent its entire displacement by an inferior currency. An illus- tration of this is found in the state of affairs that prevailed in this country in the early fifties. Through the operation of the independent trea- sury law, which forbade the government to keep the public money in banks or to accept bank notes in payment of public dues, gold coin was kept in 55 MONEY circulation in spite of the tendency exerted by the small notes of the banks to drive it out 1 The last illustration given suggests a wider ap- ' plication of Gresham's law. It operates not only when the currency is of one material, with its parts of different values, but also when the cur- rency consists of two or more forms of money such as gold and paper, or gold and silver, pro- vided both forms are legally usable in the payment of debts. There are many historical instances of the loss of metal money by a country on account of the issue of paper. In our own country the most notable occurrence of the kind was the suspen- sion of specie payment and loss of gold on account of the issue of greenbacks during the Civil War. A less obvious, but equally correct, illustration is found, however, in our monetary experience under the operation of the Sherman law of July 14, 1890. According to that law the Secretary of the Treasury was compelled to buy four million ounces of silver monthly, and to issue notes on the basis of the bullion thus secured. It was the anticipation of the friends of the measure that these notes, when they went into circulation, would increase the currency of the country and raise the level of prices. Their issue had no such result. The export of gold from the time the notes be- gan to be issued until July, 1893, almost exactly 1 Kinley, "The Independent Treasury of the United States," p. 62. 56 THE CURRENCY equalled the amount of notes put in circulation. The gold exports were $141,017,158, while the note issue was $140,661,694. Gresham's law operates because most people are completely under the influence of habit in their use of money, and only a few keenly alive to their interest in the matter. Few people have any knowledge of the laws enacted to regulate circulation. They take a coin or a note because it looks familiar. A coin may be overweight, but most of us take no notice of the fact and seek no profit from it. The force of habit in money mat- ters has sometimes been curiously shown by the difficulty of getting new coinage into circulation. Austria, for example, has found it necessary to coin the Maria Theresa dollar down to a very late date because the people of certain countries with which she trades have been so long used to it that they would use no other. Similarly the Spanish silver dollar has been hard to displace in some parts of the Orient. We thus see that Gresham's law needs to be carefully stated in order to make it describe the facts accurately. It is really a law of tendency, and must be stated hypothetically. We might put it thus : If more than one form of money is legally usable in a country, and if one of these is more valuable for some other use than it is for making exchanges, then the inferior portion of the cur- rency will supplant the superior to the extent that the two portions together exceed the need for cur- 57 MONEY rency in the country, provided that public opinion or any other economic force does not interfere with the operation of the self-interest of dealers in money. Gresham's law is really a limited statement of a more general principle, which may be thus f ormu- . lated : When a community in which competition is free and intelligent^ has a choice of means of payment, it will use the least expensive which will serve its purpose under existing circumstances. Or, still more generally: In a community in which competition is free and intelligent there is a constant effort to perform every economic service by the agency which yields the largest net results. CHAPTER V SERVICES AND NATURE OF MONEY REFERENCES: Hadley, A. T., Economics, pp. 181-185 ; Indian- apolis Monetary Commission, Report of, 1898, Pt. I., 1-18; Jevons, W. S., Money and the Mechanism of Exchange, Chs. 3, 5, 6 ; Knies, K., Das Geld, pp. 146-237 ; Laughlin, J. L., Principles of Money, Ch. I ; Laveleye, E. C., La Monnaie et le Bimetallisme International, Ch. 2 ; Nicholson, J. S., Money and Monetary Problems, 5th ed., Pt. I., Ch. 2 ; Scott, W. A., Money and Bank- ing, Ch. i ; Walker, F., Money, Chs. 1,2; White, H., Money and Banking, Ch. I. 1. Definition of Money determined by its Services. The word " money/' like so many other terms in economics, has different meanings, both in popular and in scientific usage. It is clear from what has been already said that no definition of money can be framed on the basis of the material of which it is made. . Whatever view is taken of the nature of money must be derived from the determination of its services or functions* To these services we must now turn our attention. The functions of money may be described as essential, or those which are necessary in all eco- nomic stages; as derived, or those which flow from, or are dependent on, the essential services ; and as contingent, or those which flow from the conditions of a particular economic stage. 59 MONEY 2. Essential Services of Money. The essential i services of money are measurement of value and fa- cilitation of exchange. The earliest service that can be called properly a monetary service was to enable an individual to buy directly what he wanted. In other words, the service rendered was to make it unnecessary for each individual to seek a buyer for his goods in the quantities that he had to sell, who had at the same time the articles he wanted in the quantities he wished to buy. The money article remedied this lack of coincidence in bar- ter. This service is fundamental whatever the stage of economic life, but is more important the farther the division of labor is carried. The extent to which this division can go, indeed, de- pends on the extent of the "general acceptability " of money. In an advanced economy, therefore, the emphasis must be laid, so far as concerns this function, on the fact that money promotes the division of labor by facilitating the distribution of its products. The money is a general exchange and circulating medium. It performs this service because it is accepted without question. It is taken because of the knowledge that others will take it in turn. There is no thought in the mind of him who has it that the ability to part with it depends on the promise of any third party to redeem it, or that it can be used for another purpose if it fails to pass. Its success in doing its work depends simply and solely upon the fact that it is in de- mand for the purpose of doing that work. A 60 SERVICES AND NATURE OF MONEY person who accepts money in discharge of obliga- tions due him has no thought of recourse in case of its failure to pass. The second essential service of money, that of measuring value, is inseparable from the discharge of the first, and doubtless is as old. Certainly if a person takes a thing in exchange for goods which have a certain value to him, intending to give away the thing he takes for some third article, he natu- rally expects to get something that will cause him no loss. He would not sell his goods without com- paring their value with the purchasing power of the money in terms of the things he wanted to buy. There has been some dispute as to the nature of this service of measuring value, some question whether it is truly a function of money to measure value. Some writers insist that money serves sim- ply as a common denominator of value ; that it is a term in units of which the values are declared, and does not in any true sense measure. This position has arisen partly from a wrong theory of the nature of value, and partly from an effort to find room under this theory for inconvertible pa- per money, and other things which perform the functions of money, but are said to have " no value in themselves." It is argued that because paper money has virtually no cost of production, it has, therefore, no value, and cannot serve as a measure of value; that, moreover, all values are ratios of exchange, and that ratios cannot be measured, al- though they may be compared. But value in the 61 MONEY sense of ratio of exchange is merely relative value. If we use the word in this sense, regarding value as a ratio whose numerator is a number of units of some article and whose denominator is the mone- tary unit, then we may say that money is a com- mon denominator of value. In other words, money properly may be called a common denominator of relative values. But relative values are simply the ratios of quantitative, or real, values. For value is best conceived of, not as a ratio, but as the quan- tity of marginal utility of an economic good. Now a quantity may certainly be measured, but the unit of measure must be of the same nature as the thing measured in this case, a selected amount of value. The amount of value in a chosen quan- tity of any article may be this unit. Now any article, including money, for which there is an effective demand, has value; and consequently the value in a certain amount of money may serve as a unit of measure of the values of other things. When, therefore, we say that money is a measure of value, we are using a short expression for the statement that the amount of value in a unit of money may be taken as a unit of measure of the value of goods. We say, for brevity, that the money measures the value, just as we say that an arc measures an angle, although we know that strictly the unit of measure of angular space must itself be an angle. Value is present in inconvertible paper money as truly as in commodity money, like gold and 62 SERVICES AND NATURE OF MONEY silver. Commodity money, however, has other than monetary uses. It has direct utility, and therefore value independently of its use as money. But part of its value is certainly due to the demand for it for monetary purposes. Incon- vertible paper money has no direct utility and no specific value. Its value is derived wholly from the demand for it for monetary purposes. The difference between the two kinds of money is, therefore, a difference in the bases of their value. The difference is not that one has value and the other has not. Value is present in both, and can be used to measure value in other things. So far as concerns the fact of the performance of the function, it makes no difference that the value of the commodity money is in its origin twofold, while that of the paper money is single. Money expresses the value of other things in ' prices. Price is, generally speaking, the amount of value contained in goods expressed in units of value of one article. As the thing which is com- monly used for the purpose is money, we are ac- customed to think of price as the amount of money which a thing will bring or which is necessary to buy it. 3. The Derived Functions of Money. The sec- ond class of the functions of money are involved in the discharge of the essential services that have been described. They are, to serve as a standard of deferred payments, to transfer value, and to store value. 63 MONEY The function of acting as a medium of payment of debts is not quite identical with that of facilitat- ing exchange. An article may serve as a means of payment without being a medium of general cir- culation and exchange. Wherever a credit system exists, a considerable time may elapse between the creation of a debt and its payment. As it is al- ways desired to have the payment of a debt return an amount of goods which will restore the equities between creditor and debtor, if these have been disturbed by changes in the value of money, the article used as a means of payment serves as a standard of deferred payments. Closely connected with the services of transfer- ring value from time to time is that of doing so from place to place. Money serves both for the place-transfer and the time-transfer of purchasing power. Both functions require that money shall serve as a storer of value. Objection is sometimes made to classing this as a money function, on the ground that a thing which is storing value cannot be serving as a medium of exchange. But an arti- cle cannot act as a medium of exchange unless it retains its value, and this retention of value through a period of several exchanges is certainly storing value. The objection would limit money to what was in actual circulation. But is so-called idle money not money ? Are the coins which the child has gathered in his little box not money ? Is money money only when it is in use ? To say this is to confuse the thing with its service. Steam is steam 64 SERVICES AND NATURE OF MONEY in a locomotive cylinder even when the locomotive is at rest, and the locomotive itself, though stand- ing still, is yet a locomotive. Surely we must in- sist that the idle gold held by banks be called money, although for the time being it is only serv- ing the purpose of conserving value, until the time comes when its potential force shall become active. Since money is generally acceptable and valu- able, it embodies value in its most general form. To transfer money is to transfer generic value, to pass over wealth and capital in their most mobile form. It is because it represents generic value that money is a good storer of value. Any durable article might be used to store value, but it is the value of money only that we can be sure will keep. For the demand for other things may fall away, but money is always acceptable. __ 4. Contingent Functions of Money. The con- tingent functions of money are those which arise from the characteristics of the stage of economic life in which it is used. They are at least four in number : the distribution of social income, the equalization of marginal utility in expenditures, the furnishing of the basis of a credit system, and the imparting of a general form to capital. Money is a distributer of the product of social industry. Without money, or its equivalent, the apportionment of the product among the various producers would be impossible in a stage of highly specialized labor, for otherwise each would have to get in kind his proportion of everything he helped F 65 MONEY to produce. Even then he would find it necessary to exchange for other things, since few men con- sume what they produce. Money enables each to get what he wants. The second of the contingent services is to en- able individuals so to adjust their expenditure that each unit of money spent shall bring them goods of the same marginal utility, and thus give them the largest value for their money. That is, with money each one can buy the goods that afford him the largest consumer's surplus of utility. In this way a money income brings to most individuals gains which are no man's losses. Money further serves as a basis of the vast structure of modern credit. It is a cash reserve to insure solvency, to guarantee the payment of the balances of credit transactions. "If we have a proper cash reserve of money, we can use other things as media of exchange. ... If we have not an adequate reserve of capital in the form of money, no credit system, however well devised, will act as a substitute." l The money itself is not intended for use as a medium of payment. It is used to create other media of payment, and is itself called into direct use as such only when in the round of business these other media fail to balance one another. This contingency is likely to happen at any time and, indeed, is happening all the time. Provision to meet it is necessary in order to prevent the collapse of the superstructure of credit media 1 Hadley, " Economics," p. 181. 66 SERVICES AND NATURE OF MONEY of payment. This use of money as a reserve for credit payments has grown greatly in compara- tively recent times, and is due partly to the modern method of doing business on borrowed capital. It manifests itself in the great development of bank- ing which the past century has seen. In earlier times the principal form of credit paper was the bill of exchange, which rested for its security on the goods it represented. Now the check, which represents the vast volume of bank deposits, is doubtless the most widely used form of credit paper. 5. Money the Embodiment of Generic Value. Finally, modern business utilizes money, as the embodiment of generic value, to give a liquid form to capital. There is always a certain amount of capital which is actually, or potentially, free to seek new employment. It can do so quickly be- cause it can be kept in a state of high mobility in the form of money. Does a new field of enter- prise open ? Money flows at once into that field. It is not, of course, meant that money, as money, is a productive agent. Money flows into the field, in the sense that it is passed in exchange for ma- terials and machines which can be used in the new field. These either come from other uses, or, in a brief interval of time, they are made ready for use in the new field. Thus money extends production and exercises an influence to keep it at its maxi- mum. Hence it is that nowadays a great aim in the business world is to get command over money, 67 MONEY as general capital, in order to take advantage of any opportunity to turn that capital to productive uses in any direction. Since money is the embodiment of generic value, it confers on its possessor a social and economic power which attaches to no other form of wealth. It gives him general command over the goods and services of others, so far as these are for sale. His market is the whole field of salable goods, whereas that of the would-be seller of other articles is limited. He has a certain monopoly advantage, arising from the universality and certainty of the demand for money. 6. Definitions of Money. These being the ser- vices of money, how shall we define the term so that it shall be sufficiently exclusive ? The word is used in various ways, and it is quite difficult, if not impossible, to frame a definition which will conform to the different uses and at the same time satisfy the demands of logical definition. In common usage there are three general mean- ings, or groups of meanings, for the word money. It is sometimes used to describe all media of ex- change, gold, silver, paper, checks, bank drafts or the deposits which they represent, commercial bills of exchange, and even corporation stocks. These things all effect exchanges ; in a way they all relieve the difficulties of barter. This definition, however, is too inclusive. Its error lies in including media of exchange which are not general circulating media. If this particular definition is taken, one must in- 68 SERVICES AND NATURE OF MONEY elude several things which effect exchanges be- cause those who accept them know that they have a recourse to recover their goods if these things should fail to pass. These articles do not attain general circulation, they do not attain the character of media of exchange because there is a demand for them for that purpose primarily. It is out of place to apply the name " money " to the whole group of things which are used to effect exchanges and make payments. The medium of exchange in- cludes money, but its content is greater than that of money. All money can be medium of exchange ; but not all medium of exchange is money. At the other extreme is a group of definitions which would restrict money to what may be called commodity money. Those who hold this view in- sist that money is an article of direct utility, with specific value based on its direct use for consump- tion. They hold that it must have value due to a demand for it for other than monetary purposes. The implication is that in the absence of this other demand the article would not have value, and therefore could not properly serve as a measure of value. We have seen, however, that this is not correct, because the article has value if there is a demand for it, whatever the reason for that de- mand. Common usage, moreover, is against this use of the word. May we say that the people of the United States had no money between 1862 and 1879, because the metals had been driven out of use by inconvertible paper? That would be a 69 MONEY hard saying and few would believe it. This view of the nature of money is certainly definite and clear-cut, and capable of easy definition ; but these advantages do not balance the objection that com- mon usage is not in accord with it. Between these two extremes is the view that all media of exchange and payment, whose acceptance the law requires in discharge of debts, may prop- erly be called money. Of course standard money would ordinarily be covered by this definition ; but so, also, would inconvertible paper, if it were legal tender. For legal tender inconvertible paper cer- tainly can measure value and serve as a general exchange and circulating medium. It can measure value because it possesses value, derived from the demand for it for money use. It is a general ex- change and circulating medium; for, like com- modity money, its acceptance does not depend upon the credit of any individual or corporation. Both kinds of money circulate without reference to the possibility of recovering their value from the payer if they should fail to pass, and their value as money depends entirely on the fact that they are generally acceptable in exchange ; whereas all forms of paper currency other than inconvertible paper depend for their value upon the fact that if any one refuses to take them in payment, the holder has recourse against the issuer. This position seems sound,- and we may accordingly limit the term "money" to that part of the medium of ex- change which passes generally current in exchange 70 SERVICES AND NATURE OF MONEY and settlement of debts, without making the dis- charge of obligations contingent on the action of a third party, or on the action of the payer by promising redemption if the money article does not pass. From this point of view, legal tender \ inconvertible paper, and all commodities which are \ used as general circulating and paying media, are \ properly called money. 7. The Fundamental Cause of Superiority of Commodity Money. Although, logically, legal tender inconvertible paper is properly called money, in practical use it is incomparably inferior to commodity money. There are several reasons for this inferiority, some of which we shall have to consider later, when we are discussing paper money. Here it is sufficient to notice that its sta- bility of value is far less than that of gold or silver. The value of commodity money, the supply being approximately fixed, rests upon two sources of de- mand, the demand for use as a commodity, and the demand for use as money. Even if the mone- tary use of the article should cease, it would not wholly lose its value. Now inconvertible paper money derives its value solely from the de- mand for it for monetary purposes. Its basis of demand is, therefore, narrow, and its value less stable. Moreover, it is accepted only within the political circle within which it is recognized as money ; whereas commodity money is accepted in any place where the article of which it is made is used either for monetary or for other purposes, or. t MONEY for both. Of course it is conceivable that gold and silver might go out of fashion and the demand for them fall off. The likelihood of this, however, is infinitely less than is the likelihood that a govern- ment which issues paper money may fail to redeem it on demand. In the case of one kind of money, the basis of value is general and permanent ; in the case of the other, it is likely to be contingent upon the continuance of the government that issues it, and upon the economic condition of that govern- ment. The instability which this difference pro- duces in inconvertible paper is sufficient to condemn it as something which should never be resorted to by sound and honest governments. 8. Characteristics of Good Commodity Money. - We have seen that a great many different arti- cles have, at one time or another, been used as money. There are certain qualities which the article in use as commodity money should possess in order to perform its functions to the best advan- tage. These may be enumerated as follows : (a) It must in the first place be capable of be- ing exchanged in all ratios, and should be suitable to make payments in all sums. Hence it must be easily divisible and homogeneous, so that its value divisions may correspond with its physical divisions. Not only must it be divisible for this purpose, but it must be, so to speak, aggregatable ; that is, por- tions of it must be capable of being put together into a single mass without loss of value. A dia- mond is certainly divisible ; but two small diamonds 72 SERVICES AND NATURE OF MONEY are not as valuable as one large one whose weight is equal to that of the two, and if it were possible to fuse two small diamonds into one large one, its value would be greater than the sum of the values of the two. Neither of these conditions should exist in the case of an article used as money. (b) In the next place, the article thus used must possess value, in order that it may measure and store value. As has been pointed out, this value may be due simply to the demand for it for monetary purposes. But an article of direct utility, and, therefore, of specific value, is for many rea- sons preferable to one whose utility is merely in- strumental, and whose value depends simply on its service as a medium of exchange. As we have seen, it will have greater stability. (c) In the third place, the article chosen should have a steady value. That is, its purchasing power should remain reasonably constant, from time to time, and from place to place. It must do this if it is to serve well for storing value and for acting as a standard of deferred payments. There seems to be a certain inconsistency in speaking of an article as a standard of value and as varying in value. If an article is a standard of value, how can we regard it as variable ? There is some difficulty in telling just what is meant by steadiness of value. We shall see later that there are two or three meanings of the phrase, " variation of value/' in this connection. For our present pur- pose it is necessary only to fix in mind firmly the ^ MONEY fact that variation is possible. It is important, therefore, that it should be reduced to a minimum, and that the article selected for monetary use should show as little of it as possible. In other words, the purchasing power of the monetary stand- ard should not vary from any cause, except those which arise in the articles whose exchange it is used to effect. The perfect money should not vary from causes that arise in the conditions of its own supply. Of course it is not possible to secure an article that will meet this condition. (d) The article used as money should also be durable, or, as is usually said, indestructible. If it does not possess durability, it will not serve as a means of transfer of value from place to place and from time to time. Moreover, it will not bear handling well, and a large loss would be incurred by the wear and tear to which the coins are sub- jected by daily use. It has been found that the precious metals, gold and silver, in their pure state, wear away too rapidly from usage. Coins, there- fore, are usually made of a mixture of one of these metals with some baser metal, to form an alloy which has the necessary durability. (e) The money article should be cognizable, or easily recognized. If it were not so, people who are ignorant of its character, or who do not see it fre- quently, would constantly be subjected to fraud. Business would be much hindered if it were neces- sary constantly to test the article offered in pay- ment of purchases and debts. A glance must 74 SERVICES AND NATURE OF MONEY suffice, aside from a case of probable fraud, to satisfy the receiver of the coin that it is composed of the genuine metal. (f) The article used as money should also be malleable ; that is, it should possess the physical character suitable for coining and imprinting. It must not be so brittle as to break easily, or to take too sharp an impression under the die. On the other hand, it must not be so soft that it will not retain for a considerable time the impression stamped upon it. (g) Another characteristic which the money article should possess is commonly described by saying that it should have much value in small bulk. By this is meant that it should have a high sgecificjralue. The word high, of course, is rela- tive, aricTmust be interpreted in this connection to mean as high as the ordinary payments and in- comes of a community call for. The scale of in- comes and purchases in any place determines the value of the money in general use. Copper serves in China, whereas gold is needed in the United States. In each case, however, the value of the coin is large for its bulk, relatively to the needs of the community. It is clear from an enumeration of the character- istics needed for good money that no one article is available that possesses them all. The relative im- portance of one or another of these requisites is determined by the commodity which a community uses. Every community has used that which has 75 MONEY best met its necessities, that which has satisfied the universal demand more generally than any other article could do. It is generally admitted that the precious metals combine in a higher degree than any other substance, or substances, the qualities necessary to make a good commodity money. Gold and silver are homogeneous, divisible, cogni- zable, and malleable. "It is clear," as Professor Jevons remarks, "that the metals far surpass all other substances for purposes of circulation, and it is almost equally clear that certain metals surpass all the other metals in this respect. Of gold and silver especially, we may say with Turgot, that, by the nature of things, they are constituted univer- sal money independently of aU convention or law." 1 We may notice here a question to which we will find it necessary to recur. If a single substance, like gold, while possessing most of the attributes necessary to make good money, is yet lacking in the very important quality of steadiness of value, would it not be possible to use something else as a stand- ard of value while retaining the gold as a medium of exchange ? In other words, could we not sepa- rate the functions of money and assign different articles to perform the monetary services ? It is not only possible, but, as we have seen, we actually 1 Jevons, " Money and the Mechanism of Exchange," p. 53. Of course, Turgot's remark can only mean that gold and silver, by their natural qualities, best fulfil the requirements of the money substance, and hence need no law to compel their use. 7 6 SERVICES AND NATURE OF MONEY do so to a limited extent. The article used as a standard may be different from the actual medium of exchange and from the money of account. Gold is the standard_jn this country, but in our ordinary payments 'we use paper, copper, silver, corn, and other things. 77 CHAPTER VI * THE MOVEMENT AND DISTRIBUTION OF METALLIC MONEY REFERENCES: Laughlin, J. L., Principles of Money, Ch. 10; Nicholson, J. S., Principles of Political Economy, Vol. II., Ch. 26, 1 1-15 ; Noyes, A. D., Thirty Years of American Finance, Ch. 7; Raguet, C., Currency and Banking, Ch. 4 ; Report of the Indian- apolis Monetary Convention, pp. 145-158 ; Mill, J. S., Principles of Political Economy, Bk. III., Ch. 21; Ricardo, D., Works (McCulloch's ed.), pp. 79-86, 263 ft; Walker, F., Money, Ch. 3. 1. Emphasis laid upon the Supply of Money. - How to secure for their respective countries what was regarded as their proper share of the precious metals, was long a matter of considerable solici- tude to statesmen, and much legislative ingenuity has been expended at various times to accomplish this end. There have been laws hampering the exportation of the precious metals, or even forbid- ding it altogether ; and other laws whose aim was to encourage the importation of these metals, on the supposition that the more of them a country got, the richer it became. We know now that this is not true ; yet much of our monetary legislation is still colored by the old idea, and not a little anx- iety is felt at times lest we may at some time fail to have on hand all the money that is necessary 78 DISTRIBUTION OF METALLIC MONEY to do business. Nothing is more certain, however, than that a country with a sound monetary system is sure to get, and to retain, its due proportion of the money supply of the world, and that special efforts to bring about this result by mere legisla- tion are unnecessary, unfruitful, and likely to be positively harmful. 2. The Division of the Precious Metals depends upon the Relative Demand of Different Countries. No new principle of exchange is involved in the ex- planation of the distribution of the precious metals. | Like other goods, gold and silver distribute them- } selves according to the demand for them. Wher- ever most is offered for them, there they will go. * They will flow out from places where their value is low to places where it is high. If gold and silver were the only means of pay- ment in use, each country would draw to itself a proportion of the total supply determined by the state of its commerce and industry, the amount of its wealth, and the frequency and magnitude of its ordinary payments. The stock of gold at any moment, and any new supply, will be apportioned according to the relative strength of the demands of different countries for these purposes, and this division will be unchanged as long as the proportions of demand remain the same. For, since demand and supply are in equilib- rium, there can be no motive to get more money, or to part with any that is on hand. The proportions of this division of the metals are 79 MONEY independent of their amount. No matter what the total quantity, the proportion which each countr) will draw to itself is governed entirely by the strength of its demand as compared with the total demand No country can long keep more than its due pro portion. Even a country which has mines cannol retain the entire output of them, but only such part as represents the ratio of its need to the tota' demand. We must not infer, however, that because the distribution is not affected by the total quan- tity, it is not a matter of importance whether the amount of money in circulation is large or small for it is of great importance to have an adequate amount of metallic money in a country. The poinl is that, whatever the actual amount, the part which each country gets is fixed in the way described. 3. The Value of the Precious Metals not every where the Same. It is asserted by the classical theory of the distribution of the precious metals that if, at any moment, the distribution of the ex- isting stock be supposed to be effected, then the metals " preserve everywhere the same value." A better form of statement would be that, the rela- tive values of the metals once established, any change in their supply will so distribute itself that these relative values will be maintained. This does not mean that an ounce of gold will buy as much in China as in Germany or the United States. For the comparative purchasing power of the metal in two places depends, in part, upon the expense of transportation, both of goods and 80 DISTRIBUTION OF METALLIC MONEY money, on insurance, and on the proportion of goods, not articles of international trade, which enter into the total quantity of commodities that the gold will buy in each country. There is one price level for goods which enter into international trade, and another for goods which have only a national market. The equi- librium which results from the pressure of de- mand for money for these two classes of goods may be called the national price level of a coun- try. These national price levels, acting on one another, produce the international, or world, price level. It is this international price level which is of consequence in determining the distribution of gold. There is no way of effecting changes in the relative monetary holdings of communities which have no trade, or market, relations. The law of distribution implies simply that the price level of one country is in equilibrium with that of others with which it has trade relations, so that any dis- turbance of prices in either is likely to cause a cor-^ responding change in the other. 4. Changes in Prices, and the Movement of the Precious Metals. According to the doctrine laid down by Ricardo, and commonly accepted by writers on the subject, it is through changing prices that a country rids itself of a surplus of money, or supplies a deficiency. If we suppose that, at a chosen moment, the trade of the world is in such a state that the exports and the imports of each country exactly balance, and that no coun- G 81 ' MONEY try owes a debt to any other, then there is no rea- son to suppose that the proportions of the holdings of the precious metals will be disturbed. If, how- ever, from any cause, the demand for the merchan- dise of one country increases, so that higher prices are offered for it, then that becomes a good coun- try in which to sell goods, and a poor one in which to buy. % Under such circumstances foreign goods are imported, in order to take advantage of the high prices. In other words, money has become relatively cheap, and therefore tends to go abroad, since we send abroad in payment of our foreign debts the articles which we can best spare, and which are, therefore, cheapest. The importation of goods tends to make them abundant, and therefore prices tend to fall again. Meanwhile the process is reversed in other countries. Thus an equilibrium of prices throughout the world is reestablished, and the money of the world is still distributed among the nations in due proportion. 5. Price Changes not necessarily followed by a Movement of Specie. As the theory is usually expounded, the disturbing cause of the existing distribution of the precious metals is supposed to be a new supply of the metals from the mines. This extra supply,, going into circulation, raises the price level of the country, foreign goods are im- ported, and some of the metal exported. The ex- planation is good, so far as the new gold, if it be gold, goes into circulation without displacing other media of exchange. It is far more likely, however, 82 DISTRIBUTION OF METALLIC MONEY to find its way promptly into the bank reserves of the great money centres, and to move abroad under the influence of international banking requirements, without influencing prices at home. The more usual case is not that of a change in the money supply, but in the cost and supply of articles of export. When such a change occurs, and prices alter because of it, an exportation or importation of specie is not a necessary conse- quence. Aside from the expedients, which will be discussed later, for preventing such a move- ment, it will not occur in any case unless gold is the article which the country affected can most / easily spare. Ordinarily, the balance of trade will be restored by readjustments in the prices of exports and imports. Let us assume as strong and simple a case as we can, in order to bring out the relations in question. Let us take the case of two countries, A and B, isolated from the rest of the world, but trading with each other. Let us suppose that they use the same kind of metallic money, and that neither employs credit, but that all the balances of their trade are settled with specie. Suppose, now, that, on account of decreased cost of produc- tion, some of the goods of country A become cheaper. Then the price level will fall somewhat, and goods will be more largely exported. Let us suppose that the increase of exports is such as to take out of the country A the whole amount of those goods over and above the amount which, MONEY on the new scale of prices, will necessitate the u se of the same volume of money as before. There is, thus far, no ground for supposing that specie will move into, or out of, the country. The goods exported are taken to country B. Here these goods have been exchanging for home products at certain rates. More of the imported articles are now offered for the goods of the receiving country than was previously the case. If we could assume that no more of the goods of coun- try B would be given for the imports than for- merly, we would be obliged to admit the possibility of a movement of specie from B to A. As a mat- ter of fact, a larger volume of foreign goods offered for home products will draw out a larger quantity of these products in exchange. The home prod- ucts will fall in price. The ratio of exchange will alter so that both countries will get some of the advantage arising from the lowered cost of the goods exported by A. The price level will fall to a point at which there will be a new equilibrium of exchange between the imports and the home products. Meantime a larger amount of goods has been sent from B to A. The price level will fall there also, with the net result that there oc- curs a fall in the price level of both countries, such that their average prices bear to each other the same relation that existed before, without any movement of specie. We supposed that the whole surplus of the cheapening goods of A was exported to B. In 84 DISTRIBUTION OF METALLIC MONEY practice this will hardly be the case. Such part of them will go to B as will cause the ratio of exchange between its home goods and its imports to come to an equilibrium, at the same point as is reached by the changing ratio of exchange in the first country between its increasing home goods and its increasing imports. That is, as before, the price levels of the two countries will come to rest in a ratio which will render unnecessary any change in their specie holdings. The fact of the matter is that specie will be ex- ported only if it is the cheapest article which the importing country at the moment possesses. There is no ground for saying that gold is more or less likely to be exported than is any other article in order to adjust a balance of international trade. The usual case would be that a disturbance in the price level will be met by a change in the balance of exports and imports of goods, without any move- ment of specie at all. If either country has mines, gold will be one of its regular articles of export ; but it will be exported, not to readjust a change in the price level, but simply as part of the general current of international trade. Even if the increase of a country's exports were caused by the production of an entirely new article of exportation, we could not say with certainty that there would be a movement of gold to pay for it. For it might simply replace articles already in use, and transfer the money demand for them to itself. 85 MONEY That the Ricardian explanation is too simple and sweeping is evident, again, from the fact that the amount of money which it would be necessary to export, in order to readjust the general price level, would be a considerable portion of the specie of the exporting country, but an infinitesimal part of that of the world at large. We would have, therefore, a large proportional change in the specie holdings of one country, and an indefinitely small one in those of other countries. Obviously, if it re- quired the exportation of one thousand ounces of gold to adjust a price change of two per cent, in one country, it would take many times one thou- sand ounces to cause a similar change in the price level of the world at large. The remedy for the restoration of the disturbed price level is not adequate. The Ricardian theory applies in what mathematicians would call limiting cases, and only there. If all international trade were carried on by means of direct and immediate money pay- ments, and if all countries used the same standard metal, there would undoubtedly be a movement of specie whenever a general decrease in the cost of production of goods in one country led to a fall of its prices and an increase of its exports. 6. The Ricardian Theory modified by Economic Friction. In the case of an exportation of specie which is in fact a result merely of the disturbance of trade balances, certain assumptions must be made in order that the explanation may square with the facts. The first of these is that the flow of gold 86 DISTRIBUTION OF METALLIC MONEY and the adjustment of prices is immediate, com- plete, and without expense. In no case is this true. The flow of gold is not immediate, its distribution not instantaneous. Let us suppose that a new supply of gold is added to the world's stock: Part of it will go for use in the arts, and the rest will be devoted to monetary purposes. The latter portion, if it is large, might take a long time to distribute itself among the industrial nations in such a way as to restore the equilibrium of world prices ; and during the intervening period there might be dif- ferences in the price level in different countries. The distribution is accomplished only with appre- ciable intervals in its flow, by jerks, as it were, as the new supply passes from one market to another, from one country to another. As Cairnes remarks, " Gold and silver, like all other things which are the subjects of international exchange, possess local values." l It is by a succession of operations on these local values that the distribution is gradu- ally effected. The accuracy of the principle of the distribution of the precious metals, as usually explained, is modified, further, by the fact that the equableness, as well as the period, of distribution of a new sup- ply depends somewhat upon the place in which it f first appears. A new supply of gold in a country that is industrially backward, and in which banking facilities are but little developed, will flow out into the world less freely than it would from a country 1 Cf. Cairnes, " Political Economy," pp. 408-410. 87 MONEY whose conditions were the reverse. It is true, however, that this circumstance has largely lost its importance now, because the different parts of the world are in much closer communication than they ever were before, and banking facilities and con- nections are far more general. Notwithstanding this fact, it costs more to get gold to countries far from the mines than to those near by. Hence the share which would fall to a remote country, accord- ing to the unmodified principle of distribution, would be larger than it would actually get, because its demand would be lessened by the expense of securing the supply. In the next place, the rapidity and the equable- ness of the flow of the precious metals are affected somewhat by national, or local, customs and prej- udices, as well as by legal enactment. The silver of Potosi reached the marts of the world in a different order and period from what it would have required if the laws of Spain and the eco- nomic prejudices of the country had not turned it first into the coffers of the Spanish treasury. A country whose religious ceremonies lead to a large use of the precious metals would part with a new supply from its mines less rapidly than would another country without such prejudices. In the fourth place, different commodities and different employments would respond to the influ- ences of the new supply of gold with varying de- grees of rapidity and sensitiveness. Employments whose remuneration was strongly influenced by cus- 88 DISTRIBUTION OF METALLIC MONEY torn would respond slowly. The prices of goods would be found to be affected differently, according as we considered wholesale or retail trade, or mar- kets far from, or near to, great centres of trade. 7. Influence of the Credit Mechanism on the Distribution of the Precious Metals. All these considerations make the distribution of the precious metals very different in fact from what it would be if the assumptions involved in the principle of distribution, -as-eommonly formulated, were true* Yet they do not invalidate the principle, for they in no wise change its character, and it could easily be stated in a way which would include and allow for all the factors of disturbance so far mentioned. The case is far different when we examine another assumption implied in the general statement of the mode of distribution ; namely, that the medium of payment is homogeneous. The fact is quite other- wise; the medium of exchange is highly heteroge- neous, and this heterogeneity modifies the principle of distribution, not merely by causing friction, but in a way to change its character entirely. The chief factor in making the medium of ex- I change heterogeneous, and in modifying the prin- I ciple of distribution, is the credit system. Credit not only alters the amount of the precious metals which a country gets, in the first place, but it acts as a buffer against sudden changes in this amount. Under the modern credit system, a country's sup- ply of metallic money does not depend more on its wealth and industry and the frequency and magni- r^ MONEY tude of its payments than on the extent of its use of credit and the delicacy and complexity of its credit system. In countries where the credit sys- tem is most highly developed, the amount of me- tallic money used is relatively less than in other countries, despite the fact that it is in the former cases that the total demand for medium of ex- change may be the greater. |The precious metals are distributed principally according to the need for them as a basis of credit. The more complex the credit system, the less metallic money, rela- tively, is needed for its support, and the greater the volume of payments made with a given supply. 8. The Effect of the Use of Bills of Exchange on the Movement of the Metals. Not only does credit change the distribution of metallic money which the classical theory would make, but it also renders unnecessary some changes which would, in its ab- sence, occur. According to the doctrine, a rise of prices implies an excess of money, and an export of the excess. Now, it is a well-known fact that there may be a very marked change in the price level of a country, that the balance of indebtedness may be considerably in its favor, or considerably against it, without its 1'osing or gaining any specie. Credit has supplied the modern business world with certain devices for the purpose of making the physical transfer of specie unnecessary and saving the expense of it. f The first of these devices is the bill of exchange. Of course, when we speak of one country's being in debt to another, we mean 90 I DISTRIBUTION OF METALLIC MONEY that the business men of one owe those of the other. For example, some people in England owe debts to some in France, and vice versa. Let us suppose that English merchants owe French mer- chants $1,000,000, and that French merchants owe their English correspondents $800,000 of it back again. If the French merchants to whom the English are in debt can have turned over to them in Paris the $800,000 which French debtors have to pay, and if at the same time the English creditor merchants can have their bills paid in London out of the $1,000,000 due the French, then only the balance of $200,000 would have to be shipped from London to Paris. Precisely this process is effected by means of bills of exchange. The English cred- itors draw on their debtors in Paris, and pay them- selves by selling the bills to English merchants who owe money in Paris. These send the bills to their French creditors, who collect them at home. In our example there remains a balance of $200,000 to be paid by the transfer of, specie. But this need not happen. A third country, say Germany, may owe England a trade balance of this amount, while at the same time French mer- chants owe an equal debt to their German cred- itors. The English merchants need only draw bills for the amount on Berlin and send them to their French creditors, who can sell them to the French debtors of the merchants of Germany. These debtors send them to their creditors in Berlin, who collect them from the German debtors 9 1 MONEY of the English. If the balance cannot be cancelled by the exchange of bills among the three countries, it may be offset by the debts of a fourth, or a fifth, and so on. So far may this process go that only a very small amount of specie may pass between different countries in the space of a year for the settlement of international indebtedness. For ex- ample, it has been computed that, a few years ago, the settlement of international trade balances re- quired about one dollar to every seventeen of commerce. 1 Small as this amount is, it is very much larger than what is used per dollar to settle domestic trade balances. In practice, the merchants who draw bills do not seek out fellow business men who have debts to pay in the country on which the bills are drawn. They sell them to banks and brokers, and these in turn sell them to people who have to make remittances. If the bills drawn by the merchants of one coun- try on the merchants of another should happen to be equal in amount to the bills drawn by the mer- chants of the second on those of the first, there would be no need for the transfer of money at all. Usually, however, such a coincidence does not, and cannot be expected to, occur. But, even then, the balance may not be settled by the shipment of money. There are several devices known to the business world for making such a shipment unnec- essary. In the first place, the necessity of settling 1 Muhleman, M., " Monetary Systems of the World," p. 168. 92 DISTRIBUTION OF METALLIC MONEY with gold may be obviated by drafts of merchants of the debtor country on merchants of the creditor country, in anticipation of future transactions. For example, if the merchants of the United States owed those of England a balance representing the excess of the value of imports over exports, they might, instead of shipping gold to London, draw on English grain importers, in anticipation of the sums which would become due American exporters of grain after harvest time. These bills, infuturo, simply serve to prolong the period of credit until a time when settlement can be made by the sale of goods to the creditor country. 9. Other Causes which render Export of the Precious Metals Unnecessary. It is entirely pos- sible, however, that such a use of bills to make a temporary settlement may fail to meet the whole of the balance due. Another means must be sought, therefore, in order to prevent the transfer of specie. It might be done by buying bankers' drafts, instead of bills of exchange. It is not uncommon for bankers with foreign connections to keep balances abroad, on which they sell drafts, when bills of exchange are not sufficient to supply the demands of debtors. They restore their bal- T ances with foreign bankers when the current of indebtedness is reversed. If both of these means fail to liquidate the balance of indebtedness, it may be liquidated by the transfer of securities. The bonds and other evidences of indebtedness which have a world 93 MONEY market are readily and cheaply sent from place to place. The balance of indebtedness due from English to American merchants can be quickly and easily settled, if the Englishmen or their agents sell in the New York market securities equal in value to the debt. The market for secu- rities is, perhaps, the widest and most mobile of all markets. Hence it happens that, nowadays, a balance of indebtedness between countries is much more likely to cause a flow of securities than a flow of money from the debtor country. However, it is conceivable that all these means should fail to offset the balance due, so that it would seem necessary to export or import some of the precious metals. This need not happen, how- ever, for it would be possible for the debtor country to continue in debt, or to pay its debt by borrow- ing money from some third country. This it could do by offering a sufficiently high rate of interest. Indeed, the manipulation of the rate of discount is one of the most important of modern methods of regulating the flow of money. Cred- itors will continue to leave their balances in the debtor country if the latter offers a sufficiently high rate for their use ; but if their need for their money is urgent, other people, feeling less urgency, will be content to lend the debtor country the amount which it has to pay. Even in this case, however, there may not be any actual transfer of money. As we have seen, the creditor country may be debtor to a third country, and may pay its 94 - DISTRIBUTION OF METALLIC MONEY debts to the third country by drafts upon its own debtor ; while the third country, influenced by the high rate of discount, may not demand the pay- ment of these drafts at once. 1 From all these considerations, it is very clear that the flow of the precious metals from one country to another is by no means so ready and complete as the Ricardian doctrine, in its bald form, would indicate. By the devices described, a country may even for a time hold its supply of money at a level relatively higher than that of the world at large ; and during that time many con- sequences of great importance to individuals and classes may occur, because of the difference in level. The mode of distribution of metallic money, which has been described as applicable to the passage of such money from country to country, describes also its passage from place to place within the limits of a single country. We find the mutual balance of trade and of general in- debtedness of Chicago and New York, for example, adjusted by means of direct bills on each other, or on some third place, by bank drafts, bills in future, postponed payment, and, in the last resort, the transfer of specie. 10. The Usual Causes of the Movement of Specie. If a disturbance of credit occurs, mak- ing the uncancelled balance of credit transactions 1 Cf. Goshen, "The Foreign Exchanges," I5th ed., pp. 129, 136, 138. 95 MONEY larger than usual, a larger banking reserve will be necessary, and an importation of specie will very likely take place. |The movement of gold will be brought about by a rise of the rate of discount, or by the transfer of securities, without affecting the price level or the current of trade at all. } On the other hand, an improvement of the banking system of a country may cause an export of specie. For the improvement implies that the country can now do its business with a smaller metallic reserve. Again, a transfer of specie from one country to another may be caused by a change in the ratio of exchange between gold and silver if the countries in question have different monetary standards. In such a case, a rise of silver in terms of gold will exert an adverse influence on the export trade of the silver standard country. For, at the same price level, exports of its goods bring the same amount of gold as before ; but this amount now exchanges for less silver at home. Hence the ex- ports of goods from the silver standard country will fall off, and its imports increase, as will its export of silver. The net result of these movements will be a fall of prices. This fall will go on until it off- sets the change in the gold price of silver. Then the export of silver will stop. \ 'I A permanent growth of the home trade of a country will necessitate a larger amount of specie and cause its importation if the banking system is already supplying all the currency which its pres- ent specie holdings permit. 96 DISTRIBUTION OF METALLIC MONEY 11. The Amount of Money needed by a Coun- y. Closely connected with this matter of the iistribution of the precious metals for monetary purposes is the question how much money a coun- ry needs. The doctrine which we have just dis- cussed tells us something about the method of division of the money supply among the nations of the earth, but it says nothing at all definite of the absolute amount of money that a country should have. There is no known way of telling before- land how much money a country needs. The imount depends upon the population, the total imount of business, the amount of transactions done by barter and credit, the so-called rapidity of the circulation of money, the magnitude of the country's productive enterprises, the development of transportation and communication, the methods of doing business, and general enlightenment. The population of one country may use only a frac- tional part of the money used by the same popula- tion in another country. France, with a population approximately that of England, uses a considerably larger amount of money to do her business. If productive enterprise is great, larger money re- serves are needed, as is also a larger amount of money for the payment of wages. If a million people are crowded together within the limits of a city, so that communication is easy and rapid, they need less money for a given volume of business than if they are scattered over a wide territory. If the banking habit is highly developed, if the H 97 MONEY standard of personal and business integrity is high, so that confidence is general, business settlements will be made largely with credit paper, and less money will be needed. It seems a hopeless task to try to determine either the influences of these various causes, or their mutual relations. We may say with confidence that, " other things remaining the same/' the amount of money used will vary with any one of the other factors we have men- tioned. But that is all. Must we, then, abandon the attempt to reach any definite conclusions on this question ? Of the actual quantity of money needed and the amount of its variation from time to time yes ; on the mode and causes of those variations, however, we may get a little light. This subject we proceed to discuss. 98 CHAPTER VII THE STATIC DISTRIBUTION OF THE PRECIOUS METALS REFERENCES : Jevons, W. S., Money and the Mechanism of Ex- change, Ch. 26 ; Kleinwachter, F., Lehrbuch der Nationaloekono- nie, pp. 343-346; Laughlin, J. L., Principles of Money, Ch. II ; Tucker, G., Theory of Money and Banks, Ch. 5 ; Walker, F. A., Money, pp. 48-49, 57-63, 73-74. 1. Distribution of Money in the Sense of Appor- tionment. The phrase, "distribution of money/' admits of a double meaning. It may signify either the movement of money from place to place, or the division of the existing quantity among dif- ferent countries or groups of people. It is in the latter sense that the subject has always aroused the greater popular interest ; but it is in the other sense that it has received the fuller scientific treat- ment. How much money a community uses, absolutely, or in comparison with other communi- ties of the same general economic character ; what is the composition of its medium of pay- ment ; what proportion of its payments are made with money and what by means of credit; and how, as a r mmunity grows, the constituents of its medium of exchange alter with reference to one another are questions of much interest and 99 MONEY importance, which the classical theory of distribu- tion does not touch, and to which our existing knowledge offers us unsatisfactory answers, if, indeed, it offers any at all. 2. Conditions of the Apportionment. We usu- ally feel obliged to content ourselves with saying that the amount of money which is used by a com- munity depends on its population, the amount and character of its business, the general range of prices, the degree of perfection of its credit machinery, and the ejrtent_tojyhich credit is used. Just what relationsjsxist between the quantity of money needed jind-each of the other factors men- tioned, we cannot say, Injnany. popular discus- sions, and in some scientific ones, the relation seems to be rtg^^od^sjonojoi^^implQ proportion. It is often taken -for-grauted, that twice or thrice as many people will require twice or thrice as much money, " nthgr things remaining the same " ; that a community, with twice or thrice as much business as anotherjnilL use a proportionally larger amount of money. Such, however, is not the way of_ life. Increase, in population and growth in volume ofJiusinsss imply a more intense economic activity, and not merely a quantitative increase of the econonuc^organs. If the quantity of money changes, other jthings cannot remain the same. Even in a^-purely monetary milieu, one from which credit and its complexity of conse- quences were abseiuptt\G__ s i m pl^ solution offered could hardly appljr^-and if it did, there would be 100 AMOUNT OF METALLIC MONEY NEEDED 10 way of making the necessary allowances for the introduction , of a system of credit. For we lave to do with a complex of forces, whose opera- tions are so interdependent^thatjAre cannot detect and trace the course jgfjiny Qne of them singly. The conditions of the problem make it impossible to get at the exact relationjbetween population or volume of business and the quantity of medium of exchange ; but it is possible, perhaps, to describe the character of that relation somewhat more specifically than is done in the general statements commonly made about it. t 3. An Increased Volume of Exchanges requires Larger or More Efficient Medium of Exchange, but not necessarily More Money. An increase in the volume of business necessitates an increase in the volume of the medium of exchange, or a greater efficiency in the system of exchange, While, in the long run, this usually implies, as we shall see, an increase in the quantity of money available, it does not necessitate such an increase at once, nor, possibly, for a considerable period of time, because there are several ways of effecting an enhanced volume of exchanges other than by increasing the amount of money- in use. ^ It may be done by changing the price level, or by an extension of barter, or by an improvement of the credit system either through its extension or its refinement, or by a higher efficiency, commonly called rapidity of circulation, of money, due to improved means of communication or transportation. 101 MONEY When there exist several ways of meeting an in- crease in the demand for means of exchange, that one will be chosen which is, for the time and under the circumstances, the least costly. Some impor- tant consequences follow from this general princi- ple. In the first place, if the volume of exchanges to be effected increases, the business will be done and the changes made with the existing volume of money, on a lower level of prices, if the difficul- ties of barter or the expense of extending the credit system be too great to warrant resort to either of these means of effecting exchanges ; or if the difficulties in the way of improving transpor- tation and communication make it, for the time, impracticable to increase the efficiency of the ex- isting supply of money. Since a new supply of metallic money can always be had at some price, the fact that the community does not seek or get this supply is the best of evidence that it is less costly to do the business on a lower level of prices, and suffer whatever loss that change entails, than to incur the expense of adding to the supply of metallic money. The periods of falling prices, from 1848 to 1860, and 1873 to 1896, are really to be explained in this way. There never was any good evidence that the supply of gold commer- cially available was exhausted. The real meaning of the situation was that the cost of getting gold, under the conditions of mining which then pre- vailed, was greater than the loss entailed for the world by falling price levels. When this loss be- 102 . AMOUNT OF METALLIC MONEY NEEDED came great enough to make the extension of gold mining under the old conditions once more profit- able, and, still more, to make it profitable to seek new processes of extracting the metal, capital was turned from other uses to gold production, and the supply of that metal has, in consequence, rapidly increased. If the expense of getting new gold is very large, and if the credit system is not sufficiently expan- sible, a resort to direct barter may be less costly to the community than a falling price level. It is somewhat difficult to give historical illustrations of the enlarged use of barter in a community which has become accustomed to the use of money ; yet there is reason for thinking that under a regime of fiat paper, issued in excess, some communities have preferred to enlarge the amount of their ex- changes performed in this way, rather than run the risk of further loss by depreciation. It is diffi- cult, too, to offer direct evidence of an increase in what is usually called the rapidity ^of circulation of money. Yet we know that in monetary stringencies and crises money is hoarded, or circulates less rapidly than usual, especially in rural commu- nities ; whereas, when business is good and prices are rising, money payments are much easier and more frequent, and a given quantity of money performs a larger volume of payments, while at the same time the volume of credit enlarges. It is difficult to trace any one of these movements separately, because in the complex system of ex- 103 MONEY change of a modern community more than one of these means of meeting an increased demand for means of payment are likely to be resorted to at the same time. The total result, however, is to give the community, through the play of compe- tition, the least expensive mode of meeting the demand which the conditions for the time permit. Consequently, an additional quantity of money may not be brought into use by the demand for an increased means of payment, and the relation between the quantity of money and the volume of business is, therefore, by no means one of simple proportion. 4. The Amount of Metallic Money in a Country tends to a Minimum. A second important conse- quence of the general principle that the community will make its payments by the method which is for the time the least expensive, is the tendency of a country to reduce its holdings of metallic money to a minimum. Jjt is not, as a rule, advantageous, but wasteful, for a community to accumulate metallic money beyond the amount brought to it by the ordinary operations of business. For it is usually more expensive to increase the supply of gold than to meet the additional payments by some other means, because, in order to increase this supply, real capital must ordinarily be diverted from some other use. = Hence, no commercial community will incur for long the expense of keeping mc v e gold than is necessary to perform its direct mor-ey pay- ments and to sustain its credit system/** The truth 104 AMOUNT OF METALLIC MONEY NEEDED . of this statement is most evident in the case of a new country. The people of a new community always try to get on without metallic money. This is the explanation of the attempts in our own coun- try, in the early days, to circulate a large volume of paper money. It was an effort on the part of the community to do its business without turning any of its real capital to the production of metallic money, because its real capital was employed, or was thought to be employed, in more profitable ways. Under a system of purely metallic money, this tendency of each country to reduce its hold- ings to a profitable minimum would show itself in the physical transfer of its surplus. Such trans- fers do not cease, of course, under the modern sys- tem of credit exchange, but they are, perhaps, less frequent than they would be in the absence of credit. What is transferred now is usually not the money, but the claims to money. The trans- fer, therefore, is not a physical one, but a transfer of paper evidences of ownership. 5. Readjustments in the Exchange System caused by a Demand for More Medium of Exchange. -fA demand for a more adequate means of exchange usually is met first by an adjustment of the mechan- ism of credit, and a study of some phases of credit, especially of the proportions in which it enters into payments for different population groups and volumes of business, will throw a good deal of light jn the amount of money used as population and buoiness grow. \ If credit is well developed in IO S MONEY a community, if a good credit system is in existence, so that the people have what may be called the credit habit, they will resort readily and easily to an extension of credit to meet the changed demand for means to effect exchanges. \They will increase and improve their credit machinery through con- siderable periods of time, if necessary, to avoid the expense of^dding more metallic money to their circulation. /For the credit system, in the last analysis, is ~& labor-saving device. Like new machinery or improved processes, it can be used profitably only when the operations of business are large enough to furnish a sufficient demand for its product^ Within limits, the extension of the credit system is less expensive than the devotion of real capital to the production of an increased supply of gold. Accordingly, as an increased portion of business calls for a larger medium of exchange, the first effort will be to use the existing mechanism to its fullest capacity. The bank which served three thousand people, and did the business they furnished, will be made to serve six or ten thou- sand people, without increasing its real capital. Banks will establish branches to avoid the neces- sity of duplicating capital. They will consolidate to avoid such duplication, to economize in admin- istration in order to withstand shocks, and in other ways try to bring the exchange efficiency of the money which constitutes their real capital to its maximum. This country in recent years has been passing through such an experience. No other 106 AMOUNT OF METALLIC MONEY NEEDED significance can be attached to the increase in the number of national banks from 3590, in 1899, to 4756, in 1903 ; and to the rapid multiplication of such banks with the minimum capital allowed by- law, in rural communities where banking facilities did not exist before ; to say nothing of the increase of banking institutions under other than national charters. Nor can there be any other economic meaning to the tremendous consolidations of great banking houses which the past few years have seen. All these phenomena mean only that credit is playing for the time a larger role ; that the por- tion of the volume of business effected by credit is for the time larger than before, and the amount of money smaller in proportion to the total volume of transactions. It is impossible, of course, to find direct evidence of this. No one knows the exact amount of metallic money in a country or in the world, nor is it possible to tell either the number of exchanges or the total volume of business at any time or through any period. The volume of metallic money undoubtedly has grown rapidly in the past few years. There are signs, however, that it has not grown so rapidly as has the total volume of business. While growing population and increase of busi- ness make necessary a resort to a larger use of credit, both relatively and absolutely, they at the same time furnish certain social conditions which make the use of credit easier. Increasing popu- lation implies greater density, greater complexity 107 MONEY of business relations, more extended economic interdependence conditions all of which may be described briefly as greater economic solidarity. These changes broaden and deepen that mutual knowledge and confidence which form the basis of all credit transactions, and so stimulate the growth of credit, while at the same time improved means of communication and transportation facili- tate its use. We conclude from all the circumstances that, where credit is freely used, where a well-developed credit system exists, the proportion of credit pay- ments to the whole volume of business increases, on the whole, as population and business grow, and that the amount of metallic money actually needed becomes less in proportion to the total volume of payments. 6. The Extension of Credit Exchange slower as the Volume of Exchanges Increases. The exten- sion and refinement of the credit economy cannot be carried on indefinitely, however. There is some point beyond which the extension cannot be car- ried profitably. There is some density of popula- tion, some volume of business, whose demands cannot be completely satisfied in this way. Be- yond this point' an extension of the credit means of payment must be retarded, and the amount of money put into use as compared with the whole volume of business must become larger. There are several reasons for holding this view. The first argument, to prove this slowing up of the in- 108 AMOUNT OF METALLIC MONEY NEEDED creasing use of credit in making payments rests upon the necessities of arithmetic. For not all exchanges are effected by credit. The percentage of credit paper in the medium of payment cannot exceed 100. If, for any volume of business, the percentage of payments made by means of credit is 60, this percentage cannot multiply proportion- ally with the increase in the volume of payments. If the volume of payments multiplies ten times, the total amount paid by means of credit paper may also multiply ten times, but the percentage of credit payments cannot do so. To speak alge- braically, the value of the ordinate, F, cannot exceed 100, while that of the abscissa, X, may be indefinitely large. After a time the curve showing the percentage of credit payments to all payments must, under these conditions, tend to become parallel to the axis of X. The second reason for thinking that there is a point beyond which the extension of credit goes on more slowly than before is found in the conditions of the increase of business. If we assume that at any time the exchanges of a country are effected by means of a certain proportion of credit paper and a certain proportion of metallic money, and that the credit system is extended to its point of maximum efficiency, new increments of business are likely to be carried on outside of the credit system, that is, by means of direct money pay- ments. There is, so to say, a unit of operation in the credit mechanism, a certain portion of the 109 MONEY credit machinery, a certain group of operations which must be put in motion if the machinery of credit is used at all to effect a given transaction. If a new increment of exchanges is less than this unit will perform, it cannot profitably be done by credit. The railroads of the country of late years have been increasing the size of their locomotives, until now it is a question whether the point of de- crease of profitableness in size and hauling capacity has not been reached. It certainly is not profit- able to increase the power of locomotives beyond what is necessary to do the amount of hauling which they will ordinarily be called upon to do. Similarly the credit machinery, when it has become vast and intricate, is not applicable to small ex- changes. They must be cared for by an additional supply of money. Proof of this statement is found in the way whereby clearing-house balances are settled in different places. In New York, for ex- ample, money is used to a larger extent for this purpose than in many smaller cities. Some years ago, when statistics were collected concerning the proportion of credit paper in bank deposits, the statistics of clearing-house operations were asked for, including the method of settling balances. The returns showed that a larger proportion of the balance was paid in money in New York City than in most of the smaller cities. 1 New York used $2,971,000 in United States notes, and $3,950,000 in United States currency certificates 1 Cf. Report of the Comptroller of the Currency, 1896, p. 98. iio AMOUNT OF METALLIC MONEY NEEDED t A o settle her balance of $6,921,000 on the day in question. Atlanta, Georgia, Denver, Colorado, Lou- isville, Kentucky, and many other places paid their clearing-house balances entirely by manager's checks. Yet it is in New York City that credit machinery is most delicate and extended, and where, therefore, one would expect at first thought to find the use of money for this purpose most completely eliminated. The explanation is very simple, and is found in the fact that the more com- plex and delicate the credit machinery, the larger the minimum debt which it will pay to discharge by its means ; the larger, that is, will be the bal- ance of payments made with money. In a small place, with a single bank, whose bookkeeping is simple and whose office expenses are small, it may pay to handle checks for so small an amount as a dollar, or even fifty cents. There is no clearing- house process to go through, no duplication of transfers and other records. The case is quite different in the great credit centres. The credit machinery of New York is too costly to use on sums so small. It is easier and less expensive to make such payments in money. Similarly, as the business of a community becomes larger, there is a considerable portion of it whose settlement is more cheaply made with ready money than by the costly credit mechanism. For, as population grows, an increasing proportion of it is made up of people of small means people who have small incomes and make small purchases. These small purchases are in MONEY more likely to be made with ready money. Neither the income nor the ordinary expenditures of indi- viduals in this group of population admit of the profitable use of the credit machinery. Small and frequent purchases for ready money become more common and form a larger total. The increase in the number of small stores, as a community grows in population, is evidence of this new demand for ready money. The ease with which they enable the individual to buy at a moment's notice just as much of any goods as he needs, promotes small and frequent purchases and stimulates ready money payments. Under these circumstances people need not buy their household necessaries so far ahead, and therefore need not buy so largely at a time. In the ordinary family in this country, for example, the buying of necessaries is, without doubt, done less from month to month and more from week to week, or even from day to day, than used to be the case. The changed conditions call for a larger amount of ready money. 7. Other Conditions which retard the Growth of Credit Exchanges. There is, too, a growing ten- dency to shorten the period of payment of wages and salaries. Hence the recipients get smaller sums at a time and the disbursement of money is less difficult. Many who bought on credit when the wage or salary period was a quarter year or a month will buy for cash when the period is only a week ; and since the payments are smaller, money is more convenient than checks. This 112 I AMOUNT OF METALLIC MONEY NEEDED greater use of money as incomes become smaller or more frequently paid is a matter concerning which it is very difficult to get any direct evidence. From one source, however, we get a little light. I The smaller purchases and payments must make necessary a greater use of money of the lower de- nominations. Now there is some evidence that the proportion of the lower^denominations in circulation grows as population increases. Mr. J. B. Martin, writing of the circulation of the Bank of England notes between 1844 and 1878, remarks: " There is no material alteration in the demand for bank notes of intermediate values, but in the case of those of the highest and lowest denominations the change is very remarkable. The circulation of five-pound notes here is seen to have doubled it- self in actual volume and to have risen 12 per cent, in its ratio to the total circulation, while the circula- tion of one-thousand-pound notes has diminished by more than one-half in actual volume, and 12 per cent, in its ratio to the total circulation.-. . . There can be but little doubt that the increase of banking facilities has tended to the settlement of all but very small accounts by cheque; but the increase of population, the greater amount of busi- ness done, and,. I hope we may add, the greater prosperity of the masses, have caused a still more rapidly increasing number of these small accounts to demand their settlement by bank notes." l The increase in the proportion of small change 1 Journal oj 'the Institute of Bankers, Vol. I., p. 288. MONEY has occurred in our own currency also. Some evidence of this is found in the fact that while be- tween July, 1896, and March, 1903, the total out- standing paper currency of the country increased about 33 per cent, the one-dollar notes increased in number 71 per cent ; the twos, 61 per cent ; the fives, 30 per cent. ; the tens, 48 per cent. ; and the twenties, 64 per cent 1 Another bit of evidence of the increase in the proportion of money used under the conditions discussed is found, possibly, in the fluctuation of the percentage of credit paper in bank deposits for the United States since 1881. The writer has criticised 2 the opinion that this falling off means a diminution in the use of credit mechanism. We probably find the true explanation in the thesis we are now discussing. We may have been passing through a period of relatively increasing use of money. 8. Periodic Character of the Growth of Money and Credit Payments. Since, under certain conditions, the proportion of payments made by means of credit increases, while under others that made by ready money becomes larger, there is a periodicity or, at least, an alternation 3 in the use of credit machinery and ready money to make the payments 1 Computed from data in the United States Treasury Monthly Summary of Commerce and Finance. 2 See Journal of Political Economy, March, 1897, P* I 73 8 If the credit mechanism is at its limit of application, the amount of money may not increase at once, even though business is expanding. It may be less costly to let prices fall. 114 I AMOUNT OF METALLIC MONEY NEEDED called for by new business. To bring out this fact more clearly, let us suppose the case of a com- munity of given size and volume of business. It uses a certain amount of ready money for direct payments, a certain amount as a basis for the emission of credit paper, and it effects a certain amount of its payments by cancellation through credit paper. Population and business may in- crease for a time without making necessary an increase in the amount of money used directly, or to support the credit system. The existing money basis may be made to serve as basis for an ex- tended credit by using a more refined credit system, a more complex and delicate credit machinery. But there comes a time when the expense of making payments with credit paper between the centre and the outskirts of the com- munity is as great as it was between the two separate neighborhoods before the population be- came large and dense enough to admit of a highly developed credit system ; and the expense of such a credit system in the thinly settled portions of the community is too great to justify its maintenance. It is cheaper to use more ready money. There comes a time, too, as we have seen, when a rise occurs in the minimum amount for which it pays to use the existing credit machinery. This mini- mum can be reduced again only by an extension of the credit machinery in a simpler form through the investment of new capital ; that is, by lowering the marginal unit of operation of the credit system. MONEY But before this is done, a period elapses during which it is cheaper to use more ready money. The money can be obtained in just the amount needed, while the minimum amount of capital that it would pay to invest in credit machinery would produce a larger extension of the system than the situation demanded. When the amount of a cer- tain kind of work is small, we do it by hand labor ; when it is large, we use machinery. When our need for goods is small, we buy at retail ; when it is large, we buy at wholesale. So when our need for more paying medium is small, we buy it as we need it in the shape of ready money; when our need is large, we supply it, and anticipate further needs by new investment of capital in extending the credit system. The process of development, when demand for medium of payment presses on supply, is, then : first, the refinement of the existing credit machin- ery to its maximum efficiency ; then a period during which it is less costly to supply the new demand by means of ready money ; and, third, the expansion of the credit machinery by the investment of new capital. Of course these stages of growth are not in fact distinct. Doubtless the money supply may increase, and the credit machinery be both refined and enlarged simultaneously. There must, then, be a fluctuation, an alternate expansion of the circulating money part, and the credit part, of the medium of exchange. And this alternation is not simple. It is a complex move- 116 AMOUNT OF METALLIC MONEY NEEDED ment of several series of fluctuations, of different sweep or amplitude. Each community which uses credit is, in a measure, independent of others in supplying itself with a medium of payment. As its need increases, it refines its credit system. When the point is reached where no further ex- pansion is feasible on the' basis of its internal means, it draws on the neighboring communities with which it forms an intermediate group, so to say, in the interdependent national trade organiza- tion. The undulatory movement is felt in time by this whole group^ It, in turn, relies at first on it- self to supply new needs, but in time must press on similar groups in the world's exchange area. Thus we should expect a series of undulations, one included within another. The period between the points when it will be necessary either to get more money or to make a new investment in credit machinery will, therefore, be longer where the credit machinery is extensive and complex. What has been said thus far about the method of adjustment of the medium of exchange to demand has had reference to the conditions of an increasing demand. When business is decreasing and the de- mand for means of exchange is falling off, the same general principle controls the situation. A com- munity will use the least expensive mode of pay- ment. It will, therefore, discard first its most expensive mode of payment, or it will discard por- tions of one or more modes of payment until the expensiveness of the marginal unit of each kind of 117 MONEY payment is just met by the new demand. In other words, if a community finds that it can contract its credit machinery as business falls off, with less loss than it can diminish its holdings of metallic money, it will do so. If, on the contrary, it is less expen- sive to devote some of the metal now in the form of money to use in the arts, that may be done. Still again, if the situation does not justify either of these proceedings, the efficiency of money will fall off, and the money will pass more 'slowly in circu- lation. All this, however, will occur, provided it is to the interest of a community to maintain the prevailing price level. If business will suffer less from a falling level of prices, even from a contrac- tion of the medium of exchange in any of the ways mentioned, then prices will be allowed to fall. The method of adjustment of the supply of medium of exchange to changed demand is not af- fected, if there is a sudden and unexpected increase in the supply of money. The process of adjust- ment, as it has been described, is for the moment arrested, but at once begins again on the basis of the new conditions caused by the increased supply. That is, if the increase in the supply is not con- tinuous, the price level, or the credit machinery, or the rapidity of circulation will, one or all, change, in order to accommodate the new supply of money. Business will be stimulated, the demand for medium of exchange increased, and a new equilibrium will be established among the factors mentioned. 118 AMOUNT OF METALLIC MONEY NEEDED It may serve to bring out more clearly the theory which this chapter is endeavoring to establish if we recapitulate the points in the argument. As population and business grow, creating a demand for an increased quantity of medium of exchange, / a community will endeavor to retain the prevailing level of prices by extending the credit system to meet the new demand. This process of extension will go on until it is no longer profitable. The community will then seek to add to its holdings of metallic money, provided the expensiveness of securing the necessary additions will not entail a greater loss than would be suffered by permitting the price level to fall. Thus there will be an alter- nate extension of the proportion of payments made by the credit mechanism and by money, respec- tively. There will also be a slow increase, through long periods, of the proportion of payments made by money. 9. Relation of the Theory of this Chapter to the Amount of Money needed by a Country. But of what practical value is , all this ? Does it throw any new light on the money question ? It cer- tainly does not tell us anything about the absolute amount of money that a community uses or needs. But it does throw some light upon the relative amounts used by communities of different size. To bring out its practical bearings, let us imagine a community with a fixed amount of money, a credit system well established, and a growing popu- lation and business. We neglect, as before, the 119 MONEY demand for currency for wholesale trade. We may call the money needed for actual circulation, A ; that used as a reserve for bank credits, B t which furnishes the amount of credit-paying me- dium that we will call C. Then A + C will repre- sent the total volume of payments. In other words, C represents the bank deposits ; or, more properly, that portion of the deposits which at the time in question is in active use. As business grows, a larger amount of payments medium is, of course, needed. In a modern community the demand falls first on the credit machinery. We go to the banks when we need money. The result will be a stretch- ing, or refinement, of the credit system, on the basis of the same reserve. In other words, the amount of money used for a reserve will be made to do the largest possible service. But by and by it will not suffice. Then, perhaps, the community takes some money hitherto used in making actual payments. B becomes larger at the expense of A, and the new volume of payments, which we will call A f + C, will be greatej than A + C. But there is a limit to this process. Money cannot be taken indefinitely from the amount which is ordinarily used in making direct payments. Soon the com- munity must face a condition of stationary business and falling prices, with all the evils and loss inci- dental thereto. It is possible that a supply of new money is available at a price ; but this price may be so high that there is less social loss in permitting the price level to fall for a time than in paying the I2O II MOUNT OF METALLIC MONEY NEEDED price for a new supply of money. There comes a turning-point, however, when the reverse will be true. Then the community will purchase more money ; there will be a comparatively sudden rise in the relative proportion of money payments as compared with credit payments. The supply of money would not, therefore, be steady, even apart from the vicissitudes of mining. If gold and silver mining were of a character such that a steady supply could be relied upon to meet the varying demands, we still would find periods of relatively sudden increase and sudden decrease of the volume of metallic money, as against the vol- ume of credit payments. We appear at present to be passing through a period of relative increase of metallic money. The past twenty-five or thirty years has been a period of relative increase of the use of credit payment. But the credit machinery has apparently been strained beyond the point where the existing amount of metallic money con- stitutes an adequate reserve. The world, therefore, was confronted with a regime of falling prices. That this fallen price level has been a great hardship to many, there can, of course, be no denying. But if our reasoning is correct, it must be true that the world has suffered less from the fallen price level than it would have suffered by changing its policy and increasing the volume of metallic money. Otherwise it would have done so. 10. Artificial Increase of the Money Supply In- * expedient. If these conclusions are correct, they } 121 MONEY suggest certain matters of importance. It would appear (i) that the world will get a new money supply when it really needs it. It would seem (2) that an artificial increase of the supply of money by such devices as bimetallism would only be a tem- porary expedient. It would not change the law of the growth of the relative volumes of credit pay- ments and specie payments. It would simply sub- stitute a higher price level for the existing price level for a time. It would seem (3) that an artificial stimulus of the credit machinery is also undesirable, because it hastens the time when the community will need a larger amount of metallic money in order to avoid the evils of falling prices. It is clear from what has been said, that the ratio of the increase of money is by no means one of simple proportion. Indeed, the amount of money on hand may relatively decrease, for a time, with population and business growing. This, of course, is a well-known fact. But in no case does it ap- pear that expanding business calls for a steady and proportionate increase in metallic money. The amount may be less or more than proportionate, and is never steady in its growth. 122 CHAPTER VIII THE VALUE OF MONEY REFERENCES: Del Mar, A., Science of Money, Ch. 15 ; Farrer, Lord, The Quantitative Theory of Money and Prices, Gold Standard Defence Association, No. 29 ; Hardy, S. M., The Quantity of Money and Prices, 1860-1891, Journ. Pol. Econ., March, 1895; Laughlin, J. L., The Principles of Money, Ch. 8; Mill, J. S., Political Economy, Bk. III., Chs. 8-9 ; Mitchell, W. C, The Quan- tity Theory of the Value of Money, Journ. Pol. Econ., March, 1896; Nicholson, J. S., Money and Monetary Problems, 5th ed., Pt. L, Ch. 5, Pt. II., Ch. 5; Pareto, V., Cours d'Economie Politique, Vol. L, 290 ff.; Ricardo, D., Works (McCulloch's ed.), Ch. 27; Scott, W. A., The Quantity Theory, Annals Amer. Acad., March, 1 09) ; Money and Banking, Chs. 3-4; Walras, L., Theorie de la Monnaie, Ch. 2 ; Elements d'Economie Politique Pure, 3d ed., p. 383 ; White, H., Money and Banking, 1st ed., pp. 419-426. 1. Difficulty of the Subject. The most com- plex and difficult subject in the theory of money is the determination of its value. The popular treat- ment of the subject is simple enough, and receives considerable support from the usual scientific expo- sition. Since it is obvious that the value of money must have some relation to its quantity, it is usually said that the value of money varies with its quan- tity ; that an increase in the amount of money will cause a fall in its value and a rise in prices ; and that conversely a decrease in the quantity of money 123 MONEY will cause a rise in its value or a fall in prices, in each case in proportion to the change in quantity. This view of the matter is far from being complete or accurate, and the subject requires careful analy- sis if we are to arrive at a conclusion which is defi- nite, to say nothing of being correct. 2. The Price Level distinguished from Relative Prices. The value, or general purchasing power, of money is indicated by the amount of goods which one standard unit of it will buy. This amount is the typical, or composite, unit of com- modity, which may be described as composed of a quantity of every article in the market, the value of each article in the unit being the same proportion of the value of the whole unit as that of the whole amount of the article is to the total value of all the goods on sale. The value of money is a question of the relation between goods and money, and not between one kind of goods and another. In ask- ing what is the value of money, we ask not why one article costs $i and another $2 but why the articles cost $i and $2 respectively, rather than some other amounts, as $5 and $10. The question why one article costs $i and another $2 is a ques- tion of relative prices, a question of the relation of goods to one another. The other question is an inquiry of the relation of goods to money. What we are seeking to determine is the value which will attach to the money article, as money, in con- sequence of being actually exchanged for goods at a given moment. 124 THE VALUE OF MONEY 3. Conditions assumed to simplify the Problem. The problem is one of considerable complexity, because there are so many factors of which the value of money is a resultant. An equilibrium must be de- termined, in the first place, between the value of the money article for monetary purposes and its value for use in the arts ; then between this value and that of the goods for which it exchanges. Finally, when these equilibria have been determined, they are modified by the introduction of credit and by the retention of exchange by barter. For the solution of a problem so complex it is necessary that we should isolate certain of the factors, as well as we can, and seek to determine their action when regarded as operating by themselves. Accordingly we assume, first, that the money article is used for no purpose but to effect exchanges. It facilitates exchange and serves as a measure of value, but it is of no use for direct consumption. It is assumed, further, that there is on hand, and actually offered in exchange, a given quantity of such money, and a definite amount of goods ; and that money passes at each sale, no commodity being exchanged by bar- ter or sold on credit. Under these conditions, what determines the value of money ? 4. The Value of Money a Social Fact. The value of money which we are seeking is, we must remember, a social phenomenon. It is not the purchasing power set upon money by any individ- ual. It may be that, of the indefinite number of people who participate in its determination, no T2 5 MONEY two agree, and that not one individual valuation is the same as that which finally emerges from the competitive struggle. The value in question de- pends primarily upon the service which it renders, as a medium of exchange, to society as a whole. The nature and amount of that service is found in the addition which money exchange makes to the utilities at the disposal of society, and this addi- tion marks the upper limit of the value of the money at the disposal of society. 5. Advantage of replacing Barter with Money Exchange. Let us assume a society composed of people unacquainted with exchange, who by the bounty of nature possess ten thousand million units of goods. Each member of the community consumes what he himself produces and exchanges with no one else. All the people together con- sume directly five thousand million units and are entirely contented with that amount of consump- tion, so that no further satisfaction can be obtained from the rest of the goods. The remainder of their possessions, therefore, have no utility and no value for them. Suppose, now, that one thou- sand million units of goods are bartered, and thereby get into the hands of people who want them. The result will be an increase in utilities to the community, and the amount of increase in utility will represent the advantage of simple barter, or direct exchange. If, in accomplishing this amount of exchanges, the community used any quantity of goods up to one thousand million 126 THE VALUE OF MONEY units, it would gain. Hence it could afford to consume any quantity up to that amount, in per- forming the exchanges necessary to carry off the additional one thousand million units of goods. As a result of the inability of the members of the community to get together at the right times and places, with the right amounts and kinds of goods, the other four thousand million units of goods can- not be exchanged, and their value would therefore be lost. Suppose that money is now suddenly introduced. The community all at once finds that some article possesses the quality of universal marketability, so that each individual is willing to give it for goods he wants and does not have, or take it for goods he has and does not want. By means of this money the people are enabled, we will suppose, to exchange at one moment all the remaining four million units of goods, actually paying out a piece of money in each exchange.for a unit of goods. The consequence of this change is an increase of utilities to the community, and the amount of this increase represents the advantages of a complex barter, or money exchange. In order to secure these additional utilities, the society can afford to expend any amount up to their total value. # 6. The Maximum Value of the Money Supply which a Society can afford to Ha^e. If the means, the machinery, created for performing the ex- changes, lasted through more than one period of exchanges, the society could afford to provide it, 127 MONEY if, within its life, it returned its original cost at the current profitableness of production. That is, the upper value of the means of exchange to society will be that of an investment of capital, whose product is equal to the expense of barter thus saved. In other words, let us suppose that the cost of exchanging goods by barter is represented to a community by the consumption of A units of utility, in one set of exchanges, or in one period of exchange. Let Y represent the quantity of money introduced ; and B its cost, in units of util- ity consumed in its production. If F, the money, lasts only through one set of exchanges and then perishes, society will save in performing the ex- changes A units of utility and will expend B units, thus saving by the exchange A B units. If the money lasts through two exchanges, the saving in each is AB/2] if through three exchanges, A B I '3. If there are X exchanges, the saving in each is A B/X. If X is indefinite, that is, if the money lasts through an indefinite period, as is practically the case with gold, then the fraction B I X approaches zero, and, to use a mathematical phrase, the saving would approach A. At this point, society can afford to invest a value which, at the current profitableness of production, will yield A units of utility within the period of dura- tion of one complete set of exchanges. This is true whatever the physical character of money. If the money is paper and lasts only for one or two exchanges, the cost of production, B, grows smaller, 128 THE VALUE OF MONEY and the number of exchanges through which it lasts grows smaller too. In other words, the frac- tion B/X approaches zero, as in the case of com- modity money. However, B/X will always be larger for paper money than for gold money. At the limit of profitableness of its use, therefore, the cost of production has no effect on the value of money. The maximum amount of money which a community can afford to acquire will depend, there- fore, upon the current profitableness of its industry, and will have a value such as, at that rate, will yield, within the period necessary to complete one set of exchanges, a return equal, at the maximum, to the expense of making the exchange by barter. In other words, if it be assumed that the amount and nature of money as an instrument is such as will enable exchanges with it to be so extended that the greatest possible amount of utilities deriv- able from exchange will be secured, then this greatest possible amount of utilities derivable from exchange will set the upper limit to the total value of money. 7. The Minimum Value of the Money Supply to a Society. The total value of money to society also has a lower limit. It is often said that any sum of money, however small, would suffice to per- form the exchanges ; that the only difference that would be caused by using a larger or a smaller quantity would be in the terms in which prices were expressed. In other words, it is said that to reduce, or to multiply, the amount of money in K 129 MONEY use ten times, would simply change the money valua- tion of all articles and scale prices according to the change in the quantity of money. This statement has an element of truth, but needs to be carefully made in order not to mislead. If the money in use were non-material, the statement would be true; but the money article is material. In order to serve its purpose it must be divided and distrib- uted among many people, over large areas. This physical division and distribution cannot take place unless there is a certain quantity. [There must be enough to work with, else the physical difficulties of barter would simply be replaced with the phys- ical difficulties of money exchange. When this working minimum of money, whatever it is, is ob- tained, an actual ratio of exchange between money and goods emerges. This minimum just removes the expense of the most expensive portion of barter exchange. The total value of money may, there- fore, fluctuate between this minimum and the greatest possible amount of utilities derivable from exchange, but will always be determined by the utilities which it creates or saves. The total value of money being determined, the value of the unit of money will be proportionate to the number of units. 8. The Unreality of the Above Conditions and the Actual Limits of the Money Supply. But no society, no community, no country, ever acquires this maximum ; for in none does that state of affairs ever obtain wherein a piece of money actu- 130 I THE VALUE OF MONEY ally changes hands for one, and only one, unit of goods within the period of a single set of exchanges. Each piece performs its service many times within each period. Moreover, in a society which makes its exchanges entirely without the use of credit, the money exchange would never wholly supplant the barter exchange. Nor would any society re- main content with the minimum supply. In the absence of credit, and under the conditions which were assumed as to the character and services of the money article, each society will push its acqui- sition of money to the point where the investment of further labor and capital for the exchange of an additional unit of goods would yield no utility over exchanging the goods by barter. The application of successive units of money to effect exchanges is attended by results of varying importance. Each unit applied adds a less pro- portionate value than the last preceding one, up to the point where the social cost of making another exchange will be the same whether made by barter or by money exchange. Any addition of money beyond the quantity necessary to bring this about will lower its marginal utility below the point of profitableness. The value of the unit of money would under these conditions be lessened. The total value of the money would not change, how- ever, because nothing has been added to the utili- ties afforded by money exchange. Hence the decrease in marginal utility, or the value of the monetary unit, must be, beyond this point, inversely MONEY proportional to its quantity. The use of money beyond this point would involve a social loss. 1 Subtractions from the amount of money, when it is in excess, take nothing from the total utilities its use confers on society and will not affect its total value while the excess remains ; but the value of the unit will increase in proportion to the change in quantity. ^*; If the amount of money available is less thar sufficient to substitute money exchange for barter! down to the point of equilibrium of advantage frort the two methods of exchange, additions to it$ amount will add something to the utilities deriv- able from exchange by means of money, and will in- crease its total value. For, although the value of the unit will decrease, since each succeeding unit applied in effecting exchanges adds a less propor- tionate value than the preceding one, the decrease will not be in proportion to the increase in the number of units. Subtractions from its amount will take something from the utilities derivable from money exchange, and will therefore reduce its total value, but not in proportion to the decrease in the amount, because the value of the unit will in- crease, since the last unit now used in effecting exchanges has a greater value than any of the units dropped from use. 1 Under certain conditions an addition to the quantity would add less than nothing to the utilities derivable from exchange, and would lower the value of the unit in greater rate than the increase in the number of units. This would occur, for example, if confidence in government paper were shaken when it was the only money in use. 132 THE VALUE OF MONEY 9. Limitation upon the Freedom of Choice be- tween Barter and Money Exchange. Two hy- potheses underlying this discussion are so vital to its logical consistency, and to the conformity of the theory with actual conditions, that it is impor- tant to consider how far they are realized. One of these hypotheses is that in the effort to secure the cheapest means of exchange at any time, so- ciety is able to resort, without loss, to barter or to money exchange, indifferently. This is, however, far from being possible. The use of money devel- ops an amount of business to which barter could not possibly be applied; and, moreover, even in the cases in which it was formerly used, when it has once been abandoned, it cannot be again re- sorted to to any large extent. For not only will the money-using habit have been established, but the money is a tool which, once produced, must be used. It cannot be put aside without loss. It represents to society a fixed investment which will prove a loss if its use is abandoned. It would seem, therefore, that a quantity of money once produced in excess of the amount which will make the mar- ginal exchange profitable, may be used with less social loss than its abandonment would occasion. It would seem, therefore, that the effect of a change in the quantity of money on its value could not be readily and effectually checked through resort to a larger or smaller use of barter, and would there- fore be more violent than the discussion above would indicate. MONEY The restriction on the resort to barter after the money exchange has become established is of less importance, however, than the above remarks of themselves would justify us in believing. For, in the first place, although resort to direct barter is not available, society can vary its exchanges through credit, and will do so until the marginal utility of money for effecting exchanges directly is equal to I its marginal utility for effecting them through the credit machinery. Again, the unavailability of a resort to barter to check the effect of changes in the quantity of money is offset in a measure by the fact that a change I in the quantity of money induces, immediately or I soon, a change in the amount of goods to be ex- ' changed. Society has, therefore, an economic es- cape in at least two ways from changes in the value of money due to sudden changes in its amount. 10. The Relation of the Quantity of Goods to their Marginal Utilities. The second important hypothesis which underlies our theory of the value of money is that the marginal utilities of goods are not proportional to their quantities. This seems so obvious as scarcely to need mention, yet it seems not infrequently to be ignored in discussions of the value of money. We have seen that under certain conditions the value of money is proportional to its quantity a point which we shall soon establish in another way. Too often, however, the modify- ing conditions are omitted from the statement. It holds true, as we shall see later, only when the THE VALUE OF MONEY quantity of goods for which this money is ex- changed is assumed to remain constant, so that their marginal utility does not change, although the quantity of money does change. Under these cir- cumstances the marginal utility of the money article, if it has no other use, must be constant, and the size of the marginal unit will depend entirely on the total quantity. That is, as the mathematicians say, the marginal unit whose utility remains unchanged is a magnitude of a different order from the mar- ginal unit before the change. 11. The Value of Money at any Moment deter- mined by Demand and Supply. If, then, money is available at a cost, society will gradually extend its use down to the point where its marginal service equals in value that of other means of exchange. It will do so through the competition of individuals who are seeking to exchange their products: That is, the value of the money in use at any time will be fixed by competition for it ; and, socially speak- ing, it will be the capitalized value of the service rendered in the marginal exchange. Each ex- changer of goods will be willing to give for it the capitalized value of an amount that equals the utility of money exchange over barter, as applied in the exchange of the last unit of goods he sells. For this, to him, is the marginal cost of exchange. These costs, and the utilities equivalent to them, which are created by the use of money, differ for different producers. Hence they compete for the money, offering amounts which represent the capi- 135 MONEY talized value of its service to them. As a result of this competition, the value of the money unit at any moment will be that imputed to the last unit of money demanded, as measured by the utility of the last unit of goods offered in exchange for the money. In other words, the value of the money will be the value of its marginal unit offered and accepted in exchange, and will be equal to the utility of the last unit of goods necessary to bring into use the whole amount of money demanded. In order to make this clear, let us illustrate the method of procedure by which the ratio of ex- change between two articles is fixed. Suppose there are five men who wish to sell wheat and five who have money to offer for it. Let us suppose that A offers one bushel of wheat for $0.97. B offers one bushel of wheat for $0.98. C offers one bushel of wheat for $1.02. D offers one bushel of wheat for $1.03. E offers one bushel of wheat for $1.00. That is to say, each one of these men estimates the value of a bushel of wheat to himself as equiva- lent to that of the amount of money represented by 97 cents, 98 cents, etc., respectively. Now, the owners of money who want to buy wheat do not know, any more than do the holders of wheat, what is the price that must obtain in order to carry off the entire product in exchange for all the money which they offer. Therefor^ 136 THE VALUE OF MONEY they will offer different amounts of money per bushel. To continue our illustration, let us sup- pose that A' is willing to give for a bushel of wheat $1.00. B' is willing to give for a bushel of wheat $1.05. C f is willing to give for a bushel of wheat $0.95. D' is willing to give for a bushel of wheat $0.98. E' is willing to give for a bushel of wheat $0.99. Each would-be buyer wishes, of course, to get . his wheat as cheaply as possible, and is not likely to offer his maximum price. The man who is will- ing to give $1.00 rather than go without, will wait to see whether somebody else does not get wheat at a lower price. If so, he will not give $1.00. Let us suppose that the offers begin at 90 cents and rise gradually. At 90 cents per bushel any one of the holders of money would buy, but no one of the owners of wheat would sell. This state of affairs would continue until the price offered reached 97 cents, the lowest figure which any seller is willing to take. When the price was at 97 cents four would be willing to buy and one to sell. At 98 cents four would be willing to buy and two to sell. At 98 J cents three would be willing to buy and two to sell. At 99 cents three would be willing to buy and two to sell. MONEY At 99^ cents two would be willing to buy and two to sell. At 99f cents two would be willing to buy and two to sell. At $1.00 two would be willing to buy and three to sell. At $1.05 one would be willing to buy and five to sell. It is obvious that the sales would take place at a point between a little over 99 cents and a little less than j^i.oo. 1 If there is an increase in the supply of wheat, its marginal utility will fall and more of it will be offered for the same amount of money. If there is a decrease in the supply of wheat offered, the opposite state of affairs will be true. As a result of the competitive forces in the case under con- sideration, we find, then, that the value of money is fixed at a point where approximately $i will exchange for one bushel of wheat. If, instead of wheat, we use our composite unit of commodity, there will be no difference in the illustration. The effect of offering two articles instead of one for money, at the same time, is simply to offer a com- posite commodity unit of the kind we have de- scribed, composed of two articles, each entering in to form the unit in the ratio determined by its relative value. If we add three or more, the same 1 Just where the fluctuation would stop and the exact price emerge, is still an uncertain question. 138 thir THE VALUE OF MONEY thing is true. Instead of one bushel of wheat we have now a composite unit of three or more articles. If the amount of money is increased, each addi- tional increment brings out for exchange an ad- ditional quantity of goods, which, at the former price, was kept out of the market. That is, as money is added the price rises to the value which the next marginal seller must get for each unit of goods that he is willing to sell. It is obvious, therefore, as was already said, that the value of money is fixed in precisely the same way as the value of other articles. It is equal al- ways to the marginal utility of the last unit of goods necessary to absorb, or put into use, all the units of money wanted, and the number wanted will be fixed by society at the point where the ad- vantage of money exchange will be in equilibrium with that of other means of exchange. It may happen, when the value of money has been for the moment fixed, that there are owners who impute a higher value to their goods than is contained in the amount of money which they could get for them. In that case they will either consume the goods themselves, or exchange them by barter, or suffer loss. 12. The Quantity of Money and its Value. If chc amount of goods remair^,d the same through several sets of exchanges, while the quantity of money changed, the marginal utility of the goods would be constant, the amount of money which the marginal unit would command would change, but MONEY the marginal utility of this changing amount would remain the same, since it is but the borrowed, on reflected, utility of the marginal unit of goods. In this case the value of the money would vary in- versely as its quantity. This is the same conclu- sion at which we arrived when considering the value of money from the point of view of a social investment. To bring this point out clearly, let us suppose that there are one thousand units of goods, and that the marginal utility of the goods is three units of utility. Then one unit of goods will ex- change for'yoVo^ of the money, and the marginal utility of the money also will be three. In other words, the whole quantity of money will be divided into one thousand pieces, each piece will exchange for one unit of goods and the marginal utility of each piece will be that of a unit of goods. Sup- posing now the quantity of money is arbitrarily doubled, what will be the effect on its value? Obviously, under our assumption, one unit of goods will exchange still for yoVo of all the money. The new unit of money will be twice the quantity of the old unit, but its marginal utility will be the same, for its marginal utility will be that of the goods it buys. % Obviously, therefore, the marginal utility of money h?s ^urik one-half, value of the present quantity of money whic equal to that in the former marginal unit will be i| , In other words, the value of money has changed inversely as its quantity. The same conclusion holds for diminution of the quantity of money. 140 THE VALUE OF MONEY The relation between the quantity of money and its value, under the conditions we have assumed, is, therefore, purely quantitative. The value is pro-, portional to the quantity in an inverse ratio. The reason for this is, as has been pointed out, that the money has no marginal utility of its own. It is of no use, imder our hypothesis, excepting for exchange. Once on hand, it must be used in ex- change unless, indeed, it becomes so voluminous as to check the confidence of the community in its stability of value, and so to cause it to be aban- doned. 13. The Relation of Quantity and Value in the Case of Commodity Money. The quantitative re- lation just described can exist, however, with only one kind of money, inconvertible paper. The fact isMthjjtd^^ direct utility, a marginal utility derived from the fact that it was in demand for other purposes than ex- change? The effect of the existence of a margi-*\ ^ nal utility due to other uses than exchange is to V render ineffective the relation between the quan- tity of money andjlsjsalue. TQ prove this, let us refer to our former illustration. According to that, one thousandqmits^of goods with a marginal utility of three were exchanged for one thousand units of moneyv^and_the^_marginal utility of the money was also Jthree. Wh^a we doubled the quantity of money, we found -that each unit of goods exchanged for just double the former quan- tity of money, and that the value of the money 141 MONEY was halved. But according to our present suppo- sition, the value of the money is the result of an independent force. The demand for it for direct consumption fixes a marginal utility upon it as a commodity, irrespective of its use as money. Now the marginal utility of a commodity does not vary inversely as its quantity. If we double the quan- tity of wheat, we may not thereby halve its value ; or, on the other hand, we may reduce it by more than half. Similarly, doubling the quantity of a money article of direct utility may not reduce its value one-half. Suppose the increase of quantity reduces the value one-third, so that the utility of the amount of money in the old marginal unit is 2. The amount of money which has this marginal utility is one-half that of the new marginal unit, whose utility is, therefore, 4. The marginal utility of the goods is still 3. Hence we will give, not 2 units of the old size, but i|-, for a unit of goods. For i^ units, with a marginal utility of 2 per unit, will give us 3 units of utility, which is the value of a unit of goods. Thus the former pro- portion between the quantity of money and its value no longer holds. A slight modification of the above reasoning is necessary in order to be true to facts. We assumed that the marginal utility of money was fixed inde- pendently of its use as money, by the demand for it for direct consumption. This is not wholly correct. The marginal utility of the money is a resultant of the demand for money for purposes of ex- 142 Edgeworth, F. Y., 'Thoughts on Monetary Reform, Econ. Journ., Vol. V., pp. 434-451 ; Ettinger, Einfluss der Goldwahrung auf das Einkommen der Bevolkerungsklassen und des Staates ; Farnam, H. W., Some Effects of Falling Prices, Yale Review, August, 1895, PP* 183-201; Giffen, R., Prices and Income Compared, Journ. of Royal Statistical Society, Vol. 51, p. 713 ; Laughlin, J. L., Principles of Money, pp. 388 ff.; Nicholson, J. S., Money and Monetary Problems, 5th ed., Pt. I., Chs. 5, 7, Pt. II., Chs. 4, 6 ; Philippovich, E. von, Grundriss der Politischen Oekonomie, 4te AufL, Erster Band, 98 ; Pierson, N. G., Index Numbers and Appreciation, Econ. Journ., Vol. V., pp. 239 ff.; Principles of Economics, Ch. 7, 8 ; Price, L. L., Money in its Relations to Prices, Ch. 2 ; Smart, W., Studies in Economics, Chs. 6, 7, pp. 208 ff.; Walker, F., Money, Ch. 4. 1. Questions to be discussed in this Chapter. There are three questions of importance involved in the discussion of changes in the value of money. These are : First, in what direction and to what extent has the value of money varied ? Second, are the changes in its value to be attributed to the money or to goods ? Third, how do the vari- ations affect social welfare? The first of these three questions is discussed at length in the twelfth chapter. The question is one of quantita- 176 ANGES IN THE VALUE OF MONEY tive change, a determination of the total result. To answer this question it is not important to know whether, as has been remarked, it is "the pence that are few or the eggs that are many " ; and it is a matter of indifference, from this point of view, whether the change is a consequence of variations in the prices of many articles or of few. Further, ; it does not make any difference what the effect is on any or all individuals. 2. Different Meanings of Appreciation and Depre- ciation. The discussion of the twelfth chapter will show us, however, that the terms "appreciation" and " depreciation/' of themselves, tell us nothing of the real character of the changes in the price level, the causes of these changes, or their import to social welfare. But the answer to the second question, relating to the cause of change in the value of money, involves a determination of the meaning of appreciation and depreciation. Appre- ciation, of course, means simply a change to a higher value ; depreciation, a change to a lower value. But the value referred to may be a subjec- tive value or an exchange value. Much of the discussion concerning the real nature of apprecia- tion has been due to confusion of the two kinds of value. A change in the subjective value does not necessarily imply a change in the purchasing power, or exchange value, of money. To illustrate this, let us suppose that we are using a commodity money, like gold. If the supply decreases through wear, for example, no new supply coming to re- N i 77 MONEY plenish the loss ; and if at the same time the good offered in exchange for gold decrease to a sufficient degree, it is entirely possible that the purchasing power of gold will remain unchanged, notwith- standing the diminution of its quantity. Yet in one sense gold will have appreciated, for it is scarcer than it was, and its scarcity raises its mar- ginal utility. But as, according to our supposition, the marginal utility of the goods offered for it has changed in the same degree, no difference appears in the amount of goods secured for one unit of gold. That is, the purchasing power of gold has not changed. For example, suppose we have one thousand units of gold and one thousand of our composite units of goods. Call the marginal utility of each unit of gold and of each unit of goods one. If now the amount of gold is reduced to nine hun- dred units and the volume of goods is correspond- ingly reduced, a unit of gold will command the same quantity of goods and the marginal utility of the unit of gold and that of the unit of goods will be, perhaps, i^, or 2, or some other number larger than i. The same amount of gold buys the same quantity of goods as before, but this quantity of goods yields a less amount of satisfaction. Simi- larly, there may be depreciation of gold not shown in changed purchasing power. It is possible that the cost of production of gold may diminish and that gold may increase in quantity; but if these changes are accompanied by corresponding changes in the cost of production of goods, there may be CHANGES IN THE VALUE OF MONEY 10 change in prices. Goods would be more abun- lant, indeed ; but, as Mr. Giff en has remarked, the " abundance would make itself felt in a rise of loney wages, salaries, rents, and profits, and not in lower prices." This kind of appreciation and depreciation is sometimes spoken of as absolute appreciation. It is not of importance in the dis- cussion of changes in the general price level, al- though it has considerable significance in relation to social welfare. 3. Different Manifestations of Appreciation and Depreciation. It is conceivable, moreover, that the quantity of gold might increase, or decease, without causing any change in prices, and without any accompanying change in the volume of com- modities. For the change in the quantity of gold might be accompanied by a change, in the opposite direction, in the volume of other means of payment, there being, of course, no change in the standard of value. For example, if a bank of issue is es- tablished in a community whose people have been making all their payments with gold, a certain amount of the gold may be sent out of the place without altering prices. The community gets the benefit of a less expensive means of payment. Prices remain the same, not because the amount of exchange medium, now paper and gold, is un- changed, but because gold is still easily obtainable for the paper, and for the balance of exchanges which do not offset one another. It is urged that the familiar use of the term " depreciation" associates 179 MONEY it with an excess of issue of money ; that, therefore, appreciation ought to imply a scarcity, or insuffi- ciency, of money. It hardly seems important to urge this view. Appreciation and depreciation are effects of excess and shortage of money, respec- tively, relative to demand, and do not depend upon the cause of the excess or shortage. Excess and shortage, in other words, are relative terms. By excess we mean more than the demand, and that more may be produced either by increasing the quantity of money or decreasing the quantity of goods. It is the fact that there is more that causes depreciation. Similarly, we may reason of appreciation. The question whether the change in the price level is due to changes in the quantity of money or in the quantity of goods has an im- portant bearing on the social welfare, but none whatever in determining the meaning of the terms "depreciation" and " appreciation. " s> 4. Various Phases of Appreciation. Ordinarily, then, we mean by appreciation a larger purchas- ing power of money, or falling prices of goods, whether due to diminution of the money supply or to an increase in the supply of commodities. ' In short, we mean that a given quantity of gold I buys a larger number of our composite units of I goods. This might happen either (i) because the volume of goods offered for sale is the same, while the money supply has diminished, all other factors being unchanged; or (2) because the volume of goods offered has increased, while the volume of 180 CHANGES IN THE VALUE OF MONEY money remains the same, all other factors being unchanged ; or (3) because, although the volume of goods sold and the quantity of money are un- changed, other media of exchange have become less. All other cases are variations of thgse. Let us consider the effect of each of these changes from the point of view of the community as a whole. According to the first supposition, the volume of goods offered for sale is the same, while the money supply is less, and all our other factors, including the other means of exchange, are unchanged. In this case the purchasing power of gold increases, its marginal utility increases, but the marginal utility of goods remains the same, and the total social satis- faction obtained from the goods remains unchanged, excepting, of course, so far as the change in the marginal utility of gold, in its use as a commodity, affects the marginal utility of all commodities. In the second case, we assume that the volume of goods increases, while the amount of gold re- mains unchanged, and the volume of business done by other means of exchange is constant. Here the purchasing power of gold increases, wjiile its mar- ginal utility remains constant ; the marginal utility of goods decreases, because of the increase in their supply ; and the total satisfaction which the society derives from the consumption of these goods will, of course, increase. From the standpoint of soci- ety this change is an indication of prosperity. In the third case we assume that the volume of 181 MONEY goods remains the same, and that the amount o: gold is unchanged, while the volume of business done by other means of exchange decreases. This throws a heavier burden of exchange work upon gold, so that its purchasing power is bound to in crease. The marginal utility of gold and that o; goods remains the same, however, because the sup ply of neither changes, and the total satisfaction which society derives from the consumption ol goods remains the same because the quantity oi goods has not increased. We have, in short, three classes of cases in which prices fall; but the effects, from a socia standpoint, on the subjective .value of gold and of goods, and on the total satisfaction which society gets from consumption of the goods, are different We may tabulate them thus : Case Volume of goods Amount of gold Other means of ex- change Purch'g power of gold Marg. util. of gold Marg. util. of goods Total social util. of goods I same Dec. same Inc. Inc. same same 2 Inc. same same Inc. same Dec. Inc. 3 same same Dec. Inc. same same same 5. Importance of the Distribution of the Effects of Appreciation and Depreciation. The standpoint of the direct effect on society as a whole is not, however, a good one from which to view the change on welfare produced by a fall of prices. For a 182 CHANGES IN THE VALUE OF MONEY fall of prices, of itself, tells us absolutely nothing about its effects on welfare ; it is, of itself, no indi- cation either of prosperity or of economic loss. Whether or not it imports one or the other, depends on its cause and on the distribution of its effects. It may indicate merely a change in the productive power of a community, or it may imply a rise or fall of wages or incomes, absolutely or per capita, or it may signify the burdening or oppression of one or several of the economic classes of a com- munity, or possibly the burdening of the whole community. The net result depends altogether on where the change in prices strikes, and how it works itself out. If prices change, say from 100 to no, it is obvious that the purchasing power of money has fallen in the ratio of no to 100. It does not follow, however, that the person whose income was 100 at a previous date could buy as many commodities and the same amount of labor as could the owner of 1 10 units of money at a later date. He could buy the same amount of goods only if the prices of all had changed in the same proportion. But a fall of prices does not take place in this regular way. Prices of articles change in different proportions, and the effects of the fall will be different according to the changes produced in wages, incomes, cost of production of goods, and population. To begin with, a fall of prices may conceivably take place while relative wages and incomes remain as they were before, the only change being in the ' MONEY quantity of money. If the producing capacity of society, the cost of production of goods, and popu- lation remain unchanged, the fall of prices produced by a lessening of the quantity of money would have no other effect on the economic sharers of the prod- uct of industry than to make necessary the use of a new scale of prices. It could occur, conceivably, without affecting either the welfare of society as a whole, or the relative welfare of its different groups. Practically, however, such a proportionate distribu- tion of the effects is impossible. The blow would fall on different classes, not at the same moment and in the same degree, but in time and degree dependent on the relative economic strength of the classes. 6. Different Effects of Appreciation under Dif- ferent Conditions. If the supply of goods in- creases, owing to the extension of production under the influence of improvements, while the money demand for them is the same, all other conditions remaining the same, prices will fall. Money wages and incomes being unchanged, the fall is a sign and measure of the greater producing capacity of society, and implies enlarged consumption for all classes. In this case the community is just as well off as if the volume of money had increased sufficiently to prevent the fall of prices. Indeed, it is better off, because it has saved the investment of capital and labor necessary to produce the addi- tional money. It will continue to be better off with a falling price level, under the conditions named, 184 c RANGES IN THE VALUE OF MONEY until the fall is great enough to offset the gain from the lowered cost of production of goods. If the falling cost of production be due to an increase in the efficiency of labor, the real price of labor will rise, as compared with that of goods. But as the money demand for goods is the same, their price must fall in order to afford labor a higher real return. The fall in prices under these circum- stances is merely the evidence of the increased productivity, and consequent higher real wages of labor. Producers and capitalists lose nothing. These results will follow, even if the only goods which fall in price are the goods consumed by laborers, and constituting their real wages ; for their fall will lower the general price level, but the change will imply no loss to any class in society. Again, a fall of prices may be accompanied with rising money wages and profits, if the fall be caused by decreased cost of production, population and other conditions being unchanged, provided the fall of prices be less rapid than the decrease of cost. The fall here is a sign of the increasing produc- ing capacity of society and of increased labor effi- ciency. If, however, prices fall more rapidly than cost, owing, for example, to decreased demand caused by a depression, both laborers and entre- preneurs will lose. 7. The Effect of Appreciation transmitted from Class to Class. In each of these illustrative cases of falling prices, we have assumed that, with changes in some of the conditions of price equi- MONEY librium, other conditions have remained the same. As a matter of fact, a change in one condition in- duces changes in the other conditions which de- termine the price level. If the quantity of money becomes less, prices fall, and other things cannot remain unchanged. Those on whom the burden of falling prices falls first, will naturally try to shift it. When prices fall, the advantage, what- ever it is, accrues first to money owners at the expense, primarily, of producers. The owners of money, however, are not allowed long to keep their advantage, for the producers, finding their profits curtailed, diminish production in order to raise prices ; or else they force down the rate of wages, or in some other way try to recoup themselves for their loss of profits. Now, if production be cur- tailed, part of the loss felt by producers is passed on to wage-earners and consumers. The laboring class will by and by receive less in total money wages and, unless the population falls away, in per capita wages also ; while, as consumers, they will pay higher prices. Other consumers in the community will feel the change by having to pay higher prices for goods. If the fall of prices resulted in reducing wages, the laboring class would for a time suffer most, or all, of the loss. In time, however, their diminished consumption would cause a diminution of produc- tion and a rise of prices, and other consumers would share the loss. In a stationary society, in which producing capacity, cost of production, and 186 CHANGES IN THE VALUE OF MONEY population remain the same from period to period, the final result of a fall of prices would be a dis- tribution of the burden among the economic sharers of the product, with more or less equity. It might seem that if this could be done, the change of price level would be devoid of significance for the indus- trial welfare of the community. The psychological effect of this change, however, cannot be neglected, even if the economic relations of the different classes be unchanged; for a lower range of in- comes, prices, and wages accustom people to small things and lower standards, and the habit of look- ing at things in a small way deadens enterprise, and is likely to act against a recovery from the conditions which produced it. 8. The Normal Case of Falling Prices. The normal case of falling prices for a long period is that of a progressive community whose producing capacity is on the increase at a diminishing cost of production, and with a growing population. Money wages and incomes do not fall and may even rise, and the fall of the price level would import pros- perity to the community. It would mean that the advantages of decreasing cost of production and growing producing capacity are distributed among the different classes in society. The distribution would be gradual, however. Some one group or class at first would get more than its share of the advantage, as is the case in all economic changes, whether in the direction of economic improvement or deterioration. The entrepreneur would gain first 187 MONEY from diminished cost, then the capitalist, then the consumer as such, and finally the wage-earner. For a lessened cost of production brings unusual profit to the entrepreneur and stimulates enterprise until the unusual margin of profits tends to disappear. The stimulation of enterprise causes an increased demand for capital and forces up the rate of inter- est ; and the competition of producers to sell their goods tends to lower prices and to give consumers an advantage, while at the same time their desire ' to extend their business leads them to offer higher wages. Under these conditions the community at first endeavors to do the extra work of distributing a larger volume of goods with the same means of exchange, because for a time there is a larger net gain in straining the existing means of exchange to do the additional work, than in sinking more capital to increase the volume of money. This condition will continue until the net gain disappears and society finds it more profitable to increase the volume of money. This is doubtless the explana- tion of the relative decrease in gold in such a period as the twenty-five years following 1873. Throughout all this period, despite crises and oc- casional apparent retrogression, the population of the industrial countries of the world increased, to- gether with their producing capacity ; while inven- tion, discoveries, the adoption of better business organization, and the utilization of new and more fertile land, all tended to force down the cost of production of commodities. The profit from in- 188 CHANGES IN THE VALUE OF MONEY vesting in the production of other kinds of com- modities than gold was greater than could be had, under existing physical and economic conditions of its production, from investments in producing gold. Under the conditions above described, prices will continue to fall, until the fall wipes out the differential gain from other investments to a suf- ficient degree to make it profitable to extend investments in the production of the money com- modity; or else men will be stimulated to the (discovery of a cheaper process of production of the money commodity, in order to secure from investments in this direction as large returns as from the production of other kinds of goods. This is what has happened in recent years. The production of gold fell away, not because of the physical exhaustion of gold, but because, under the old conditions, its cost of production was so high as to make the margin of profit from investing in its production less than could be obtained in other ways. New processes of reduc- tion of the ore, however, lowered the cost of pro- duction, so that the margin of profit from producing the standard money commodity became greater. Since then its output has increased. Whether or not the increase in the output has been the chief cause of a higher jprice level is at least open to dispute. The effect of the increased output might, under proper conditions, manifest itself in this way, and after a time its lower value would again lessen the production. Under the conditions 189 MONEY that prevail now, however, it is likely that the net result has been further to stimulate the produc- tion of other goods, and to extend the credit machinery, so that the increased output is profit- able on the rising scale of prices. 9. The Effects of Appreciation on Debtors and Creditors. In our discussion thus far, we have considered the effects of a changing price level on the sharers of the product, in the economic sense of the word " sharers." That is, we have in- quired into the effects of the appreciation of gold on the entrepreneur, the capitalist, and the wage- earner. Another line of economic cleavage gives us, however, a different classification. We may divide the people most affected by the change in price level into creditor and debtor classes. It is important to determine how the debtor class as such is affected by the appreciation of money. It is commonly understood, of course, that such a change is always detrimental to them, and bene- ficial to the creditors. The question is an impor- tant one, because, nowadays, production is carried on so largely on borrowed capital, and the whole producing class is properly regarded as a debtor class. It is clear, from what has been said, that in all cases of appreciation of gold, or falling prices, in which the cost of production of goods does not decrease, and money wages and money interest do not fall, the debtor producers must lose, and their creditors must gain correspondingly. Now, in a normal case, in a progressive society, 190 CHANGES IN THE VALUE OF MONEY the fall of prices is accompanied by a decreased cost, and the debtor producers lose less the more nearly the cost of production and the price level fall in the same degree. It is supposable, indeed, that they may even gain, but this is so highly un- likely as not to be worth discussing. As a rule, the debtor loses under appreciation, whatever may be its cause, and the effect on the welfare of some social classes may be serious, or even disastrous. Much depends, of course, upon the period of the debt. The longer the period, the greater is the burden likely to be. The distribution of the in- come of society is changed, then, by the apprecia- tion of money. In the case mentioned at the beginning of the chapter, in which increased pro- duction of goods is accompanied with proportion- ate increase of the amount of money, so that the price level does not change, the advantage of the increased production is distributed throughout the community, and the social welfare increases. This is not the case, however, when the increase of production is not accompanied with a due increase of gold. The welfare of society as a whole may be improved, but only at the expense, in part, of, some classes. 10. Comparative Disadvantages of Appreciation and Depreciation. There has been a good deal of discussion of the question whether appreciation or depreciation is more advantageous to society. The usual opinion is that contraction and falling prices are a greater evil than is appreciation of money, 191 MONEY because, it is supposed, the gradual appreciation of money in terms of commodities stimulates pro- duction and expands industry. It is urged that the prospect of rising prices constantly urges the entrepreneur to increase his product, in order to anticipate further increases. This statement, how- ever, cannot be made as a general truth; for, in the first place, if the cost of production falls faster than prices do, the producer will gain just as truly as he will if prices are slightly raising. It is a matter of indifference to him what the cause of his larger profits is whether they are due simply to a rising price, or to a cost decreasing faster than a slowly falling price. In the second place, the result to the producer depends partly on the way in which the change takes place. If the fall of prices occurs for all industries at the same time, and in the same degree, then it would be true that depreciation would be more beneficial to the pro- ducer than would its opposite. This simultaneous and proportionate fall of prices, however, is not usual. Indeed, it may be doubted whether it ever can occur. A change in the purchasing power of money in terms of goods shows itself in a fall of the prices of some articles sooner than it does in those of others. The consequencejs Jtojessen^the. expenses of production of all producers who use these articles in their business, so that each pro- ducer makes a gain, until the price of the articles which he himself makes also falls to the same degree as his cost of production has been dimin- 192 CHANGES IN THE VALUE OF MONEY shed. Moreover, it is questionable whether any gain which the producers make from the gradual depreciation of money in terms of commodities yields any gain to society unless money wages and incomes increase in such a way as to distribute the benefit among the various producing classes. 11. Causes of Appreciation and Depreciation. The causes of changes in the purchasing power money in terms of goods are very numerous, and the movement of changing prices may begin at different points in the economic scale. They may be due, in the first place, to changes in the physical conditions of production of the exchange medium. Much has been said in the past twenty years about the exhaustion of the gold mines. Of course, the truth about the matter is, that under the economic conditions of mining which prevailed, it did not pay as well to invest capital in producing more gold as it did to invest capital in producing something else. There really has never been any reasonable ground for the belief that the supply of gold was near exhaustion. The output of gold, or the amount of gold which it is profitable to produce, depends more on economic considerations than on physical conditions. That this is the case is well shown by the recent change in the gold-mining industry. The exhaustion of placer deposits, and the consequent unprofitable- ness of gold production, stimulated invention and discovery, so that, by new processes of extraction and refinement, the cost of production of the pre- o I93 MONEY cious metals has been very much reduced, and the profitableness of investment in their production correspondingly increased. A second cause of change in the purchasing power of gold is found in changing economic conditions. As has been repeatedly pointed out, undgr some conditions there is more profit in other lines of investment. Moreover, the capitalistic production of gold now is greater than the ac- cidental production, although the opposite was formerly the case. That is to say, gold was obtained as a result of accidental discovery, by \ prospective miners who had no capital, while now gold mining has become a more or less regu- lar industry, with large investment of capital. Like other industries, it has its periods of de- pression or comparative unprofitableness ; and if these continue long enough, the capital invested in gold mining is gradually withdrawn, or, at any rate, is not increased. A sgond economic change which influences the price level is an extension of the use of gold, either by the demonetization of other things used previ- ously as money, so throwing a heavier demand on gold, or by an extension of the gold standard to a new country. For example, it is a common belief that the demonetization of silver by Germany con- tributed not a little to the rise in the price of gold. While undoubtedly too much emphasis has been placed upon this historical event, it is doubtless true that the influence, so far as it went, was in 194 L RANGES IN THE VALUE OF MONEY the direction indicated. Of course, the adoption of the gold standard by countries which previously used silver, raises the price of gold only as the actual use of gold is increased thereby. A third economic change affecting the price level is the resumption of specie payments by countries which, for a considerable time, have been on a depreciated paper basis. This was the case in the United States in 1879, and in the empire of Austria-Hungary in 1892. In such cases a fund of gold is usually accumulated, even if it is not brought into general circulation. A jhird group of causes affecting the price of gold is found in political and social changes, as distinct from economic. War, for instance, may cause a cessation of the production of gold, as was the case during 1899-1902, the years of the Boer War in South Africa. Between 1898 and 1900 the gold production of Africa fell from 120,566 kilograms to 13,048. Aside, however, from the direct influence on gold production by war, the disturbance of industry which it causes may affect general prices. Production is likely to be changed in a measure from its ordinary channels, and a large amount of goods is unproductively consumed. A social change which leads to a larger use of gold in the arts also has an effect on the price level, unless the production of gold is changing fast enough to offset the change in this demand. If fashion, for example, calls for more general use of gold for ornaments, or for artistic purposes, the MONEY result is to raise the marginal utility of the money commodity, and very likely, too, its purchasing power. A change in the purchasing power may be caused by legislation which seeks to foster the private interests of the owners of gold and silver mines. The Bland- ah9? later, the Ai-fiaon law in the United States, each of which provided for the purchase of a certain amount of silver by the United States government, are instances of this kind. The avowed purpose, and for a time the actual result, was to raise the price of silver; although, of course, later, the higher price stimu- lated production, and resulted in a renewed fall. Although silver was not then the monetary stand- ard in the United States, the result /of silver legislation was to cause a great increase in the amount of silver in circulation as money, so that for some years there was a heavy export of gold in excess of our production, and an impairment of business confidence which led to depreciation and falling prices. 12. Effect of Changes in Production on the Value of Money. On the other side of the shield must be mentioned economic changes in the supply of goods. Technical improvements in production, which reduce the cost and increase the 'output, > will, other influences remaining the same, cause /I4lan appreciation of gold. So, too, may prolonged ^strikes, and a rise in money wages and incomes. Closely allied with changes which corne from 196 ,; : CHANGES IN THE VALUE OF MONEY schnical improvements is the growth of industry and commerce due to the opening of new countries or undeveloped markets. New sources of raw ma- terials, and the opening up of cheaper routes of transportation, have effects similar in character to technical improvements in production. Some authorities, like Mr. Sauerbeck, emphasize, for ex- ample, the opening of the Suez Canal as an im- portant factor in the fall of prices during the twenty-five years following 1873. Undoubtedly, the development of the railway systems of the United States, and the consequent opening up of new and more fertile lands, has been for many years an important factor in the falling prices of grain. The extension or contraction of credit, moreover, irrespective of changes in the supply of money commodity, will have an effect precisely similar in character. The effect of a general extension of banking is to lessen the demand for gold for actual payments, and for a time, therefore, to make the supply greater than the existing demand at the old ratio of exchange. A temporary contraction of credit, from industrial and commercial depres- sion, will, for a time, cause a greater demand for gold in order to make payments, because the credit part of the exchange medium is less, and so will produce a fall of prices. Different in character from any of the cases which have thus far been mentioned as affecting the purchasing power of gold, is that attributed 197 MONEY to the effect of the fall of the gold price of silver on the gold price of goods. It is urged that since some countries with large export trade use silver, if silver falls in terms of gold, while the prices of other things in silver countries remain steady, then the gold prices of other articles of export will fall. Undoubtedly this may happen for a while, but such an effect can hardly be either general or permanent. 198 CHAPTER XI CREDIT AND PRICES REFERENCES : Colwell, Stephen, The Ways and Means of Pay- ment, Ch. 7 ; Hadley, A. T., Economics, Ch. 8, 274 ; Jevons, W. S., Money and the Mechanism of Exchange, Ch. 26 ; Knies, K., Der Credit, Ch. 6 ; Laughlin, J. L., Principles of Money, Ch. 4, 8 ; Macleod, H. D., Theory of Credit, Vol. II., Pt. I., Ch. 12; Ibid., Report of the Royal Commission on Gold and Silver, 1888, pp. 234, 245 ; Mill, J. S., Principles of Political Economy, Vol. II., Bk. III., Ch. 12 ; Nicholson, J. S., Money and Monetary Problems, Pt. I., Ch. 6 ; Philippovich, E. von, Grundriss der Politischen Oekonomie, 4te Aufl., Erster Band, 109 ; Willis, H. P., Credit Devices and * the Quantity Theory, Journ. Pol. Econ., Vol. IV., p. 281. 1. Meaning of Credit. By credit we mean the power which one person has to induce another to put economic goods at his disposal for a time, on promise of future payment. Credit is thus an at- tribute, or power, of the borrower. There can be no transfer of goods from one person to another for future payment unless that other has some power or influence that induces the transfer. This power is not merely a desire to borrow. To be of avail in the market, to become- an economic force, the desire must be, like the demand, effective. *"Credit, or borrowing power, is usually, if not al- ways, expressed in terms of money. This custom, however, does not imply that money loans, or 199 MONEY deferred money payments, are the only kind of credit transactions. Indeed, as a rule, it is not money that is borrowed at all, but goods, or a credit of wider circulation than the credit of the borrower. If a person buys goods from a mer- chant on a promise of future payment, his credit demand is simply a demand for goods additional to the direct money demand, and not a demand for money. Or, the credit of an individual may be exchanged for that of a bank, because the credit of the bank is more widely accepted. In the last analysis this latter credit demand is also a demand for goods. But whether the credit exchange be one or the other of these two kinds, it appears as a claim to money. Credit is to be distinguished from mere confi- dence, although confidence is an important element of credit. Indeed, the essence of credit is con- fidence on the part of the creditor in the bor- rower's power and willingness to pay the debt. That confidence may arise from the creditor's belief in the integrity of the borrower, or from the offering by the debtor of sufficient property as security. Both forms, personal and secured, or real credit, are very commonly employed. Secured credit, so far as concerns bank loans, is most com- monly employed in call, or demand, loans ; while loans on time, which are usually discounts of mer- cantile paper, are more generally unsecured by a deposit of collateral. For example, the total loans of the national banks of the United States 200 CREDIT AND PRICES on September 9, 1903, were $3,481,446,722. Of this aggregate, demand loans to the amount of $717,258,621, and time loans to the amount of $655,439,130, or a total of $1,372,697,751, were secured by the deposit of stocks, bonds, and other collateral. On the other hand, loans to the amount of $2,108,749,021 were unsecured. Of the unsecured loans, $283,108,946 were call, or demand, loans, while the balance was time loans. 2. Nature of Credit Transactions. Credit, or the power of borrowing, manifests itself in credit transactions. It is the credit transaction which is evident, which pushes itself upon our attention and attracts our notice. A credit transaction is one kind of exchange. It is a present transfer of economic goods or services, or property, in con- sideration of a promise of a future return of equiv- alent value. The transfer may be physical or merely legal ; that is, it may consist in the transfer of an actual thing, or in the transfer of the title to a tW^jp^The essential features of a credit trans- action are these : goods are given up by the creditor to the debtor; the creditor must have confidence that he will be paid ; his action is vol- untary ; payment is expected after a definite period ; the thing transferred is economic goods, or titles thereto ; the debtor receives a legal prop- erty in these, and the creditor receives in exchange a corresponding legal property in the shape of a title to future goods. 201 MONEY 3. Credit Documents. Out of credit transac- tions arise various kinds of credit paper, or instru- ments. The most common of these are bills of exchange, promissory notes, checks, and drafts. These differ in the matter of their origin, as to whether created by debtor or creditor; in their power of circulation, and in certain details of form ; but all are evidences of a debt on the one hand, and of a credit on the other, and all purport to be claims for money. Nevertheless, in the last analy- sis, all but the bank drafts are based upon goods rather than upon money. Each piece of credit paper represents the purchase, or sale, of a certain amount of goods, whose value is expressed in terms of money on the face of the instrument. Credit instruments, therefore, are simply a means of facilitating the exchange of goods, and the obligations created by these credit instruments are met, in the main, by the cancellation, or offsetting, of the instruments against each other. 4. Difficulty of determining the Effect of Credit on Prices. Perhaps the most important question in the theory of credit is the effect of credit trans- actions upon the price level. We may approach the subject from either one of two points. We may regard credit purchases as additions to the demand for goods, and trace the effect of the in- creased demand for commodities on prices ; or, we may take into consideration the increase in the supply of the medium of exchange, in the shape of credit paper, and trace the effects of this 202 CREDIT. AND PRICES ^.K . increased supply upon the level of prices. On the whole, it is simpler to take the former course. We must distinguish the influence of credit upon relative prices from the part played by credit as one of the determinants of the price level. An increased demand for particular goods, due to credit purchases, will, of course, raise their prices. The tradesman feels that he must be insured against possible loss through bad debts, and must be remunerated for lying out of the use of his capital. How much insurance and how much remuneration depends on the length of the credit period, on the ordinary rate of interest, on the ra- pidity with which the merchant ordinarily turns over his capital, and on the estimated risk of loss. I We are not concerned here, however, with changes in relative prices, which are caused partly by differ- ences in the amount of credit demand for different classes of goods. 5. Different Theories of the Relation of Credit to Prices. There are several possible views of the character of the influence exerted by credit on the price level. In the first place, the jyjfiw may h ^ taken that_credit usually, or normally, has no^offect jicuprices. This view is based upon the supposi- tion that credit demand, taken as a whole, cancels itself; that the credit demand has existed from the beginning of exchange, side by side with money demand, and that therefore it is not perti- nent to say that credit has any influence on 203 MON^Y prices. 1 At first sight this theory seems plausible. But if credit has no influence on prices because it is coexistent with the level of prices, similarly money can have no influence on prices. If it is reason- ing in a circle to say that we do not have a price level without credit, and that credit is therefore not a determinant of the price level, the same remark is equally true of money. In order to determine the influence of one of the factors of the price level, we must do our best to find out what would be the state of affairs in the absence of that particular factor. It is not enough to say that this factor is always present, and, therefore, we need not try to decide what would be the situa- tion if it were absent. If it is present, it must have some effect. In the next place, the view is* sometimes taken that an increased demand for goods due to credit is precisely similar in its effect to an increased demand due to money. Here emphasis is laid on the fact that there is an increase in demand, and the fact is overlooked that the increase in de- mand in a measure automatically cancels itself by a simultaneous increase of the supply of goods, so that the total credit demand does not play directly on prices. Hence it is not correct to say 2 that the price level is influenced by the whole mass of credit 1 This seems to be Professor Laughlin's view. See his " Prin- ciples of Money." 2 Cf. Macleod, Report Royal Commission on Gold and Silver, 1888, pp. 234 and 245. 204 ind CREDIT AND PRICES instruments created. It is not true that the prices of commodities are determined directly by the total amount of all the different kinds of circulat- ing medium, rather than by the demand for, and supply of, standard money, under given conditions of the exchange mechanism. Nor is it quite cor- rect to say, with Walker, that the general level of prices is determined by the amount of, and demand for, the standard medium of exchange ; that on the level of prices thus fixed credit transactions occur, which cancel one another without the use of money ; and that the credit instruments on which these transactions are based disappear when the transactions are closed, without exercising any in- fluence on the level of prices. The uncancelled^ balance of indebtedness based on credit does, in- deed, create a demand for money and will have a certain influence on the price level ; but the whole amount of this unsettled balance, or the credit in- struments which represent it, does not, as a matter of fact, enter in, like so much standard money, to influence prices. 6. Credit One of the Determinants of the Price Level. According to the theory advanced in this book, every community has a choice of methods of exchange and means of payment, including direct barter, money exchange, and cancellation, or credit exchange. Under fixed conditions of economic life a community which has such a choice will push the use of each method of exchange and payment to a point where its use for the exchange of an addi- 205 MONEY tional unit-volume of goods would cause a loss to the community. At this point, since prices are ex- pressed in terms of money, the marginal utility of the available money supply would indicate the level of prices. But the marginal utility of this money supply depends, in part^ upon the demand for money for use asja^reserve, to settle the uncan- celled balance of credit transactions. Credit is therefore properly called one^of the determinants of the price level. If credit exchanges were wiped out, without causing any diminution in the demand for goods, money would take on a higher marginal utility than before; that is, its value would rise, and the price level would fall. With the introduc- tion of credit payments, an equilibrium would be established between the marginal utility of money for reserve purposes and its marginal utility for direct payment. This would mean a change of the price level from that which obtained in the absence of credit sales. This equilibrium would emerge when credit exchanges and direct money exchanges had each been pushed down to the point where the expensiveness of exchange to society by each method is proportionate to the volume of exchanges performed by each method. 7. The Effect of Credit on Prices depends on the Completeness of the Cancellation of Indebtedness. - Let us suppose that the volume of transactions in a given community at a particular time be called ten, all of which are done by direct money pay- ment. Let us suppose, further, that over-night, as 206 CREDIT AND PRICES it were, credit exchange is suddenly introduced, to such an extent as to effect exchanges to the extent of five of the ten units of transactions, on the basis of existing prices. If, of the five units of exchanges now performed by credit, exchanges to the amount of four units cancel one another, one unit is left to be settled by means of money, and the community must keep a reserve sufficient to do this on the old price level. The four unit-volumes of money formerly used have now been set free, and if it were destroyed, or sent out of the com- munity, the price level would not be changed, be- cause the work formerly done by this money is now done by means of cancellation, without any addi- tional strain on the money which is left in use. This money, replaced with credit cancellation, is likely, in part at least, to remain in monetary use. It will, therefore, raise prices to a new level. The price level will not rise in proportion to the num- ber of money units used for direct payments, but will settle at some point where there will be an equilibrium between the marginal utility of money for use in direct payments, and for use as reserve. Another effect, however, will be to make a larger reserve necessary for the same volume of transac- tions because of the higher level of prices. The money set free on the old level of prices will, there- fore, distribute itself between the reserve money and direct payment money. If we suppose the case of a country on an exclu- sively metallic basis, into which credit is suddenly 207 MONEY introduced, the reserve necessary to settle the un- cancelled balance of credit transactions may be furnished by the money which is set free from direct payment by the introduction of credit pur- chases. If this should happen, we would have a smaller amount of money to exchange for a smaller amount of goods by direct payment, but not a proportionally smaller amount of money. The amount of goods will be less, proportionally, than the amount of money, because the credit pur- chases may be two or three times the amount of the metallic basis. Again, the introduction of a less expensive l ' medium of exchange lowers the marginal utility of the money medium in use, saves some of the cost of exchange to the community, and, therefore, again raises the price level. Now the extension, or refinement, of the credit mechanism does just this thing. Credit exchange is essentially a return to barter by representative transfers of goods rather than by physical transfers. Hence it saves some expense of transfer. In doing so it diminishes the volume of exchanges made with money, and thus causes an increase in the quantity of money rela- tively to the volume of work it has to do. There^ fore it lowers^ thgjnarginal utiljj^ofjnoney, or, in othjCwor3^]^i^es_^eJ,evel of prices. 8. Causes which Produce a Permanent Balance of Indebtedness which must be settled with Money. 1 Not necessarily cheaper to secure, but of larger net efficiency, or profit, to the community. 208 CREDIT AND PRICES /e have said that by means of credit we can make ^changes of goods for goods by simple cancella- tion of values. The goods sold on credit approxi- mate in value those bought on credit; there is, therefore, a constant approximation to a complete cancellation. If this cancellation were complete, credit, as has been remarked, could never be in excess of the means of payment available to set- tle balances. The cancellation, however, is never complete, but always shows a balance of opera- tions. This balance is caused by a variety of cir- cumstances, of varying importance. In the first place, it is quite impossible in trade to prevent lack of coincidence in demand and supply, either in time or in volume. In order to effect a com- plete cancellation of all goods bought and sold on credit, it would be necessary that the whole amount bought at one moment, or in one period, should equal the whole amount sold in the same time. Now, many purchases on credit are purchases for deferred payment, and, therefore, at the time of purchase, offer no goods which can cancel the demand. The demand, in other words, is present ; the supply which would cancel it is future. There must, therefore, be a balance in such cases. If all credit were based on goods already produced and offered for sale, and if in all cases the amount of credit based on these goods equalled their market value, then the credit demand for goods would cancel itself. In order to illustrate this most simply, let us suppose the case of a manufacturer p 209 MONEY of cotton goods and a planter of cotton. The manufacturer, having finished some goods, ships them to the cotton planter and draws on him for the purchase price. This draft he gets discounted at his bank. In the meantime the cotton planter ships the manufacturer an equivalent value in raw cotton, and draws on him in turn, and gets his draft discounted. Obviously the transactions balance, and the drafts coming together, we may suppose in some New York bank, will cancel each other. In actual trade, however, the opera- tion is not so simple as this, nor can we usually secure an exact cancellation. Either the demand of the manufacturer or that of the planter will be in excess and will not cancel the other. It is this anticipatory credit demand which chiefly deter- mines the magnitude of the uncancelled balance of credit and influences prices. If business is good, the demand for loans not based upon fin- ished goods, but upon some security which does not immediately cancel the loan, is likely to in- crease. In other words, opportunities for invest- ment increase, and loans may be paid for not with present but with future goods. Therefore the bal- ance of credit indebtedness is likely to become larger, and the demand for standard money to settle the balance must therefore increase. In the. second place, exact cancellation is pre- vented by the disturbances or accidents of pro- duction and trade. Changes in demand for goods, mistakes in correctly forecasting the demand and 210 : CREDIT AND PRICES calculating the supply, changes of fashion, mis- takes of judgment in determining the proper proportions of fixed and of circulating capital in some industry, and a hundred and one incidents of business which are continually occurring, are likely to cause such a disturbance. Moreover, an unsettled balance of credit demand may be caused by a breakdown of the credit ma- chinery at some point, leaving a number of engage- ments unfulfilled. This uncancelled balance, too, calls for money to settle it, aside from that which is used for direct money exchanges. Against this uncancelled balance a reserve must be provided whose amount depends upon the state of trade, the business habits of the community, and many other factors. The need for money to settle this uncancelled balance of credit demand is increased, moreover, by the distress and fear that some people exhibit in business transactions, which make them unwilling to wait through the credit period for the fruition of enterprises in which they have sunk their money. The more perfect the cancellation, however, as has been repeatedly remarked, the less the amount of money needed, and the less, therefore, the re- serve that needs to be kept. As credit machinery becomes more perfect and more widely extended, we should therefore expect a reduction of the amount of what may be called the normal bank reserve ; that is, in the amount which in ordinary times the banking institutions of the country find 211 MONEY it necessary to keep on hand to meet the demands of their customers for ready money. 9. The Influence of Reserves of Money for Credit Transactions on its Value. The conclusion of all that has been said is that the credit balance causes an extra demand for standard money, since credit exchange does not dimmish the money exchange as much as it would do if the cancellation of credit purchases were complete. Now, it is through the demand for money to settle this uncancelled bal- ance that credit influences the price level. The amount of money needed to settle this uncancelled balance at any moment is the reserve of money which a community needs to sustain its credit oper- ations. With a given supply of money, a com- munity will so adjust its credit exchanges, on the one hand, and its direct money exchanges, on the other, that the money supply will be divided be- tween use as a reserve and use for direct payments, in such a way as to make the marginal utility of the money for the two uses the same. But an in- crease of the balance of indebtedness necessitates an increase in the reserve money at the expense of money used in direct payments, and will, therefore, raise the marginal utility of money and cause a fall in the price level. Now, the total volume of trans- actions which yield a particular balance may be large or small, for the same remainder may be ob- tained from minuends and subtrahends of very dif- ferent amounts. In theory, therefore, the credit demand for goods may increase indefinitely, while 212 CREDIT AND PRICES the demand for money as a basis of credit transac- tions need not increase simultaneously, or not so rapidly, because the balance of the credit demand, ' the only part for which money is needed, may not increase. If. on two selected dates th^ ynlnmfi ^f transactions done on credit is the same, but thejpjjj^. anceis less orTthe second occasion than on the first, then the demand for money will be less, its value. an** prWc w ji] hp; .higher for the same volume of business. For with a given supply of money, the demand available for direct payments under these conditions will be larger. On the other hand, prices may fall, without any change in the amount of money. If, apart from a check to business confidence, the balance of credit transac- tions becomes greater at one time than another, although the total volume of transactions has not increased, but may have diminished, the demand for money must become greater too. Hence its value will rise, and the value of goods will fall. Reserves must become larger in proportion to the total volume of credit, and a new equilibrium must be established between the marginal utility of money for reserves and its marginal utility for direct payment. It follows that the level of prices! may rise or fall without any change in the vol-^ ume of standard money, but only a change in its distribution for use as reserve and as a means of direct payment. These changes are due, in other words, to the inexactness of cancellation of credit transactions. Most of our credit transactions are 213 MONEY based upon bank loans and discounts. The bank needs to keep on hand an amount of money suffi- cient to pay the balance of indebtedness which ex- perience shows is likely to accrue from day to day. If, now, the balance of credit transactions increases, the need for money for settlement becomes greater. The banks, feeling the pressure of the demand, raise their rate of discount. This curtails credit operations and reduces the difference resulting from the offsetting of the credit claims against one another. In other words, it reduces the volume of business. If, on the other hand, the balance of credit trans- actions decreases, money becomes more plentiful in the banks and the rate of discount falls. Bor- rowing becomes easier and credit transactions are thereby stimulated. A new balance is thereby established, and consequently a new equilibrium is fixed between credit balances and the money reserve. / 10. Limits of the Influence of Credit on Prices. / Now this variation in the price level, due to a / change in the amount of credit operations, is self- limiting. Let us consider a case where prices are rising, due to an increased demand based upon the ^xtoision of credit* As prices go higher, the periods of returns to investments in different lines are likely to vary more and more. The probability grows less that a given amount of debts will be off- set by a given amount of other debts, as the total number of debts increases. Hence, the balance of indebtedness grows larger. Some borrowers find 214 CREDIT AND PRICES MONEY time this money is divided in a certain proportion between the credit and the ready-money transac- tions. On a given price level, a certain volume of ready-money business is done, and a certain amount of money is needed to do it. At the same time a certain volume of credit business is done, and a certain amount of money is needed as a reserve, or basis, on which to do this. It has been pointed out that if there is a more complete can- j cellation of indebtedness and, therefore, a smaller balance, from the offsetting of credit instruments ' against one another, the amount of reserve needed will become less. A certain amount of ready money is, therefore, Jet free from supporting credit transactions. We have supposed that it will be- come the basis, or reserve, for an additional volume of credit operations ; but if we take into account, as we are now doing, the presence of transactions in ready money, it may happen that the money set free from the support of credit business may all go into circulation in the sphere of the ready-money business. In that case the value of money, the supply being increased, will fall, and prices will rise, so far as they are dependent upon the quan- tity of money available for the unchanged amount of direct money payments, or, what is the same thing, upon ready-money demand for goods. This result is precisely what we arrived at when we supposed that the money set free would be used as a basis of new credit operations. Whichever way the freed money turns, therefore, it will give an up- 216 CREDIT AND PRICES jward fillip to prices. All the free money cannot go to the ready-money transactions, however, for it would thereby raise prices above the level pro- duced by the credit demand. Practically, the price level will be a new .equilibrium between the amount necessary as a reserve for the diminished balance I of credit and the increased volume available for direct payments. Similarly, if the existing equilibrium between the balance of indebtedness and the money reserve is disturbed by an increase in the balance of indebted- ness, a strain is thrown upon the money used in the ready-money transactions. Its value rises, and prices, therefore, tend to fall. In a regime where there were no ready-money transactions, the result would be only a contraction of credit transactions, in order to diminish the credit balance ; practically, both results would doubtless follow. Credit will contract far enough to produce a balance of in- debtedness which, in conjunction with an increased demand for money in ready-money transactions, will produce a new price equilibrium. It will be necessary to consider now what results will follow if the existing price equilibrium is dis- turbed primarily by a change in the amount of money used in ready-money transactions. It is not hard to trace these effects, after what has been said. If, for any reason, the demand for money in the ready-money part of business should in- crease, the necessary addition could be drawn only from the reserve on which credit transactions were 217 MONEY based. Means would have to be taken to reduce the balance of indebtedness by a more complete cancellation, or the total volume of credit transac- tions must decrease, until a new balance was found which could rest upon the diminished money re- serve. Under the pressure of these changes, th marginal utility of money would be greater, and the price equilibrium somewhat lower. Similarly, if the need for money in ready-money business should fall off, the reserve available for credii business would be larger, there would probabl; be a disturbance of the uncancelled balance, an the price level would be a new equilibrium between the marginal utilities of money for the two services, on a higher level of prices. The resulting price level would be found somewhere between the points at which it would settle from a change in the ready- money business, and from a change in the credit business, acting alone. In order to make our discussion complete, we need now to consider the effect of an increase in the total volume of money. This has been so fully discussed in another connection that we need only refer to it here. The first effect would probably be to stimulate credit business, because new money finds its way into circulation generally through the banks. An increased credit demand for goods would raise their prices, and a higher price level would necessitate a larger amount of money in active circulation, in order to perform easily the ready-money portion of busi- 218 CREDIT AND PRICES ness. The additional money would be divided, therefore, between the reserve necessary for credit and the money necessary for ready-money business, in a proportion which would produce a margi- nal utility for reserve money identical with that of the money used in direct payments, and this would be a lower value, or a higher price level. Professor Essars has shown 1 that the German banks, where checks are largely used, need a smaller balance in turning over a given amount of money than do the French banks with a smaller use of checks. This means that the more com- monly payments are made by check into a bank, so that the smaller the difference, or balance, between its debts and credits, the less money is needed by the bank. This difference may be regarded, as has already been remarked, as a normal reserve, and doubtless tends to become smaller as cancellation becomes more perfect. 12. Influence of Different Kinds of Credit Transac- tions on Prices. Credit transactions are to be distinguished according as they do, or do not, give rise to credit instruments which circulate, or perform payments by passing from hand to hand like money. A purchase on credit may be registered in a book, and cancelled at a later time by another similar entry. This is the sim- plest form of book credit, or registering of de- ferred payments. In this case, the credit granted 1 "La Vitesse de la Circulation de la Monnaie," Jour, de la So- ci'et'e de Statistique de Paris, April, 1895. 219 MONEY is not used as a basis for new credit. On the other hand, a purchase or a loan may be evi- denced by the issue of a piece of paper, whether note, check, or bill of exchange, that may be used to make more than one payment before it is re- tired. It is important to determine whether the former kind of credit transactions exert less or more influence on prices than do the latter. Not infrequently it is thought that the circulating char- acter of certain credit instruments gives greater power over the price level to the class of transac- tions out of which they arise, than is imputable to ordinary book credit. This opinion doubtless is based, in part at least, upon the close resemblance of the service which these credit instruments per- form to the work of money. It is plausible to think that since credit instruments discharge obli- gations as does money, they are simply an addition to the medium of exchange, with all the functions that money possesses. This, however, is hardly a correct view to take. Strictly speaking, these credit instruments do not giv rise to a greater volume of credit ; rather are they results of a greater volume of credit. They give greater mobility to the credit demand to which a given amount of goods gives rise. In the case of ordinary book credit, the volume of the credit demand remains unchanged and uncancelled until the expiration of the credit period. In the case of credit demand out of which credit instruments arise, the credit granted is immediately made the basis of a new 220 CREDIT AND PRICES credit, and this, in turn, of another, creating a series of transactions, only the last of which is likely to call for money. The credit instruments, then, are simply a means of giving greater mobility to the credit demand. The greater the duration of their circulation, the larger the total volume of credit cancellation which they will perform, but the larger is the uncancelled balance of credit demand for goods likely to be. For this reason, a given volume of credit transactions of the class that gives rise to circulating instruments of credit is likely to influence prices more than an equal volume of credit transactions which do not origi- nate such instruments. The greater influence of this kind of credit transactions on prices is due, therefore, not to anything in the nature of the instruments of credit, but to the fact that, making possible, as they do, a greater volume of credit de- mand, the uncancelled balance is likely to be larger. 13. Deposit Currency. -^ Modern banking has developed a method of cancellation by means of book credit which is far more rapid and effective than can be attained by circulating instruments like bank notes. This bank-book credit is called deposit currency, and consists of the deposits to the credit of individuals on the books of the bank. It is these deposits against which checks are drawn, and which form the most common paying medium in highly developed commercial centres. Indeed, in such centres, deposit currency plays a far more important part than does note currency. 221 MONEY The latter is adapted more particularly to com- munities in which the population is more widely scattered, and access to banks is more difficult. Under such conditions the possibilities of can- cellation are less, and a larger amount of cur- rency is needed, of the kind which will pass from hand to hand indefinitely; whereas deposit cur- rency, represented by checks, must, from its very nature, return quickly to the banks. The relative importance of the two kinds of medium of exchange may be seen from the fact that on September 9, 1903, the national banks of the United States held $3,156,333,499 individual deposits against which checks were drawn, and only $375,037,815 of notes outstanding. This deposit currency arises from discounts. When a merchant takes a bill of exchange, or a promissory note, to his bank, the bank gives him its face value minus the discount* and credits him with the amount as a deposit/ Obviously, if all the merchants of a community did their business at the same bank, their checks coming into this bank would cancel one another, and the whole discharge of indebtedness between them could be performed by transfers of credits on the books of the bank. Of course there is usually more than one bank in a community, and not all the tradesmen of the same place do busi- ness at the same bank. Under these circum- stances the cancellation is accomplished through an agency known as a clearing-house. This is simply an institution, or a place, where the banks 222 CREDIT AND PRICES in the community exchange the checks on one ' another, received from their patrons, and pay the balance against them in jL^sh. Indeed, they do not always pay the balances in cash, but some- times by drafts on the clearing-house, which are entered in the books of that institution to the credit of the banks in favor of which they are drawn. Cancellation is thus carried to its most profitable extent, and the amount of money necessary to settle a huge volume of transactions is reduced to a minimum. It should be noticed that the influence of credit in raising prices is cumulative. If the credit de- mand for goods raises the price, the possessor, of those goods can get larger credit at his bank, since he borrows on the new valuation. If business is good, and if confidence and buoyancy prevail, this process may repeat itself until prices are forced to a very high level. The amount of credit based upon goods at this high level of prices may be so great that the balance, after cancellation, may be greater than the reserve can carry. In that case the business community is face to face with a monetary stringency, if not a crisis. The credit must be contracted, or an increased amount of money must be obtained for a reserve. Herein lies the great danger of credit as a means of pay- ment. Unless the granting of credit is carefully guarded, it may lead to an inflation of prices that will destroy confidence and cause great loss to the community by a sudden fall of the price level. 223 CHAPTER XII THE MEASUREMENT OF VARIATIONS IN THE PUR- CHASING POWER OF MONEY REFERENCES : Adams, T. S., Index Numbers and the Standard of Value, Journ. Pol. Econ., December, 1901, March, 1902; Com- mons, J. R., Quarterly Bulletin No. 2, Bureau of Economic Research, October, 1900; Edgeworth, F. Y., Report of the British Association for the Advance of Science, 1887, pp. 254-301, 1888, pp. 188-219, 1890, pp. 133-164; Econ. Journ., Vol. IV., p. 159; Journ. Royal Statis. Soc., 1883 (Vol. XLVL), p. 714, 1888 (Vol. LI.), p. 346; Falkner, R. P., United States Senate (Aldrich) Report on Wholesale Prices, 1893 > Jevons, W. S., Investigations in Currency and Finance, pp. 13-159; Journ. Royal Statis. Soc., 1879, 1884, 1886, pp. 592, 648, 1893, PP- 220, 247, 1903, pp. 87, 616; Laspeyres, E., Die Be- rechnung einer mittleren Waarenpreissteigerung, Jahrb. fur Nat. u. Stat., B. XVI., pp. 296-314; Laughlin, J. L., Principles of Money, Ch. 6 ; Nicholson, J. S., Money and Monetary Problems, 5th ed., pp. 312-342 ; Padan, R. S., Prices and Index Numbers, Journ. Pol. Econ., March, 1900; Pierson, N. G., Further Considerations on Index Numbers, Econ. Journ., March, 1896 ; Taussig, F. W., Results of Recent Investigations on Prices in the United States, Yale Rev., November, 1893 J Walras, L., Elements d'Economie Politique Pure, pp. 431-432, 457-468; Theorie de la Monnaie, Pt. 3; Walsh, C. M., The Measurement of General Exchange Value. 1. On the Possibility of measuring Changes in the Value of Money. Attempts have been made from time to time to measure in terms of goods the amount of change which the purchasing power of money undergoes. In such attempts, of course, 224 MEASUREMENT OF CHANGES IN PRICES no attention is paid to the causes of the changes. The inquiry has to do merely with the extent of the change. It makes no difference for this pur- pose whether " it is the pence that are few or the eggs that are many " ; nor is it of importance to ask whether a change in value due to a change in the supply is, or is not, influenced by simultaneous changes in commodities. The sole question con- cerning the change is : Can we measure it ? The possibility_-0f-doing so has been scouted by some, who insist tha_t__we cannot measure the variation of one thing in terms of another thing, if both vary at the same time, partly or wholly, from indepen- dent causes. But surely this position is not cor- rect. Although our standard varies, if we can measure its variations, or can show that they are according to a certain law, it will serve the pur- pose of a standard as well as if it were absolutely fixed. 2. The Importance of Measurements of Price Changes. Ability to measure variations in the purchasing power of money is of importance for several reasons. It is desirable, in the first place, in order to fix the value of deferred payments, especially those which run for a long time. We have seen that hardship may be caused by varia- tions in the value of money. If we could measure these variations periodically, and correct them, we would attain the purpose of an invariable standard ; for all that it would be necessary to do to prevent one person from gaining at the expense of another, Q 225 MONEY on account of the variation, would be to compute its amount. In the second place, the ability to measure such variations enables us to compare the relative values of wages and incomes in different places, and at different times. This is a matter of some moment to those who have expenditures to make in many places. The investor whose capital is placed in the enterprises of half a dozen countries is a much interested party in the comparative values of one ounce of gold in these different places. Nor is the academic reason for desiring to measure these variations altogether to be despised. It is of no little interest to be able to compare the pur- chasing power of money at different periods in history, for the inquiry throws much light upon the economic condition of the various social classes at different times, and affords a kind of measure of social progress. 3. Nature of the Problem. What we are called on to do is to determine, in the first place, the relation of a certain property of one variable, A, which is subject to numerous, undetermined causes of variation, to a similar property possessed by a multitude of variables, of which A itself is one, similarly subject to numerous causes of variation, which are not fully known ; in the second place, to do this for different times, so as to compare these ratios, although in the meantime new causes of variation may have come in and old ones may have dropped out, and the relative importance of 226 MEASUREMENT OF CHANGES IN PRICES the various causes may have greatly changed. If we might seek an illustration to enforce the idea of the complexity of the problem, we might say that we are to determine at a certain moment the ratio of the height of one wave of the sea to the average height of all the waves, including the one which is selected for comparison. The problem is theoreti- cally solvable and the answer is some kind of an average. This average tells us nothing about the prices of individual goods. They may be higher or lower than the general level, in approximately equal numbers ; or many may differ from it only a little, and a few a great deal. In comparing any average with an average computed at a previous date, if we find it higher we must not conclude that the price of every article has risen ; nor when a fall in general prices or in the " price level " has occurred, that the price of every article has fallen. It is conceivable that all but one may have risen or fallen, but the average will not show this. The change may be due to the one, and not to the many. Our result will therefore be more or less valuable according to the extent of our knowledge of the factors which determine it, and according to the purpose for which we intend to use it. Differ- ent averages are suited to different purposes. Any intelligent use of an average of prices must have regard, therefore, to the purpose for which that average was prepared. 4. Index Numbers. The usual method of measuring changes in the purchasing power of 227 MONEY money is by means of index numbers. I An index number is a number which represents the price of a chosen commodity, or group of commodities, or the average of closely consecutive prices of those commodities, at a selected date, which is used as a standard wherewith we may compare the prices of the same article at later dates. ) Suppose, for example, that sugar is quoted at 20 pounds for $i to-day, and at 16 pounds for $i at some day next week. The price of 20 pounds on the latter date will be $1.25, and the latter price is to the former as 125 to 100, and the 100 may be called the index number. Instead of taking the price of a single article as a standard, jtqs better^ howeyerLjaJ&k^ prices, ofanumber of jjjfferent articles, either at a slnglejelected date, or for a selected period. The price of each article on the selected date is called 100 and the number which expresses its price, in terms of this base, at another date, is in the ratio of the later price to the earlier. The sum of the later numbers divided by the number of the arti- cles will give the average for the later date, and the difference of this average from the base, 100, will show the change in the purchasing power of money over the goods that are chosen to make up the table. The standard formed either of all ven- dibles, or of a selected list, whose prices are thus manipulated for the determination of the base for the price level, is called a tabular standard. We may illustrate the formation of index num- 228 MEASUREMENT OF CHANGES IN PRICES bers by the following table of prices of six selected commodities : 1880 1890 1900 PRICE BASE PRICE RED. TO BASE PRICE RED. TO BASE Steel, per ton . . . $25.00-100 #23.00- 92 $26,00-104 Corn, per bu. . . .50-100 .45- 90 v^ .55-110 Wheat, per bu. . . .90-100 .92-102 ' 95- I0 5 Wool, per Ib. . . .30-100 .25-83*- .28- 90 Coal, per ton . . . 2.OO-IOO 1. 80- 90 - 2.10-105 Sugar, per bbl. . . 15.00-100 14.50- 96| 14.00- 93 IOO 6)554 6)607^ 92* I0l In 1880, the first date selected, the price of each article is called 100. Hence the simple average of the prices, or the base, is 100. In 1890, the prices having changed as indicated*, 4he, average , becomes 92 J ; and in 1900, 101^. Thjft is, as com- pared with 1 880 the average of prices, estimated in these goods, was 7 per cent, lower in 1890, and I J per cent, higher in 1900. Instead of regarding the price of each article in the basic year as 100, we might simply add the actual prices of each year and divide by the num- ber of articles. The ratio of the average of each later year to that of 1880 would then show the courses of the averages. Thus, the averages would be 43.70, 40.90, and 43.88. Regarding the first as 229 MONEY 100, the others are 93.6 and 100.4, respectively. The results are different, but the course is the same. 5. Limitations of Index Numbers. The ac- curacy and serviceableness of such an index as has been described are open to criticism both on theoretical and practical grounds. Its value depends upon the kind of average used in com- puting the base, upon the number of articles selected, upon the amount of each articlq, upon the kind of prices used, whether wholesale or retail, upon the accuracy of the price observations, and upon the extent of territory within which the price observations may be regarded as applicable. There are, then, many "if's" in the way of se- curing a satisfactory table of prices. If (i) we could be sure of getting an accurate and just mean for our base ; if (2) all goods could be included in making a tabular standard ; if (3) we could deter- mine in what proportion the goods should be used in order to form a universally just measure; if (4) we had to do always and everywhere with the same goods in the same quantities and of the same qualities; if (5) their exact prices were ascer- tainable and universally applicable ; and if, finally, sundry other conditions, which depend upon the specific purpose in hand, could be fulfilled, then we might, perhaps, frame an accurate measure of the variation of the purchasing power of money in terms of goods. In other words, we could measure changes in the price level so far as it is 230 1 MEASUREMENT OF CHANGES IN PRICES determined by the value of material things. But the value of money may vary with reference to other things than material goods, as wages, rent, and incomes from other sources. The unit of measure in all these cases would be different from the one which we have hypothetically described. 6. The Kind of Average used in Computing Index Numbers. The first thing necessary is to decide on the kind of average of prices which we are to use as a basis in making our comparisons. Differ- ent writers have used different averages, including the arithmetical, the geometric, the harmonic, and the median. If we use the arithmetical average as the aver- age, or mean, price of an article through a period, we simply add the terms of the series of prices and divide by their number. If we use the geo- metric average, we multiply the numbers in the series of prices in the period and take that root of the product indicated by the number of terms. If we use the harmonic average, we find the reciprocal of the arithmetical average of the series of prices. The median is that term of the series which has as many terms above it as below it. To illustrate : Suppose the price of a pound of cotton for five successive days was S, 6, 8, 9, and ii cents, respectively. The arithmetical average price would be 7.8; the geometric, 7.5; the har- monic, 7.2 ; and the median, 8. The arithmetical average of a given set of numbers is larger than the geometric or the harmonic. 231 MONEY Apparently, the answer to the question ho\ much prices have changed in a given period, wil depend largely upon the particular average choser It might appear, therefore, a matter of some ir portance to decide which is the proper, or the best, mean to use. The arithmetical mean is sim- ple and easily found, but it is much disturbed by violent fluctuations. That is, it gives emphasis to the large numbers. The geometric mean, on the other hand, increases the influence of the smaller numbers, but it is more tedious to calculate. It is appropriate in a problem where the " quaesitum is a real thing or at least a unique type (as the aver- age stature of a nation), or if the errors or devia- tions from the true mean which the data present obey a certain law of dispersion, which there is some reason for expecting prices to fulfil/' 1 Moreover, the geometric mean is " more likely than the arithmetic mean to correspond to the greatest ordinate of the un symmetrical curve which the statistics of prices are apt to form." 2 The median, like the arithmetical mean, is easily found, but it may vary much from type ; that is, it may be far from any actual price. It is less dis- turbed, however, by sudden great changes than is the arithmetical mean. The harmonic mean is best to apply if there is a large number of low prices, and a small number of large ones, in the series. 1 Edgeworth in Econ. Journ., Vol. IV., p. 159. *Journ. Royal Stat. Soc., 1888, p. 356. 232 MEASUREMENT OF CHANGES IN PRICES But the mathematical characteristics of the dif- ; ferent means do not enable us to determine which one to use. No one of these means is to be chosen, becausejt is mathematically the most exart The basis of choice is the economic purpose in view. If we have a number of prices that vary but little from one another, and our purpose is to determine how much money must be given on two separate dates, assuming that the same number of units of goods are sold on the two dates, the arithmetical mean is best. If we want to determine changes in the purchasing power of money as measured by total mass of goods purchasable, irrespective of their proportions, the geometric mean will best serve our purpose. If, in the series of prices, there are a good many which changed but little, and a few which had changed very largely, the harmonic mean would be the best to use. 7. The Number of Articles necessary to Furnish Proper Averages. The number of articles to be chosen for the table of prices is mainly a question of convenience, provided it is large enough to be fairly representative, and provided that the articles are those of the widest demand. Opinions differ, of course, as to what things should enter into the list, at least after a certain number have been named ; but there are many on which all persons agree. The error due to a restriction of a number of vendibles cannot, then, be wholly, eliminated ; but the whole calculation is of so rough a character that we can afford to neglect the error due to this 2 33 MONEY cause. Moreover, we must understand in the case of this source of error, as in the case of others, that if it is approximately constant, it cannot affect the correctness of the relationships indicated by the results. We may, therefore, conclude that a list of articles ordinarily chosen in such tables as those of Sauerbeck and Soetbeer are sufficiently numerous to serve the purpose. 8. Relative Proportions, or Weights, of Articles Used. But after we have determined what arti- cles shall enter into our table, we must also fix upon the relative proportions of these articles. Goods are not all of equal importance. A table which gave equal weight to wheat and pepper, for example, would be misleading. As to what con- stitutes, or determines, the importance of goods in this connection, opinions differ widely, so that vari- ous measures have been suggested. The relative importance of goods, economically speaking, may be estimated, for the purposes of index numbers, on the basis of the relative quantities produced, of the relative amounts exported or imported, of the proportions in which they enter into the consump- tion of the mass of the people, or in any one of half a dozen other ways. Mr. Inglis Palgrave has chosen to weight the articles in his computation according to their relative importance in exports and imports. Soetbeer and Sauerbeck weight the articles in their tables according to their relative annual consumption. Professor Falkner, in the United States Senate Report on Wages, Prices, 234 MEASUREMENT OF CHANGES IN PRICES d the Cost of Living, chose to list the articles in his tables in the proportions in which they enter into the budget of expenses of the average work- ingman ; and Mr. Giffen, a good many years ago, proposed 1 to use as his index numbers the ratio whose numerators are the price of the whole amount of each article consumed in the standard year, taken at the prices of each later year ; and whose denominators are the same quantities at the prices of the standard year. Here again we find that, whichever method is adopted, we may expect, >n the whole, similar indications in the results. All that is necessary is that the calculation of the price level at successive dates shall be made in the same way, with data which show the same facts for dif- ferent periods. Indeed, although on the face of the argument it would seem impossible to get correct indications from tables of unweighted in- dex numbers, in reality the advantage of weight- ing is questionable. In the first place, it is exceedingly difficult to select proper weights, and impracticable to apply them to a long list of arti- cles ; and, in the next place, if the number of arti- cles is large, the use of weighted prices has little influence on the result. We must notice, however, that the relative quantities chosen, at the date when the table is first computed, may not represent the relative importance of the same group of goods at any subsequent date. Many articles are in great 1 Report on Imports and Exports, 1885, Table V. 235 MONEY demand to-day and almost out of use to-morrow. Their vogue depends upon the whim of fashion. Consumption changes its character. With the exception of a few articles included among the necessaries of life, there is almost nothing the demand for which may not change very much, between two dates of computation. If the rela- tive values of the commodities which enter in to make up the table change during the interim, the quantities exchanged will be different, and the proportions in which they should enter into the table of prices at subsequent dates should change. 9. Influence of New Commodities. Still further, it may be urged with much force that the useful- ness of the averages obtained from such tables of prices is impaired by the fact that new articles may come into use between the dates on which averages are struck. Such articles must, of course, be taken into account if the tables are to serve the purpose for which they are devised. This diffi- culty, however, may be overcome in a measure by making frequent revisions of the table. As Pro- fessor Marshall has pointed out, when a new article appears on the market no notice should be taken of it, in comparing the average of prices in the tabular standard, at the date of its first appear- ance. At the next subsequent date of making up the table, however, the article should be put in the list. The interim will allow its price to settle down to a normal condition. 236 MEASUREMENT OF CHANGES IN PRICES 10. Whether Wholesale or Retail Prices furnish the Better Comparison. In the next place, it is important to know whether we should use whole- sale or retail prices in making our index numbers. The choice depends on our purpose. If we wish to show simply and solely the change in the level of prices, there is no theoretical objection to the use of wholesale prices. If, however, we wish to discover the effect of changes in the price level on the economic condition of a certain social class, we should use retail prices, because these are the prices that the people pay. Wholesale prices are, however, more uniform and more easily gotten. They apply to a larger area, and they are more sensitive, more subject to the breath of com- petition. U. The Different Purposes of Tables of Prices determine their Character. There are certain other possible causes of error which need careful con- sideration before we can finally make up our minds concerning the usefulness of index num- bers. A table may give the same average level of prices at two different times, although in the mean- time there have been many and great variations in the price of the different articles, because the variations may have offset one another. To a person who is interested in but a few of the com- modities in the table, it is of little interest or im- portance to know that the price level has remained constant, while the goods that he deals in have either fallen or risen. The importance of this 237 MONEY objection depends, again, on the purpose of the tables of prices. If the aim is to show changes in the level of prices, the objection loses force ; for it is not claimed that the index numbers tell us about relative prices, and it is obvious that the same average may be derived from many different values of the same series of articles. If, however, the tables are intended to show changes in relative welfare of different social classes, the objection is important. Even if all the difficulties thus far mentioned could be overcome, the result would be more or less misleading, according to the area over which the chosen prices prevail. The prices which one is likely to obtain are not, of course, universal. They do not hold good in all the markets of the world. The mean price of the same article may, therefore, be very different in different places, for the same series of dates. Moreover, the mean may be seriously affected by extreme variations of prices in the same locality. Professor Marshall points out that if we take as an index number the mean price of strawberries in May, June, and July, we will have an average which is not representa- tive. It is made up of prices to which equal arith- metical weight is given, although some of them do not apply to the bulk of the supply of the com- modity. Strawberries are most plentiful in the middle period of the three months mentioned. At the beginning of the season we find them sell- ing at a high price, soon there is a considerable 238 MEASUREMENT OF CHANGES IN PRICES and somewhat sudden drop to a price which varies but little until near the close of the season, when there is again a sudden and a large rise. If we strike an average giving equal weight to the mean price in May, June, and July, we will get a result that is too large. The price in the middle of the season may apply to a thousand times more berries than the price of early May, or of late July. To get a correct mean, therefore, in a case like this, we must weight the price for the middle of the season. In general, in forming our tables, we must give less weight to articles whose prices vary very frequently. Whether or not wages and rent in the ordinary sense, will be included in deriving the index num- bers, depends altogether upon the use to which the numbers are to be put. If they are for the simple purpose of indicating the changes in the general purchasing power of money, wages and rent need not be included, because they are already counted in the prices of goods. If, however, we are seeking light upon the condition of wage re- ceivers and income receivers, we must include both of these items in our table. 12. The Services of Tables of Prices. After all these things have been attended to, all causes of error eliminated, or corrected as far as possible, and the table constructed in the^ way best suited to the purpose, of what value is the result ? It certainly cannot be regarded as very accurate. Yet it serves very well the purpose of students of 239 MONEY economic history to show changes through long periods, in the general purchasing power of money, and in economic conditions at different times. The more numerous the commodities represented in the table, the more closely, as has already been remarked, will the index numbers do this, provided the other conditions necessary remain the same. The result, however, will be of little importance to any individual or, perhaps, to any class. Like the ready-made suit of clothes, it may fit the average man, but the average man is nowhere to be found. It becomes of more importance to an individual, or class, in proportion as the list of things included conforms to a list which the in- dividual or the class buys or sells. It has been remarked several times that the selection of articles for a table of prices, and the method of using the data for deriving a set of index numbers, should be determined by the purpose in view. Hence, as Professor Edgeworth remarks, " there are there- fore many methods not one method of meas- uring and ascertaining variations in the value of money. The path which we have to investigate has many bifurcations. To decide at each turn which is the right direction is either impossible or at least presumptuous. It is impossible when both ways are right, directed to different, but equally legitimate, ends." 1 The purpose may be (i) to find for the use of the student of economic history a rough measure of changes in welfare from time 1 Report of the Brit. Assoc. for Adv. of Sci., 1887, p. 259. 240 MEASUREMENT OF CHANGES IN PRICES to time, as shown by changes in the value of money; (2) to furnish a standard to keep general prices steady in order to keep trade stable ; (3) to furnish a basis for the equitable discharge of long-time debts ; and (4) to supply a means for measuring the purchasing power of wages and incomes in different places or people. We can form tables which will serve very well each one of these pur- poses, with much more ease, and much more accu- racy, than we can form a table that will serve them all at once. As Professor Taussig puts it, " Pro- ceeding from the social point of view, it might be possible from a given set of figures, to conclude that the expense of living for the workingman had risen ; while yet from the simple monetary point of view, the same figures might make it clear that prices had fallen." l For the first and second purposes enumerated, all vendibles ought properly to be included. As this is impossible, the tables should be as ex- tensive as practicable, and should contain not only material goods, but wages of labor and in- comes. For the third purpose, sufficient accuracy would be obtained by choosing for our list the articles common to the demand of both creditor and debtor. Perfect coincidence is of course un- attainable, except in peculiar cases. For the fourth purpose, it would be best to select a " cer- tain region of industry and get an index number from its products which indicates changes likely 1 Yale Rev., November, 1893, P 2 35 R 241 MONEY to become general." l We would need as many tables as there are classes who have money to spend. The more exactly the articles in the table are those consumed by a special social class, the more accurately, as has been said, does the result represent changes in the value of money for the members of that class. We might, therefore, con- struct a table of index numbers for each social class, according to the different kinds and amounts of wealth that its members consume. For the entrepreneurs, or employing class, such a table should include the price of labor. For wage- earners considered as consumers, the things they most largely consume should make up the table ; while as producers the varying value of money for them should be measured by index numbers of wages. For the wealthier classes of society, the list selected should contain the necessaries of life, as before ; but should include many things which are beyond the reach of the mass of the people, and should also include wages paid for personal services. Other forms of a table could be sug- gested, but these are sufficient to indicate the variety that is possible. 13. The Best Kind of Table for General Pur- poses. For general purposes, however, changes in the value of money can be fairly shown by a table constructed of the prices of articles of gen- eral consumption. It is true, as Professor Foxwell has urged, that the " consumer is not every one " ; 1 Report of the Brit. Assoc. for Adv. of Sci., 1887, p. 257. 242 MEASUREMENT OF CHANGES IN PRICES but it is also true that every one is a consumer. In constructing a table on the basis of quantities con- sumed, raw materials should be excluded, except- ing in those cases where we cannot get accurate prices of the finished products. The question of the choice between wholesale and retail prices is of great importance here. Consumers, as con- sumers, usually pay retail prices ; on the other hand, these are subject to much friction, and show innumerable local variations. Wholesale prices, as has been pointed out, are easier to get and usually differ less as between different places ; yet they may not be accurate, because the producer may be obtaining the same price for an article at two different times, although the lessened cost of transportation may make the quoted market price lower at the second date than it was at the pre- ceding one. Now, it is market prices which areH used in making up index numbers. On the whole, however, in this special table, as in a table of a more general character, we are likely to get into less trouble by using wholesale instead of retail prices. As to the relative weights to be assigned the different articles, the relative quantities pro- duced at the given dates may well be used ; or the relative quantities marketed or consumed at the given dates, either by consumers in general, or by the working classes as shown by their budget of expenses. If we use the latter method of weight- ing, we run across another source of error in the possible inaccuracy of the budgets. 243 MONEY In this consumption standard the table of wages of labor employed in producing commodities, as distinguished from the labor expended in personal services, should not be included. For the wages of the former have already been allowed for in the prices of the goods produced, and it is necessary in calculations of this kind that the various obser- vations made, or statistics obtained, should be as far as possible independent of one another. More- over, what we want to know from this table is the change in the power over goods due to changes in the value of money. We should defeat our pur- pose to a certain extent, so far as the inquiry re- lates to the laborer, if we included in our table records of the wages which he gets. Wages paid for personal services, however, are on a different footing. They are not represented in the prices ,of goods, and they represent expenditures by an- other social class. As to rent, in the economic sense, it should not be included in the tables. For it represents a differential advantage, and does not affect the prices of commodities. Rent in the common sense, such as house rent, as distinguished from rent of location, may, however, be included because it is one of the ordinary expenses of the people. 14. The Similarity of Results in Different Tables. At first thought it seems a surprising fact that computations of price changes made in the crudest way yield results of the same general character as are yielded by calculations into which enters every 244 Ml MEASUREMENT OF CHANGES IN PRICES refinement of mathematics for the correction of the various errors that have been described. They all show, for example, that the prices of goods, measured in gold, rose from the period of 1845- 1850 to 1873, and fell from that date until within the past half-dozen years. The agreement is not so surprising, however, when we recall the large number of possible sources of error. As has been remarked already, to seek refinement of method with data that can never be accurate is useless labor. 15. The Table of the London " Economist" Dif- ferent tables of index numbers have been con- structed, but the best-known examples are those of the London Economist, Jevons, Soetbeer, Sauer- beck, and Falkner. The method of the London Economist begun by Mr. Newmarch 1 is, perhaps, the simplest and crudest. It contains 22 articles, the simple average of whose prices for six years, from 1845 to 1850, constitutes the base. The price of each article was noted on January I and July i. The mean of these was taken for the price at the starting-point, and called 100. As there are 22 articles, the index number for all is 2200. Each year thereafter the percentage of rise or fall of each article is added to, or taken from, the original 100. The sum is found, and according as this sum varies from the original 2200, so has the price level 1 See the Economist, March, 1864. The articles are coffee, sugar, tea, tobacco, butchers' meat, wheat, cotton, wool, raw silk, flax and hemp, indigo, oils, timber, tallow, leather, cotton cloth, copper, iron, lead, tin, Pernambuco cotton, and cotton yarn. 245 MONEY varied. The Economists table, with the figures for January I only, is as follows : THE "ECONOMIST'S" TABLE* YEAR TOTAL OF ALL ARTICLES AVERAGE FOR ALL ARTICLES YEAR TOTAL OF ALL ARTICLES AVERAGE FOR ALL ARTICLES 1845-50 2,200 100 1882 2,435 III 1851 2,293 104 1883 2,342 106 1858 2,612 119 1884 2,221 101 1861 2,727 124 1885 2,098 95 1862 2,878 131 1886 2,023 92 1863 3492 159 1887 2,059 94 1864 3,787 172 1888 2,230 101 1865 3,575 163 1889 2,187 99 1866 3,564 162 1890 2,236 102 1867 3,024 137 1891 2,240 102 " 1868 2,682 122 1892 2,133 97 1869 2,666 121 1893 2, 1 2O 96 1870 2,689 122 1894 2,O82 95 1871 2,590 118 1895 ,923 87 1872 2,835 129 1896 ,999 9i 1873 2,947 134 1897 ,95 88 1874 2,891 131 1898 ,890 86 1875 2,778 126 1899 ,918 87 1876 2,711 123 1900 2,145 97 .1877 2,715 123 1901 2,126 97 1878 2,529 "5 1902 1,948 89 1879 2,225 101 1903 2,003 9i 1880 2,538 115 1904 2,197 99 1881 2,376 108 This table is crude, its list of articles is too short to be representative, and the small number gives undue weight to a change in the price of a single one, since the prices are not weighted. Moreover, 1 The Economists Monthly Supplements. 246 IM] on EASUREMENT OF CHANGES IN PRICES e article, cotton, appears too often ; and the choice of the prices of two single days, January i and July i, to represent the price of the year, is likely to cause large error. 16. The Work of Jevons on Index Numbers. Professor Jevons it was who first attacked the study of price changes in a thoroughgoing and masterly manner. His first publication l on the subject, in which he used 39 articles, appeared in 1863. He found the arithmetical average of the prices of each of these for the six years from 1845 to 1850, and used this as the base. To get his yearly average price for each article, he took the arithmetical average of the mean monthly prices of the highest and lowest grade of each. He then di- vided this annual average by the basic average. The resulting percentages showed the price changes. He manipulated his data in other ways and used certain refinements of mathematical calculations, as the geometric mean and logarithms, but they do not really add anything to the value of the result. 17. Soetbeer's Tables. Soetbeer chose 114 arti- cles, the prices of 100 of which he took from the Hamburg market, and those of the other 14 from the English market. 2 1 " A Serious Fall in the Value of Gold ascertained and its Social Effects set Forth." See his "Investigations in Currency and Finance." 2 See his " Materialen zur Erlaiiterung und Beurtheilung der Wirthschaftlichen Edelmetallverhaltnisse und der Wahrungsfrage," (transl. in "Bimetallism in Europe," United States Exec. Doc. No. 34, 50th Congress, 1st Sess., 1887). 247 MONEY SOETBEER'S TABLE OF RELATIVE PRICES 1 1847-1850 = 100 I II III IV V YEAR AGRICUL- TURAL ANIMAL TROPICAL, ETC. EAST INDIA GOODS, ETC. MINERAL 1847-1850 IOO.OO 100.00 IOO.OO IOO.OO IOO.OO 1851 99.00 110.38 90.00 99-94 95.70 1852 110.71 106.68 95-33 99-95 95.76 1853 IRcA 128.18 114.94 124.78 115.28 109.24 54 1855 1 50.49 158.82 123.54 142.03 121.02 119.10 l85I-l855 129.99 114.79 110.43 110.97 107.03 l8 5 6 149.03 127.61 155.95 123.95 116.65 1857 138.11 140.18 169.32 140.32 124.58 1858 119.92 127.02 120.69 112.76 109.04 1859 119.48 130.69 113.40 "5.74 108.57 1860 133-75 133.75 120.36 20.28 108.66 1856-1860 131-84 132.31 134.72 22. 6l "3-59 1861 131.46 124.79 122.08 17.19 102.40 1862 126.80 127.19 H3.93 17.28 101.88 1863 120.12 124.12 114.97 16.87 102.92 1864 117.89 129.21 109.4! 25.74 104.53 1865 126.48 135-23 114.01 46.11 98.93 1861-1865 124.46 128.24 114.13 18.64 102.11 1866 137.64 135-64 126.30 17.90 96.54 1867 146.38 132.68 126.44 14.35 93.28 1868 I4L59 133.48 120.75 16.75 91.76 1869 132.40 143-25 115.58 22.10 96.33 1870 I3L23 I39.3 2 118.57 20.56 9 9 .68 1866-1870 137.74 136.35 121.54 18.32 95-47 1871 144.76 144.14 122.99 20.22 101.85 1872 144.17 155.82 125.36 30.25 121.63 1873 146.21 156.72 132.15 34.32 140.60 1874 150.99 157.76 145.02 36.74 116.70 1875 138.16 158.59 I3L35 32.11 107.49 1871-1875 144.90 154.57 131.50 30.72 116.90 1876 141.06 155-79 128.69 29.74 106.27 1877 145.34 152.51 140.55 30.29 98.87 1878 132.50 141-53 I34.34 25.61 94.14 1879 132.92 137.60 139.10 23.34 84.28 1880 I38.TI 147-30 154.65 22.92 88.33 1876-1880 138.12 146.76 138.91 26.38 94-35 1881 137.50 151-21 146.57 22.60 84.87 1882 138.45 155-17 139.23 22.47 86.99 1883 143-33 156.40 142.38 20.17 82.93 1884 123.85 150.26 120.16 17.90 78.69 1885 110.75 140.45 123.78 16.39 74.23 1881-1885 130.77 150.65 134-41 19.91 81.55 1886 101.31 133-53 122.44 15.45 70.52 1887 96.28 129.93 121. 8l 16.59 72.50 1888 98.18 128.97 120.09 16.41 75-57 1889 102.06 130.95 127.57 18.82 78.55 1890 107.53 129.85 138.61 19.35 83.54 1886-1890 101.07 130.64 126.10 17.32 76.13 1891 119.88 131.66 J 3999 13.56 84.72 1 U. S. Sen. (Aldrich) Report on Wholesale Prices, Vol. I., p. 294. 248 [EASUREMENT OF CHANGES IN PRICES SOETBEER'S TABLE OF RELATIVE PRICES 1 1847-1850 = 100 YEAR VI TEXTILE MATERIALS VII DIVERS VIII BRITISH EXPORTS I-VIII TOTAL OF 114 ARTICLES 1847-1850 IOO.OO IOO.OO 100.00 00.00 1851 104.39 103.98 97.98 00.21 1852 105.01 95-09 95.98 01.69 1853 101.43 105.17 100.61 13.69 1854 111.64 119.44 99-53 21.25 1855 103.58 109.63 98.27 24.23 1851-1855 105.20 106.65 98.47 12.22 1856 100.02 100.50 98.50 23.27 1857 112. l8 108.01 101.25 30.11 1858 103.59 99.70 100.91 13.52 1859 104.69 "5-57 105.77 16.34 1860 108.74 116.83 105.60 120.98 1856-1860 107.12 108.21 102.41 120.91 1861 110.85 119-65 105.84 118.10 1862 124.31 156.99 114.22 122.65 1863 1864 151.84 154.26 161.36 162.58 133.45 146.53 125.49 129.28 1865 117.80 121.06 137-80 122.63 1861-1865 131.83 144-33 127.56 123.59 1866 134.94 111.30 140.36 125.85 1867 130.31 108.13 I33.9I 124.44 1868 127.18 101.25 127.56 121.99 1869 130.52 98.17 128.15 123.38 1870 122.87 III. 21 122.68 122,87 1866-1870 129.17 105.90 130.55 123.57 1871 119.23 117.48 122.64 127.03 1872 22.79 128.54 130.07 135.62 1873 19.58 119.14 128.52 138.28 1874 12. 80 112. 21 126.06 136.20 1875 11.47 98.74 24.96 129.85 1871-1875 17.17 114.98 26.44 133.29 1876 105.54 IOI.78 19.23 128.33 1877 108.33 99.80 14.04 127.70 1878 102.33 97.24 11.03 120.60 1879 98.76 90.21 05.93 * 117.10 1880 96.72 95.23 08.15 121.89 1876-1880 102.33 96.79 11.70 123.07 1881 99.29 94.89 03.03 121.07 1882 95.10 99.10 04.72 122.14 1883 95-93 95.38 104.72 122.24 1884 97.02 84.82 103.36 114-25 1885 95.89 8l.35 100.48 108.72 1881-1885 96.65 91.11 103.28 117.68 1886 89.76 78.75 97.03 103.99 1887 81.42 77.30 95.98 102.02 1888 82.17 74.31 94.91 102.04 1889 89.05 86.41 96.60 106.13 1890 81.92 91.70 94.90 108.13 1886-1890 84.86 81.69 95-88 104.46 1891 80.40 85.06 95." 109.19 1 U. S. Sen. (Aldrich) Report on Wholesale Prices, Vol. I., p. 294. 249 MONEY His tables, which are probably the best we have, begin with 1847 anc ^ extend to 1888, the period for which data were collected by the Hamburg Bureau of Trade Statistics. Dr. Soetbeer continued his table from other sources, from 1886 to iSgo. 1 He used the simple arithmetical average, taking as his base the average of the period 1847-1850. He grouped his articles into eight classes, according to their character : agricultural, animal, tropical and kindred products, East India goods, mineral, textiles, sundry, and British exports. His table is on pages 248, 249. 18. Sauerbeck's Tables. Sauerbeck's table of English prices is, perhaps, the most generally quoted. He uses the unweighted arithmetical average and takes average prices for 1867-1877 as his base. Thirty-seven different articles are used, but several of them are introduced more than once in different grades, so that a total of fifty-six items appears. They are all raw materials. This last fact is, of course, a defect. So, too, are the small number of articles used, the absence of weights, the admitted inaccuracy of some of the price quo- tations, and the occasional use of actual single prices instead of averages. Sauerbeck's table is as follows : 2 1 Jahrbuch fur Nationaloekonomie und Statistik, III., F. B. III., pp. 588 ff. 2 United States Senate (Aldrich) Report on Wholesale Prices, Vol. I., p. 247; Journ. Royal Statis. Soc., 1886, 1893, I 93 250 MEASUREMENT OF CHANGES IN PRICES SAUERBECK'S INDEX NUMBERS GROUPS OF ARTICLES AND TOTALS 1867-1877 = 100 VEGETABLE FOOD (CORN, ETC.) Q - > <; H &r M fg Cfl < Q 1 H) MINERALS TEXTILES K w < TOTAL MATERIALS Q o 1 06 81 98 95 92 77 86 85 89 129 88 87 105 94 78 86 86 95 92 83 6 9 84 78 64 77 73 78 79 7 1 77 76 77 67 75 73 74 74 67 87 75 77 78 80 78 77 73 68 84 74 75 75 79 76 75 80 69 75 75 80 78 84 81 78 IOO 82 87 9 1 105 87 101 97 95 120 87 85 IOI 115 88 109 104 102 1 20 87 89 IOI 109 84 109 IOI IOI 109 88 97 99 no 89 109 102 IOI 105 89 119 102 108 92 119 I0 7 105 87 83 97 88 96 84 102 94 91 85 85 1 02 89 98 88 I0 7 98 94 99 Q J 107 98 97 90 III IOO 99 102 Q J 96 97 Q J 92 I0 9 99 98 9 8 86 98 94 Q J 123 106 107 IOI 87 85 99 89 93 149 IOI "5 103 79 89 1 06 88 96 162 98 119 105 84 97 97 91 Q J 134 97 108 101 95 96 94 95 Q J 130 99 107 IO2 115 89 94 IOI 87 no IOO IOO IOO "3 88 96 IOO 85 1 06 IO2 99 99 91 96 98 94 89 109 IOO IOO 98 88 98 95 93 8 9 1 06 99 99 96 94 IOO IOO 98 93 103 105 IOI IOO IOI IOI 104 102 127 114 1 08 115 109 106 109 1 06 I0 7 141 103 106 114 III 105 103 105 IO4 116 92 96 IOO 1 02 25 1 MONEY SAUERBECK'S INDEX NUMBERS GROUPS OF ARTICLES AND TOTALS 1867-1877 = 100 M 3 Q L W O o o If s g bf 1 O *-" is in < Q | I MINERALS TEXTILES SUNDRY MATERIALS TOTAL MATERIALS H Q M O i8 75 93 108 IOO IOO IOI 88 92 93 96 1876 92 1 08 98 99 90 85 95 9i 95 i8 77 IOO IOI 103 IOI 84 85 94 89 94 1878 95 IOI 90 96 74 78 88 81 87 i8 79 87 94 87 90 73 74 85 78 83 1880 89 IOI 88 94 79 81 89 84 88 1881 84 IOI 84 91 77 77 86 80 85 1882 84 104 76 89 79 73 85 80 84 1883 82 103 77 89 76 70 84 77 82 1884 71 97 63 79 68 68 81 73 76 1885 68 88 63 74 66 65 76 70 72 1886 65 87 60 72 67 63 69 67 69 1887 64 79 67 70 69 65 67 67 68 1888 67 82 65 72 78 64 67 69 70 1889 65 86 75 75 75 70 68 70 72 1890 65 82 70 73 80 66 69 7 1 72 1891 75 81 7 1 77 76 59 69 68 72 1892 65 84 69 73 7 1 57 67 65 68 1893 59 85 75 72 68 59 68 65 68 1894 55 80 65 66 64 53 64 60 63 1895 54 78 62 64 62 52 65 60 62 1896 53 73 59 62 63 54 63 60 61 1897 60 79 52 65 66 5 1 62 59 62 1898 67 77 51 68 70 51 63 61 64 1899 60 79 53 65 92 58 65 70 68 1900 62 85 54 69 1 08 66 71 80 75 1901 62 85 46 67 89 60 7 1 72 70 1902 63 87 41 67 82 61 7i 7i 69 252 MEASUREMENT OF CHANGES IN PRICES 19. Falkner's Tables. The table of prices and index numbers 1 which for extensiveness takes pre- cedence of all others, is that compiled by Professor R. P. Falkner, formerly of the University of Penn- 'sylvania. Professor Falkner gathered together continuous lists of prices for go articles for the 50 years preceding 1891 ; and for 223 articles for the 30 years preceding that date. Of the 223 quotations, 8 1 were for different varieties of the same article. The basic year is 1860, and its prices, on the first of January, are called 100. Many of the price quotations are not aver- ages, but prices on selected dates. The index numbers were computed both from unweighted prices and from prices weighted according to the importance of the articles in the budgets of ex- penses of 2561 families of workingmen in the United States. Such a method of weighting is excellent for tables designed to show changes in the economic condition of the class whose expen- diture the budgets represent ; but the results can show changes in the command of money over goods in general only so far as the articles in the budgets enter into the expenditure of all classes, and that, too, in the proportions in which they are weighted. Budgets in whose accuracy and com- pleteness confidence can be had are difficult to get, and introduce into index numbers errors pecul- iar to themselves. In Falkner's tables somewhat 1 United States Senate (Aldrich) Report on Wholesale Prices, etc. 253 MONEY W 2 H ' h Q ON CO rf H **f- O O\ O\*O vovo O ' PJ oi ts q\ rt-oq PI q\ tooq to <* M vq rj-oq co tooo rt- vo w TJ- q t> PJ O^IOCOCOPJPJHPJHMOOONOOOOOONONONONONONON H-* ^ s y q pJtoiocoqoqioQvq pj ON covq q* ix to q ^ q q\vq PJ d co PJ 5 << H pi d co pi vd oo* tx co txoo d vO t>OO Ovo tNtNt^rxtvCxCNtxtN txoo oooooooooooooooo. _ OTooooOTcoojo^oDooOToooqooaDcooqcowoqoqoooooooo << ^ M cd txoo d *t tood vo xood co o\od cxxoiod\pi rj-copi d ^Tj-pi pi pi ON ON ONOO 00 oo ON ONOO oo oo ON ON O O O M M H O O ON O co tv CO a 10 tx PJ cooq M ts ts q q\vq H to ** *$ co tovq H q q ONOO H ^ tx od oo co ON d\ pi vd vd pi oo" pi ^oo* co covd oo*^g\oidiopipid\d ON ON ONOO OO ON ON ON ONOO ONONOvOOOOOOOOONOPJTj-ON & ' G ^F w o U K oq oq oq to o^oq ^^"^"tN^OvtxH O^H pj tooq PJ q vq oq vq ..._ 6 : - x > x tx H M pi vd o H oo" w to pi o\ pi co co pi M Q d d tvod d vd pqppppqoNpqoo'-'HHHOoooMrfONM do O w PJ CO * -OvO txoo ON O M PJ CO rf tovO txOO ON Q H PJ CO ^ >p ooooccocpcooqoqoqTOOTaioqoqoqcociqoqoqoq' fa o y 2 > 3 W 254 tEASUREMENT OF CHANGES IN PRICES ss than 70 per cent, of the total expenditure f the social class considered was represented. Of Durse the prices were for the United States, and Dies were made both of retail and of wholesale ices. These tables carried the prices down to 1891. In 1900 Professor Falkner prepared a second table of wholesale prices from 1890 to 1900, which is substantially a continuation of his previous table, although in a somewhat different form and for a fewer number of articles. Ninety- nine series of prices were used in the second tables, and the base used was the average of nine quarterly prices from January i, 1890, to Janu- ary i, 1892. Falkner's table is on page 254. Professor Falkner's supplementary table gives average prices for each quarter, from January, 1890, to July, 1899. The January figures 2 are as follows : YEAR ALL ARTICLES YEAR ALL ARTICLES 1800 . IO2.O i8gq. 84.7 1891 100.6 1806. 8q.2 1802 . 06. c 1807 . 82.O 1803 . Q7.2 1898 8^.1 1804 . 8Q.6 1899. 86. q A comparison of all these tables shows, what has been already urged, that the same general 1 United States Senate (Aldrich) Report, etc., Vol. I. 2 Bulletin of the United States Department of Labor, No. 27, March, 1903, p. 263. 2 S5 MONEY conclusions are reached by all the methods al- lowed, so that the labor involved in mathematical niceties is hardly worth while. 20. Other Tables of Prices. The tables men- tioned are by no means the only ones that have been compiled. Among others which are worthy of mention are the English tables of Rice Vaughan, who compared the prices of 1650 with those of 1352; of Bishop Fleetwood in 1707; of R. H. I. Palgrave, and Mulhall ; those of the Ger- man writers Laspeyres, 1831-1863, Paasche, 1863- 1872, continuing the work of Laspeyres; andj Conrad ; the French table of De Foville, who compiled a table of French prices of imports and! exports, 1847-1880; and the tables of the United : States Department of Labor. 1 21. Other Methods of Measuring Price Changes. Other methods than the use of index numbers have been suggested for measuring variations in the value of{ money. Two or three of them are important enough to deserve mention. Dr. Dro- brisch has suggested 2 a comparison of the values at different epochs of an average 100 weight of goods. Of course, there is no such thing as an average 100 weight of goods, so that the method is a purely fanciful one. Professor Newcomb has proposed to measure changes in the value of gold by noting the change 1 Bulletin of the United States Department of Labor, March, 1902. 2 See Report of the Brit. Assoc. for Adv. of Sci., 1887, p. 265. 256 MEASUREMENT OF CHANGES IN PRICES in the value of the product of an average indi- vidual worker per unit of time. It is easy to measure an electrical current, or a head of water, by noting changes in the amount of work done under fixed conditions ; but we cannot fix the con- ditions of individual character. There is no aver- age individual, and if there were, the value of his product would be one of the factors entering in to cause variations in the value of gold. Professor Nicholson has suggested a somewhat elaborate method, which takes account theoreti- cally of all things bought and sold. It -is briefly as follows: let/, p^p^ /, represent the price per unit of every commodity sold on a certain date. Let <7, <7 X , ^ 2 , q n represent the total number of units of each article. Then/^ p l q l p^q^ p n q n are equal to the total value exchanged, or $X. Hence the value of $i will be pq p\q\ p HC S MD ** ll 00 H London, High prices 3.8 4.4 3-6 5-4 5-' 3-7 3 .0 Low prices 3-2 3-2 2.6 3- 2.6 2-5 2-5 New York, High prices 9.1 7-4 7.0 5-3 Low prices 9.1 6.7 5.1 5- 1 Berlin, High prices 4.6 3-7 3-3 Low prices 3-4 3-2 2.7 Paris, High prices 4.1 2.6 Low prices 2.4 2.6 Calcutta, High prices 6.2 5-4 Low prices 5-6 6.2 Tokyo, High prices, 12.3 10. 1 Low prices I2.O IO. I Shanghai, High prices 6.0 Low prices 5-7 " Of the 21 comparisons contained in this table, 1 7 show higher rates for high-price years than for low-price years, I shows the opposite condition, and 3 show equal rates in the two cases. As the table covers 68 years for London, 40 for New York, 30 for Berlin, 20 for Paris, 19 each for Cal- cutta and Tokyo, and 9 for Shanghai, or 205 years in the aggregate, the result may be accepted with great confidence that high and low prices are usually associated with high and low interest, respectively." l The reasons for the lack of exactness in adjust- ment are to be found in the unequal ability of 1 " Appreciation and Interest," Amer. Econ. Assoc. Pub., Vol. XL, No. 4, p. 56. 325 MONEY investors to discount changes in the price level, and in the fact that time is necessary for the adjust- ment. The imperfectness of adjustment for short periods is not of much importance, since the change in the value of money through short periods is likely to be inconsiderable. Of course, a change in the rate of interest, operating in be- half of debtors, does not decrease the burden of debts which have been contracted at a fixed rate and cannot be converted at a lower rate. In these cases the burden must be borne, but the long- period debts whose conversion is not practicable are fortunately a small proportion of the whole, and are likely to become less as loanable capital increases. Consequently, speaking generally, the burden imposed on debtors by falling prices is more or less lightened by a falling rate of interest. "We thus see that the farmer who contracts a mortgage in gold is, if the interest is properly ad- justed, no worse and no better off than if his con- tract were in a * wheat ' standard or a ' multiple ' standard." 1 Whatever loss he incurs arises from the slower movement of the interest rate, as com- pared with that of the value of money. 8. Difficulty of doing Justice by Artificial Cor- rections of Price Changes. Finally, it is at least questionable whether a correction of any given change in the purchasing power of money would not do as much harm as good, because a correc- 1 " Appreciation and Interest," Amer. Econ, Aswc, Pub,, Vol. XI., No. 4, p. i6 f 326 FACTORS MITIGATING PRICE CHANGES tion that was made for debts of one duration would not do for those of another. If we could create a price level which would relieve the bur- den of debts running for three years, we might be adding to the burden of those which run for some longer period. This is true, altogether apart from the social loss that would be caused by abandon- ing the principle of the inviolability of contracts. Moreover, we must distinguish carefully between hardship and injustice. The debtor who suffers hardship on account of a fall in the price of his goods at a time when he is in debt, does not neces- sarily suffer injustice thereby. In contracting his debt, it may be for improvements or for the en- largement of his business, he takes his chances of such a change and such loss, and society requires him to estimate its probability fairly and to dis- count it correctly. 9. Gold Monometallism Probably does Substan- tial Justice in the Long Run. In the light of all the considerations going to show that the effects of gold monometallism, in varying prices and in en- hancing the pressure of debts, are far less evil than is often claimed, and in view of the impossi- bility of finding a standard which would not be open to even greater objections than is the gold standard, especially as any evil results of the latter to debtors are offset by the other influences that we have discussed, it is safe to conclude that the common judgment of the most progressive coun- tries in favor of the gold standard is undoubtedly 327 MONEY wise. Theory leads, on the whole, to the same conclusion as experience has done ; and while, in the future as in the past, there will be times when the vicissitudes of life will give rise to demands for scaling debts and for relieving some people from burdens which they have been either unfor- tunate enough, or foolish enough, to put them- selves under, yet, all things considered, the maintenance and extension of gold monometallism promises more of good and less of harm than any other system thus far proposed. The system is simpler, the monetary utility of the metal is high enough to meet the demand of economic progress for such a money, and the fluctuations in its value cause no greater difficulties, in the long run, than would occur in prices under the bimetallic system. Moreover, a sufficient supply of gold is certain enough. A relative lessening of the annual prod- uct, under some conditions of mining, does not mean that the supply is, or is likely to be, ex- hausted ; but only that new processes are needed for the extraction of the metal. Surely the expe- rience of the nineteenth century in invention and discovery justifies one in believing that the diffi- culties caused by a relative scarcity will be duly met by new discoveries. 328 CHAPTER XVI INCONVERTIBLE PAPER MONEY REFERENCES : Hepburn, A. B., Contest for Sound Money, Pt. I., Chs. 4-11 ; Jevons, W. S., Money and the Mechanism of Exchange, Ch. 1 8 ; Knies, K., Das Geld, pp. 344 ff.; Knox, J. J., United States Notes, Chs. 1-3, 13; Laughlin, J. L., Principles of Money, Chs. 13-14; Mill, J. S., Principles of Political Economy, Bk. III., Ch. 13; Noyes, A. D., Thirty Years of American Finance, Ch. i; Pareto, V., Cours d'Economie Politique, Vol. I., 327 ff.; Ricardo, D., Works (McCulloch's ed.), Ch. 27; Scott, W. A., Money and Banking, Ch. 6; Sumner, W. G., History of American Currency; Walker, F. A., Money, Pt. II.; Money, Trade, and Industry, Chs. 8-9 ; White, A. D., Paper Money Inflation in France ; White, H., Money and Banking, 2d ed., Bk. III., Chs. 1-6. 1. Kinds of Paper Money. The idea of sup- planting metal with paper money for use in mak- ing exchanges is not modern. It is true, of course, that the ancient world did not know how to make paper, but they used articles like papyrus, the bark of trees, skin, leather, and other available substitutes. Paper money was used in China as early as the ninth century, and probably long be- fore, and there is reason for believing that its use was not unknown in ancient Assyria and Baby- lon. Paper money may be, as we have already noted, of three kinds: representative; convert- ible, redeemable, or fiduciary ; and inconvertible, 3 2 9 MONEY or irredeemable. Representative, paper money is simply certificates of deposit, or receipts, certify- ing that so many dollars, or pounds sterling, or marks, have been deposited with the issuer of the paper, returnable to the owner on presentation of the receipt. They are more convenient to use than are coins, especially for large sums, and are in all respects the exact equals of the specie they represent. They are, so to say, representatives plenipotentiary of specie. They may be issued by banks or by governments. 2. Meaning of Convertibility. By convertible paper we mean notes issued by an individual, or by a public or private corporation, or a govern- ment, promising to pay the value expressed on the paper in coin, and redeemable in coin as a matter of fact on presentation, without demur or delay. The term is not correctly applied to paper which is payable in anything else than legal tender coin. Notes which promise to pay so many acres of land, or so many bushels of wheat, or so many tons of coal or iron, would not be convertible, in the proper sense of the word, Convertible paper must at all times, and under all circumstances, be instantly mutable into the money which is the standard legal tender of the country in which the paper is issued. Whether or not the notes bear on their face a promise to pay in specie, in land, or in goods, unless they are as a matter of fact paid in specie on demand, they are inconvertible paper. It is important to emphasize this point, 330 INCONVERTIBLE PAPER MONEY that notes to be convertible must be payable in legal tender specie, because the advocates of fiat money sometimes urge that if paper is payable in goods or land, it has the attribute of convertibility. This, however, is not a correct statement. Such notes are redeemable in the goods which they call for, but they are not in any proper sense of the word convertible paper. The word " convertible" is restricted in monetary science to redeemability in legal tender standard money, and in that alone. This is the case because what business men need, if they use paper money in making payments at all, is a kind of paper immediately exchangeable for something which they can use at once where paper money itself will not pass. The only kind of money available for this purpose is standard metallic money. No security of land or goods can take the place of the standard metal for this purpose. What is wanted is that the paper shall be exchangeable for a given amount of metal money at once on demand, and not at some future \ time, after the lapse of the period necessary to sell the land or goods which are held as security for the paper. 3. Characteristics of Irredeemable Paper. Ir- redeemable, or inconvertible, paper money consists of notes for which specie is not obtainable on 1 demand. This, too, may be issued either by gov- ernments or by banks. It may consist of notes which, although originally convertible, have lost their convertibility through the insolvency of their 33* MONEY issuers, or it may consist of paper originally issued without the expectation or intention of paying it in specie. The latter form is properly called fiat money. The two kinds of inconvertible paper differ in their mode of issue only ; in their behavior and effects they are in all respects the same. A government may issue inconvertible paper money on the security of government land, or on the security of taxes specially assigned to redeem it. On the other hand, such paper may be issued without security, and put into circulation by politi- cal authority. If a government is sufficiently autocratic and strong, it may for a time force such paper upon a people unwilling to receive it. We recall that the sole condition of the use of any article as money is that it shall be generally ac- cepted in the discharge of obligations, the pay- ment of purchases and of debts. Its general acceptability is a result either of social habit or convention, of custom, of law, or of the credit of the issuer. ^Gold and silver pass current by force of social habit, due to their capacity for directly satisfying human desire. A check, or a bill of exchange, is accepted in payment because the maker of the paper commands the confidence of those who receive it. Inconvertible paper money issued by a government passes from hand to hand, if it passes at all, either because the people have no better money, and the quantity of it is so limited that its evils do not yet appear, or because 33 2 INCONVERTIBLE PAPER MONEY the government is strong enough to compel its citizens to accept the paper. Since it answers their purpose, the people are content to use it. 4. Benefits and Dangers of Irredeemable Paper. The advantages, as well as the dangers, of irre- deemable paper money have been many times recited. Paper money has been likened by Adam Smith to a wagon way through the air, the use of which leaves the land under it available for raising produce to satisfy human wants. That is to say, paper money makes it unnecessary for society to invest real capital for the sake of getting a medium of exchange. Gold and silver are expensive to produce. The necessary amount of them requires the labor of many people and the consumption of much wealth. If a way is devised which makes it unnecessary to use gold and silver in exchange, clearly the labor and the goods formerly used in their production can be devoted to the production of goods that are directly consumable, the wealth of the community would be increased, and the gen- eral standard of consumption would be raised. If paper, whether convertible or inconvertible, is is- sued by a country which already possesses metallic money sufficient for its needs, the specie will partly or wholly cease to be used. Some of it will be di- verted to use in the arts^ and some will be exported to places where perhaps it can be of more service. A displacement of metallic money in use by paper money is, therefore, beneficial only if not done by all countries at once. If all countries attempted to 333 MONEY secure this benefit at the same time, no saving of real capital would result, because the capital necessary to produce the existing specie has been invested already. The only advantage would be to divert a larger amount of the money metal to the arts. A real saving would be made, however, by the uni- versal issue of paper, in so far as it rendered un- necessary the further investment of capital for additions to the metallic money supply to meet the needs of expanding trade. The perception of this saving of real capital by the use of paper money has led men and nations often to pass the danger line of issue, on the supposition that because a cer- tain quantity of paper money was a good thing, its use for all purposes of exchange and payment would also be good. A second advantage to society in the use of paper money lies in saving the wear and tear to which the metals are subjected when used as a means of exchange. The loss from this source is considerable. Moreover, paper money is more convenient for individuals to handle ; it is easy to make large payments with it, because a note for $1000 is as easily carried and transferred as a note for $i ; and finally, paper money is more con- venient for making payments in distant places. The expense of sending it is less, as is also, per- haps, the risk of loss. The fiscal advantage of paper money should not be passed by. When a government finds its credit so low that it cannot borrow money to meet its 334 INCONVERTIBLE PAPER MONEY expenses, unless, perhaps, at exorbitant rates of interest, it sometimes can find a less expensive way to secure what it needs by issuing notes. It can do this successfully only if the circulating medium of the country is wholly, or largely, composed of specie which the paper can replace. Paper money is, of course, far less stable in value than gold money. As we have seen, its circulation depends, in the last analysis, on the confidence re- posed in the political authority which issues it, whereas that of gold is based on social habit of, universal and perennial prevalence. Consequently, the area of acceptability of paper money is re- stricted. Such money is, generally speaking, national money, without value beyond the boun- daries of a particular country. Its smaller area of acceptability makes the demand for it variable, and its value uncertain and changeable. Additions to the supply are dependent on the caprice, or the policy, of a government, while additions to metallic money are obtained only at a cost ; and this differ- ence causes greater variations in the value of the paper. 5. Influence of the Issue of Irredeemable Paper on Specie. In a purely metallic monetary system, when a country is using metal which is used else- where as money, any surplus of money which it may have is at once revealed by the higher prices which prevail in its markets, and is turned into the channels of trade of other countries ; while any de- ficiency from which it may be suffering, under 335 MONEY similar circumstances, will be supplied from the circulation of foreign countries. Not so with fiat paper. Business may be stagnant, the demand for money may be small, and prices may fall, so that less money really would be needed, and yet the flood of inconvertible paper may rise in ever swelling proportions. When a country with me- tallic money begins to issue paper, the first re- sult is to drive the specie out of circulation. The metallic money may be taken by the government in payment of taxes, and used to defray those pub- lic expenses which must be met in gold. It may be reduced to bullion for use in the arts, because the enlarged supply available has lowered the price and increased the demand. It may be hoarded in the form of coin by people who are afraid to part with it, or who look for the return of better times when it will be once more available to make payments. Or, finally, it may be exported to discharge foreign indebtedness. If the amount of the medium of exchange de- manded by the business of the country does not increase as fiat money comes into use, the metallic money will disappear as fast as the paper goes into circulation. If the need for the medium of exchange increases in the meantime, the specie may not disappear so rapidly, and the total volume of the means of exchange in the country, paper and metallic, will increase. During this process the money of the country will be mixed paper and coin. If, however, the output of paper money be 336 INCONVERTIBLE PAPER MONEY persisted in, it will in time become sufficient to perform by itself the exchanges of the country, all the coin will be melted, hoarded, or exported, and the currency of the country will consist wholly of paper. No positive harm may be done up to this point of the process. But if the issue of the paper becomes still larger, its mischievous effects will be at once felt. In other words, the positive harm arises from over-issue, or the output of a quan- tity larger than the specie it displaces. The paper, unlike the gold and silver, cannot be exported, nor diverted to use in the arts. The merchants of , foreign countries cannot use it, and will not accept it in payment. After the paper has driven out the coin, further issues go to swell the volume of - home currency and accumulate like water in a pond that has no outlet. 6. Signs of Excessive Issue. The first effect and the first sign of an issue in excess of the whole volume of metallic money displaced, or of the amount of exchange medium needed by the coun- try, is a premium on gold. Speaking broadly, the issue of the paper does not alter the exchange relation of gold and goods. Payments for goods bought abroad, and for some other purposes, must continue to be made in gold. But if the gold is no longer in circulation, it must be bought in the form of bullion, and a premium will be paid for it in terms of the new paper money. This premium will show itself in a rise in the rate of foreign ex- change. Foreign business indebtedness is ordi- z 337 MONEY narily discharged by means of bills of exchange, but bills of exchange are quoted in terms of gold. If, on a specie basis, a bill of exchange for ^1000, drawn in London on New York, can be paid by $4870, it would require $4969 to pay it if the cur. rency of the United States were paper which had depreciated two per cent. That is, the American importer will have to pay $4969 in paper money, in order to buy a bill payable in gold to the amount of 1000. Now, such a condition is extremely bad for the foreign trade of the country in which gold is at a premium. It must make its foreign payments with one kind of money, and dis- charge its domestic obligations with another. The greater its balance of foreign indebtedness, the more heavily does the burden of the premium on gold diminish the profits of its exports and render its trade unremunerative. On so small a margin is trade carried on, that, in some cases, the pre- mium on gold would turn an expected profit into a loss. Consequently, a small premium, or, indeed, the mere likelihood of a premium on gold, makes the foreign creditor demand a more favorable ex- change in order to offset the premium, or discount the risk of loss involved in its possible appearance. The domestic importer, being subjected to a loss, will try to recoup himself by raising the prices of his goods in the home currency. This step in the process brings us to a consideration of the second evil of inconvertible paper money. When the specie has been driven out of circula- 33* INCONVERTIBLE PAPER MONEY tion, prices are no longer quoted in gold, but in paper. That is, they rise as the value of the paper falls. Thus the paper becomes a kind of sec- ondary monetary standard. If the excess of paper over the specie displaced is small, it is pos- sible that no change in the prices of goods will be noticed. For the force of custom on prices, in some places and for some articles at least, is very strong. It is a sort of economic friction, which in- terferes with the freedom of the price movement. An excess of paper great enough to show itself in a slight rise of the foreign exchanges may not manifest itself, therefore, in general prices. But the appearance of the premium on gold as shown in the exchanges is proof that inflation of prices and depreciation of the paper, in goods as well as in gold, is close at hand, and that ere long the price level in the country of issue will be different from that of the rest of the world ; or, more ac- curately, will not bear the same relation to the world price level as existed under the specie regime. 7. The Relation of the Quantity of Inconvert- ible Paper to its Value. It is important to dis- cover how far prices respond to an increase in the paper-money issues after these exceed in amount the specie they displace. We have seen in another connection l that it is with inconvertible paper money that the so-called quantity theory of prices, within certain limits, holds true. Paper money 1 See pp. 139-141. 339 MONEY derives its value solely from the demand for it for exchange purposes. Its marginal utility is always merely the reflected marginal utility of the goods it exchanges for. If the marginal composite unit of goods exchanges for a certain amount of paper, thus fixing the price level, that marginal unit will call for double the quantity of paper money if the whole volume of paper be doubled ; provided, in the meantime, the total quantity of commodities has not changed, and credit transactions and the efficiency, or rapidity of circulation, of the paper money are constant. That is, under the fixed con- ditions assumed, the value of the paper money varies inversely as its quantity. Such is the ac- cepted theory. Of course these fixed conditions are never realized, and the quantitative relation cannot be proved or disproved, statistically. But the statement that the value of the paper depends on its quantity, is not altogether correct, under any conditions. It depends partly upon the confidence of the community in the power of the paper to continue to circulate, and this confidence becomes less as the volume of the paper enlarges. If the depreciation is slow and approximately regular, prices and other conditions will accommodate themselves to the increasing quantity. But if the depreciation be very rapid, people lose confidence in their ability to pass the paper without consider- able loss, many of them will refuse to accept it, and its value will fall more rapidly than in the pro- portion of the increased output. To pay $1000 340 INCONVERTIBLE PAPER MONEY for a breakfast, as Secretary Chase thought might be possible from the issue of United States notes in the early days of the Civil War, would so demoralize men's confidence in the stability of the money as to cause a fall in its value altogether disproportionate to its increase of quantity. More- over, as confidence that others will take the money grows less, on account of the increasing quantity, the danger of loss from this fact is discounted by the present sellers of goods, and the purchasing power of money is still further decreased. The marginal utility of the instrument of utility for use falls more rapidly the nearer we approach surfeit, just as the marginal utility of consumable goods does under like circumstances. The relation be- tween the value and the quantity of paper money couldbe true, then, only under impossible condi- tions, and only if its quantity were either fixed or increasing very slowly. ~TT The Effect of an Issue of Paper Money on the Price Level. An output of paper money in one country at first gives an upward impulse to the world's level of prices. The truth of this state- ment does not depend upon the truth or falsity of the quantity theory of the value of money, at any rate, as usually stated. All assumes is that some relation existsjy-twftp.n supply of money and its value, just as in the case oT^other commodities. A change in the supply, unless so small as to be entirely checked by economic friction, must always have some effect, MONEY although it may not appear in a modification of prices, but be entirely lost to view by concomitant changes in credit exchanges, in barter exchanges, in the efficiency of money, or in the volume of goods put upon the market. Let us suppose that the metallic money of the United States were arbitrarily and instantaneously withdrawn from use, and an equal amount of paper money substituted. No reason appears why such a change should occasion any alteration in the price level of the world's goods. Let us sup- pose, further, that this change having been made, the gold which was withdrawn is arbitrarily and suddenly put into circulation in those countries which retain their metallic money. So far as con- cerns this change alone the level of the world's prices will tend to rise, and the prices in the United States, under its regime of paper money, will share in the upward swell. If, instead of the arbitrary withdrawal of specie, we have a gradual exportation of it, as paper money is put out in increasing volume, until all the gold has been driven out, the character of the result is not changed although the degree may differ much. As a matter of fact, gold, when supplanted with paper, disappears in several ways. The release of the metal from the service of demand for a means of payment lowers its value, and some of it is consequently attracted to use in the arts. Some, too, may be hoarded, and some will undoubtedly be exported to specie-using countries. Whatever 342 INCONVERTIBLE PAPER MONEY the division of the amount between the uses, the value of the metal is lowered in consequence of the cessation of its use in one country. In some measure, therefore, does the level of prices throughout the world tend to rise. If, in accord- ance with our first supposition, the specie pushed out went out of use altogether, the amount of paper money which would be needed to replace it in order that prices should not be affected by the change, considered by itself, 1 would be exactly the amount of specie displaced. But as paper comes in specie does not go out of use, but sim- ply changes its location, raising the price level as it goes. Hence the amount of paper which a country can issue, without causing its price level to vary from that of the world at large, must be greater than the amount of specie displaced, by a degree dependent on a change in the world's price level. The amount of paper which will exactly displace the specie, as the latter goes into use elsewhere, is greater than the amount which would replace it if it were suddenly destroyed. In the latter case, the price level which prevailed under the use of specie would remain ; in the former case, a higher one would take its place ; in both cases, the price level in the paper-using country would be the world level. Therefore, an amount of paper equal to...the specie displaced would be excessive, on the old price level. It follows from what has been said that the 1 Irrespective of any impairment of public confidence. 343 MONEY fluctuations of prices, to which a country using inconvertible paper money is subjected, have three sources. First, the prices of its goods are subject to the same fluctuations as are those of gold-using countries, due to the progress and vicissitudes of trade and industry. No country can escape these unless the excessive use of incon- vertible paper diminishes its business. Such a country must suffer, in the second place, from the fluctuations in prices caused by the varying value of its paper money in terms of gold ; and, in the third place, from variations due to speculative attempts on the part of business men to protect themselves by discounting future changes in the value of the paper. ^ 9. The Premium on Gold and the Depreciation of Paper in Commodities. The amount of inflation of prices of goods, in terms of paper money, is the measure of the depreciation of the paper/ Since a given quantity of goods is exchangeable for a certain amount of gold as well as of paper, it would seem, at first thought, that the depreciation of the paper money in terms of goods would exactly equal the premium on gold. In other words, it would seem that the paper price of bullion would be greater than the mint price, by an amount equal to that by which the foreign exchange is below the real exchange. It has long been a matter of remark, however, that the premium on gold does not exactly measure the amount of depreciation of the paper, or the 344 INCONVERTIBLE PAPER MONEY inflation of prices. The purchasing power of inconvertible paper money is a little less, when measured in goods than it is when measured in gold. There are several possible reasons for this difference. In the first place, the differ- ence between the depreciation of paper in gold and the inflation of prices is probably enhanced by the probable risk of an increase in the quantity, and of future changes in the purchasing power of the paper. It might seem that the discount of this risk would affect gold and other goods in equal degrees. But the prices of other commodities can- not be changed as quickly as can the price of gold. Hence they cannot adapt themselves so quickly as can gold to changes in the supply of paper. The period for which the risk of change must be dis- counted is, therefore, longer for other commodities than for gold, and the amount of discount larger. Consequently the total depreciation of paper money in goods is greater than in gold. A second causfL-of the difference in the amount of depreciation of paper in terms of gold and other goods, respectively, is found in the lower value of gold caused by its ejection from the country which adopts paper. As we have seen, the export of the gold raises the world level of prices ; that is, it lowers the value of gold. Since prices are ex- pressed in paper money, in the country which has adopted it, an increase of paper lowers its own value in gold and goods, or raises their value in terms of itself ; but gold has fallen from its pre- 345 MONEY vious value, and this fall in a measure offsets the rise due to the increase of the paper. As nothing of the kind happens to commodities, their prices show the full rise due to the increase of paper. Thus gold suffers a double fall in price as against one fall suffered by other commodities. If, on the other hand, paper money contracts, its value rises as compared with goods and gold. Another cause of the difference in depreciation as measured by gold and by goods, respectively, is found in the fact that the inconvertible legal-ten- der paper serves as a basis of credit. Besides the increased money demand for goods, caused by the additional issues of paper, there is also a credit demand due to the credit based on these extra issues. Hence the demand for goods is increased by more than the amount of the paper, and prices rise in a greater degree than the extra paper of itself would warrant. But no such twofold demand acts on gold. Hence an extra issue of paper does not cause the value of gold to rise so much as that of other goods, and therefore the paper depreciates more in terms of the latter than in the former. Suppose now that the excess of notes is withdrawn. The credit demand based on these must also be withdrawn. Prices of goods will fall under the twofold influence. Gold will fall under the influence of the retirement of the notes only. The degree of depreciation of an inconvertible paper currency is affected by several circumstances, aside from its quantity. If it be issued in increas- 346 INCONVERTIBLE PAPER MONEY ing quantities at a time when the demand for a medium of exchange is growing fast enough to absorb it, it will not depreciate. If the demand for currency happens to be decreasing, the depre- ciation will be increasing. If, again, the issue be made when for some reason gold is being hoarded, as in a time of war, or of a great commercial panic, depreciation might not ensue. There is never any certainty, however, that the issue of paper money will be timely, and no confidence can be felt beforehand that the evil effects of excessive issues would be counteracted by the influences mentioned. 10. Special Provision for maintaining the Value of Irredeemable Paper. It sometimes happens that an attempt is made to give artificial value to fiat money by making it receivable for taxes. The effect of such a measure is temporary and, unless the quantity is carefully regulated, very small. If the amount of paper money issued is larger than the amount of metal displaced, by a quantity just equal to current government income, the excess over and above the demand needed for effecting ex- changes is the amount which the government with- draws from circulation. The effect of receivi this excess in payment of government dues is cisely the same as the current redemption of the excess, provided it is held in the treasury after it is received. This could occur only if it were surplus revenue. If, however, the excess, over and above the amount equal to the metal displaced, 347 MONEY is greater than the current government revenue calls for from day to day, then this channel- of overflow for surplus paper money is choked, and the effect is the same as if the current redemption were not large enough to take care of the excess. Beyond this point the course of the purchasing power of the paper money will be unaffected by the fact that it is receivable for government dues. It is further urged at times that if the people have confidence that the money will ultimately be redeemed by the government that issues it, its value will be sustained. This belief is utterly without foundation, except so far as the belief in ultimate convertibility leads to hoarding. The value of a promise to pay may be sustained under such circumstances if the paper is held as an investment, but its value as a medium of exchange will not be affected at all. The purchasing power, which is an essential characteristic of a medium of exchange, is present, not future, purchasing power. It is what a piece of money will buy now that de- termines what it will pass for. If the paper were at a discount, and the certainty of redemption were established at a period not too remote, a portion of the paper would probably be withdrawn from cir- culation as money, and held as an investment, and the purchasing power of the remainder would thereby be raised. Aside from this probability the certainty of ultimate redemption would have no effect. 348 INCONVERTIBLE PAPER MONEY 11. The Evils of Irredeemable Paper. The evils of depreciating and fluctuating paper money can- not easily be over-emphasized. Inflated prices introduce an element of uncertainty into busi- ness. Business men cannot be sure that the prices at which they contract to sell or buy will remain the same from the time the contract is made until the transaction is closed. Speculation of the worst kind becomes a feature of business life. Business sagacity is thwartecL and the spirit of prudence gives place to that of gambling. Risks of change, the probability of inflation or contrac- tion, must be discounted, with a wide margin. The result is to produce greater changes in prices than the mere difference in the amount of money would of itself cause. Moreover, the speculative fever thus engendered introduces a demoralizing influ- ence into a community ; a desire to get rich' quickly is stimulated, to the detriment of that security and steadiness which are essential to sound business methods and morals. Expensive living becomes the fashion. The nominal price of all property rates so much higher than it for- merly did that people regard themselves as grown suddenly rich, forgetting that the change is a nominal, and not a real one. When a contrac- tion of the paper money flood takes place, these changes are reversed ; but as it is so much harder to retrench the expenses of living, and to think of one's self as becoming poor by the fall in nominal values, the feeling of sacrifice and loss engendered 349 MONEY depresses a community, and for a time deadens enterprise. Moreover, the fluctuations of the value of inconvertible paper defraud creditors or debtors, according to the direction of the movement, with- out any corresponding advantage or offset, and they bear down severely on wage-earners. Wages are paid in paper, and, since wages do not rise as early or as rapidly as prices do, the cost of living is increased to all wage-earners. 12. The Fiscal Advantage of Irredeemable Paper. The fiscal advantage which the government has in securing a loan without interest, by the issue of such paper, is dearly bought by the community. It is, in effect, an unjust method of taxation ; for it strikes hardest the poor and ignorant, and it makes the burden of taxation variable and uncer- tain. When a government once yields to the temptation to issue inconvertible paper, it has entered upon a path that is likely to lead it downward in the scale of political integrity and national honor. The amount of paper money which a government is likely to issue depends primarily on its need for revenue. It is a fiscal need, rather than a business need, that determines what the quantity of this kind of money shall be. Yet money is, first and foremost, a tool of the business world. Its quan- tity must depend on the demand for a means of exchange, its value must not be caused to vary any more than the accidents of business bring about, and, above all things, should be free from the vari- 350 INCONVERTIBLE PAPER MONEY ations due to forces outside of business and alto- gether unconnected with the service which money is intended to render. When once paper money has been issued in excess of the needs of a com- munity, and the price level has begun to rise in consequence, demoralization is inevitable. Fiat pa- per has been well called the alcohol of commerce, whose fumes, entering the brains of individuals and of government officers, seem to make them incapable of sober judgment or self-restraint in the matter of further issue and further demoralization. 13. Motives to the Issue of Irredeemable Paper. While the fiscal necessity of a government is gen- erally the primary cause of issuing fiat money, the ease with which the money is obtained and the apparent temporary profit which it brings to the government easily create a popular demand for its continued and larger use. It is not evident to the people at large that the temporary benefits of paper issues have a very definite limit, and that the use of fiat paper beyond this limit will cause only harm and loss. Besides the fiscal motive for the use of fiat money, pressure for its increase comes from the debtor class. When the paper has driven up prices, debtors find it easier to pay debts which were contracted when prices were low. Of course, payment in depreciated paper is not an equitable return ; but as long as human nature is as it is, there will always be some who are ready to take advan- tage of any means for escaping their just burdens. MONEY Still another reason which makes it difficult for a country to stop short of disaster when once it has entered upon a career of depreciated paper, is found in the proper and honest desire of many people to secure for the people at large whatever saving is effected by the use of paper money. In the view of these people, money is a tool of society, and the community as a whole should obtain what- ever advantage comes from the improvement of it. The purpose of this demand is entirely proper, but the use of fiat paper money to effect this saving is very questionable, in view of the dangers which it invites. There are ways of securing to the public whatever benefit there is in the use of paper money without inviting the dangers of depreciation. 14. Some Noted Historical Examples of Irredeem- able Paper. The most noted instances of incon- vertible paper money are the French assignats and mandats, the notes of the Bank of England dur- ing the so-called period of restriction following the Napoleonic wars, the notes issued by the Conti- nental Congress, and the greenbacks issued by our government during the Civil War. The assignats were issued by the revolutionary government of France in 1789. These were legal tender notes secured by the lands confiscated from the clergy. That is, these lands were pledged for the ultimate redemption of the notes. To facilitate their circulation, moreover, bank-note issues were prohibited ; but they fell rapidly in value because of excessive issue, and in 1 796 a one-hundred-franc 35 2 INCONVERTIBLE PAPER MONEY note was worth one-third of a franc in gold. They were replaced later with the so-called mandats. These differed from the assignats only in the respect that for their payment specified portions of land were assigned. The first issue of paper money by our Conti- nental Congress was in 1775, to the amount of $10,000,000. These were not made legal tender by the Congress, although they were made so later by the various colonies. Before the time of the Declaration of Independence $15,000,000 had been issued. Within four years the volume of in- convertible paper ros% to more than $240,000,000, and its value fell so rapidly that by 1781 it was worthless. This fall took place in spite of many efforts of the public and the legislature to pre- vent it. The United States greenbacks, or legal-tender notes, were first authorized by Congress in 1862, to the amount of $150,000,000. Within four months $150,000,000 more were authorized. The maxi- mum sum issued during the war was $450,000,000. They fell to 35 cents per $i in 1864, and fluctu- ated at various rates until the resumption of specie payment in 1879. The amount outstanding is $346,681,016. 15. Regulation of Irredeemable Paper. Waiv- ing the question, which many people answer in the negative, whether it is ever really necessary for the government of a wealthy country to resort to fiat paper, it is important to determine some means 2A 353 MONEY of regulating the amount of issues so as to avoid the evils of depreciation and inflation. We have seen that some people think it possible to measure the fluctuations in prices and to enlarge or contract the amount of paper money accordingly. Aside from the unsound theory which underlies this pro- posal, the measurement proposed is practically impossible. A premium on gold, however, is a sure sign of excess of issue of paper. Therefore, the quantity of paper should be so regulated as to prevent the appearance of this premium. The most successful instance of the management of paper issues in this way is that of the Bank of France during and after the Franco-Prussian War. 354 CHAPTER XVII CONVERTIBLE PAPER CURRENCY REFERENCES: Conant, C. A., History of Modern Banks of Issue, Ch. I ; Dunbar, C. F., Theory and History of Banking, Ch. 5 ; Gilbart, J. W., History, Principles, and Practice of Banking, Vol. I., Ch. 10 ; Jevons, W. S., Money and the Mechanism of Ex- change, Chs. 1 6, 17 ; Laughlin, J. L., Principles of Money, Ch. 13 ; Macleod, H. D., The Theory and Practice of Banking, Vol. I., Ch. 4; Nicholson, J. S., Banker's Money; Scott, W. A., Money and Banking, Chs. 7-9; Walker, F. A., Money, Pt. III.; White, H., Money and Banking, 2d ed., Bk. III. 1. By whom Convertible Paper Notes are Issued. By convertible paper currency is meant .paper for which the party who issues it will /pay specie on demand. The holder, therefore, has a medium of payment of the same value as the amount of gold called for, and is saved the inconvenience of handling the metal. Paper pay- able with any other commodity than specie is not properly called convertible. Such paper may, as a matter of fact, pass in exchange for gold, or goods, without depreciation ; but the cause of its so passing is not that it is secured by land, goods, or what not. As to its origin, convertible paper is usually put out by banks. Sometimes, however, it is a 355 MONEY government issue, like our own United States notes or greenbacks, at the present time. In the latter case, the action of the government in issue and redemption partakes of the nature of banking, and the government is said by critics of this ser- vice to be in the banking business. Convertible paper currency, when issued by a government, may be put out against the specific deposit of a sum of gold, or silver, as the case may be, equal to the amount called for by the notesxa and actually held on deposit for their redemption ; or it may be issued without specific pledge, on the general credit of the government. The former notes are really certificates of deposit, of the na- ture of warehouse receipts, and constitute what is called repxesentative money in this book. The gold and silver certificates issued by the United States Treasury are good examples of this kind of paper. In the case of treasury notes, like the greenbacks, the government does not keep specie equal to the value of the outstanding issues, nor does it retire the notes when presented for redemp- tion or in payment of public dues. It treats them as money, paying them out again in discharge of its obligations, but guarantees their redemption in metallic money on demand, and keeps on hand a certain amount of specie for this purpose. 2. The Advantages of Government Convertible Currency. The advantages to the people, of the use of government convertible currency, are those common to all paper money ; the saving of 356 CONVERTIBLE PAPER CURRENCY capital in the production of gold and silver, the prevention of wear of the coins, and the greater convenience of paper. The advantage to the gov- ernment is the fiscal one of securing a certain amount of revenue without resorting to ordinary forms of taxation. *xt)ver against this fiscal advan- tage must be set the expense of getting and main- taining the specie reserve necessary to insure prompt redemption of the notes. This expense increases the more frequent and large the presen- tation of notes for redemption. Moreover, the likelihood of frequent and voluminous redemption endangers the whole system of government note issue. For the specie reserve cannot be quickly increased to meet unusual demands. It can be enlarged only from taxation, or from the sale of bonds; but taxation, aside from being too slow to answer the purpose, would have to be increased to meet the extra payments and would thus wipe out the profit of note issue. The sale of bonds would be open to the same objections. The interest charges would very likely be much greater than any profit arising from the paper issues. In order to avoid the danger of being confronted with a demand for redemption beyond the power of the treasury to meet, the amount of convertible paper is usually limited by law. This limitation, together with the mode of issue, deprives govern- ment paper of the power automatically to vary in volume with the need of business men for currency. The treasury notes are put out in payment of gov- 357 MONEY ernment dues; they cannot be put into circulation as loans to people who need more money to carry on trade. Hence they lack a very important char- acteristic which attaches to convertible paper issued under suitable provisions by banks. Government paper does not possess the quality of elasticity; bank paper does. 3. Convertible Bank Paper. A bank note is a note given out by a bank, promising to pay in stand- ard, or in legal-tender, money, the amount specified on its face. These notes. get into circulation in this way : a customer may deposit metallic money with his bank and receive in exchange the more convenient notes; or, more commonly, he may give his own promissory note, or a bill of ex- change to his banker, and receive in exchange the notes of the bank. In doing this he exchanges his own credit for that of the bank. Being a merchant, for example, he has incurred debts which he cannot at the moment pay. He could offer his creditors his promissory notes ; but they, like him, are in debt, and want a medium of payment which they can pass on to their creditors in turn. His credit is not well enough established, or known, to admit of his notes passing current. But it is well known at the bank, and that of the bank is well established throughout the community in which the circle of indebtedness just described prevails. Hence the promissory notes of the bank will be accepted widely in payment. Therefore the merchant in question exchanges his promissory notes for those 358 f CONVERTIBLE PAPER CURRENCY of the bank in convenient denominations, and with them pays his debts. The process is simply an exchange of credit of narrow circulation, or accept- ability, for credit of wider circulation or accepta- bility. The bank notes therefore pass from hand to hand and perform the services of exchange, as does standard money. Of course the bank keeps on hand a sufficient reserve of specie to redeem these notes as they are presented to it. Bank notes are now commonly issued in the second way described, that is, by way of discount. Business men in need of cash take their promissory notes, or bills, to the bank. The bank buys these with its own notes, charging for the exchange the interest on the amount at current rates for the period during which the customer's notes run. This charge is collected in advance and is called dis- count, and the process is known as discounting the customer's notes or bills. The term " discounts" is also applied to the advances thus made by the bank. 4. The Meaning of the Term " Elasticity "as applied to Convertible Paper Currency. It is evident that the amount of the bank's discounts is determined by the volume of the notes and bills offered by its customers for bank notes. That volume depends, in turn, on the need of business men for currency. Hence the note issues of the bank are ultimately fixed by the demand of the business of the com- munity, and vary with this demand. This power of bank notes to adjust their volume to the need for currency is called elasticity. 3S9 MONEY The exact meaning, the desirability, and, indeed, the existence of what is called elasticity have long been much disputed. It was the debate on this topic, and on its corollary doctrine of the true theory of the management of paper issues, which occurred in England during the second decade of the nineteenth century that gave to the world the famous Report of the Bullion Committee; and, a little later, a series of papers on the subject unsurpassed for the brilliancy and exhaustiveness of their treatment. By elasticity is commonly meant the quality of a body by virtue of which it can resume its previous size and shape, when these have been changed by temporary pulling or com- pression. If applied strictly to money, the term, accordingly, should mean that the existing volume of money should do more service under the tension of additional demand, and less on the relaxation of demand. As ordinarily used, however, elasticity of money means the power of the volume of money to increase and decrease with changing demand. These two meanings are not the same, and some con- fusion has arisen from failure to notice their differ- ence. The difficulty arises from using the terms of physics in connections where their use can be only figurative. When a demand for money becomes more intense at one place than at another, under a system of 1 metallic money, the metal leaves the place of less intense for that of more intense demand. Its j total quantity, however, is not increased. Under 360 CONVERTIBLE PAPER CURRENCY a system of convertible paper, an increased local demand for money is met by the issue of more paper, not by the transfer of some from another place. If we are to resort to physical analogies, the proper term for the characteristic under dis- cussion would be fluidity, or mobility, in the case of the metallic money, and variability of volume in the case of paper. The so-called elasticity of gold money means a changed distribution ; that of paper money implies a larger or smaller volume than before, in some place or places, but not at the expense of the supply of any other place. Metallic money has fluidity, not elasticity; convertible paper money has fluidity only to the extent that it flows to its centres of redemption and not to centres of demand for money, if this demand is elsewhere than at the points of redemption. If, then, either kind of money has elasticity, in the sense of varia- bility of volume under pressure, it is convertible paper. It is the possibility and desirability of this quality of variability over and above, or otherwise than, that of metallic money that has been the subject -of warm discussion in the theory of convertible paper money. 5. On the Desirability of Elasticity. Of the desirability of having a currency that is elastic, or variable in volume, rather than merely fluid, or mobile, there is little doubt. There are certain local needs for an increased amount of money, dependent on the seasons and the kind of industry. The seasonal demands of agricultural communities 361 MONEY have long been well known. With an elastic cur- rency, like bank credits, these demands can be met without an extra strain on the money supply else- where, and without the expense of transferring specie. Bank notes serve the purpose better than deposits subject to check, because the people who want the seasonal extra supply of currency are too far from banks ; they receive and spend sums too small to make their accounts profitable to a bank, and they are more or less unaccustomed to the business procedure connected with keeping active bank accounts. The currency is wanted largely to pay wages and small accounts. It is urged by those who oppose elasticity of the medium of exchange, that these local and seasonal demands do not occur everywhere at the same time; that when the demand for the medium of exchange at one place is strong, it is weak at some other place. Hence, it is argued, no addition to the currency, but simply a transfer of part of it, is necessary. There is some force in this statement, but the fact that money may flow from a place of slack demand to one of intenser demand does not disprove the advisability of supplying additional currency, unless it can be shown that the amount transferred is sufficient, without causing strain elsewhere. Moreover, the expense of transfer may be greater than that of additional local bank issues, and the necessary supply should come by transfer only if that be less expensive ; otherwise, additional issues should be made. 362 CONVERTIBLE PAPER CURRENCY It is also urged that the stronger demand for money will cause a greater rapidity of circulation of the existing money supply, and therefore make an additional supply unnecessary. This is true, provided the increased efficiency of the existing money supply suffices to satisfy the demand. But this argument, like the preceding, simply says that there are other ways of meeting the demand. The reply is that from the variety of ways society will choose the one which is adequate and most effective, its expensiveness being considered. It is argued further, that no attempt should be made to supply the demand for extra medium of exchange for seasonal and similar reasons, because it is better to let the stringency be felt in order to check speculation. This contention also has some force ; but these demands are not always specula- tive, and in so far as they are not, the argument is beside the point. 6. The Banking Theory and the Currency Theory of Note Issue. The different opinions held con- cerning the elasticity of bank notes have given rise to two theories of the proper mode of issue and management of such paper. One theory holds that the paper issues, if kept always convertible, cannot be issued in excess ; that, consequently, they cannot depreciate, and that they will, under this condition, behave just as a like amount of metallic money would do, and, with good banking, will always be safe. This is known as the banking theory. According to this theory, if the notes are 363 MONEY always kept convertible, and are in fact constantly redeemed in specie, no precaution is necessary to prevent their excessive issue and depreciation, except good banking, the refusal to discount paper which is not wholly good, based on sound trade transactions, and made by men of integrity in business. Opposed to this view is the theory that bank paper can vary in volume independently of the gold and silver whose place it takes ; that it can be put in circulation in excess of the specie which would replace it in a wholly metallic system, be- cause as fast as it is put out it will inflate prices in x proportion to its quantity and so cause a demand for additional issues. This is known as the cur- rency theory. The currency principle insists, contrary to the banking principle, that good banking and constant convertibility are not sufficient to prevent over- issue, depreciation, and inflation ; that, on the con- trary, the great influence of banks enables them to put their notes into circulation in excess of the specie which these displace; and that conse- quently the mixed currency of gold and paper will vary in purchasing power in a way different from that which would be shown by the purely metallic currency to whose behavior, according to the theorists of both schools, the mixed paper and gold currency ought to conform. According to this theory, bank currency must, therefore, be regulated so as to prevent its issue in excess of 364 CONVERTIBLE PAPER CURRENCY the specie it displaces, or represents. From the view-point of the currency theorist the function of the bank, as a note-issuing agency, is merely to exchange credit for specie and specie for credit. To prevent the issue of notes beyond the specie displaced, the amount must be restricted by re- quiring some kind of special security. 7. The Power of a Bank to force its Paper into Circulation. Despite the clearness and conclu- siveness of the proof of the truth of the banking principle, and despite its acceptance by most au- thorities on the subject, it is the currency theory which has in the main been put into practice. The Bank of England, the Reichsbank of Ger- many, and the national banks of the United States are all organized, as note-issuing institu- tions, on the currency theory. Their issues are limited and safeguarded by various devices. The Bank of France, on the other hand, is an excellent illustration of an institution founded on the bank- ing principle. The experience of all these banks has furnished evidence so strong as to be conclu- sive in support of the truth of the banking prin- ciple, and the fallacy of its rival. The aim of the banks operated on the currency theory is to ex- change paper for gold and gold for paper, to let no paper into circulation except as gold is taken out, and to issue no gold except in exchange for notes paid in, so that the stock of money may be kept exactly the same as it would be if wholly metallic. It is not necessary to quote figures from 365 MONEY the history of the currency-theory banks to show that they have not been able to do this ; nor to recite all the arguments whereby the Bullion Com- mittee and their adherents proved that it could not be done. These arguments got their color from the fact, which somewhat obscured the points in dispute, that note issue was a far more important form of discount at the time of the great debate than it is now. At that time it was the note-issuing function of banks that was thought to be their most important social, and their most profitable private, service. The belief in the potency of bank notes to affect the public welfare was long the chief inspiration of bank legislation, and led to the enactment of many laws directed to control the banks in the exercise of this power. Long rows of Blue Books and congressional documents and treatises on this subject fill the shelves of our libraries, silent wit- nesses to the belief of our fathers and grandfathers that as banks increased, so, too, would grow the importance of this particular function. How dif- ferent is the fact from the expectation ! The check, not the note, is to-day the symbol of bank- ing progress, the instrument of large exchange. On January 22, 1904, the outstanding notes of the national banks of the United States amounted to $38o>93 2 >3P7> while the individual deposits, subject to check, were $3,300,619,8918. It is the deposit and the check that we must reckon with to-day. But the change of form of the bank function has 366 CONVERTIBLE PAPER CURRENCY not changed its character. When a bank buys a piece of mercantile paper, by discounting a bill of exchange or a promissory note, it creates a debt against itself, whether it gives its customer notes, or credits him on its books. To discount a piece of mercantile paper by issuing notes in pay- ment for it, differs in no respect from discounting the same paper and crediting its seller with a proper amount as a deposit to be drawn out by checks at the convenience of the holder. To ask, therefore, whether a bank can issue its notes in excess is to ask whether it can sell its credit in excess of the demand therefor. The answer of the adherents of the banking principle is in the negative ; that if the bank discounts good paper, and meets all de- mandsdn it for the redemption of its notes, it can- not issue notes or create deposits to a degree to inflate prices. For banks can sell their credit only by purchasing securities, mercantile or other. Merchants will not borrow unless their business makes borrowing profitable, nor will they continue to pay interest on loans, whether of notes or de- posits, longer than they must. Increase of trade, and of the volume of payments, is not caused by an enlarged demand for currency ; the enlarged demand for currency is a consequence of the larger volume of business. To say that currency can be issued in excess of the demands of business is therefore to reverse cause and effect. If busi- ness grows and the volume of payments to be made enlarges, more means of exchange must be 367 MONEY obtained to settle obligations, whether the currency in use be specie or paper, and the increase of the medium of exchange would come in either case. There can be no difference. It is true that banks sometimes lend incautiously, that they sometimes discount paper based on hazardous undertakings, and that the stimulation of industry of which such enterprises are the cause and the sign is followed by, or accompanied by, an increase in the emission of bank paper. But this larger emission is a re- sponse to the demand for increased means of pay- ment which such enterprises create. An expansion of bank credits can come, therefore, only as a result of an expanded demand and a higher price scale, and they cannot exceed in amount the specie they represent, for this is the amount needed to do business on the higher price scale. The proper means of preventing enlarged emis- sions is to prevent the unhealthful stimulation of trade which causes them. True, it may be said that the inability to secure a larger volume of cur- rency would check the unsound business under- takings. But it would also check new enterprises that were legitimate and sound. The limitation of issues in order to prevent inflation from unsafe enterprises would at the same time deprive the community of the very important advantages which elasticity of the currency confers. It is an act of questionable wisdom to cure one set of ills by creating others, when the good can be obtained in other ways without incurring the harm. Moreover, 368 CONVERTIBLE PAPER CURRENCY the banker's interest works against over-issue. If he grants credit in excess of the legitimate need of business for it, the excess will return to him, for deposit at interest, or, failing that, for exchange into specie. He will therefore subject himself to loss. 8. Some Practical Considerations which modify the Above Conclusions. Such is the reasoning of the banking theory, and it is without a logical flaw. Experience tells us, however, that banking is not always sound and careful ; that men are sometimes carried away by extravagant expectations of busi- ness growth ; that banks and bankers can, and do, stimulate this speculative feeling by making dis- counts easy and by lending on business ventures that have no substantial basis of success ; that men are not always careful to insist on the instant and full convertibility of bank notes; that banks can sometimes create a feeling in the community against insistence on convertibility ; and that, in conse- quence of all these facts, bank issues of notes or of deposits may possibly exceed the due needs of legitimate business, and subject the community to the evils of a depreciated currency. For this reason some strength is lent to the demand that measures be taken to prevent the undue expansion of bank credits, of whatever form ; and although, as we have seen, there is no difference in character between bank notes and bank deposits, considered as forms of credit, nor in the principles which should guide banks in regulating them, their be- 2B 369 MONEY havior after issue may differ so much as to make different treatment necessary. The banking principle may be safely relied on for the control of the vast and ever changing accu- mulation of bank deposits, the result of the dis- count of commercial paper. The world over, these deposits are the property of people who are keen and able in the protection of their own interests. The depositor chooses his bank and the form of credit which he will take from it. He is in a posi- tion to judge, with at least reasonable certainty, of the soundness of his bank and the character of its management. He is in close touch with it, he can close his account with it at short notice, with little trouble. Deposit currency, in short, is per- fectly suited to a commercial community, with its highly organized business relations, the close con- tiguity of its members, and its rapid means of com- munication. For these conditions, which are the very ones that need and favor a currency of the highest mobility, furnish at the same time protec- tion against its possible evils. The case of note issues is somewhat different. The notes, if they are to answer their purpose, will frequently, indeed usually, come into the hands of people who have no means of judging whether they are good or bad, and may never have heard of the bank which put them out. It will not do to say that people are not obliged to take bank notes, because to refuse them would be, in many instances, to injure themselves in a business way. 37 CONVERTIBLE PAPER CURRENCY Wage-earners, for example, would find it rather hard to refuse such paper. But it is precisely the economically helpless in such matters who are most commonly the victims of fraud or error. For these reasons the note fprm of bank credit, if abused by bad management or over-confidence, is likely to do more harm than is the deposit form. " In a coun- try where there is one chief bank, possessing an im- mense capital and unbounded confidence, the notes of such a bank, even if payable in gold, may be issued to such an extent as to cause an advance in prices, until an unfavorable course of the exchange shall cause payment of the notes to be demanded in gold." l The same condition may be brought about where the banks of issue are numerous and possess the confidence of the community. The notes get into the hands of people who have no interest in de- manding redemption. They are scattered through the community in comparatively small amounts, so that an individual holder would gain nothing by depositing his holdings. Moreover, the trouble of making the deposits, where population is scattered, would act as a check on contraction. These con- ditions are more likely to be found in an agricul- tural community than elsewhere, and probably had much to do with the inflation caused by the wretched issues of our earlier state banks-. Practical necessities, therefore, justify the de- mand for some safeguarding of convertible bank 1 Gilbart, " History, Principles, and Practice of Banking," Vol. I., p. 150. 371 MONEY paper, the need for which the economic principle correctly enough denies. The theory is sound and its principle is the one which must be followed to enable banks to accomplish the purpose of their existence. But human nature and some social conditions may interfere with its operation, and some people who are expected to be guided by it may occasionally find their temporary interests promoted, or apparently promoted, by violating it. The public evils that flow from its violation, or from friction in its working, justify the community in insisting on safeguards against them. On these grounds only can be found any defence for the claims of the currency principle that note issues should in some way be regulated by law. 9. Provision of Proper Safeguards for Note Issue. All these arguments, however, do not justify the requirement of the currency theorists that the amount of convertible paper currency should be fixed by law. They justify merely the insistence on safeguards which will leave issues free for all legitimate business needs, while pro- viding against the evil effects of expansion to meet illegitimate needs. The arguments justify regu- Jation, not a priori definite limitation. For the legislator cannot determine Tieforehand what issues are proper and what are not. He must leave that to the banker to decide as occasion arises. The banker must be left unhampered to extend his credit, whether by note issues or deposits, to what- ever amount is called for by the securities created 372 in ! ? CONVERTIBLE PAPER CURRENCY by commercial transactions, and presented to him for discount. The owners of the securities, the business men of the community, are the best judges of what form should be taken by the bank credit which they want. The only interference which is economically justifiable, then, is the institution of proper safeguards against the abuse of the credit- issuing power of banks, and against the evil effects of this abuse on the public when it occurs. The whole matter has to do, not with limitation, but with the insistence that the banker shall regulate his note issues properly. 10. Regulation of Note Issues by limiting their Volume. There are many methods of regulating convertible note issues in the interest of safety, but the principal ones may be grouped into these classes : those which act directly on the notes ; those which, without limiting the volume of issue, rovide for its safety by acting on the reserve ; ose which provide jysecial security, apart from the reserve ; and those which support the notes simply with the general crediLpf the issuer. The plan of regulation which acts directly on the notes consists merely in fixing a maximum 1'mit to their volume. The theory of this limita- tion is that a certain amount of money is always needed by the business community ; that this amount, of whatever kind of currency it may con- sist, will always be equivalent to gold, because it never exceeds the demand for money on the pre- vailing scale of prices. This money, it is said, 373 MONEY may as well be paper, since there will never be any call for its conversion into gold to any large extent, and the other kinds of currency in use furnish all the leeway necessary to accommodate changes in trade and in demand for specie for export. It is on this principle that the government of Canada sup- plies the small bills current in daily business, and restricts the bank to the issue of notes of denomi- nations of over five dollars. Our own greenbacks now occupy a somewhat similar place in our mone- tary system. The objection to this mode of regu- lation has already been set forth in the criticism of the currency theory. The currency thus furnished has no elasticity, and no real correspondence with the demands of trade. 11. Regulation of Note Issues by controlling Reserve. The second group of methods for regulating convertible paper money consists of those which operate on the reserve, instead of directly on the issues. The law may require banks to protect their notes by keeping on hand a , fixed minimum amount of specie, or a stock of specie equal to the notes afloat, or equal to a certain pro- portion of these notes. Instead of specie, the law may require the holding of a reserve of securities,, as bonds, stocks, and commercial paper. The amount of these paper securities may be, as in the case of a specie reserve, a fixed minimum, or equal to the whole issue, or to a certain proportion of it. As Professor Jevons has pointed out, these methods of regulation may be combined in various ways. 374 CONVERTIBLE PAPER CURRENCY 12. The Minimum Reserve Method. The mini- mum reserve method of regulation, which requires that a fixed amount of specie shall be on hand at all times, whatever the amount of notes afloat, is prejudicial to good management, and under some conditions affords but slight protection. The pur- poses of a reserve are to protect the bank against danger of failure to redeem its obligations, and to afford relief to people who need money when it is hard to get. If, however, the bank be required to keep its reserve intact, these purposes are defeated at the time when the need for their accomplish- ment is greatest. Such a plan virtually means that banks must redeem their obligations until their reserves fall to a certain point, and must not do so beyond that point. It may, of course, be said that the bank is legally and morally bound to keep its reserve at sufficient height to preclude the danger of its falling to the fixed minimum. Yet there is a certain inconsistency in saying that a reserve sufficient for all demands must always be kept; but if it should not be sufficient, then re- demption must cease. It is like telling a boat load of shipwrecked people that they may row for the shore while they have two oars, but must cease their efforts if one of them is lost or broken. Such a restriction on redemption would very likely in- crease the difficulties of the community in a time of business distress. If, at such a time, the re- serve held against the notes approaches the mini- mum fixed by law, the fear of some people that 37S MONEY the notes they have may not be redeemed will cause a sudden increase of the demand for re- demption, and precipitate the evil the reserve is designed to prevent. 13. Proportional Reserve Method. Similar ob- jections may be made to the proportional reserve method. A demand for the payment of a consid- erable amount of notes may reduce the reserve to a quantity equal to the legal proportion of the notes still left in circulation. In that case no more could be paid, and the proportional reserve would be virtually a fixed minimum reserve. For example, if the amount of notes in circulation is $60,000, and the reserve required by law is one- third of the issue, or $20,000, the redemption of $15,000 of the notes would reduce the outstanding amount to $45,000; but the reserve would be lessened by a similar amount and would become $5000, an amount less than the legal requirement. Whatever advantage the proportional reserve method has over that of a minimum reserve comes from fixing the reserve at a high propor- tion of the total issue. But while a large reserve would better insure the safety of the notes, it would pari passu defeat the main purpose of using paper, namely, the saving of investment in metal- lic money. 14. Simple Deposit Method. The plan of keep- ing on hand a stock of specie equal to the whole amount of notes issued, known as the simple deposit method, gives the notes the character of 376 CONVERTIBLE PAPER CURRENCY warehouse receipts, or certificates of deposit, which have been already described. Such paper is certainly safe if the warehouse man is honest ; but it possesses none of the advantages claimed for bank money, except the mere saving of the wear of the coins. Moreover, under an autocratic government, or a government which can control the management of the bank of issue, such a stock of specie is a sore temptation to the authorities in times of treasury distress. Historical instances of the seizure of such deposits are not wanting. Those of the Bank of Amsterdam were secretly loaned to the government of Holland prior to the French invasion of 1795. The English govern- ment borrowed the gold of the Bank of England in 1797 by causing a suspension of specie pay- ments ; and that of France took a similar step with reference to the specie in the Bank of France in 1870. 15. The Partial Deposit Method. By what Jevons has called the partial - deposit system, a certain part of the notes are issued against stocks, bonds, and other securities, and further issues must be protected by the deposit of specie, dollar for dollar. This is the method employed by the Bank of England, which is permitted by law to put out a maximum of ^17,500,000 l of notes on the security of government bonds. One advantage 1 The amount was originally ^"14,000,000, but has been increased by the lapsed circulation of country banks which have ceased to issue notes. 377 MONEY of this system is that as the amount of outstanding notes increases, the proportion of specie reserve to the whole issue increases, and thus insures greater safety to the whole. But this safety is obtained at the expense, to some extent, of whatever advan- tage in the way of elasticity is furnished by bank notes proper. 16. The Bond-deposit Method. Under the bond- deposit system the notes are secured by the stocks and bonds of governments. The notes of the national banks of the United States are thus se- cured. The banks are required by law to pur- ^chase bonds of the United States with their capital stock. These bonds are deposited with the treas- urer of the United States at Washington, and the banks receive in return notes equal in arftount to the par value of the bonds, but not in excess of their market value, nor of the capital stock of the bank. There are several serious objections to the plan of securing note issues with public stocks. In the first place, the bond security, by itself, does not insure convertibility in the proper sense. It pro- vides for ultimate redemption, but not for that immediate payment in gold, on demand, which is essential to business. Our own national bank notes may be paid in treasury notes, and these in turn may be presented to the treasury for gold. Evidently the bank notes command gold only so long as the treasury notes do so. Hence, our bank notes are convertible, not because their redemption 378 CONVERTIBLE PAPER CURRENCY as bank notes is properly provided for, but because the government is solvent. However, even if the law did not provide for the payment of national bank notes with government paper; if, in other words, the banks were required to redeem their notes directly in gold, the possession of bonds and other securities would not be a guarantee of their ability to do so, nor a sure means of enabling them to do so. The bonds would have to be sold to get gold to pay the notes. At a time of monetary stringency the holders of the notes present them to get gold because the need for the metal is great. If the banks must sell their securities to get this gold, the price of the securities is likely to be forced down, and that of gold raised, at a time when the need for it is greatest. A second objection to the bond-deposit system is that the purchase of the bonds uses the real capital of the bank in procuring its notes by in- vestment, instead of leaving it free for discounting commercial paper, which is the purpose for which the bank is organized. Further, a system of bond-secured issues is in- elastic. The volume of notes depends primarily on the price of bonds, and not on the amount of commercial paper offered for discount. If busi- ness is expanding and the need for currency be- comes greater, it can be supplied only by buying bonds. But the briskness of business which causes the demand for more currency also raises the prices of bonds, so that their purchase as a 379 MONEY basis for new issues is less profitable. When busi- ness is dull, the prices of bonds fall and lead to an increased output of notes, although the need for more is less. Moreover, the enlargement and con- traction of the circulation under this system is not immediate and automatic. Administrative ma- chinery must first be put in motion, and this usually requires so much time that the pressure of demand may pass before it can be met. Still further, under the bond-security system of note issue, the expansion and contraction of the currency may be adversely affected by local rates of discount If the price of bonds is low, places in which the rate of discount is low may find it more profitable to buy bonds as a basis of further note issue ; while other places, in which the rate of discount is high, and in which, therefore, there is need of an expansion of the currency, may find it less profitable to purchase bonds than to use their capital as an immediate basis of discount. The compulsory investment of bonds under cir- cumstances like the above, constitutes in effect a forced loan from the community where interest is high to one where interest is low. Those who are in need of all their capital are compelled, in other words, to share its use with people who are in less need than themselves. Nor are notes secured by the deposit of bonds necessarily safer than issues based on a partial metallic reserve. For if the credit of the govern- ment is impaired, its bonds will sink in price, and 380 CONVERTIBLE PAPER CURRENCY the security will be lessened. " The issue of notes against deposited securities did not save the note- holders from loss before the war, while careful and intelligent systems of banking like those of Louisiana, Massachusetts, and the state banks of Indiana and Ohio did protect them fully.'' 1 Of course, these remarks, about the safety of notes secured by government bonds lose much of their force in the case of a strong and wealthy popular government like our own. There is certainly no more danger most of us will say far less that the safety of our national bank notes will be im- perilled by impaired national credit than there would be if their management were left wholly to the banks that issue them. The bond-deposit system of security is also objectionable because it makes necessary a per- manent public debt. The rapid retirement of United States bonds available as a basis of circu- lation has at times raised a question as to the permanence of our system of note issue. Indeed, resort to other kinds of bonds has at times been urged, such as bonds of states and cities, and of great corporations. Such a step is to be depre- cated. No matter how great the care with which such bonds may be chosen, public confidence in them would never be so great as in those of the national government, and trust in our bank paper could not fail to be shaken by their use. 17. The Safety-fund Method. Notes may also 1 Horace White, Annals Amer. Acad., March, 1893, p. 20. 381 MONEY be kept convertible by the creation of a common fund of specie by contribution from the note-emit- ting banks. This fund, called a safety fund, is de- posited with some public officer, the Comptroller of the Currency, for example, and out of it are redeemed the notes of any banks which fail. If the fund is impaired by such redemptions, it must be restored by further contributions. The expe- rience of forty years with our present national banking system has shown that the fund which would have been required to cover the losses on notes, caused by all the failures of the period, could have been provided by a tax of about one- fifth of one per cent, per annum on the circulation. A fund which would fully insure the safety of the notes could therefore be created and maintained by so small a tax on circulation that no bank could reasonably object to it. The safety-fund system leaves the volume of notes absolutely free to respond to business needs for currency ; it would leave the capital stock of the banks free for ordinary banking business, and it would provide as safe a currency as does our present system. 18. Notes issued on General Assets. If no special provision is made for the security of notes, but they are treated simply as one of the liabilities of the bank, dependent on its property and general credit, the notes are said to be issued against gen- eral assets. This system properly regards notes and deposits subject to check as liabilities of iden- 382 CONVERTIBLE PAPER CURRENCY tical character, and aims to provide for the proper protection of both indifferently. With good bank- ing, this system is scientifically perfect; but, as has been pointed out, experience shows that bank managers cannot, any more than other industrial leaders, always be depended upon for unerring sagacity and continued honesty. Hence, bad bank- ing occurs, and would be likely to cause greater hardship in case of a failure, under a system of asset issue. As a precaution, it is frequently proposed to make the notes a first lien on the assets. Doubtless this additional security would in most cases suffice. For the notes are becoming a much smaller proportion of total liabilities, be- N cause the growth of deposits, against which checks are drawn, is more rapid than the growth of notes. It is difficult, however, to convince the public that this is the case ; and in the matter of note issue the establishment of public confidence is absolutely essential. 19. The Advantages of Combining Several Methods. It is evident that no plan of insur- ing the immediate payment of notes in specie is free from objection. No plan can be devised for insuring escape from reliance, somewhere in the management, on the integrity and faithfulness of men. Two purposes, incompatible in their nature, are aimed at by every scheme for regulating bank credits. One is to secure for society the saving afforded by dispensing with gold ; the other is to avoid the dangers of inflation and depreciation that 383 MONEY accompany the use of paper. Now, it is idle to expect that the full benefits can be obtained at the same time that all of the danger is avoided. One might as well expect to secure the rapid transpor- tation furnished by a modern express train, and at the same time suffer no greater loss or injury from its wreck than one would suffer if travelling in an ox cart that lost its wheel. The benefits of complicated machinery cannot be had without in- curring risks of greater loss than was experienced under simpler conditions, when the storm and stress of life break upon the more complex ar- rangements of society. All that we can reasonably ask is to secure a balance of advantage and risk of loss. In the matter of paper money it is far better to aim at a small portion of the advantages of its use, and run but little risk of loss, than to try to secure a large advantage at great risk. For in case of the failure of any bank to pay its notes on demand, the loss falls on many innocent people, and is likely to be distributed much more widely than is the case with the benefits during a period of successful management. In view of these facts, that system of manage- ment of bank issues is best which minimizes the danger of loss, whether by restricting the issues well within the limits of safety or by insisting on the provision of an adequate reserve. On the other hand, there is such a thing as making the notes too good. If they are put wholly beyond the risk of loss, their elasticity is interfered with. 384 CONVERTIBLE PAPER CURRENCY While business people who receive notes will de- posit them for the sake of receiving interest, this motive is of small force when the amount to be deposited is small. In such a case the paper is just as likely to be kept on hand by numerous small holders, if they feel that there is no danger at all that it will not be redeemed. If there are any notes which are not protected by their equiva- lent in metallic money, there is some risk. This danger is more or less, according to the amount of metallic reserve held. The amount left unpro- tected should be large enough to remind holders that it is to their interest constantly to demand redemption. A specie reserve should actually be held some- where. It is sometimes said that the reserve should be made profitable by investment, for example, in government bonds. But if it is so used, it is no longer a specie reserve. It is idle to try to devise a plan whereby a specie reserve can be kept for the purpose of redeeming notes, and used for profit at the same time. The two things are in- compatible. There is no way of making a profit on idle capital, and money kept for reserve is idle capital ; or, at any rate, capital which is productive only in an indirect way. It is productive only in the sense that it makes the- employment of the rest of the capital safer, or lessens the probability of a loss. 20. Comparative Advantages and Disadvantages of Government and Bank Issues. We have seen 2C 385 MONEY that paper money may be issued either by banks or governments. If the notes issued are gen- erally acceptable, they will serve the purpose of a medium of exchange. Several reasons are ad- vanced, however, against the exercise of the func- tion of issue by governments. In the first place, it is argued that the issue of paper money is not a proper function of the government. We cannot here go into a discussion of the proper sphere of government, and it is well not to dogmatize about it. Whether or not the statement is true depends on one's ideas as to what are the proper functions of government. It may be said, however, without fear of successful contradiction, that the experience of governments that have issued paper money has been so generally disastrous as to establish in a high degree the improbability of success in main- taining the notes convertible at par in times of fiscal exigency. Experience, therefore, is against government issues. The argument that the issue of paper money is equivalent to coinage, and there- fore is a sovereign function to be exercised by the government, is based on a wrong notion of the nature of coinage. The coinage of specie and the engraving of paper money differ in a very impor- tant particular, and that, too, a particular which justifies us in calling the issue of one a sovereign function and that of the other not so. Notes are a species of credit instruments ; gold is not. For the government to go into the business of issuing paper money is, therefore, to draw on its credit, 386 CONVERTIBLE PAPER CURRENCY and to lay itself open to the possibility of financial weakness in times of sudden fiscal stress. In per- forming the function of coinage proper, govern- ments incur no liability ; in issuing notes, they do. The likelihood of excessive issues is greater with government paper than with bank issues. Offi- cers of the government are likely to be influenced to issue paper money beyond the needs of busi- ness, by the necessities of the public treasury, or by public clamor, or by the ignorance and corruption of lawmakers. Yet it is also true that bankers have sometimes yielded to the same temptation for their own profit. It may be fairly said that, as a rule, we can expect as much honesty in the manage- ment of our public finances as has been shown by private corporations that have had the privilege of issuing paper money. It would be rash to say that the distress caused by our own early banking, or by the depreciation of Bank of England notes pre- viously to 1819, was less than the evils caused over equal periods from excessive government issues. Therefore, no argument for or against government issues, founded on the honesty or efficiency of the government as compared with private corporations, is of much permanent weight. There is, however, a very strong argument in favor of private issues in the fact that they should come out in response to business demand, that the amount of notes should adapt itself to the need of the country for currency." It is easy enough for government issues to expand, but very difficult for them to contract. Hard meas- 387 MONEY ures, such as bond sales or higher taxes, are usu- ally needed for contraction. But neither of these methods is directly related to business ; and contrac- tion, when it comes, may be either more or less than business requires. It has been suggested, even by so high an authority as Ricardo, 1 that a government commis- sion for the regulation of paper money might suc- cessfully vary the currency in response to the ebb and flow of business demand. This, of course, is possible, provided that this commission acted as bankers. It is likely, however, that people would rely too much on such a commission, and so en- courage speculation. The work which Ricardo proposes for such a commission is, of course, very different from what is in the minds of those people who propose a commission to vary the currency for the purpose of keeping the price level con- stant. It is sometimes urged against private bank issues, that the conferring of the power of issue on banks is likely to create a money power whose interests run contrary to those of the people at large. This argument is not to be altogether ridiculed. It cer- tainly is not true that the interests of the banks and the interests of the people are always identi- cal. In a higher sense, indeed, they are so, in the long run, but at particular times they may be oppo- site. But this is really an argument for controlling banks, not for forbidding them to issue notes. Cer- 1 Works, McCulloch's ed., p. 219. 388 CONVERTIBLE PAPER CURRENCY tainly no one's rights are curtailed and no harm is done by a proper regulation of the power of issue. 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Appreciation, causes of, 193-196; disadvantages of, 191-193 ; distri- bution of effects of, 182-187 5 and debts, 190-191, 320; and indus- trial improvements, 318 ; and in- terest, 322-326 ; and the laborer, 318; manifestations of, 179-180; meanings of, 177-179 ; phases of, 180-182. Aristophanes, reference in, to bad money, 53, note. Aristotle, on the origin of money, 15-16. Asset currency, 382-383. Assignats, French, 352-353. Balance of indebtedness, and credit, 206-212 ; and prices, 215-218. Banking theory of note issue, 363- 365, 369-372. Bank notes, 358-359 ; comparative advantage of government and, 3 8 5-3 8 9; regulation of, 372-385. Banks, increase in number of, 107 ; power of note emission, 365- 369- Barter, 18, 19, 26, 60; advantages of money exchange over, 126- 127; and the value of money, I 33~ I 34 160-162. Bills of exchange, and movement of precious metals, 90-93. Bimetallism, 292-316; advantages of, 294-296; burden of debts under, 304-306 ; compensatory action of the double standard, 296-299; depreciation and, 306; and Gresham's law, 297; in France, 296, 308; increase in gold and, 309-310 ; Latin Mone- tary Union and, 308; obstacles to international, 307-309 ; and the par of foreign exchange, 295 ; and prices, 301-304 ; and the ratio of gold to silver, 296-301. Bond deposit system of note issue, 378-381. Brassage, 34. Business, volume of, and the quan- tity of money, 101 ; volume of, and the value of money, 146-149. Cairnes, Professor J. E., on distri- bution of precious metals, 87. Cancellation of indebtedness, 206- 212. Capital, money a general form of, 9,67. Checks and reserves, 219. Circulation, by tale, 32 ; causes of, 50-52 ; Gresham's law of, 52-58 ; of metallic money, 48-49; of paper money, 49-56; principles of, 50-58 ; rapidity of, 101, 103, 151-158, 363. Clark 7 Professor J. B., on the stand- ard of deferred payments, 283. Clearing-house, 222-223. Coinage, 27-38 ; charge for, 34-38 ; international, 8-9; materials used in, 29-31, 72-77; origin of, 29- 30, 33 ; requisites of good, 31-33 ; right of, 33. 411 INDEX Commissions for regulation of price level, 313-316. Commodity money, 20-23, 71-76; characteristics of - good, 72-77 ; value of, 141-143. Compensatory action of the double standard, 296-298. Consumption of wealth, effects of money on the, 9-11. Convertibility, meaning of, 330. Convertible paper currency, 355- 389- Cost of money and its value, 163- 165 ; to a country, 171-172. Credit, adaptation of, to scale of exchanges, 108-112; definition of, 199-201 ; and amount of money needed, 105, 114-119 ; and cancellation of indebtedness, 206- 208 ; and crises, 223 ; and dis- tribution of the precious metals, 89-96; instruments of, 43-44, IIO-H2, 202; limits of, 109; and money, 220-221 ; and prices, 199- 223 ; and volume of business, 107; and wage period, 112. Creditor, effects of change in stand- ard on, 190-191, 262-265. Currency, composition of, 40; de- posit, 221-223 ; systems of metal- lic, 47-49; systems of paper, 49-5- Currency theory of note issue, 363-365- Debtors, and changes in the stand- ard, 190-191, 262-265, 317-318; and industrial improvements, 318 ; and paper money, 351-352. Debts, and appreciation, 190-191, 320; burden of, and bimetallism, 304-306 ; burden of, lessened by various factors, 317-328; and rate of interest, 322-326 ; charac- ter of modern, 319-320. Deferred payments, standard of. See STANDARD. Denominations of money, relation of, to scale of incomes and prices, 41-43; paper, 112-114. Deposit currency, 43-44, 221-223. Depreciation, causes of, 193-196; degree of, with inconvertible paper, 344-347 ; disadvantages of, 191-193 ; distribution of effects of, 182-184, 185-187 ; meanings of, 177-179 ; of standard, 262-263. Discounts, 359. Distribution of the precious metals, 78-122 ; between gold and silver standard countries, 96 ; credit and the, 89-95 ; double meaning of, 99 ; and the foreign exchanges, 90-95; national habit and the, 88; rate of discount and the, 94; Ricardian theory of the, 81-88 ; trade conditions and the, 83-86. Distribution of wealth, effects of money exchange on the, 11-13, 65, 190. Disutility of labor standard of de- ferred payments, 283. Double standard. See BIMETAL- LISM. Economist, index numbers of Lon- don, 245-247. Edgeworth, Professor F. Y., on measuring price changes, 240,258. Elasticity of the currency, 359-363. Essars, Professor, on rapidity of circulation, 219. Evolution of money, 14-26, 29. . Exchange, progress and the system of, i ; methods of, 18-19 ; system of, and the money demand, 105. Exchanges, volume of, and amount of money, 101-104; volume of, and credit, 108. Exportation of the precious metals, 78. Falkner, Professor R. P., on index numbers, 234, 253-255. 412 INDEX Fisher, Professor Irving, on mar- ginal utility and prices, 174; on appreciation and interest, 322-326. Foreign exchanges, and movement of precious metals, 90-95; and paper money, 338-339. Free coinage, 34. Freedom, the monetary system and, 6. Functions of money. See SER- VICES OF MONEY. Giffen, Sir Robert, on appreciation, 179; on index numbers, 235, 258. Gold, increase of, and bimetallism, 309; monometallism, 327-328; premium on, and depreciation of paper, 337~339, 342-3431 in- creased production and value of, 167-170, 187-190, 193-195 ; value of, in arts and as money, 195-196. Government paper money, 332-335, 350-353. 356-358, 385-389- Greenbacks, United States, 353. Gresham's law, 52-58, 297. Hildebrand, on monetary evolution, 16. History, early, of money, 14-17. Incomes, scale of, and denomina- tions of money in use, 4, 113. Inconvertible paper money, 329- 354- Index numbers, 227-256; Econo- mist table of, 245-246 ; Falkner's tables of, 253-255; Jevons on, 247; Sauerbeck's tables of, 250-252; Soetbeer's tables of, 247-250 ; regulation of prices by, 3I3-3I6. Interest, appreciation and, 322-326. Jacob, William, on production of gold and silver, 165-166. Jevons, Professor W. S., on index numbers, 247 ; on metallic money, Labor, as a standard of deferred payments, 281-284; effects of appreciation on, 318; monetary system and division of, 5. Latin Monetary Union, 308. Legal tender, 47. Mandats, French, 352. Marginal utility, of money, 159- 162, 206-207, 212-213 1 f goods, 134, 174-175 ; standard of de- ferred payments, 284. Markets and the development of money exchange, 24. Marshall, Professor Alfred, on index numbers, 236, 238. Martin, J. B., on denominations of bank notes, 113. Medium of exchange, composition of, 20-21, 39-46, 60. Metals as money, 24; distribution of, 78-122; production of, 165- 171. See GOLD and SILVER. Minimum reserve method of note issue, 375-376. Mint price, 37. Monometallism, gold, 327-328. Multiple standard. See TABULAR STANDARD. Nationality, the monetary system and, 8. Newcomb, Professor S., on meas- uring price changes, 256. Nicholson, Professor J. S., on measuring price changes, 257. Palgrave, R. H. I., on index num- bers, 234. Paper money, circulation of, 41-43, 50-58, 332 ; convertible, 329-330, 355-389; irredeemable, 331-354; kinds of, 329-330 ; over-issue of, 413 INDEX 341-349, 387-389; systems of, 49- Paulus on origin of money, 16. Population and amount of money, 100, 105-108. Premium on gold, 337~339 344~347- Price defined, 63. Price, Professor Bonamy, on mone- tary evolution, 20. Prices, balance of indebtedness and, 212-214; changes in, 102, 187-197, 224-259 ; cost of pro- duction and, 184-185 ; credit and, 197, 202, 208, 219-223; distribu- tion of precious metals and, 81- 86; level of, 81, 83-86, 124, 150, 313-317; marginal utility and, 174-175 ; normal case of falling, 187-190; paper money and, 341- 344; relative, 124, 172-175; ser- vices of tables of, 239-244; U. S. Senate report on, 253-255; vol- ume of business and, 146-149; wages and, 185-187. See APPRE- CIATION, BIMETALLISM, DE- PRECIATION, INDEX NUMBERS, STANDARD OF DEFERRED PAY- MENTS. Production of goods and quantity of money, 162. Progress and the system of ex- change, i. Proportional reserve method of note issue, 376. Prosperity, the monetary system and, 9. Purchaser's surplus standard of deferred payments, 287-291. Quantity of money, needed by a country, 97, 99-122; and its value, 139-143, 158-160, 167, 170- 171, 196-198, 313-316, 339-34 1 - Rapidity of circulation, 101, 151- 158, 363- Ratio, the bimetallic, 296-301. Representative paper money, 329- 330. Reserve, specie, 212-214, 219, 357- 358, 374-378, 385- Ricardo, David, on the distribution of the precious metals, 81-88 ; on regulation of paper currency, 388. Safety-fund system of note issue, 381-382. Sauerbeck, on falling prices, 197; on index numbers, 234, 250-252. Securities, stock, as currency, 45. Seigniorage, 34. Services of money, 19, 59-70. Sherman silver law, 56.- Silver, demonetization of, 194 ; pro- duction of, 165-167 ; ratio of, to gold, 296-301 ; Sherman law, 56. Socialism, monetary system and, 13- Soetbeer, A., on index numbers, 234, 247-250. Speculation and price changes, 322. Standard of deferred payments, 260-291 ; invariable, 268-269 ; disutility of labor, 283; equities of changing, 262-266, 269-272, 326-327; labor-cost, 281-282; labor-time, 281; marginal utility, 284; purchaser's surplus, 287- 291 ; single commodity, 273-275 ; a social concept, 266-268 ; stabil- ity of, 261-262 ; the tabular, 275- 281 ; total utility, 285-287. Standard money, 46. Store of value, money as a, 64-65. Subsidiary coins, 37, 42-43. Symmetallism, 311. Table of prices. See INDEX NUM- BERS. Tabular standard, 275-281. Tolerance of the mint, 32. Transportation, development of, and prices, 196-197. 414 INDEX Truck payments, 7. United States notes, 353. Value, measure of, 61-63. Value of money, 123-149; barter and the, 133-134, 160-162 ; causes of changes in, 176-198, 224-259; cost of production and the, 163-165; credit and the, 134, 160-162 ; an equilibrium between various demands and the sup- P lv I 35~ I 45; local, 171-172; quantity theory of the, 139-144, 158-160, 167-171, 196-198, 313- 316, 339-344; rapidity of circula- tion and the, 153-155; a social phenomenon, 125-126; as a social investment, 127-130; sta- bility of the, 71, 150-175 ; volume of business and, 146-149. Wages, credit payments and, 112; falling prices and, 185-187; pa- per money and, 350. Wealth, monetary system and the distribution of, 11-13. 415 THIP UNIVERSITY OF CALIFORNIA LIBRARY This book is DUE on the last date stamped below, ule: 25 cents on first day overdue Ft 50 eents on fourth day overdue One dollar on seventh day overdue. OCT 9 1947 25 RECD L.D OCT 24 1960 CIR. JAN 15 '81 D 21-100m-12,'46(A2012sl6)4120 UNIVERSITY OF CALIFORNIA LIBRARY