Readings in Money and Banking Part 19

Referring to the nature of credit and the economic qualities of credit instruments, the somewhat figurative expression "goods coined into a means of payment" is a striking and accurate characterization. It is possible that all legitimate market values, under normal trade conditions, may be liquidized through credit agencies, and the goods in which they are incorporated be thus rendered immediately and conveniently exchangeable. This process may be consummated independently of prices and with slight regard to the actual supply of money. The truth of this a.s.sertion is, in fact, demonstrated daily in the marts of trade.

J. Laurence Laughlin[76]: There is time to answer briefly only a few of the points raised by several speakers. First, Professor Fisher's equation of MV + M'V' = PT is to my mind not a solution, but only a statement, of the problem of price levels. It can be read backward as well as forward. For instance, it does not follow that the level of prices (P) will rise with an increase of M', since--as Professor Taussig has pointed out already--an active development of trade and industry (T) would itself be a reason for an increase of banking loans and deposits subject to check (M'), thus equalizing effects on both sides of the equation without necessarily increasing P. This result is, in fact, one of the points on which I have steadily insisted in my own exposition of the theory of prices and credit; and Professor Fisher's equation allows it to appear distinctly. His equation does not show causes; it states a static situation, into which various causes may be read. The facts between 1876 and 1896 disclose an increase of bank deposits of 500 or 600 per cent., and yet that period was distinguished as one of falling prices. Therefore M' cannot be regarded as having been proved to be a cause of higher prices.

Second, Professor Fisher ... seeks to establish a causal relation between the amount of money in circulation (M) and the amount of deposits (M') which, in my judgment, is wholly unfounded. He has developed this in his paper in the _Royal Statistical Journal_. The error consists in supposing that a man's deposit account at any time varies with the amount of money in his possession. Rather, the deposit account varies with a man's wealth. The rich man does not carry much more money to pa.s.s from hand to hand than the man of moderate means.

Monetary habits in the community require a certain level of circulation for all persons, but the deposits of an individual may soar above the common level without regard to the money he keeps in circulation. His bank deposits are rather a measure of the saleable goods he has sold, "coined into means of payment."

Third, I well recognize the high position Professor Fisher occupies in the mathematical school of Walras and others; but has he not made an error in stating the essence of the price relation in his mathematical symbols? So far as I understand him, he seems to deny the fundamental value-concept (on which there has. .h.i.therto been general agreement) that price is a ratio between goods and gold. In furtherance of that idea, he thinks that, before individual prices can be arrived at, the general price level must be ascertained. Now, in my exposition using the ratio-concept, I explained in detail how the general level of prices might be affected by causes affecting the gold side of the ratio.

Therefore, I did not neglect to account for the general level and that too without doing violence to the accepted value-concept. But the ratio-concept (which Professor Fisher seems to deny) allows the forces acting on goods also to affect the general level of prices as I have shown. In my opinion, he wrongly works from a general level of prices to particular prices; while I hold that particular prices, or actual quotations, are the bases from which all averages, or price levels, are always and inevitably computed. Moreover, in his diagrams, the level of prices he used was the one computed from individual quotations. Hence his whole reasoning on the conformity of the statistics to the terms of his equation is vitiated. Indeed the better agreement he finds--after elaborate statistical computations--between the elements and their result on prices ...--is due, I think, to relying on an equation which is nothing more than a statement that the whole is equal to the sum of its parts....

Finally, when Professor Johnson suggests that I am wrong in stating that forces affecting the goods side of the price ratio have an influence on prices, he certainly cannot mean that conditions affecting the producing, marketing, and financing of goods have no effect on prices.

How else, for instance, can we explain the rise of the prices of agricultural products? The special causes affecting them have little to do with the quant.i.ty of "money." Moreover, the term "money" itself is used so loosely and vaguely that we can come to agreement on price theories only by first agreeing upon what we mean by "money." In my paper, I have discussed the relations of goods, and their prices, to gold. But, in this country, we use gold little as a medium by which goods are exchanged. Thus the relation of the prices of goods to our media of exchange has been practically omitted. And yet the price-making process generally precedes the creation of the usual banking media of exchange by which most goods are exchanged.

Irving Fisher[77]: In connection with the statement and explanation of the equation of exchange it was shown (1) that prices vary directly as the quant.i.ty of money, provided the volume of trade and the velocities of circulation remain unchanged; (2) that prices vary directly as the velocities of circulation (if these velocities vary together), provided the quant.i.ty of money and the volume of trade remain unchanged, and (3) that prices vary inversely as the volume of trade, provided the quant.i.ty of money--and therefore deposits--and their velocities remain unchanged.

Let us now inquire how far these propositions are really _causal_ propositions. An examination of the influence of each of the six magnitudes on each of the other five will afford answers to the objections which have been raised to the quant.i.ty theory of money.

To set forth all the facts and possibilities as to causation we need to study the effects of varying, one at a time, the various magnitudes in the equation of exchange.

Our first question is: given (say) a doubling of the quant.i.ty of money in circulation (_M_) what are the normal or ultimate effects on the other magnitudes in the equation of exchange, viz.: _M'_, _V_, _V'_, the _p_'s and the _Q_'s?

We have seen that normally the effect of doubling money in circulation (_M_) is to double deposits (_M'_) because under any given conditions of industry and civilization deposits tend to hold a fixed or normal ratio to money in circulation. Hence the ultimate effect of a doubling in _M_ is the same as that of doubling both _M_ and _M'_. We propose next to show that this doubling of _M_ and _M'_ does not normally change _V_, _V'_ or the _Q_'s, but only the _p_'s. The equation of exchange of itself does not affirm or deny these propositions.

For aught the equation of exchange itself tells us, the quant.i.ties of money and deposits might even vary inversely as their respective velocities of circulation. Were this true, an increase in the quant.i.ty of money would exhaust all its effects in reducing the velocity of circulation, and could not produce any effect on prices. If the opponents of the "quant.i.ty theory" could establish such a relations.h.i.+p, they would have proven their case despite the equation of exchange. But they have not even attempted to prove such a proposition. As a matter of fact, the velocities of circulation of money and of deposits depend, as will be seen, on technical conditions and bear no discoverable relation to the quant.i.ty of money in circulation. Velocity of circulation is the average rate of "turnover", and depends on countless individual rates of turnover. These depend on individual habits. Each person regulates his turnover to suit his convenience. A given rate of turnover for any person implies a given time of turnover--that is, an average length of time a dollar remains in his hands. He adjusts this time of turnover by adjusting his average quant.i.ty of pocket money, or till money, to suit his expenditures. He will try to avoid carrying too little lest, on occasion, he be unduly embarra.s.sed; and on the other hand to avoid enc.u.mbrance, waste of interest, and risk of robbery, he will avoid carrying too much. Each man's adjustment is, of course, somewhat rough, and dependent largely on the accident of the moment; but, in the long run and for a large number of people, the average rate of turnover, or what amounts to the same thing, the average time money remains in the same hands, will be very closely determined. It will depend on density of population, commercial customs, rapidity of transport, and other technical conditions, but not on the quant.i.ty of money and deposits nor on the price level. These may change without any effect on velocity. If the quant.i.ties of money and deposits are doubled, there is nothing, so far as velocity of circulation is concerned, to prevent the price level from doubling. On the contrary, doubling money, deposits, and prices would necessarily leave velocity quite unchanged. Each individual would need to spend more money for the same goods, and to keep more on hand.

The ratio of money expended to money on hand would not vary. If the number of dollars in circulation and in deposit should be doubled and a dollar should come to have only half its former purchasing power, the change would imply merely that twice as many dollars as before were expended by each person and twice as many kept on hand. The ratio of expenditure to stock on hand would be unaffected.

If it be objected that this _a.s.sumes_ that with the doubling in _M_ and _M'_ there would be also a doubling of prices, we may meet the objection by putting the argument in a slightly different form. Suppose, for a moment, that a doubling in the currency in circulation should not at once raise prices, but should halve the velocities instead; such a result would evidently upset for each individual the adjustment which he had made of cash on hand. Prices being unchanged, he now has double the amount of money and deposits which his convenience had taught him to keep on hand. He will then try to get rid of the surplus money and deposits by buying goods. But as somebody else must be found to take the money off his hands, its mere transfer will not diminish the amount in the community. It will simply increase somebody else's surplus.

Everybody has money on his hands beyond what experience and convenience have shown to be necessary. Everybody will want to exchange this relatively useless extra money for goods, and the desire so to do must surely drive up the price of goods. No one can deny that the effect of every one's desiring to spend more money will be to raise prices.

Obviously this tendency will continue until there is found another adjustment of quant.i.ties to expenditures, and the _V_'s are the same as originally. That is, if there is no change in the quant.i.ties sold (the _Q_'s), the only possible effect of doubling _M_ and _M'_ will be a doubling of the _p_'s; for we have just seen that the _V_'s cannot be permanently reduced without causing people to have surplus money and deposits, and there cannot be surplus money and deposits without a desire to spend it, and there cannot be a desire to spend it without a rise in prices. In short, the only way to get rid of a plethora of money is to raise prices to correspond.

So far as the surplus deposits are concerned, there might seem to be a way of getting rid of them by cancelling bank loans, but this would reduce the normal ratio which _M'_ bears to _M_, which we have seen tends to be maintained.

We come back to the conclusion that the velocity of circulation either of money or deposits is independent of the quant.i.ty of money or of deposits. No reason has been, or, so far as is apparent, can be a.s.signed, to show why the velocity of circulation of money, or deposits, should be different, when the quant.i.ty of money, or deposits, is great, from what it is when the quant.i.ty is small.

There still remains one seeming way of escape from the conclusion that the sole effect of an increase in the quant.i.ty of money in circulation will be to increase prices. It may be claimed--in fact it has been claimed--that such an increase results in an increased volume of trade.

We now proceed to show that (except during transition periods) the volume of trade, like the velocity of circulation of money, is independent of the quant.i.ty of money. An inflation of the currency cannot increase the product of farms and factories, nor the speed of freight trains or s.h.i.+ps. The stream of business depends on natural resources and technical conditions, not on the quant.i.ty of money. The whole machinery of production, transportation, and sale is a matter of physical capacities and technique, none of which depend on the quant.i.ty of money. The only way in which the quant.i.ties of trade appear to be affected by the quant.i.ty of money is by influencing trades accessory to the creation of money and to the money metal. An increase of gold money will, as has been noted, bring with it an increase in the trade in gold objects. It will also bring about an increase in the sales of gold mining machinery, in gold miners' services, in a.s.saying apparatus and labor. These changes may entail changes in a.s.sociated trades. Thus if more gold ornaments are sold, fewer silver ornaments and diamonds may be sold. Again the issue of paper money may affect the paper and printing trades, the employment of bank and government clerks, etc. In fact, there is no end to the minute changes in the _Q_'s which the changes mentioned, and others, might bring about. But from a practical or statistical point of view they amount to nothing, for they could not add to nor subtract one-tenth of 1 per cent. from the general aggregate of trade. Only a very few _Q_'s would be appreciably affected, and those few very insignificant.

We conclude, therefore, that a change in the quant.i.ty of money will not appreciably affect the quant.i.ties of goods sold for money.

Since, then, a doubling in the quant.i.ty of money: (1) will normally double deposits subject to check in the same ratio, and (2) will not appreciably affect either the velocity of circulation of money or of deposits or the volume of trade, it follows necessarily and mathematically that the level of prices must double. While, therefore, the equation of exchange, of itself, a.s.serts no causal relations between quant.i.ty of money and price level, any more than it a.s.serts a causal relation between any other two factors, yet, when we take into account conditions known quite apart from that equation, viz., that a change in _M_ produces a proportional change in _M'_, and no changes in _V_, _V'_, or the _Q_'s, there is no possible escape from the conclusion that a change in the quant.i.ty of money (_M_) must _normally_ cause a proportional change in the price level (the _p_'s).

While the equation of exchange is, if we choose, a mere "truism," based on the equivalence, in all purchases, of the money or checks expended, on the one hand, and what they buy, on the other, yet in view of supplementary knowledge as to the relation of _M_ to _M'_, and the non-relation of _M_ to _V_, _V'_, and the _Q_'s, this equation is the means of demonstrating the fact that normally the _p_'s vary directly as _M_, that is, demonstrating the quant.i.ty theory. To throw away contemptuously the equation of exchange because it is so obviously true is to neglect the chance to formulate for economic science some of the most important and exact laws of which it is capable.

We may now restate, then, in what causal sense the quant.i.ty theory is true. It is true in the sense that one of the _normal effects of an increase in the quant.i.ty of money is an exactly proportional increase in the general level of prices_.

I have no desire, as some one has humorously suggested, to hide behind an equation, but I do find it necessary to take refuge behind my book on the _Purchasing Power of Money_. So many new questions have been asked that, in the few moments at my disposal, I could not answer them all satisfactorily. I believe they have all been answered in the book referred to. For instance, a chapter has been devoted to transition periods in which it has been shown, as Professor Taussig has suggested, that during transition periods an increase in _T_ may cause an increase in _M'_.

THE TESTIMONY OF RICARDO

[78]Let us suppose that the circulation of all countries were carried on by the precious metals only, and that the proportion which England possessed were one million; let us further suppose, that, at once, half of the currencies of all countries, excepting that of England, were suddenly annihilated, would it be possible for England to continue to retain the million which she before possessed? Would not her currency become relatively excessive compared with that of other countries? If a quarter of wheat, for example, had been both in France and England of the same value as an ounce of coined gold, would not half an ounce now purchase it in France, whilst in England it continued of the same value as one ounce? Could we by any laws, under such circ.u.mstances, prevent wheat or some other commodity (for all would be equally affected) from being imported into England, and gold coin from being exported? If ...

the exportation of bullion were free, gold might rise 100 per cent.; and for the same reason, if 35 Flemish schillings in Hamburgh had before been of equal value with a pound sterling, 17-1/2 schillings would now attain that value. If the currency of England only had been doubled, the effects would have been precisely the same.

Suppose, again, the case reversed, and that all other currencies remained as before, while half that of England was retrenched. If the coinage of money at the mint was on the present footing, would not the prices of commodities be so reduced here that cheapness would invite foreign purchasers, and would not this continue till the relative proportions in the different currencies were restored?

If such would be the effects of a diminution of money below its natural level, and that such would be the consequences the most celebrated writers on political economy are agreed, how can it be justly contended that the increase or diminution of money has nothing to do either with the foreign exchanges, or with the price of bullion?

Now, a paper circulation, not convertible into specie, differs in its effects in no respect from a metallic currency, with the law against exportation strictly executed.

Supposing, then, the first case to occur whilst our circulation consisted wholly of paper, would not the exchanges fall, and the price of bullion rise in the manner which I have been representing; and would not our currency be depreciated, because it was no longer of the same value in the markets of the world as the bullion which it professed to represent? The fact of depreciation could not be denied, however the Bank Directors might a.s.sure the public that they never discounted but good bills for bona fide transactions; however they might a.s.sert that they never forced a note into circulation; that the quant.i.ty of money was no more than it had always been, and was only adequate to the wants of commerce, which had increased and not diminished;[79] that the price of gold, which was here at twice its mint value, was equally high, or higher, abroad, as might be proved by sending an ounce of bullion to Hamburgh, and having the produce remitted by bill payable in London bank notes; and that the increase or diminution of their notes could not possibly either affect the exchange or the price of bullion. All this, except the last, might be true, and yet would any man refuse his a.s.sent to the fact of the currency being depreciated?

Could the symptoms which I have been enumerating proceed from any other cause but a relative excess in our currency? Could our currency be restored to its bullion value by any other means than by a reduction in its quant.i.ty, which should raise it to the value of the currencies of other countries; or by the increase of the precious metals, which lower the value of theirs to the level of ours?

FOOTNOTES:

[43] _The Purchasing Power of Money_, pp. 14-71. The Macmillan Company.

New York. 1911.

[44] This theory, though often crudely formulated, has been accepted by Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter, Kemmerer and most writers on the subject. The Roman Julius Paulus, about 200 A. D., stated his belief that the value of money depends on its quant.i.ty. See Zuckerkandl, _Theorie des Preises_: Kemmerer, _Money and Credit Instruments in their Relation to General Prices_, New York (Holt), 1909. It is true that many writers still oppose the quant.i.ty theory. See especially, Laughlin, _Principles of Money_, New York (Scribner). 1903.

[45] See Scott, "It has been a most fruitful source of false doctrines regarding monetary matters, and is constantly and successfully employed in defense of harmful legislation and as a means of preventing needed monetary reforms." _Money and Banking._ New York, 1903, p. 68.

[46] [For a method of determining the velocity of the circulation of money, see Appendix A.]

[47] It is important to bear in mind that wherever _P_ is used in this chapter it represents the index number, or scale of prices, at which the trade, _T_, is conducted.--EDITOR.

[48] An almost opposite view is that of Laughlin that normal credit cannot affect prices because it is not an offer of standard money and cannot affect the value of the standard which alone determines general prices. See the _Principles of Money_, New York (Scribner), 1903, p. 97.

Both views are inconsistent with that upheld ... [here].

[49] This fact is apparently overlooked by Laughlin when he argues that there is not "any reason for limiting the amount of the deposit currency, or the a.s.sumption of an absolute scarcity of specie reserves."

See _Principles of Money_, p. 127.

[50] Interesting changes in the magnitudes of the equation of exchange between 1896 and 1914 are given in the appended diagram, which is taken from a reprint of Professor Fisher's article, _The Equation of Exchange for 1914, and the War_, the _American Economic Review_, Vol. V, No. 2, June, 1915.--EDITOR.

[51] Adapted from Irving Fisher. _Recent Changes in Price Levels and Their Causes_, Bulletin of the American Economic a.s.sociation. Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 43-44.

[52] Irving Fisher, _The Purchasing Power of Money_, pp. 74-88.

[53] _Ibid._, pp. 149, 150.

[54] _Causes of the Changes in Prices since 1896._ Bulletin of the American Economic a.s.sociation, Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp.

27-36.

[55] There is a possible error here of perhaps $500,000,000.

[56] The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director of Mint, 1909, p. 80.