XI. A SYMPOSIUM ON THE RELATION BETWEEN MONEY AND GENERAL PRICES…

XI. A SYMPOSIUM ON THE RELATION BETWEEN MONEY AND GENERAL PRICES

The form of this chapter was suggested by the proceedings of a session of the 1910 Meeting of the American Economic Association, devoted to a consideration of the causes of the rise in prices between 1896 and 1909. Selections from papers there presented, and from the relative discussion, make up a considerable part of the chapter, and it is suggested that all of the selections, except the last, may well be considered for purposes of study as having come from the papers and discussion of the session referred to, although numerous additions and substitutions have been made in order to render the treatment one of principles involved in the determination of general prices without special reference to any particular period of years.

IRVING FISHER[43]: Overlooking the influence of deposit currency, or checks, the price level may be said to depend on only three sets of causes: (1) the quantity of money in circulation; (2) its "efficiency" or velocity of circulation (or the average number of times a year money is exchanged for goods); and (3) the volume of trade (or amount of goods bought by money). The so-called "quantity theory,"[44] i.e., that prices vary proportionately to money, has often been incorrectly formulated, but (overlooking checks) the theory is correct in the sense that the level of prices varies directly with the quantity of money in circulation, provided the velocity of circulation of that money and the volume of trade which it is obliged to perform are not changed.

The quantity theory has been one of the most bitterly contested theories in economics, largely because the recognition of its truth or falsity affected powerful interests in commerce and politics. It has been maintained--and the assertion is scarcely an exaggeration--that the theorems of Euclid would be bitterly controverted if financial or political interests were involved.

The quantity theory has, unfortunately, been made the basis of arguments for unsound currency schemes. It has been invoked in behalf of irredeemable paper money and of national free coinage of silver at the ratio of 16 to 1. As a consequence, not a few "sound money men," believing that a theory used to support such vagaries must be wrong, and fearing the political effects of its propagation, have drifted into the position of opposing, not only the unsound propaganda, but also the sound principles by which its advocates sought to bolster it up.[45] These attacks upon the quantity theory have been rendered easy by the imperfect comprehension of it on the part of those who have thus invoked it in a bad cause.

Personally, I believe that few mental attitudes are more pernicious, and in the end more disastrous, than those which would uphold sound practice by denying sound principles because some thinkers make unsound application of those principles. At any rate, in scientific study there is no choice but to find and state the unvarnished truth.

The quantity theory will be made more clear by the equation of exchange, which is now to be explained.

The equation of exchange is a statement, in mathematical form, of the total transactions effected in a certain period in a given community. It is obtained simply by adding together the equations of exchange for all individual transactions. Suppose, for instance, that a person buys 10 pounds of sugar at 7 cents per pound. This is an exchange transaction, in which 10 pounds of sugar have been regarded as equal to 70 cents, and this fact may be expressed thus: 70 cents = 10 pounds of sugar multiplied by 7 cents a pound. Every other sale and purchase may be expressed similarly, and by adding them all together we get the equation of exchange for a certain period in a given community. During this same period, however, the same money may serve, and usually does serve, for several transactions. For that reason the money side of the equation is of course greater than the total amount of money in circulation.

The equation of exchange relates to all the purchases made by money in a certain community during a certain time. We shall continue to ignore checks or any circulating medium not money. We shall also ignore foreign trade and thus restrict ourselves to trade within a hypothetical community. Later we shall reinclude these factors, proceeding by a series of approximations through successive hypothetical conditions to the actual conditions which prevail to-day. We must, of course, not forget that the conclusions expressed in each successive approximation are true solely on the particular hypothesis assumed.

The equation of exchange is simply the sum of the equations involved in all individual exchanges in a year. In each sale and purchase, the money and goods exchanged are ipso facto equivalent; for instance, the money paid for sugar is equivalent to the sugar bought. And in the grand total of all exchanges for a year, the total money paid is equal in value to the total value of the goods bought. The equation thus has a money side and a goods side. The money side is the total money paid, and may be considered as the product of the quantity of money multiplied by its rapidity of circulation. The goods side is made up of the products of quantities of goods exchanged multiplied by their respective prices.

The important magnitude, called the velocity of circulation, or rapidity of turnover, is simply the quotient obtained by dividing the total money payments for goods in the course of a year by the average amount of money in circulation by which those payments are effected. This velocity of circulation for an entire community is a sort of average of the rates of turnover of money for different persons. Each person has his own rate of turnover which he can readily calculate by dividing the amount of money he expends per year by the average amount he carries.

Let us begin with the money side. If the number of dollars in a country is 5,000,000, and their velocity of circulation is twenty times per year, then the total amount of money changing hands (for goods) per year is 5,000,000 times twenty, or $100,000,000. This is the money side of the equation of exchange.

Since the money side of the equation is $100,000,000, the goods side must be the same. For if $100,000,000 has been spent for goods in the course of the year, then $100,000,000 worth of goods must have been sold in that year. In order to avoid the necessity of writing out the quantities and prices of the innumerable varieties of goods which are actually exchanged, let us assume for the present that there are only three kinds of goods,--bread, coal, and cloth; and that the sales are:

200,000,000 loaves of bread at $ .10 a loaf, 10,000,000 tons of coal at 5.00 a ton, and 30,000,000 yards of cloth at 1.00 a yard.

The value of these transactions is evidently $100,000,000, i. e., $20,000,000 worth of bread plus $50,000,000 worth of coal plus $30,000,000 worth of cloth. The equation of exchange therefore (remember that the money side consisted of $5,000,000 exchanged 20 times) is as follows:

$5,000,000 x 20 times a year = 200,000,000 loaves x $ .10 a loaf + 10,000,000 tons x 5.00 a ton + 30,000,000 yards x 1.00 a yard

This equation contains on the money side two magnitudes, viz. (1) the quantity of money and (2) its velocity of circulation; and on the goods side two groups of magnitudes in two columns, viz. (1) the quantities of goods exchanged (loaves, tons, yards), and (2) the prices of these goods. The equation shows that these four sets of magnitudes are mutually related. Because this equation must be fulfilled, the prices must bear a relation to the three other sets of magnitudes--quantity of money, rapidity of circulation, and quantities of goods exchanged. Consequently, these prices must, as a whole, vary proportionally with the quantity of money and with its velocity of circulation, and inversely with the quantities of goods exchanged.

Suppose, for instance, that the quantity of money were doubled, while its velocity of circulation and the quantities of goods exchanged remained the same. Then it would be quite impossible for prices to remain unchanged. The money side would now be $10,000,000 x 20 times a year or $200,000,000; whereas, if prices should not change, the goods would remain $100,000,000, and the equation would be violated. Since exchanges, individually and collectively, always involve an equivalent quid pro quo, the two sides must be equal. Not only must purchases and sales be equal in amount--since every article bought by one person is necessarily sold by another--but the total value of goods sold must equal the total amount of money exchanged. Therefore, under the given conditions, prices must change in such a way as to raise the goods side from $100,000,000 to $200,000,000. This doubling may be accomplished by an even or uneven rise in prices but some sort of a rise of prices there must be. If the prices rise evenly, they will evidently all be exactly doubled.... If the prices rise unevenly, the doubling must evidently be brought about by compensation; if some prices rise by less than double, others must rise by enough more than double to exactly compensate.

But whether all prices increase uniformly, each being exactly doubled, or some prices increase more and some less (so as still to double the total money value of the goods purchased), the prices are doubled on the average.... From the mere fact, therefore, that the money spent for goods must equal the quantities of those goods multiplied by their prices, it follows that the level of prices must rise or fall according to changes in the quantity of money, unless there are changes in its velocity of circulation or in the quantities of goods exchanged.

If changes in the quantity of money affect prices, so will changes in the other factors--quantities of goods and velocity of circulation--affect prices, and in a very similar manner. Thus a doubling in the velocity of circulation of money will double the level of prices, provided the quantity of money in circulation and the quantities of goods exchanged for money remain as before....

Again, a doubling in the quantities of goods exchanged will not double, but halve, the height of the price level, provided the quantity of money and its velocity of circulation remain the same....

Finally, if there is a simultaneous change in two or all of the three influences, i. e., quantity of money, velocity of circulation, and quantities of goods exchanged, the price level will be a compound or resultant of these various influences. If, for example, the quantity of money is doubled, and its velocity of circulation is halved, while the quantity of goods exchanged remains constant, the price level will be undisturbed. Likewise, it will be undisturbed if the quantity of money is doubled and the quantity of goods is doubled, while the velocity of circulation remains the same. To double the quantity of money, therefore, is not always to double prices. We must distinctly recognize that the quantity of money is only one of three factors, all equally important in determining the price level....

We now come to the strict algebraic statement of the equation of exchange.... Let us denote the total circulation of money, i. e., the amount of money expended for goods in a given community during a given year, by E (expenditure); and the average amount of money in circulation in the community during the year by M (money). M will be the simple arithmetical average of the amounts of money existing at successive instants separated from each other by equal intervals of time indefinitely small. If we divide the year's expenditures, E, by the average amount of money, M, we shall obtain what is called the average rate of turnover of money in its exchange for goods, E/M that is, the velocity of circulation of money. This velocity may be denoted by V, so that E/M = V; then E may be expressed as MV. In words: the total circulation of money in the sense of money expended is equal to the total money in circulation multiplied by its velocity of circulation or turnover. E or MV, therefore, expresses the money side of the equation of exchange. Turning to the goods side of the equation, we have to deal with the prices of goods exchanged and quantities of goods exchanged. The average price of sale of any particular good, such as bread, purchased in the given community during the given year, may be represented by p (price); and the total quantity of it purchased, by Q (quantity); likewise the average price of another good (say coal) may be represented by p' and the total quantity of it exchanged, by Q'; the average price and the total quantity of a third good (say cloth) may be represented by p'' and Q'' respectively; and so on, for all other goods exchanged, however numerous. The equation of exchange may evidently be expressed as follows:

MV = pQ + p'Q' + p''Q'' + etc.

The right-hand side of this equation is the sum of terms of the form pQ--a price multiplied by a quantity bought. It is customary in mathematics to abbreviate such a sum of terms (all of which are of the same form) by using "Sigma" as a symbol of summation. This symbol does not signify a magnitude as do the symbols M, V, p, Q, etc. It signifies merely the operation of addition and should be read "the sum of terms of the following type." The equation of exchange may therefore be written:

MV = Sigma_pQ_.

That is, the magnitudes E, M, V, the p's and the Q's relate to the entire community and an entire year; but they are based on and related to corresponding magnitudes for the individual persons of which the community is composed and for the individual moments of time of which the year is composed.

The algebraic derivation of this equation is, of course, essentially the same as the arithmetical derivation previously given. It consists simply in adding together the equations for all individual purchases within the community during the year....

[We are now] ... prepared for the inclusion of bank deposits or circulating credit in the equation of exchange. We shall still use M to express the quantity of actual money, and V to express the velocity of its circulation.[46] Similarly, we shall now use M' to express the total deposits subject to transfer by check; and V' to express the average velocity of circulation. The total value of purchases in a year is therefore no longer to be measured by MV, but by MV + M'V''. The equation of exchange, therefore, becomes:

MV + M'V' = Sigma_pQ_ = PT[47]....

With the extension of the equation of monetary circulation to include deposit circulation, the influence exerted by the quantity of money on general prices becomes less direct; and the process of tracing this influence becomes more difficult and complicated. It has even been argued that this interposition of circulating credit breaks whatever connection there may be between prices and the quantity of money.[48] This would be true if circulating credit were independent of money. But the fact is that the quantity of circulating credit, M', tends to hold a definite relation to M, the quantity of money in circulation; that is, deposits are normally a more or less definite multiple of money.

Two facts normally give deposits a more or less definite ratio to money. The first ... [is] that bank reserves are kept in a more or less definite ratio to bank deposits. The second is that individuals, firms, and corporations preserve more or less definite ratios between their cash transactions and their check transactions, and also between their money and deposit balances.[49] These ratios are determined by motives of individual convenience and habit. In general, business firms use money for wage payments, and for small miscellaneous transactions included under the term "petty cash"; while for settlements with each other they usually prefer checks. These preferences are so strong that we could not imagine them overridden except temporarily and to a small degree. A business firm would hardly pay car fares with checks and liquidate its large liabilities with cash. Each person strikes an equilibrium between his use of the two methods of payment, and does not greatly disturb it except for short periods of time. He keeps his stock of money or his bank balance in constant adjustment to the payments he makes in money or by check. Whenever his stock of money becomes relatively small and his bank balance relatively large, he cashes a check. In the opposite event, he deposits cash. In this way he is constantly converting one of the two media of exchange into the other. A private individual usually feeds his purse from his bank account; a retail commercial firm usually feeds its bank account from its till. The bank acts as intermediary for both.

In a given community the quantitative relation of deposit currency to money is determined by several considerations of convenience. In the first place, the more highly developed the business of a community, the more prevalent the use of checks. Where business is conducted on a large scale, merchants habitually transact their larger operations with each other by means of checks, and their smaller ones by means of cash. Again, the more concentrated the population, the more prevalent the use of checks. In cities it is more convenient both for the payer and the payee to make large payments by check; whereas, in the country, trips to a bank are too expensive in time and effort to be convenient, and therefore more money is used in proportion to the amount of business done. Again, the wealthier the members of the community, the more largely will they use checks. Laborers seldom use them; but capitalists, professional and salaried men use them habitually, for personal as well as business transactions.

There is, then, a relation of convenience and custom between check and cash circulation, and a more or less stable ratio between the deposit balance of the average man or corporation and the stock of money kept in pocket or till. This fact, as applied to the country as a whole, means that by convenience a rough ratio is fixed between M and M'. If that ratio is disturbed temporarily, there will come into play a tendency to restore it. Individuals will deposit surplus cash, or they will cash surplus deposits.

Hence, both money in circulation ... and money in reserve ... tend to keep in a fixed ratio to deposits. It follows that the two must be in a fixed ratio to each other.

It further follows that any change in M, the quantity of money in circulation, requiring as it normally does a proportional change in M', the volume of bank deposits subject to check, will result in an exactly proportional change in the general level of prices except, of course, so far as this effect be interfered with by concomitant changes in the V's or the Q's. The truth of this proposition is evident from the equation MV + M'V' = Sigma_pQ_; for if, say, M and M' are doubled, while V and V' remain the same, the left side of the equation is doubled and therefore the right side must be doubled also. But if the Q's remain unchanged, then evidently all the p's must be doubled, or else if some are less than doubled, others must be enough more than doubled to compensate....

The factors in the equation of exchange are ... continually seeking normal adjustment. A ship in a calm sea will "pitch" only a few times before coming to rest, but in a high sea, the pitching never ceases. While continually seeking equilibrium, the ship continually encounters causes which accentuate the oscillation. The factors seeking mutual adjustment are money in circulation, deposits, their velocities, the Q's and the p's. These magnitudes must always be linked together by the equation MV + M'V' = Sigma_pQ_. This represents the mechanism of exchange. But in order to conform to such a relation the displacement of any one part of the mechanism spreads its effects during the transition periods [i.e., periods of rising or falling prices] over all parts. Since periods of transition are the rule and those of equilibrium the exception, the mechanism of exchange is almost always in a dynamic rather than a static condition....[50]

[51]It is interesting to make a quantitative comparison of the various magnitudes with the increase in the quantity of money as the most important factor in raising the price level. While it is true, as shown by the diagram, that the volume of deposits subject to check has increased greatly, the major part of the increase has to be ascribed to the increase in the quantity of money. Only so far as the volume of deposits subject to check has increased relatively to the money in circulation, can the increase of deposits be regarded as an independent cause of the rise in prices. We have thus to consider the relative importance of the five causes affecting prices:

1. The quantity of money in circulation (M).

2. The volume of bank deposits subject to check considered relatively to money (M'/M).

3. The velocity of the former (V').

4. The velocity of the latter (V).

5. The volume of trade (T).

We may best compare the relative importance of these five magnitudes by answering the question: What would the result have been had any one of these magnitudes remained unchanged, assuming that the other four changed in the same manner that they actually did change. We find (1) that if the money in circulation, M, had not changed, between the years 1896 and 1909, for example, the price level of 1909 would have been 45 per cent. lower than it actually was; (2) that if M'/M, the relative deposits, had not changed, during the same period the price level in 1909 would have been 23 per cent. lower than it actually was; (3) if the velocity of circulation of money, V, had not changed, the price level for 1909 would have been 1 per cent. lower; (4) if the velocity of circulation of deposits, V', had not changed, the price level in 1909 would have been 28 per cent. lower; (5) if T had not changed, the price level in 1909 would have been 106 per cent. higher.

Thus the changes in the first four factors have tended to raise prices, while the change in T has tended to lower prices. The relative importance of the four price-raising causes may be stated in terms of the per cent. already given which represents how much lower prices would have been except for each of these causes separately considered. According to this test we find the relative importance of the four price-raising factors to be as follows:

The importance of V is represented by 1,

The importance of M'/M is represented by 23,

The importance of V is represented by 28,

The importance of M is represented by 45.

That is, the increase in the quantity of money had an importance nearly double that of any other one price-raising factor, during the period mentioned.

INDIRECT INFLUENCES ON PURCHASING POWER[52]

Thus far we have considered the level of prices as affected by the volume of trade, by the velocities of circulation of money and of deposits, and by the quantities of money and of deposits. These are the only influences which can directly affect the level of prices. Any other influences on prices must act through these five. There are myriads of such influences (outside of the equation of exchange) that affect prices through these five. It is our purpose ... to note the chief among them....

We shall first consider the outside influences that affect the volume of trade and, through it, the price level. The conditions which determine the extent of trade are numerous and technical. The most important may be classified as follows:

1. Conditions affecting producers.

(a) Geographical differences in natural resources.

(b) The division of labor.

(c) Knowledge of the technique of production.

(d) The accumulation of capital.

2. Conditions affecting consumers.

(a) The extent and variety of human wants.

3. Conditions connecting producers and consumers.

(a) Facilities for transportation.

(b) Relative freedom of trade.

(c) Character of monetary and banking systems.

(d) Business confidence.

1 (a). It is evident that if all localities were exactly alike in their natural resources, in other words, in their comparative costs of production, no trade would be set up between them.... Cattle raising in Texas, the production of coal in Pennsylvania, of oranges in Florida, and of apples in Oregon have increased the volume of trade for these communities respectively.

1 (b). Equally obvious is the influence of the division of labor....

1 (c).... The state of knowledge of production will affect trade. Vast coal fields in China await development, largely for lack of knowledge of how to extract and market the coal. Egypt awaits the advent of scientific agriculture, to usher in trade expansion. Nowadays, trade schools in Germany, England, and the United States are increasing and diffusing knowledge of productive technique.

1 (d). But knowledge, to be of use, must be applied; and its application usually requires the aid of capital. The greater and the more productive the stock or capital in any community, the more goods it can put into the currents of trade....

Since increase in trade tends to decrease the general level of prices, anything which tends to increase trade likewise tends to decrease the general level of prices. We conclude, therefore, that among the causes tending to decrease prices are increasing geographical or personal specialization, improved productive technique, and the accumulation of capital. The history of commerce shows that all these causes have been increasingly operative during a long period including the last century. Consequently, there has been a constant tendency, from these sources at least, for prices to fall.

2 (a).... An increase of wants, by leading to an increase in trade, tends to lower the price level. Historically, during recent times through invention, education, and the emulation coming from increased contact in centers of population, there has been a great intensification and diversification of human wants and therefore increased trade. Consequently, there has been from these causes a tendency of prices to fall.

3 (a). Anything which facilitates intercourse tends to increase trade. Anything that interferes with intercourse tends to decrease trade. First of all, there are the mechanical facilities for transport. As Macaulay said, with the exception of the alphabet and the printing press, no set of inventions has tended to alter civilization so much as those which abridge distance,--such as the railway, the steamship, the telephone, the telegraph, and that conveyer of information and advertisements, the newspaper. These all tend, therefore, to decrease prices.

3 (b). Trade barriers are not only physical but legal. A tariff between countries has the same influence in decreasing trade as a chain of mountains. The freer the trade, the more of it there will be....

3 (c). The development of efficient monetary and banking systems tends to increase trade. There have been times in the history of the world when money was in so uncertain a state that people hesitated to make many trade contracts because of the lack of knowledge of what would be required of them when the contract should be fulfilled. In the same way, when people cannot depend on the good faith or stability of banks, they will hesitate to use deposits and checks.

3 (d). Confidence, not only in banks in particular, but in business in general, is truly said to be "the soul of trade." Without this confidence there cannot be a great volume of contracts. Anything that tends to increase this confidence tends to increase trade....

We see, then, that prices will tend to fall through increase in trade, which may in turn be brought about by improved transportation, by increased freedom of trade, by improved monetary and banking systems, and by business confidence. Historically, during recent years, all of these causes have tended to grow in power, except freedom of trade....

Having examined those causes outside the equation which affect the volume of trade, our next task is to consider the outside causes that affect the velocities of circulation of money and of deposits. For the most part, the causes affecting one of these velocities affect the other also. These causes may be classified as follows:

1. Habits of the individual.

(a) As to thrift and hoarding.

(b) As to book credit.

(c) As to the use of checks.

2. Systems of payments in the community.

(a) As to frequency of receipts and of disbursements.

(b) As to regularity of receipts and disbursements.

(c) As to correspondence between times and amounts of receipts and disbursements.

3. General causes.

(a) Density of population.

(b) Rapidity of transportation.

1 (a). Taking these up in order, we may first consider what influence thrift has on the velocity of circulation. Velocity of circulation of money is the same thing as its rate of turnover. It is found by dividing the total payments effected by money in a year by the amount of money in circulation in a year. It depends upon the rates of turnover of the individuals who compose the society. This velocity of circulation or rapidity of turnover of money is the greater for each individual the more he spends, with a given average amount of cash on hand; or the less average cash he keeps, with a given yearly expenditure....

1 (b). The habit of "charging," i.e., using book credit, tends to increase the velocity of circulation of money, because the man who gets things "charged" does not need to keep on hand as much money as he would if he made all payments in cash. A man who pays cash daily needs to keep cash for daily contingencies. The system of cash payments, unlike the system of book credit, requires that money shall be kept on hand in advance of purchases. Evidently, if money must be provided in advance, it must be provided in larger quantities than when merely required to liquidate past debts....

But we have seen that to increase the rate of turnover will tend to increase the price level. Therefore, book credit tends to increase the price level....

1 (c). The habit of using checks rather than money will also affect the velocity of circulation; because a depositor's surplus money will immediately be put into the bank in return for a right to draw by check....

We see, then, that three habits--spendthrift habits, the habit of charging, and the habit of using checks--all tend to raise the level of prices....

2 (a). The more frequently money or checks are received and disbursed, the shorter is the average interval between the receipt and the expenditure of money or checks and the more rapid is the velocity of circulation.

This may best be seen from an example. A change from monthly to weekly wage payments tends to increase the velocity of circulation of money. If a laborer is paid weekly $7 and reduces this evenly each day, ending each week empty-handed, his average cash ... would be a little over half of $7, or about $4. This makes his turnover nearly twice a week. Under monthly payments the laborer who receives and spends an average of $1 a day will have to spread the $30 more or less evenly over the following 30 days. If, at the next pay day, he comes out empty-handed, his average money during the month has been about $15. This makes his turnover about twice a month. Thus the rate of turnover is more rapid under weekly than under monthly payments....

Frequency of disbursements evidently has an effect similar to the effect of frequency of receipts; i.e., it tends to accelerate the velocity of turnover, or circulation.

2 (b). Regularity of payments also facilitates the turnover. When the workingman can be fairly certain of both his receipts and expenditures, he can, by close calculation, adjust them so precisely as safely to end each payment cycle with an empty pocket. This habit is extremely common among certain classes of city laborers. On the other hand, if the receipts and expenditures are irregular, either in amount or in time, prudence requires the worker to keep a larger sum on hand, to insure against mishaps.... We may, therefore, conclude that regularity, both of receipts and of payments, tends to increase velocity of circulation.

2 (c). Next, consider the synchronizing of receipts and disbursements, i. e., making payments at the same intervals as obtaining receipts.... This arrangement obviates the necessity of keeping much money or deposits on hand, and therefore increases their velocity of circulation....

3 (a). The more densely populated a locality, the more rapid will be the velocity of circulation.

There is definite evidence that this is true of bank deposits. The following figures give the velocities of circulation of deposits in ten cities, arranged in order of size:

Paris 116 Berlin 161 Brussels 123 Madrid 14 Rome 43 Lisbon 29 Indianapolis 30 New Haven 16 Athens 4 Santa Barbara 1

Madrid is the only city seriously out of its order in respect to velocity of circulation.

3 (b). Again the more extensive and the speedier the transportation in general, the more rapid the circulation of money. Anything which makes it easier to pass money from one person to another will tend to increase the velocity of circulation. Railways have this effect.... Mail and express, by facilitating the transmission of bank deposits and money, have likewise tended to increase their velocity of circulation.

We conclude, then, that density of population and rapidity of transportation have tended to increase prices by increasing velocities. Historically this concentration of population in cities has been an important factor in raising prices in the United States....

[SUMMARY]

[53]The purchasing power ... of money has been studied as the effect of five, and only five, groups of causes. The five groups are money, deposits, their velocities of circulation, and the volume of trade. These and their effects, prices, we saw to be connected by an equation called the equation of exchange, MV + M'V' = SigmapQ. The five causes, in turn,... are themselves effects of antecedent causes lying entirely outside of the equation of exchange, as follows: the volume of trade will be increased, and therefore the price level correspondingly decreased by the differentiation of human wants; by diversification of industry; and by facilitation of transportation. The velocities of circulation will be increased, and therefore also the price level increased by improvident habits; by the use of book credit; and by rapid transportation. The quantity of money will be increased and therefore the price level increased correspondingly by the import and minting of money, and, antecedently, by the mining of the money metal; by the introduction of another and initially cheaper money metal through bimetallism; and by the issue of bank notes and other paper money. The quantity of deposits will be increased, and therefore the price level increased by extension of the banking system and by the use of book credit. The reverse causes produce, of course, reverse effects.

Thus, behind the five sets of causes which alone affect the purchasing power of money, we find over a dozen antecedent causes. If we chose to pursue the inquiry to still remoter stages, the number of causes would be found to increase at each stage in much the same way as the number of one's ancestors increases with each generation into the past. In the last analysis myriads of factors play upon the purchasing power of money; but it would be neither feasible nor profitable to catalogue them. The value of our analysis consists rather in simplifying the problem by setting forth clearly the five proximate causes through which all others whatsoever must operate. At the close of our study, as at the beginning, stands forth the equation of exchange as the great determinant of the purchasing power of money.

J. Laurence Laughlin[54]: To my mind, the following propositions contain the essence of the theory of prices.... As every one will appreciate, only general statements, without any limiting qualifications to speak of, can be given in so small a compass.

1. The price of a commodity is measured by the quantity of a given standard for which it will exchange.

2. A change of prices may be due to changes in the conditions affecting the supply (thus including expenses of production) of goods, as well as to changes in the demand for and supply of gold. A statistical statement of a change of price is not a statement of the cause of the change.

3. Probably there is not so much difference of opinion regarding the theory of prices as is sometimes supposed. Other causes being supposed constant, an increased supply of gold would tend to raise prices. No one can fail to see that, if by "money" is meant gold, a change in its quantity would, other things being equal, be a factor affecting prices. An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of prices occurred, their cause must be sought in the influences touching the producing and marketing of goods.

4. The effective demand for goods (granting their utility) is limited by the buyer's purchasing power. This purchasing power is not identical with the quantity of the media of exchange in circulation, any more than the value of the total exchangeable wealth of the community is identical with the value of the total money in circulation.

5. The general level of prices is not independent of particular prices; since there can be no such thing as a general level, or average, of prices which is not the resultant of a number of particular prices each arrived at by individual buyers and sellers. The causes of price changes must be sought in the forces settling particular prices. This does not exclude the consideration of any causes affecting the value of the standard in which the prices of goods are expressed, because the standard is itself a particular commodity.

6. In particular cases, competitive prices in this country are arrived at by the higgling of the market, which depends on buyers' and sellers' judgment of the demand and supply of the commodity (e. g., wheat); and, when the price is fixed, the credit medium by which the commodity is passed from seller to buyer comes easily and naturally into existence and, of course, for a sum exactly equaling the price agreed upon, multiplied by the number of units of goods. Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed (cf. 10).

7. The offer of "money" for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods (cf. 6). That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process. The supposed offer of money has no money as its basis, but is only the offer of a purchasing power, previously existing, based on saleable goods, which at the moment of payment appears expressed in terms of the standard. By credit devices the actual transfer of the standard is reduced to an inconsiderable minimum. In reality (as in foreign trade) goods are exchanged against goods.

8. The effect of credit on prices is to be found mainly in banking facilities by which goods are coined into means of payment, so that, expressed in terms of the standard gold, they may be exchanged against each other. Thus credit devices relieve the standard to an incredibly great degree from the demand for the use of gold as a medium of exchange, and thus remove a demand, as trade increases, which would otherwise have enormously affected the value of gold. Thus the effect of credit on the general level of prices in considerable periods of time is shown by a tendency to reduce the demand on the standard gold, and hence to prevent the tendency toward falling prices.

9. A general proposition is that banks are limited in making loans by the possession of capital, a bank of large capital and deposits being able to make large loans, a bank of small capital and deposits, small loans. A second proposition is that the demand for legitimate loans varies with the exchanges of goods and collateral and the opportunities for investment. With an increasing activity in business, however--either sound or speculative--the expansion of loans is limited by the resources of the bank. Next, a bank trying to carry a certain amount of loans, must hold a specified proportion of reserves to demand liabilities under the rule of banking experience or law. The amount of its capital and the funds left with it determine the relative size of its loan item; and the sum of its loans and resultant deposits determine the amount of its reserves. The reserves of a bank are thus a consequence of the loan operations. This conclusion, however, as it affects the practical problem of the present day, is not, in my opinion, invalidated by the conceivable cases arising, when business tends to outrun banking facilities, in which anything that makes increasing reserves possible would increase the power of the banks to lend. When gold becomes increasingly abundant, the banks having large resources more easily get the gold reserves needed for their operations. It still remains true that the fact of an increased supply of gold does not of itself increase loans, unless conditions of business demand an increase in loans. Therefore, the expansion of business is not a necessary consequence of an increasing supply of gold, any more than an expansion of railway traffic is the necessary consequence of an increasing supply of cars. If increasing goods are in existence to be transported, then, of course, there is an increasing demand for cars. Likewise, if there are more bank resources and loans, there is an increasing demand for that which is lawful reserve; from which it is claimed that the use of new gold in bank reserves, under present conditions, is not the significant causal force which expands business and raises prices (although it may be contemporary with it).

10. The problem of explaining the general level of prices is one of arriving at the adjustment between two terms of a ratio (the standard on the one side, and goods on the other), each of which is influenced by supply and demand. Gold being one, and goods being many, a cause working on gold alone, and important enough to show an appreciable effect, might explain a general movement of prices. In practical operation, however, because of the large existing stock of gold, very considerable additions may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of prices are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....

In the problem of discovering the causes of changes in the level of prices, it is necessary first to reach a conclusion as to those causes which operate on the gold standard in which our prices are expressed. By so doing we may locate the general level--so far as the standard is concerned--or the one thing which might work as a cause common to all goods. The relation between gold and goods might be illustrated by the familiar mechanical illustration: a rod balanced on a fulcrum, on one end of which works the forces affecting the value of gold, and on the other end the forces affecting the value of particular goods. The relation between goods and gold being a ratio, as one end of the rod goes up, the other necessarily goes down.

There are, as we all know, various forces at work to produce the resultant price level. We may here start from a proposition on which we can all agree. An increase in the quantity of the monetary standard in the world--such as gold--would tend, other things being equal, to lower its value and thus raise prices. In trying to find the causes in the price level at any given time (as in 1896-1909) it is necessary, therefore, after stating the facts as to the increase of gold, to examine into the influence of "the other things."

To begin, we may take up the demand for gold, which, of course, is both monetary and non-monetary. First as to the non-monetary uses, such as abrasion, shipwreck, and disappearance in the arts: The statistics of consumption in the arts are unsatisfactory; at the best they are only estimates. Although the total production of the world, 1493-1850, was $3,158,000,000, there is no evidence as to the available stock in 1850. My belief is that there was not more than $2,000,000,000.[55] In the period of 1851-1895, the production was $5,641,000,000, and the consumption in the arts, at the average rate of $50,000,000 a year requires a deduction of $2,250,000,000, which leaves $3,391,000,000. The arts in recent years are estimated to use more than $100,000,000.[56] In the period, 1896-1905, if $1,000,000,000 be deducted from the production of $2,899,000,000 we have $1,899,000,000. Thus the total available stock in 1905 would be about $7,690,000,000. The production of the last four years, 1906-1910, is about $1,600,000,000, or, less the consumption in the arts, about $1,200,000,000.

The monetary demand for gold, on the other hand, has shown certain definite characteristics. Whether it be prejudice, or enlightened business judgment, the commercial nations of the world have shown a persistent and continuing disposition to adopt a gold monetary system as soon as their own means, or the forthcoming supply of gold, has made it possible. The United States led in 1853, when we declined to change the ratio in order to bring silver into circulation when only gold was in use. From 1871-3, Germany, the countries of the Latin Union, Austria-Hungary, the United States (with the resumption in gold in 1879), and India (in 1893), in response to the preferences of the commercial world, placed themselves on the gold standard by legal enactments. The demand for gold all through this period was based upon considerations independent of the movement of prices. For this was a time of falling prices when much was heard of the appreciation of gold and the need of silver. In spite of this tendency toward falling prices, the movement toward the adoption of gold went on.... It was precisely this large new supply of gold which enabled the commercial nations to gratify their desire for what they believed was a more stable standard.

As we enter the present period (1896-1909) we find this momentum towards the gold standard still in force: and other countries in emulation planned to put themselves on an equally stable standard with those whose means had permitted an earlier action--quite irrespective of the fact that this last was a period of rising prices, while the former was one of falling prices. In this period, Russia, Japan, various states in South America, such as Peru, Argentina, and Brazil, and recently Mexico, have emphasized the movement away from silver to gold. Moreover, as backward lands, like Turkey, parts of Asia, Egypt, and various districts of Africa, have developed their resources and increased their trade, they have taken on gold in their monetary systems. With increasing trade also there are more exchanges of goods; hence, even in countries (like Great Britain and the United States) that do not use gold to speak of, except in reserves, there are increasing loans and deposits and thus a demand for more gold reserves. Consequently, in countries long ago established on the gold standard there will be a steadily increasing demand for gold as exchanges expand. We find thus a special characteristic of the demand for gold (certainly not existing in the demand for silver). The power of developing countries to soak up new gold is as marked a part of present conditions as is the power of a porous and sandy soil to soak up a heavy rainfall. We must, therefore, take full account of the noticeable fact that the recent demand for gold seems about to keep pace with the new supply; that a shipment of gold from the mines to London is to-day eagerly competed for, not only by European countries, but by Egypt, India, Turkey, Argentina, and Brazil.

Consequently it may be of interest to see which countries have taken the largest amounts of gold into their stocks since 1895:

United States $994,000,000 Russia 427,000,000 Germany 419,000,000 South American States 213,000,000 British Empire 194,000,000 Austria-Hungary 163,000,000 Italy 160,000,000

Besides the demand for gold in the arts, and the apparent monetary demand, as thus already presented, we must not omit to take into account also the large stocks of gold held by banks and institutions which publish no statements. In the hands of large private institutions like those of the Rothschilds, Bleichroders, and others, great amounts of gold are carried. It is from such stores that the needs of states, such as Austria-Hungary, France, Italy, and even the United States (in Cleveland's administration), have been supplied without drawing down visible reserves.

Thus far, then, we have examined the one factor of demand for gold, among the "other things" (which were supposed to remain equal). There is abundant evidence to show that the demand for gold, in this recent period of rising prices (1896-1909) has been as strong as, or even stronger than, the demand for gold in the previous period (1873-1896) of falling prices.

It looks very much as if we must seek for the causes of rising prices since 1896 in some of the "other things" not yet examined. There is no time, however, for extended discussion on these points....

The effects of Tariffs and Taxation, Unionism and higher Wages, and changing Agricultural Conditions in increasing expenses of production in all industries are so patent as to require no enlargement. Immediately after the passage of the Dingley Act in 1897, a large list of articles rose in price precipitously. Moreover, just so far as higher money wages for the same work, or the same money wages for a reduced number of hours, have been granted without a corresponding increase in the efficiency of the labor, the expenses of producing goods in general--and consequently prices--have risen. But, without doubt, one of the most important factors in raising prices--directly and indirectly--has been the increased price of food due to the changing conditions of agriculture. This most influential cause of higher prices is one of the "other things" which has been at work quite independent of the quantity of new gold. Moreover, the indirect effect of high prices of food produces the most serious practical problem. It wipes out all the gain of previous increases of wages, and drives laborers to repeat their demands for higher pay, thus working again to increase expenses of production. It is not too much to say that the gains of industry, shown by the fall in prices, as they stood about 1890 have been lost to us by the high tariffs of 1897 and the wastes of bad farming and the recent high costs of agriculture.

Our analysis would be inadequate, however, if we stopped here with our examination of expenses of production. The really practical problem is still before us in trying to analyze the forces at work fixing prices in that vague and dangerous margin between actual expenses of production and the prices in fact paid by the consumer....

The whole raison d'etre of monopolistic combinations is to control prices, and prevent active competition. As every economist knows, in the conditions under which many industries are to-day organized, expenses of production have no direct relation to prices. In such conditions, there is a field in which the policy of charging "what the traffic will bear" prevails; and this includes industries that are not public utilities.

Furthermore, we must face the fact of increasing riches not only in this country, but all over the world. New wealth makes a liberal spender. The retail dealer finding his expenses increasing and--even when they are not--tries the experiment of charging his richer customers an increasing price. The newly rich pay and do not feel it. But what can the poorer unorganized buyer do when retail prices are raised? What can he do if his meat bill, or his plumbing-repairs bill, rises enormously? The extravagance of the rich has increased the cost of traveling, the rates at hotels, the fees, the luxury of steamships and automobiles, the consumption of fruits and vegetables out of season once never thought of, and has generally raised the standard of expenditure. Those of smaller income find they also must pay the higher prices. Thus we have reached a point where we have to pay almost whatever any one asks. Organized buyers are the only offset to organized sellers.

Moreover, rising prices due to high expenses of production, or to combinations of sellers, present a paradise for speculation. A movement upward based on facts can be easily converted into a further rise based only on speculative manipulation. A rise of prices which brings large profits to a combination, thus directly affects earnings and gives especial opportunity to speculation in the securities of industrials. Hence, the field of speculation spreads from commodities to securities. The facts as to the movement of prices of securities are well shown in Brookmire's Economic Charts since 1885; and, while the presence of gold serves as a fund of lawful money in reserves, the spread of speculation has gone on seemingly unaffected by the new supplies of gold. That is, speculative conditions may arise and disappear antecedent to and seemingly independent of the gold supplies.

* * * * *

D. F. Houston[57]: The discussion of money and prices to-day reminds one very strongly of the discussion forty years ago. Now, as then, the opinion is that prices have risen; but now, as then, there is wide difference as to the explanation. Now, as then, a highly respectable body of economists attribute the rise mainly to the new gold; and now, as then, a number of economists attribute the rise to influences immediately affecting the cost of production of commodities in general, instancing such things as labor unions, monopolies, extravagance, the tariff, general prosperity, etc....

That the tariff has played a part in the situation, I should of course not deny. By preventing us from securing supplies where they can be more economically produced, and by making it possible for domestic manufacturers to monopolize the market, and by tending to compel the payment for exports in gold, it has unquestionably played a part and is a notable factor.... In considering the tariff as a factor, however, we must not forget that we have had the tariff since the beginning, and that the rates have been nearly as high since the Civil War as they are to-day; and we must remember, further, that in one of the great countries which has no protective tariff the tendency of price has been upward; furthermore, we must not overlook the fact that many of the tariff rates, which are very high now, are not effective or not nearly so effective as they were in the earlier period, and also that its influence is probably greater in things in which the rise of price has been less marked.

I should not deny that labor unions and monopolies have had an influence in increasing price. The evidence seems to justify the conclusion that monopolies have had some effect in increasing price. I am not sure that there is sufficient evidence in regard to labor unions to enable us to form a conclusion....

Much has been said in discussion about the influence of extravagance. This has played a part in similar discussions at all times; every era has its cry of extravagance, and it is not clear that it has been more marked in our time than in former times. And one thing is quite clear, that the extravagance, or economic waste, resulting from the prosecution of war and its after effects, has been conspicuously absent during the last fifteen years....

The stock of gold in the leading western commercial nations, with which we are concerned in discussing prices, probably did not exceed $5,000,000,000 at the end of 1895. During the next fourteen years there was added to the stock of gold of these countries an amount nearly equal to the existing stock. In addition, a number of these countries enormously developed their credit devices. According to all economic law, these facts create a strong presumption that gold has been the main factor affecting price. No sufficient evidence has been presented to overthrow this presumption.

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E. W. Kemmerer[58]: An adequate discussion of the papers presented by Professors Fisher and Laughlin would require much more time than the few minutes at my disposal. I shall accordingly limit myself to a few points and support my conclusions principally by footnote references. This procedure is perhaps the more justifiable in view of the fact that my own philosophy of the relationship between money and prices is given in detail in the book[59] on money and prices to which Professor Fisher has so generously referred.[60]

I have had the opportunity of reading in manuscript Professor Fisher's forthcoming book on Price Levels, of which his paper to-day represents one chapter, and find myself in substantial agreement with his main contentions. His discussion is a permanent contribution to monetary science of very great value. To a number of minor points, however, it seems to me, exception must be taken....

Professor Fisher's formula expressing the relationship between the circulating media and prices is essentially the same as my own,[61] but he pays little attention to the factor of business confidence, which is a most important consideration in the interpretation of the formula. The ratio of deposit currency to bank reserves is a function of business confidence.[62]

The distinction Professor Fisher draws between the prices of individual commodities and the general price level appears to me, as to Professor Laughlin, to be untenable. It is, moreover, contradictory to his general philosophy of money. His index numbers recognize no general price level distinct from individual prices. He illustrates the point that the price of any individual commodity presupposes a general price level by saying that "the position of a particular wave in the ocean depends on the general level of the ocean." I can conceive of no such distinction between the general price level and individual prices as his statements seem to imply. General prices "are but a combination, or composite photograph, as it were, of individual prices."...[63]

Passing to Professor Laughlin's paper, which has been presented to me merely in the form of an abstract, we find ten propositions, which to a considerable extent are repetitious. His first five propositions are rather commonplace generalizations and few economists will be disposed to dissent from their essential soundness. They place him much closer to the quantity theory of money than most of us, judging him from his previous writings, were disposed to think he would go; and in his third proposition he says, "Probably there is not so much difference of mind regarding the theory of prices as is sometimes supposed."

With reference to Professor Laughlin's fourth proposition it may be said that no economist of standing claims that purchasing power is "identical with the quantity of the media of exchange in circulation." Effective purchasing power, however, in our modern business communities, does depend upon the possession of money or of the right to demand money. The amount of deposit currency which can be used at any time in purchasing goods is limited by bank reserves because commercial deposits are payable in money on demand at the order of the depositor. Other assets, no matter how good, cannot be used for the purpose of meeting deposit obligations, except when the entire credit machinery breaks down and suspension is resorted to under the euphemistic name of clearing house loan certificates.

Professor Laughlin's sixth and seventh points are essentially the same and may be considered together. He says:

... Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed.... The offer of money for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods.... That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process....

This contention appears to me to result from a superficial view of the price-making process. The offer of money for goods and the offer of goods for money are of course not the first steps. Each person has his own individual or subjective prices on all sorts of commodities; these subjective prices represent the valuations which he places upon the respective commodities in terms of the valuation which he places upon the money unit. The more of a particular commodity he has the lower his subjective valuation of a unit of that commodity; the more money he owns the lower his estimation of a dollar and the higher his subjective prices; and vice versa. Through a process of competition, selection, and adaptation, some of these subjective prices develop into market prices, that is, prices at which both buyer and seller benefit, and at which therefore an exchange takes place. To paraphrase an old adage, the proof of the market price is in the exchange. It is a common observation that stock quotations to be of much value must show the number of sales effected at the prices quoted. A stock for which the maximum bids were 100 and the minimum offers were 110, would not possess a market price in the strict sense of the word. The fact that sales have recently been made at a certain price, or are now being so made, is of course presumptive evidence that intending purchasers can buy at about that price. A market price, however, is the amount of money paid for a commodity, not the amount asked, offered, or promised.

Professor Laughlin's ninth proposition I find very difficult to follow. His premise that reserves are "a consequence of the loan operations" is a dangerous half truth; they are also a consequence of most other kinds of banking operations, cash deposits, cash withdrawals and clearing house balances, foreign and domestic exchange operations, etc. His other premise, that "the fact of an increased supply of gold does not of itself [the italics are mine] increase loans, unless the bank possesses the control of the capital which is a condition precedent to the loans," contains an element of truth, but is misleading. While an increased supply of gold does not of itself increase loans it normally has that result; and the bank's discount rate and the condition of its reserve are powerful factors in influencing its loan account. His premises, I believe, are not sound, and his conclusion, namely, that "the expansion of business is not a direct consequence of an increasing supply of gold, any more than an expansion of railway traffic is the direct consequence of an increasing supply of cars," would not follow from his premises, even if they were sound. The normal causal chain is more nearly this: increased gold production results in greatly increased amounts of gold coming into the monetary uses.[64] This gold comes into the hands of individuals and is to a large extent deposited in banks; increased money incomes on the part of individuals lower their estimations of the value of the money unit, raise subjective prices, and as a consequence market prices; larger money deposits in banks result in larger reserves, banks do not make interest on money held in reserves, and accordingly take measures to invest such surplus money, keeping these reserves as low as is consistent with law and their ideas of safety;[65] inducements to borrowers are made in the form of more favorable discount rates; collateral is not scrutinized so carefully; the speculative market is stimulated by increasing supplies of call money; confidence everywhere increases; new enterprises spring up and old ones are expanded; and in a short time the new gold is absorbed by a higher price level and an overstimulated business activity. This was the situation after the Californian and Australian gold discoveries of the last century and it has been the result of the greatly increased gold production of the last few years.

Professor Laughlin's final point is that since 1895 the new demand for gold has roughly equalled the new supply, and that the changes in prices since 1896 must be sought mainly in the "other things," which have not remained equal. In support of this conclusion he offers two principal arguments. The first is as follows:

... Because of the large existing stock of gold, very considerable changes may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of price are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....

In reply it may be said that the production of gold since 1895 represents a very large percentage of the total supply. The Soetbeer figures as supplemented by those of the Director of the Mint show that the world's gold production for the 405 years 1492-1896 inclusive was in round numbers $8,982,000,000,[66] and that for the eleven years 1897-1907, was $3,513,000,000; in other words, for these eleven years it was over 39 per cent. of the total for the preceding 405 years. Probably the effective supply represents a much larger proportion of recent gold because of (1) the large amount of loss chiefly by abrasion of the gold produced in the earlier years, and of (2) the greater degree to which this early gold has assumed specialized forms, such as jewelry, plate, etc.

Satisfactory index numbers of prices for recent years are not available for all the principal countries of the world. Such as we have, however, point to a decided rise of prices in all gold standard countries since about 1897. Comparing standard price index numbers in six of the chief countries of the world for the years 1897 and 1907, we find the general price level to have risen as follows:[67]

United States--Bureau of Labor figures 44.4% Canada--Coats figures, (weighted) 43.7% England--Sauerbeck figures 29.0% France--de Foville, figures for export prices[68] 13.3% Germany--Hamburg figures 30.8% Italy--Necco figures for export prices 23.4%

If we average these figures together, assigning the same importance to the figures of each country, in order to get a rough idea of the movement of world prices in gold standard countries during the eleven years in question, we find that the average increase was 30.8 per cent. If we follow Professor Laughlin and compare the years 1895 and 1907, we find the average increase in prices to have been 25.8 per cent., and the world's gold production for the 13 years 1895 to 1907 to have been about 42 per cent. of that for the preceding 404 years. When to this is added the fact that the evidence points to a smaller percentage of the world's annual gold production going into the industrial uses than formerly, and the further fact that during the period in question the increase and improvements in the world's banking facilities have greatly economized the uses of money, we see that a very substantial increase in general prices would be expected, despite a great expansion of business. World prices in fact have not increased nearly as rapidly as the flow of gold into monetary uses since 1897, not to mention the enormous development of deposit currency. The Director of the Mint estimates each year the amount of the world's new gold used in the industrial arts. Computations I have made based upon these figures show a tendency for a decreasing percentage of the annual production to be used in the arts, although there is considerable irregularity. For the seven years 1895-1901 the average percentage was 27.1, and for the seven years 1902-1908 it was 25.3.[69]

Professor Laughlin's second argument in favor of the proposition that the recent rise in prices has not been due primarily to the increased gold production is one of the most beautiful examples of begging the question that I have seen in economic literature. He says:

"In recent discussions one of the 'other' factors which has been slighted is the demand for gold since 1895. The examination shows that the new demand in countries turning to the gold standard, and in those already using gold and extending their demand, amounts in round numbers to about $3,000,000,000. Hence the new demand has roughly equalled the new supply, since 1895--a fact which jumps with the known conditions in the great financial markets like London, where new arrivals of gold are eagerly competed for by European banks."

Of course the demand for gold equals the supply, as does the demand for wheat or any other commodity, when one interprets demand and supply as one should, in terms of market prices. The general price level is the very thing which equilibrates the demand for gold and the supply. The higher price level about which we are talking is an expression of the absorption of most of this new gold into the world's circulation. Banks and merchants eagerly compete for it, because higher prices require more money to do a given amount of exchange work, and rising prices stimulate business.

* * * * *

Joseph French Johnson[70]: I am glad to observe that there appears to be a tendency toward agreement with regard to the fact that the value of money depends upon the demand for it and supply of it. Professor Laughlin likes the word standard better than I do. It suggests something permanent and fixed, whereas money is a very changeable thing. While I am in agreement with Professor Laughlin in the conclusion that the general level of prices depends upon the demand for and supply of money, I am unable to give assent to many of the propositions which he puts forward as links in the chain of reasoning leading to that conclusion.

For example, Professor Laughlin says, "A change of prices may be due to changes in the demand for and supply of (thus including the expenses of production) goods as well as to changes in the demand for and supply of gold." This proposition is true with regard to changes in the prices of particular commodities. The price of wheat may rise or fall as a result of a change in the demand for or in the supply of wheat. The proposition, however, is not true with regard to a change in the general level of prices. An increase in the supply of goods will lower the level of prices for the simple reason that it will increase the demand for gold. I am not certain that I have understood Professor Laughlin's exposition of his theory, but he certainly seemed to me to argue that there could be a change in the general level of prices without any change whatever in the demand for or supply of gold. Such a position, it seems to me, is absolutely untenable.

That Professor Laughlin seeks to hold this untenable position, it seems to me, is made evident by the qualification with which he accepts the statement that a change in the quantity of money, other things being equal, would be a factor affecting prices. He says, "An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of price occurred, their cause must be sought in the influences touching the producing and marketing of goods." The second conditional clause in that last sentence introduces an impossible supposition, for if a new supply of gold is offset by a new demand for it, there could be no change in the general level of prices, so that no cause for any change would have to be sought in the "influences touching the producing and marketing of goods." Professor Laughlin appears to have in mind forces affecting the general level of prices which are entirely hidden from my sight. A change in the level of prices means a change in the value of gold, and how can there be a change in that if the new demand for gold just offsets the new supply?

Professor Laughlin's analysis of the price-making process is incomplete and misleading. He is correct when he says that the causes of price changes must be sought in the forces settling particular prices, but he is manifestly wrong when he states that the price of wheat is "arrived at by the higgling of the market, which depends on the buyers' and sellers' judgment of the demand for and supply of wheat." Such higgling would determine only the value of wheat. The price of wheat is not fixed until buyer and seller have reached an agreement in their estimates as to the value not only of wheat, but also of money. If wheat is comparatively easy to get, the price falls. If money is easier to get, the price rises. The demand for and supply of money is evidently just as important in the determination of the price of wheat as is the demand for and supply of wheat itself. When Professor Laughlin says that the offer of money for goods is only a resultant of price-making forces previously at work, he must have in mind some price-making process and price-making forces of which I have never heard. I know of no market in which goods are lowered in price except for the reason that at the higher price not enough money is offered to absorb the supply; nor of any market in which goods are raised in price except for the reason that buyers are willing to offer more money for the goods.

In his analysis of credit and its relation to the value of money, Professor Laughlin seems to me to have in mind a hypothetical financial world, the like of which does not and could not exist on earth. He strives to show that a bank's ability to make loans depends upon the amount of its capital and deposits, and that therefore any increase in the supply of gold would not in itself lead to an increase of loans. "Expansion of business," he remarks, "is not a direct consequence of an increasing supply of gold any more than an expansion of railway traffic is the direct consequence of an increasing supply of cars." He is quite right if he means that an increase in the amount of gold will not necessarily cause the exchange of more goods. But this does not appear to be his meaning. He holds that the use of new gold in bank reserves cannot be a causal force raising prices, for the bankers cannot increase their loans, in his opinion, unless the condition of business demands such an increase. In his hypothetical financial world bankers are willing to carry idle stocks of gold and to wait until business conditions make necessary an increase in their loans. In the real financial world, of course, bankers do nothing of the sort. Bankers with surplus gold immediately tempt borrowers by lowering the rate of discount and thus increasing the money demand for goods in the markets. As a result there is an irregular and general rise of prices. More goods may not be bought and sold and there may be no expansion of business, but expressed in terms of money the totals are bigger. There is no analogy between dollars and freight cars. The carrying capacity of a car is fixed and unchangeable, but the carrying capacity of a dollar is elastic--so elastic, in fact, that dollars are always fully loaded no matter how small the supply of goods. As Professor Laughlin points out, although he apparently does not see its significance, the new demand for gold since 1895 has "roughly equalled the new supply." Surely it could not have been otherwise, and no statistics are necessary to prove the fact.

* * * * *

Murray S. Wildman[71]: My comments on these interesting papers will be directed upon the methods employed, and certain assumptions involved, in the arguments of both. Granting that Professor Fisher's analysis shows a perfect correspondence between the course of prices on the one hand and the quantity of money and credit instruments on the other hand, I am still unable to see which magnitudes are properly to be regarded as causes and which as effects. That variations in the value of gold and in the price level must be reciprocal, all will admit. If we regard M as denoting the gold supply for the present, a causal relation between M and P cannot be denied. But may it not be possible that variations in M', or credit, and V and V', the velocity of circulation of both money and credit, be simply in consequence of the variation in M and P? Why is P the only passive term or why is it passive at all?

Suppose that the problem set was to discover the cause of credit expansion from 1896 to 1910. Would we not seek at once to explain it by reference to rising prices and greater volume of goods, making a broader basis for credit, while along with that is a greater gold supply which promotes the convertibility of an extended credit? Then might we not invoke Professor Fisher's algebraic formula, with terms rearranged, and show by this method of reasoning, supported by statistical verification, that the high prices afford an adequate cause for the present expansion of credit?

But we are seeking the cause or causes of rise in the price level. This is equivalent to seeking the cause of decline in the value of gold. Does the "quantity theory" as newly expounded give us the solution? I think not. Rather it shows us that as gold has grown in supply, and fallen in value, credit has grown in magnitude and in rapidity of circulation, and that these changes in values and volumes have gone hand in hand with proportional changes in the price level and in the magnitude of commodity exchanges.

This view of the case brings me to substantial approval of Professor Laughlin's method of analysis and argument. That is, we must seek the facts regarding supply and demand as applied to gold, and those which bear upon supply and demand as touching goods, in so far as the demand for goods is expressed in offers of gold and gold representatives. Here the algebraic formula would be invoked to support his reasoning since M' and V and V' may be regarded as factors in the demand for gold.

To accept Professor Laughlin's method does not involve the necessity of his conclusions. The terms, by this method, do not lend themselves to exact mathematical statement and statistical proof, so conclusions cannot be exact and definite. This may be illustrated in a consideration of demand for gold. Some say that demand has grown step by step with supply and therefore gold has not been cheapened. Others say that supply has grown more rapidly than demand, and so gold has been cheapened and to that extent prices are raised.

Either statement may be wrong. I do not believe we have yet any reliable data regarding the demand for gold in the sense of a value-making factor. Most efforts to measure demand are based on statistics of gold in use. If one can show that consumption of gold in the arts, in the circulation, and in greater bank reserves, has increased pari passu with production, we are told that the value of gold has not been lowered by the greater supply.

But statistics of consumption give no clue to demand in the value-determining sense. We have many staple commodities, such as wheat and cotton, whose price drops sharply when the supply exceeds a certain normal volume, even though the whole crop is consumed. Statistically speaking, the demand for a cotton crop always rises as supply rises, and falls as supply falls, but that is because demand and supply become equated through a variation in price. Demand, in this sense of quantity demanded, is in part a result rather than a cause of value.

When we can properly speak of demand as potent for the determination of value, we are thinking of demand from the point of view of intensity rather than the point of view of magnitude. But the demand which makes for value--demand intensively considered--is only measured by the purchasing power offered. Applied to gold, I know of no measure of demand except in the goods and services offered in exchange. To say that goods and services offered for an ounce of gold in 1910 are less than are offered for an ounce of gold in 1896, is simply to say that prices are higher. But it is these prices that we are trying to explain by giving the effect for the cause, when we say that demand has risen with supply.

Those staple commodities whose value falls off abruptly with any increase of supply beyond a customary stock are said to be subject to an inelastic demand, and those whose value declines uniformly with excessive supplies are said to have an elastic demand. Is the demand for gold elastic, or is it inelastic? And is it possible by independent analysis to construct the curve of elasticity which properly belongs to gold, and so avoid circular reasoning from the very prices we are trying to explain?

If the demand for gold is inelastic and the demand curve drops off abruptly after a certain supply is in evidence, the presumption is that in the conditions of gold production, rather than in the conditions of commodity production, lies the cause of our high prices. Moreover, if this be the case, we can readily see the cause of cheapening of gold, even though the product of a single year bears a small proportion to the existing stock.

If on the other hand the demand for gold be very elastic, so that it expands with growing supplies with no substantial alterations in value, then we are driven to seek the cause of high prices in influences directly touching the goods and services rather than in those directly affecting gold.

It would seem therefore that both methods of treatment have left something to be desired. The algebraic analysis, even as verified, presents the relations between magnitudes without showing the cause of high prices. The argument directed immediately at the value of gold of necessity involves consideration of the demand for gold, which, as a price-making factor, remains an unknown quantity.

* * * * *

T. N. Carver[72]: Professor Fisher ... has demonstrated beyond all question the accuracy of his formula. The question remains, however, whether his formula supports his own conclusion or Professor Laughlin's. If, for example, it should be found that P is the cause of M, the formula would to that extent support Professor Laughlin's position. I believe that to a certain extent P is actually the cause of M. If the growing scarcity of agricultural land, or the increase in population and the increased demand for agricultural products without an increase in land, should increase the marginal cost of producing agricultural products to supply this larger demand, that would tend to increase the exchange value of these products, even according to the formula of Cairnes as quoted by President Houston.[73] Even without any increase in the gold supply, this would cause each unit of product to exchange for a little more gold; then, in order that a given number of exchanges in agricultural products could be carried on, it would be necessary to have a larger number of ounces of gold, or a larger number of gold coins, or some other form of money of given denominations to do the money work. This, in other words, would necessitate a larger supply of money: and, if other forms than gold were not forthcoming, it would necessitate that a larger proportion of the stock of gold should be coined into money in order to do the work. Thus, without any increase whatever in the world's total gold supply, there would come to be an increase in the proportion of that supply used as money, or in the amount of gold coin actually used in circulation. I believe that this has taken place, and that it is one of the factors in the problem, although there has also been a very large increase in the gold supply to still further accentuate the tendency.

* * * * *

F. W. Taussig[74]: I congratulate Professor Fisher on his admirable paper. I am in accord with him in his method of reasoning and in all his essential results. His investigation of this subject adds another to the brilliant studies with which he has enriched economic science.

It deserves to be said, perhaps, that the term M' (deposits) in his equation is not entirely independent, but is in some degree a function of T. I say to some degree; it is dependent on T in part only, and not for very long periods. Professor Fisher has here treated it as dependent simply on M.... He has indicated the qualifications which must be attached to this dependence of deposits on bank reserves. He has pointed out that though a general dependence appears over long periods of time, it is affected by changes in banking ways, and by the tendency to build up a higher superstructure of deposits in times of active business. But there is also a connection between T, volume of trade, and M'. That is, for short periods--nay, for periods of some years--an increasing volume of trade tends of itself to bring about an increasing volume of deposits. (I may say, parenthetically, that "volume of trade" does not seem to me an apt expression; "units of commodities," the other phrase used by Professor Fisher, is better.) Though I would by no means go the length of Professor Laughlin's reasoning, which seems to imply that every act of exchange supplies automatically its own medium of exchange, it does seem to me that our modern mechanism of deposit banking supplies an elastic source of deposits, which, for considerable periods, enables them to run pari passu with the transactions and loans resting on them. In the end, an increase of deposits finds its limit in the volume of cash held by the banks. But there is some elasticity of adjustment, by which loans and deposits increase as fast as transactions or faster; and this accounts in no small degree for the rise in prices during periods of activity. The phenomenon shows itself most strikingly in stock exchange loans, especially in a center like New York. There the business creates for itself quasi-automatically its own medium of exchange. I suspect it is undue generalization from operations of this sort that has led Professor Laughlin to take his extreme position--a position which I can not but think untenable. Some allowance for the temporary interaction between M' and T is necessary for the completeness of Professor Fisher's reasoning.

* * * * *

Ralph H. Hess[75]: Professor Fisher's formula (MV + M'V' = PT) approximately expresses the mathematical equality of purchase and payment which cannot be questioned. I say approximately because M' (defined by Professor Fisher as "bank deposits subject to check"), if it be made to express an accurate measure of circulating credit, should include not only open bank accounts, but certain other values which constitute current means of payment, such as bankers' bills, trade bills, cashiers' checks, and certified checks....

The relation which Professor Taussig has pointed out between M' and T (the value of negotiable credit and the contemporary volume of trade) is not only possible, but, in any community of modernized commerce, is actual. Moreover, a knowledge of the process by which commerce is financed by the existing mechanism of discount, loan, deposit, and draft justifies the conclusion that, if the volume of trade (T) be resolved into its factors, namely, materials of trade and their frequency of exchange, the latter factor of T is quite commensurate with the velocity of credit (V').

To me it seems incontestable that the volume and velocity of credit currency, as represented by bank deposits and other circulating media, vary directly as the volume and value of the materials of trade in the process of exchange, and are, mathematically speaking, dependent functions thereof. Granting this relation, an analysis of the equation of exchange establishes PT as the major determinant of M'V', and, in so far as paper money may be authorized and issued upon the security of commercial assets, of M. That part of the money in circulation which does not derive its circulating powers from actual and potential commercial values is itself material of barter incorporating so-called intrinsic values.

The conclusion is clear that P (price) is independent of all other terms and factors of Professor Fisher's equation, that V and V' are determined by the mechanical circumstances and organization of exchange, and that the value of M and M', taken collectively, is a spontaneous derivative of PT. The fundamental determinants of prices and of "price levels," therefore, are to be found outside of monetary and credit agencies per se.

As to the nature and order of the price-making process and the actual forces behind price movements, I am in substantial accord with Professor Laughlin. That prices, individually and collectively considered, express the value-proportion of demand for and supply of goods on the market to demand for and "visible supply" of the standard commodity is fundamentally logical. Nor is there occasion to quibble over the paradox of disturbed equilibrium of demand and supply. Physically considered, the goods which objectify these terms are, of course, identical; but, in the valuation process, demand and supply denominate, respectively, desire and utility--the generally acknowledged antecedents of value. Price is the equalizing factor between the effective demand for gold and the effective demand for other goods, each taken in conventional units; and price changes are resultants of, and commensurate with, net variations in the value-factors of the standard and of the objects of exchange.

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 assertion 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 pass 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 hitherto 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 quantity 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 quantity 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 quantity of money and the volume of trade remain unchanged, and (3) that prices vary inversely as the volume of trade, provided the quantity 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 quantity 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 quantity 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 quantities of money and deposits might even vary inversely as their respective velocities of circulation. Were this true, an increase in the quantity 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 "quantity theory" could establish such a relationship, 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 quantity 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 quantity of pocket money, or till money, to suit his expenditures. He will try to avoid carrying too little lest, on occasion, he be unduly embarrassed; and on the other hand to avoid encumbrance, 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 quantity of money and deposits nor on the price level. These may change without any effect on velocity. If the quantities 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 assumes 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 quantities to expenditures, and the V's are the same as originally. That is, if there is no change in the quantities 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 quantity of money or of deposits. No reason has been, or, so far as is apparent, can be assigned, to show why the velocity of circulation of money, or deposits, should be different, when the quantity of money, or deposits, is great, from what it is when the quantity is small.

There still remains one seeming way of escape from the conclusion that the sole effect of an increase in the quantity 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 quantity of money. An inflation of the currency cannot increase the product of farms and factories, nor the speed of freight trains or ships. The stream of business depends on natural resources and technical conditions, not on the quantity of money. The whole machinery of production, transportation, and sale is a matter of physical capacities and technique, none of which depend on the quantity of money. The only way in which the quantities of trade appear to be affected by the quantity 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 assaying apparatus and labor. These changes may entail changes in associated 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 quantity of money will not appreciably affect the quantities of goods sold for money.

Since, then, a doubling in the quantity 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, asserts no causal relations between quantity of money and price level, any more than it asserts 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 quantity 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 quantity 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 quantity theory is true. It is true in the sense that one of the normal effects of an increase in the quantity 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 circumstances, 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 assure the public that they never discounted but good bills for bona fide transactions; however they might assert that they never forced a note into circulation; that the quantity 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 assent 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 quantity, 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 quantity. 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 quantity 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 assumption 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 Association. 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 Association, 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.

[57] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52.

[58] Ibid., pp. 52-61.

[59] Money and Credit Instruments in their Relation to General Prices, 2d edition, 1909. New York: Henry Holt & Company.

[60] The passages referred to are omitted.--EDITOR.

[61] Kemmerer, Money and Credit Instruments, pp. 9-18, 74-82.

[62] Ibid., pp. 82-8, 121-6, 145-8.

[63] Ibid., p. 9. [See Fisher: Purchasing Power of Money, pp. 175-180.]

[64] The value of gold bullion deposited at the United States mints and assay offices increased from $87,924,000 for 1897 to $205,036,000 for 1907. Figures furnished by the Director of the Mint.

[65] It is noteworthy that the reserves of the New York associated banks for example are usually kept very close to the legal reserve requirements. Cf. Sprague, Crises under the National Banking System, p. 222.

[66] Gold produced before 1492 represents an insignificant part of the existing supply.

[67] Useful tables summarizing all of these index numbers, except those of Canada, are given by Achille Necco, in his article on La curva dei prezzi delle merci in Italia negli anni 1881-1909, in La Riforma Sociale, Sept.-Oct., 1910.

[68] Comparison is for 1897 and 1906, figures for 1907 not being available.

[69] De Launay thinks that the industrial consumption averages somewhere between 40 and 50 per cent. of the annual output, but believes that for several years past the industrial uses have been absorbing a decreasing proportion, though an increasing amount. (The World's Gold, pp. 176-7.)

[70] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61.

[71] Ibid., pp. 61-63.

[72] Ibid., p. 64.

[73] The quotation here referred to is omitted.--EDITOR.

[74] Ibid., pp. 64-65.

[75] Ibid., pp. 65-67.

[76] Ibid., pp. 67-69.

[77] Adapted from The Purchasing Power of Money, pp. 150-157; and Bulletin of the American Economic Association, Fourth Series, No. 2. Papers and Discussions of the Twenty-third Annual Meeting, December, 1910. p. 70.

[78] David Ricardo, Reply to Mr. Bosanquet's Practical Observations on the Report of the Bullion Committee, Works, pp. 326-328. John Murray. London. 1888.

[79] The Bank could not on their own principles, then urge that most erroneous opinion, that the rate of interest would be affected in the money market if their issues were excessive, and would therefore cause their notes to return to them, because, in the case here supposed, the actual amount of the money of the world being greatly diminished, they must contend that the rate of interest would generally rise, and they might therefore increase their issues. If, after the able exposition of Dr. Smith, any further argument were necessary to prove that the rate of interest is governed wholly by the relation of the amount of capital with the means of employing it, and is entirely independent of the abundance or scarcity of the circulating medium, this illustration would I think afford it.

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XII. THE GOLD EXCHANGE STANDARD

It is an essential feature of the gold exchange standard as it exists in the Philippines, for example, that premiums charged by the Government in Manila for exchange on New York, and in New York for exchange on Manila are fixed at a point somewhat below the gold export points in each case. Thus the would-be exporter of gold in the Philippines never finds it profitable to ship gold to New York. On the other hand, international bankers in New York never find it profitable to ship gold or currency to the Philippines, because the authorised agent of the Philippine government in New York always stands ready to sell in exchange for United States currency, drafts drawn upon Manila at a premium less than the cost of shipping gold or currency. Through a regulation of the supply of silver pesos in actual circulation in the Philippines they are maintained at a definite ratio to--not gold in the Philippines, but--gold, or its equivalent, in New York. The way in which the supply of local currency in the gold-exchange country is regulated will be made clear in what follows.

The gold exchange standard has not entirely escaped criticism. Professor J. Shield Nicholson has recently attacked this standard in India. (Economic Journal, June, 1914.) It is his contention that inflation may occur in India, if it has not already occurred, on account of the "impeded convertibility of rupees into gold." After a certain point is reached in the inflation the decline in the general purchasing power of the rupee must be followed, he affirms, by a specific depreciation as regards gold; and then the main object of the plan would be defeated. He offers no evidence, however, that prices have risen faster in India than in gold standard countries. With the exception of Mexico, where currency conditions have become extremely chaotic, the historical material here reprinted is in accord with the recent monetary history of the countries under discussion.

[80]When the Government of British India sought, in 1893, to give a fixed gold value to about L120,000,000 in rupee silver, it undertook an experiment of great importance to the financial world, and one which was naturally viewed in many quarters with grave misgivings. The experience of fifteen years which have followed that experiment has taught many lessons in monetary science. It may, indeed, be said to have blazed a new path in the principles of money--at least, in their practical application. The effort to raise the coins to a fixed gold value by scarcity alone was not successful, but it led to other devices, which, imitated or improved upon in Mexico, the Philippines, and the Straits Settlements, as well as in India, have created a new type of monetary system which has come to bear the title of the gold exchange standard.

The gold exchange standard differs in several respects from the limping standard. It has been the product of definite purpose and plan in the Philippines and in Mexico and to a certain extent in India. While in British India it has been, like the limping standard, a compromise with existing conditions, it has there, as elsewhere, received a definite form and substance which separated it from the limping standard as evolved in France and in other countries which found themselves with a large amount of legal-tender silver on their hands when the metal had fallen below the official parity. There are two other essential differences between the limping standard and the gold exchange standard. One is that the gold exchange standard contemplates a circulation of token coins of silver without any necessary concurrent circulation of gold or paper. The other is that the gold exchange standard contemplates definite and comprehensive measures to maintain the value of token coins at par with gold instead of relying purely upon custom and scarcity to give them value.

The essential principle upon which the exchange standard has been established is that the value of money is governed by the law of supply and demand. So long as supply was indefinite and excessive, as under the system of the free coinage of silver, there was no way of preventing safely and effectively the decline in the gold value of the coins to the bullion value of their silver contents. The moment, however, that Government undertook to limit the supply of coins to the demand for them, it took an important step to separate their value from that of their bullion contents and to give them a value based upon the demand for them as money signs required for carrying on exchanges. Strangely enough, while this principle had been in operation for many years in the case of subsidiary coins, its bearing upon the use of silver in countries where the standard had been depreciating was not clearly comprehended until within recent years. Those who understood the principle doubted its sufficiency to give a fixed value to silver coins as the sole medium of exchange, or they distrusted the ability of any government to judge accurately the number of coins required.

Upon the latter point they would have been correct if dependence had been placed upon guesswork or any empirical method of determining the amount needed. It remained to find the true solution of the problem by so regulating the quantity of the coins that it would respond automatically to the demands of trade. The correct method of doing this is through the system of exchange funds. As this system is operated in the Philippines, it is not possible to obtain gold coin for silver certificates in small quantities; but it is possible always to obtain drafts upon New York at par, plus the usual charges for exchange between gold standard countries. These drafts have to be purchased with actual silver coin or coin certificates. In either case the coins and certificates are, by the requirements of the coinage law, held in the Philippine Treasury. The law does not permit their deposit by the Treasury in current account at a bank, which would turn them back into the general circulation.

For practical purposes the volume of currency in circulation is contracted to the same extent as if a corresponding amount of gold were taken from the circulation for export. When the current turns and rates for money become high in the Philippines, Philippine currency can be released for local circulation by the purchase in New York from the gold standard fund of bills upon the Philippine Treasury. This rule of locking up the proceeds of the sale of bills is not rigidly applied to the funds in New York, because the influence of the Philippine purchases upon the local circulation there would be insignificant. On the contrary, the Government obtains a generous interest rate, which has at times been as high as 4 per cent., upon the deposit of Philippine funds with New York bankers. During the stress of the autumn of 1907 considerable transfers of capital were made from Manila to New York by means of the purchase of New York drafts from the Philippine Treasury. The process, often repeated even under less serious pressure, clearly shows that the monetary system of the Philippines is linked to gold, and that capital can be freely transferred upon a gold basis between Manila and other markets.

The experience of fifteen years since the free coinage of rupees was first suspended in British India, of five years since the new system was established in the Philippines, and of nearly four years since it was in operation in Mexico, have settled most of the doubts which were felt when the experiment was undertaken in India. In the first place, it has been made clear that the value of the coins in exchange, as fixed by law, has not been influenced by variations in the price of silver bullion. This statement, of course, applies only to one side of the problem--the fall of the gold value of the silver in the coin below its face value. It would not be possible under any system yet discovered, except such uneconomic devices as prohibiting exportation, to prevent the disappearance of silver coins when the [bullion] value of their contents rises above the legal value in exchange. Both the Philippines and Mexico have faced this menace to their monetary circulation since their systems were inaugurated, but both have succeeded in removing it. In the Philippines the contents of the silver unit--the peso--was reduced in 1906 from about 371 grains to 247 grains in pure silver. The amount fixed by the law of 1903 was practically the same as the contents of the old Mexican dollar. The adoption of a coin of this weight was caused partly by the desire to avoid the distrust which some feared might arise from reducing the weight. At the time of the passage of the law, moreover, the price of silver was nearly at the lowest point in its history, having touched the minimum of 21-11/16 pence in January, 1903, and being at an average price of 22-1/2 pence in March. The adoption of so heavy a coin, however, was not in accordance with the original recommendation made by the present writer to the War Department in November, 1901. The weight then recommended was 385 grains, nine-tenths fine, or about 347 grains of pure silver.

In Mexico the rise of the silver coins above the legal gold value proved a blessing in disguise. It enabled Mexico to go almost to an absolute gold standard by selling her silver at a premium. From May 1st, 1905, to October 22nd, 1907, the old silver piasters were exported to the amount of $85,956,202, while gold coinage was executed to the amount of $71,646,500 (about L7,200,000).[81] The gold has gone chiefly into the reserves of the banks, which have in circulation about $95,000,000 in notes. Gold holdings of the banks, which were only $15,832,840 in January, 1906, were $54,165,483 in October, 1907, while silver holdings declined over the same period from $49,781,155 to $14,399,924.[82] This influx of gold came about because silver at 33 pence was above the Mexican coinage ratio of about 32 to 1, and much of it was sold by the Commission on Money and Exchange at a direct profit to the Mexican Treasury. In view of the subsequent fall in silver below 23 pence, at which rate Mexico is in a position to replenish her supply of subsidiary coinage, her statesmen may claim the credit of following the great rule of profit in the commercial world as well as on the stock exchange--to sell when things are dear and to buy when things are cheap.

The coincidence in the rise of silver and the adoption of the Mexican monetary reform in 1905 was in some degree accidental. It facilitated the reform, not only by introducing gold, but by removing the objections which would otherwise have been heard from the miners of silver to the rise in gold wages which would have accompanied a fixing of the exchange at a point above the value of silver bullion. It was the intention of the Mexican Government, however, to proceed resolutely, though deliberately, to a fixed exchange, and they would undoubtedly have accomplished this result, even if they had not been aided by the rise in the value of silver. Its subsequent fall has in no wise impaired the stability of the gold standard.

Some fears were expressed in the Philippines as to the willingness of the natives and of Chinese traders to accept a silver coin at a gold value fixed by law which was obviously above its value as bullion. This difficulty has proved almost negligible. Silver within less than three years has been above 33 pence per ounce and below 23 pence. It is doubtful if the Government officials in India or the Philippines have so much as taken note of the daily fluctuations since the price dropped below the legal parity of the coins, and it is certain that the exchange value of the coins has been in no wise impaired by their fall in bullion value. When the last reduction was made in the weight and fineness of the Philippine coins, lowering by almost 30 per cent. their silver contents, the precaution was taken of advising the public by means of an official circular, translated into the various languages and dialects of the Islands, why the change had been made, and that it would not affect the exchange value of the coins. Provincial and municipal treasurers were also directed to carry on a campaign of education among the people by way of explaining the character and effect of the change. The greatest menace to the value of the new coins lay with the Chinese, for in China for many hundreds of years local bankers and merchants have adhered to the rule that a coin derived no value from the stamp, but was worth just what it would fetch on the scales. The Chinese traders at first undertook to discriminate in this manner against the new coins of the Philippines. In some cases they refused to receive them except at a discount varying from 20 to 40 per cent. They also offered 105 in the new coins for 100 in the old, evidently in the hope of exporting the old at a profit while they continued to be worth as bullion more than their legal gold value. The success of this discrimination was local and extremely short-lived. The first consignment of the new coins reached Manila on May 4, 1907, and when the Treasurer of the Islands prepared his annual report on October 15th, 1907, he was able to make the following statement of conditions:

At this time, October 15, the new coin is accepted without question in every part of the Islands, and no reports or complaints have been received for the past two months as to discounting it, and, so far as can be ascertained, no premium is now paid for the old coin. In fact, the demand for the new coin for exchange purposes has so far exceeded the supply that it became necessary to withdraw nearly half a million of the new pesos from the banks to meet the requisitions therefor from the provinces.

The hesitation which prevailed, therefore, in many quarters in regard to the ability of a government to overcome the conservatism of the East in its preference for coins of full bullion value has not been warranted by events. This demonstration is of importance if the exchange standard is to be considered for China. At present the Government of China is not perhaps strong enough and sufficiently centralised to assure its subjects that it can give a definite gold value to a token coin and maintain it honestly and efficiently. The trial of the system, however, in the Philippines, in British India, and in the Straits Settlements, in all of which there are many Chinese, has probably so far cleared the air upon this point that the Chinese Imperial Government would be able to establish the gold exchange system if it did so under sufficient guarantees to the financial world that it would be honestly and intelligently maintained.

Next in importance to the settlement of this question of native willingness to accept the new system may be considered the degree of difficulty in maintaining it. It is not surprising, perhaps, that when it was proposed in an incomplete form for British India, it should have been denounced as a "fair weather" device--"a leap in the dark," which would not stand the test of business depression, deficient crops, and an unfavourable balance of trade.[83]

The most serious difficulty which has been foreseen by critics of the gold exchange system relates to the sufficiency of the exchange funds. Up to the period of the general panic of 1907 and the crop failure in India in the spring of 1908, it might fairly be said, perhaps, that the system had not been subjected to any but "fair weather" conditions. The experience of India, however, has thrown striking light upon the possibilities and limitations of the system in time of stress. The test in India has been of such magnitude, moreover, that its results are much more conclusive than any test which might have been afforded in a smaller country dealing with a less enormous mass of token coins. If the test had come before the exchange funds had acquired a respectable size, the system might have been allowed to break down, through timidity and delay in taking proper measures of protection, and discredit have thus been cast upon it before it had been fairly tried.

What happened in India was that the failure of the crops deprived the country of the usual means of compensating by exports the heavy imports of foreign goods which had been contracted for. It became necessary, under the settled principles of exchange, to find gold to fill the gap. Usually the exchange account substantially balanced itself by the sale in London of Council drafts upon the Indian Government to obtain gold to pay the interest on the debt held in England. These drafts were purchased by importers in London, and used to pay for the Indian crops; but all through the spring of 1908 purchasers for drafts failed to appear, because there had been no considerable exports of Indian crops to be paid for. Hence Council drafts were without a market, and for a moment it seemed that the link which bound the Indian monetary system to the gold market of London had been severed, and that the silver rupee might drop as disastrously as the Mexican dollar before its free coinage was suspended. This would have added the influence of an appalling disaster to the burden already imposed upon Indian finance by the failure of the crops, for it would have compelled the Indian importer of English goods to find a greatly increased number of rupees to meet his gold obligations in London. Obviously, it was a disaster which, if it had occurred, would have invited the bankruptcy of the country, reflected lasting disgrace upon English financial foresight, and perhaps even have led to organised revolt.

The Indian Government had available for meeting the crisis about L18,500,000, principally invested in securities in London. This fund, known as the gold standard reserve, was distinct from the currency reserve, consisting of gold received for currency notes, which amounted in the spring of 1908 to about L12,000,000. It was against the former fund that the Indian Government felt compelled to offer to sell exchange in India. Such offers were made for a time in limited amounts of L500,000 each, but they proved substantially adequate for meeting the demand, and by early summer the demand fell below the supply. The offer of exchange in this form for rupees maintained the value of the rupee coinage, contracted the amount of rupees in circulation in India, and enabled the Indian merchants to meet their obligations without the loss which they must have suffered if the currency had been allowed to depreciate in gold value. The actual sales of bills upon the exchange funds in London reached, between March 26th and August 13th, 1908, the considerable total of L8,058,000. Of this amount about L2,000,000 was taken from the currency reserve in gold, which was "earmarked" at the Bank of England, incidentally affording relief to the London money market which was keenly appreciated. Most of the remainder was obtained by the sale of securities to an amount which reduced such holdings from L14,019,676 on March 31st to L9,415,708 on July 31st.

The test to which the Indian system, as the most important example of the gold exchange standard, was thus subjected was perhaps of a higher importance than was realised by those in the thick of the conflict. It was plainly intimated, however, in the annual report on financial conditions for 1908 that, if necessary, the Indian Government would have issued short-dated securities in order to still further replenish the exchange funds in London. This would have been the true means of meeting the situation if the existing fund had been unduly impaired. The argument against it would have been that the demand was indefinite, and might become so large as to be unmanageable. The fact that the demand for exchange was met without the issue of new securities and without trenching upon the reserve funds beyond the amount of L8,000,000 out of L18,500,000 affords pretty strong evidence that there is a natural limit to such demands.

It is in this principle, that there is a natural limit to the possible drain upon the exchange funds, that the security of the new system lies.... It is only the supply of local currency on the margin of possible export demands which needs to be safeguarded. The substratum, which can never leave the country unless under the influence of an almost inconceivable economic cataclysm, is analogous in some respects to the "authorised" circulation of the Bank of England. It represents the irreducible minimum below which the local need for currency can never fall. If the supply on the margin of the international exchange movement is adequately guarded, then the whole system is secure. If it were conceivable that the demand for exchange would equal the whole amount of the local currency, or even the half of it, then it would be necessary to maintain exchange funds equal to the whole amount of token coins or the half of them in order to insure safety. But obviously this could never be the case.

This argument against the exchange standard is only a repetition of the dilemma sometimes presented by untrained minds in regard to bank-notes: what would happen if all the notes should be presented at one time for redemption? That question has been answered by banking experience; the question in regard to the gold exchange system has been and must be answered by experience in substantially the same manner. No country can be subjected to such stress as to consent to part with its entire monetary circulation, or even the half of it. On the contrary, every influence which tends to contract the circulation tends to create a condition which makes further contraction more difficult. Rates for the loan of money are affected, prices of imported goods are influenced, imports fall off and exports increase, and inevitably in the modern money market local equilibrium is restored, often with considerable strain, but none the less without pulling down the pillars of the financial temple.

The experience of last spring in India proves the adequacy of a reserve of 15 or 20 per cent. of the circulation to maintain the steady parity of a token coinage. There is apparently no evidence that serious distrust of the rupee arose, even when the Government was hesitating as to just what steps should be taken to meet the demand for exchange. Even if such distrust had arisen, however, it could have expressed itself through financial channels only by the demand for drafts on London. These would not have been very valuable to the average local tradesman except as he was able to sell them back again to the banks for the very rupees which had aroused his distrust. In this respect the gold exchange standard may be said to put a brake upon the disposition to export currency from fear alone, when the exportation is not demanded by the balance of trade.

If any mistake was made in the management of the Indian currency, it was in the investment of too large a proportion of the gold standard reserve in securities. While investment in securities is naturally attractive because of the income earned, and while it is not subject to just criticism while kept within certain limits, the possession of actual gold to a considerable amount is highly desirable. It would not be necessary, perhaps, that such gold should be "earmarked." If the Indian Government had a large deposit account in such an institution as the Union of London and Smith's Bank, or the London City and Midland, it would possess for the purposes of the Indian Government the character of gold. Drafts against such a deposit could be sold without the discount or delay which might be required in disposing of securities. It seems highly desirable, therefore, in spite of the prudence with which the recent pressure was met, that at least 30 or 40 per cent. of the gold standard reserve should in the future be kept either in "earmarked" gold or in the form of demand deposits.

In the case of the Philippine Islands the reserve is not "earmarked," but is at present entirely in the form of deposits with New York bankers. The problem in the Philippines is really child's play compared to that in British India. The entire circulation of the Philippine Islands is about 40,000,000 pesos (L4,000,000), against which a large reserve has accumulated as the result of the recoinage at a reduced rate as well as by the profits on the original coinage. It is hardly conceivable that an emergency would arise which would impair this reserve; but if this should occur, the scratch of a pen in Washington would remedy the situation. This would be accomplished by depositing gold or its equivalent in the exchange fund in New York to the credit of the war and navy, and placing an equivalent amount of local currency at the command of the military forces in the Philippines. Such a deposit would operate to increase the resources at the command of military disbursing officers in the Islands without increasing the amount actually in circulation until the occasion arose to disburse it. The Panama currency has been steadily maintained at par by friendly interchanges of this sort, even with a very insignificant official exchange fund. No Governor of the Philippines, therefore, need have any fear of his ability to maintain the parity of the Philippine coinage.

Whether the exchange standard would stand the strain of a great war is yet to be subjected to practical test.[84] It may be said, however, that its capacity to meet such a test would run upon all fours with the capacity of any monetary system which does not consist exclusively of gold coin. The experience of France in the war with Prussia seemed to justify the suspension of specie payments for the purpose of husbanding the national stock of gold. The history of the Spanish exchange, where the coins have followed the value of the bank-notes instead of that of silver bullion, is another case in point. Both Russia and Japan, however, in the war of 1904-5, succeeded in maintaining complete convertibility of their bank-notes. There is no reason why the gold exchange standard should not be successfully maintained so long as the country where it was established retained its national independence and pursued a sound financial policy. The issue of large amounts of debt would not in itself impair the stability of the standard, unless the Government, in order to obtain gold, ravished the exchange funds in financial centres. The questions involved would be substantially the same as those involved in maintaining the parity of bank-notes or paper money: first, the disposition of the Government to maintain its credit; secondly, the resources which the Government was able to command. Without either good intentions or monetary resources, the monetary system, along with the fiscal system, would break down. It is not apparent, however, that a country operating upon the gold exchange system would find any greater difficulty in maintaining the system than the Bank of Japan had in maintaining the convertibility of its notes during the war with Russia.

If there were a disposition in time of war to transfer capital abroad by excessive demands upon the exchange funds, it could be counteracted in three ways. One would be the automatic influence of the deficiency of currency which would arise at home. Another would be the issue of loans abroad, from which exchange demands could be met. A third would be the deliberate elevation by a small percentage of the charge for exchange. This would amount to a slight depreciation in the currency, but if kept within prudent bounds, it would probably permit the maintenance of an adequate circulation without disturbance to local prices and without even a theoretical depression below the 2 or 2-1/2 per cent. which affected the notes of the Bank of France in the war of 1870.

The gold exchange system may indeed be said to be an extension of the bank-note system to token coins. The token coin is, in effect, a metallic bank-note, whose maintenance at gold par is subject to the rules of sound banking. Its advantages over the bank-note in undeveloped countries are that it conforms to a strong prejudice in favour of "hard money," not subject to the vicissitudes of tropical climes, and that the output can be more safely regulated, where new coins are issued only for gold, than where a bank may increase its note issues to take over assets of speculative or doubtful character. In the advanced countries, with a highly organised credit system, gold, and gold alone, is the proper form of full legal-tender coin; but in the less advanced countries of the Orient silver token coins have the advantage that they conform in size and denominations to the small scale of local transactions, that they are not so rapidly absorbed by hoarding, and that their very non-exportability enables the Government to keep in circulation a quantity of currency which might under a different system be drained away to richer countries, and leave the community denuded of an adequate medium for carrying on exchanges.

OBJECTIONS TO THE GOLD-EXCHANGE STANDARD FOR THE STRAITS SETTLEMENTS ANSWERED

[85]... the establishment of the gold standard in the Straits Settlements ... in the spring of 1903 ... provided for the recoinage of the British and Mexican dollars then circulating in the Malay Peninsula into new Straits Settlements dollars ... of the same weight and fineness as the British dollar, and for the subsequent raising of the value of these new dollars to an unannounced gold par by means of limiting the supply, in accordance with the principle by which India raised the gold value of the rupee....

The objections urged to the adoption of the gold-exchange standard are [were]: (1) That it would unduly interfere with the [foreign exchange] business of the banks. (2) That it would encourage banks to work on dangerously low cash balances, knowing as they would that they could obtain dollars of the Government on a moment's notice by the purchase of cable transfers on Singapore from the crown agents for the colonies in London. (3) That there would be danger of the Government's notes [a part of the circulating medium] depreciating unless they were redeemable in gold in the country itself. (4) That the monetary circulation of the Straits Settlements was too small to make the plan feasible there. (5) That the plan would require a larger reserve fund than would otherwise be necessary, because the Government would be compelled to keep a reserve both in London and Singapore; and that in each place the reserve would have to be large, because drafts on the fund through the sale of telegraphic transfers would not give the Government any such warning in advance of the demands liable to be made as would enable it to replenish the reserve.

The above arguments, all of which were urged upon the writer either by officials or business men in the Straits Settlements, do not appear to be conclusive for the following reasons, which may conveniently be stated in the same order as the objections.[86] (1) If the rates for the sale of government drafts were fixed at the "gold points," as they presumably would be under the gold-exchange standard, and if only drafts of large amounts were to be sold by the Government, redemption by the sale of drafts would not interfere appreciably more with the business of the banks than would redemption in coin. Under these circumstances the banks themselves would be the principal purchasers of government drafts, and such drafts would be purchased and forwarded merely in lieu of the shipment of sovereigns. (2) The sale of telegraphic transfers, while desirable in the interest of currency elasticity, is by no means a necessary feature of the gold-exchange standard. If the Government were opposed to making a minimum legal reserve requirement of banks, it could limit its sales of drafts to demand drafts or even, if need be, to short-time drafts. (3) If government notes were redeemable in silver dollars on demand, and if the silver dollars were redeemable in gold exchange on demand, depreciation would be impossible in a country where the people have the confidence in the Government which they have in the Straits Settlements. (4) The system of the gold-exchange standard is better suited to a country with a small circulation than to one with a large circulation. It is evidently easier to maintain a small reserve abroad than a large one and the operations with a small reserve are less disturbing to the money market of the financial center in which the reserve is located. (5) It is not probable that the Straits Settlements would require so large a reserve under the gold-exchange standard as it will under the system to be adopted. Under either system it would need a sovereign reserve and a dollar reserve. Under the system to be adopted both reserves will be located in Singapore; under the gold-exchange standard the dollar reserve would be located in Singapore and the sovereign reserve in London. The sale of cable transfers is not a necessary part of the system, as above pointed out; and, even if it were, the movement of market rates of exchange would ordinarily give ample warning of a demand for dollar drafts or sovereign drafts. Emergency cases, if such should arise, could be met through the temporary transfer of funds to the gold reserve from the security portion of the note guarantee fund, or through the transfer of dollars to the credit of the home government in Singapore in exchange for an equivalent amount of sovereigns placed to the credit of the Straits government in London.... A prolonged and severe drain upon the reserve fund, which in a country like the Straits Settlements would be an extremely improbable contingency if the Government withdrew from circulation dollars presented in the purchase of government drafts, could of course always be met by the forward sale on the London silver market of the redundant dollars piling up in the Government's dollar reserve in Singapore. The gold-exchange standard would probably enable the country to get along with a smaller gold reserve than will the system to be adopted, inasmuch as it would keep gold coins out of circulation and the demands upon it would be limited to the requirements of meeting foreign trade balances--the only monetary use to which the dollars could not be applied. The Straits Settlements, inasmuch as it is a country for whose trade requirements silver coins are better adapted than gold, and a country which is anxious to maintain its reserve at as small an expense as possible, would in fact seem to be a place peculiarly adapted to the gold-exchange standard. The premiums which the Government would realize on its sale of exchange, together with the interest it would obtain on that part of its reserve deposited abroad, would doubtless yield sufficient profit, as in the Philippines, to pay the expenses of administering the currency system and to provide in addition a substantial annual increment to the gold reserve.

FOOTNOTES:

[80] Charles A. Conant, The Gold Exchange Standard in the Light of Experience, The Economic Journal, Vol. 19, June, 1909, pp. 190-200.

[81] Le Marche Financier en 1907-8, p. 711.

[82] These figures are from the annual budget statements of the Minister of Finance.

[83] For some of these doubts see London Bankers' Magazine, October, 1908, LXXXVI, p. 435.

[84] Throughout August, 1914, while sterling rates in other countries rose to unprecedented heights, India succeeded in maintaining rates on London in the neighborhood of the gold export point--a striking testimony to the soundness of the Indian arrangements.--EDITOR.

[85] E. W. Kemmerer, A Gold Standard for the Straits Settlements II., Political Science Quarterly, Vol. XXI, No. 4, p. 663, 678-680.

[86] The answers given to the objections just stated have been confirmed and strengthened by the actual operation of the gold-exchange standard as later adopted by the Straits Settlements.--EDITOR.

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XIII. A PLAN FOR A COMPENSATED DOLLAR

[87]In the Purchasing Power of Money (1911) I sketched a plan for controlling the price level, i. e., standardizing the purchasing power of monetary units. This plan was presented more briefly, but in more popular language, before the International Congress of Chambers of Commerce, at Boston, September, 1912. The details were most fully elaborated in the Quarterly Journal of Economics, February, 1913. Following these and various other presentations of the subject, especially the discussion at the meeting of the American Economic Association in December, 1912, the plan was widely criticized by economists, both favorably and unfavorably, as well as by the general public.

On the whole the plan has been received with far more favor than I had dared to hope and even the adverse criticism has usually been tempered by a certain degree of approval.

The object of the present paper is briefly to state the plan and to answer the more important and technical objections which have been raised. Answers to the more popular objections, omitted from this article through lack of space, will appear in a book, Standardising the Dollar, which I hope to publish in 1915.

I shall begin with a skeleton statement of the plan; space is lacking for more. In brief, the plan is virtually to vary each month the weight of the gold dollar, or other unit, and to vary it in such a way as to enable it always to have substantially the same general purchasing power. The word "virtually" is emphasized, lest, as has frequently happened, any one should imagine that the actual gold coins were to be recoined at a new weight each month. The simplest disposition of existing gold coins would be to call them in and issue paper certificates therefor. The virtual gold dollar would then be that varying quantum of gold bullion in which each dollar of these certificates could be redeemed. The situation would be only slightly different from that at present, since very little actual gold now circulates; instead, the public uses gold certificates, obtained on the deposit of gold bullion at the Treasury, and redeemable in gold bullion at the Treasury at the rate of 25.8 grains, nine-tenths fine, per dollar. The only important change which would be introduced by the plan is in the redemption bullion; we would substitute for 25.8 a new figure each month. The gold miner, or other owners of bullion, would, just as now, deposit gold at the United States Mint or Treasury and receive paper representatives, while the jeweler, exporter, and other holders of these certificates would, just as now, present them to the Treasury when gold bullion was desired.

There would also be a small fee or "brassage," of, say, 1 per cent. for "coinage," i. e., for depositing the bullion and obtaining its paper circulating representative. In other words, the Government would buy gold bullion at 1 per cent less than it sold it. This pair of prices, for buying and selling, would be shifted in unison, both up or both down, from month to month, it being provided, however, that no single shift should exceed 1 per cent., a figure equal to the amount by which the two differ. The object of this proviso is to prevent speculation in gold.

To determine each month what the pair of prices should be, or, what is practically the same thing, to determine what amount of gold bullion should be received and paid out in exchange for paper, recourse would be had to an official index number of prices. If, in any month, the index number is found to deviate from the initial par, the weight of bullion in which it shall be redeemable the next month is to be corrected in proportion to this deviation. Thus, the depreciation of gold would lead to a heavier virtual dollar; and an appreciation, to a lighter virtual dollar.

There are, of course, other details and possible variants of the plan, some of which will be referred to later when necessary. The objections to the plan are classified under the following heads:

1. "The plan assumes the truth of the quantity theory of money." There is nothing whatever in the plan itself which could not be accepted by those who reject the quantity theory altogether. On the contrary, the plan will seem simpler, I think, to those who believe a direct relationship exists between the purchasing power of the dollar and the bullion from which it is made--without any intermediation of the quantity of money--than it will seem to quantity theorists.

2. "It contradicts the quantity theory." This objection, the opposite of that above, is raised by some, who, like Professor Boissevain, believe in the quantity theory, but imagine that the operation of the plan could not affect the quantity of money at all (or would not affect it to the degree needed). But evidently an increase in the weight of the virtual dollar, i. e., a reduction in the price of gold bullion, would tend to contract the currency, by diverting gold from the mint into the arts; because its reduced price would cause an increased demand and consumption. A decrease, of course, would have the opposite effect.

3. "It might aggravate the evils it seeks to remedy." This objection, raised by Professor Taussig and a few others, is based on the preceding. It is claimed that an increase in coined money may take place for years "without visible effect on prices; then comes a flare-up, so to speak." I doubt if Professor Taussig meant the first half of this statement to be quite so strong. The evidence only justifies the statement that the rise is slow at first and rapid later while similarly the effect of a scarcity of money is slow at first and rapid later. Professor Taussig then proceeds to apply the same idea to my plan:

The cumulative consequence would be like the cumulative consequence of a long continued decline in gold production. After a season or two of declining bank reserves, tight money, and so on, a sudden collapse might be occasioned, and apparently caused, by the announcement of some particular seigniorage adjustment. Then there might be a decline in prices much greater than in proportion to the bullion change.

But the working of the compensated dollar would not be in the least analogous to the operation of gold inflation or contraction, even as Professor Taussig supposes it. The plan always works cumulatively toward par, never cumulatively away from par. One often sees a wagon with its wheels on a street-railway track having some difficulty getting off; the front wheels have to be turned at a large angle before they are forced out of their grooves; then of a sudden they jump away. This is analogous to the delayed "flare-up" of prices which Professor Taussig supposes under the influence of a long continued decline or increase in the gold supply. But if the driver instead of trying to turn out is trying to keep the wagon on the track he will pull the horse back at every tendency to turn to the right or left. The more the horse turns to the right the harder will the driver endeavor to turn him to the left. Clearly the effect of the driver's efforts will be to avert or delay, not to aggravate or hasten, any jumping out of the grooves which other causes may tend to produce.

In other words, if it takes as much time as Professor Taussig fears for a pressure on prices to move them, then so much the more certain is it that, under the plan, deviations from par, though they may be persistent, cannot be either rapid or wide. A long continued small deviation gives plenty of time for the counter pressure exerted by the compensating device to accumulate and head off any wide deviation.

Suppose that, following Professor Taussig's ideas, some cause such as an increase of gold production would, in the absence of the compensated dollar plan, gradually lift the price level as follows: during the first year, not at all; during the second year, 1 per cent.; during the third year, 2 per cent.; after which would come a "flare-up" of 10 per cent. We may suppose then that, if the plan were in operation during the first year, there being no deviation visible, there would be no change in the weight of the dollar. After the first month of the second year when prices were 1 per cent. above par, the weight of the dollar would according to the plan be raised 1 per cent. If this were unavailing, so that in the second month the deviation were still 1 per cent., the weight of the dollar would be again increased 1 per cent. Every month, as long as the deviation of 1 per cent. lasts, the weight of the dollar would receive an additional 1 per cent. Unless some effect were produced on the supposed original schedule of deviations, the weight of the dollar of the second year would be increased 12 per cent., and by the end of the third year by 24 per cent. more, or 36 per cent. in all. But it is clear that by this time, with so swollen a dollar, the "flare-up" scheduled for the fourth year could not occur, but that a counter movement would set in--in fact, would have set in long before the dollar became so heavily counterpoised. Nor could the result of the counterpoise, even if so heavy, be to swing suddenly prices far below par. Prices would, by hypothesis, yield slowly and again give time for taking the counterpoise off. If the price level sank, say to 1 per cent. below par for six months, then to 2 per cent. for another six months and to 3 per cent. in the next six months, evidently the entire 36 per cent. would be taken off in eighteen months (since 1 x 6 + 2 x 6 + 3 x 6 = 36). The compensating device is thus similar to the governor on a steam engine. It is the balance wheel that is largest and hardest to move which is the most easily controlled by the governor. So if the "flare-up" theory is true, the system will work more perfectly than if it were not true.

4. "It would not work unless every single mint in the world employed it." This is an error. Although it could be easily shown to be politically inadvisable for one nation alone to operate the plan, this would not be economically impossible. Those who hold the contrary are deceived by the term "mint price." They reason that our mint price ($18.60 an ounce of gold, 9/10 fine) and England's mint price (L3 17_s._ 10-1/2_d._ for gold 11/12 fine) are now "the same," and that, consequently, if our price were lowered 1 per cent., i. e., to $18.41, while the English price remained unchanged, all our gold would be taken to England to take advantage of the "higher" price there. But these comparisons between English and American prices are based on the present "par of exchange" ($4.866 of American money for the English sovereign): which par of exchange is in turn based on the relative weights of the dollar and the sovereign. As soon as our dollar were made 1 per cent. heavier, not only would the new American mint price go down 1 per cent., but the par of exchange would also go down 1 per cent., to $4.82. Consequently, the new mint price of $18.41, although in figures it is lower than the old, yet, being in heavier dollars, would still be "the same" as the English mint price of L3 17_s._ 10-1/2_d._ This sameness of mint price as between the two countries means at bottom merely that an ounce of gold in America is equivalent to an ounce of gold in England.

It is true that each increase in the weight of the virtual dollar in America--in other words, each fall in the official American price of gold--would at first discourage the minting of gold in America. The miner would at first send his gold to London, where the mint price was the same as formerly, and realize by selling exchange on the London credit thus obtained. But the rate of exchange would soon be affected through these very operations, by which he attempted to profit, and his profit would soon be reduced to zero; the export of gold to England would increase the supply of bills of exchange in America drawn on London and lower the rate of exchange until there would be no longer any profit in sending gold from the United States to England and selling exchange against it. When this happened it would be as profitable to sell gold to American mints at $18.41 per ounce as to ship it abroad; and $18.41 in America would be the exact equivalent at the new par of exchange ($4.82) of the English mint price of L3 17_s._ 10-1/2_d._

5. "The system would be destroyed by war." Professor Taussig fears that if money were stabilized, the system would itself be upset by war. "Any war would put an end to it." To this I would reply: first, that if war did put an end to it the system would do good so long as it lasted and its discontinuance would do no more harm than the existence of our present unscientific system is doing at all times; secondly I do not see any reason for thinking that war would put an end to it.

Possibly Professor Taussig has in mind the first form in which I explained the plan, viz., in my book, The Purchasing Power of Money. In that form one country was to serve as a centre and all other countries were to have the gold exchange standard in terms of gold reserves in the central country, just as now the Philippines have a gold exchange standard with reference to the United States and India with reference to England. Professor Taussig's objection would undoubtedly apply, to some extent, in cases where the plan was carried out through the gold exchange mechanism. But where the system was independently established in each country simply parallel to the systems in other countries, there would be no more need for its abandonment in case of war than for the abandonment now by Germany of the gold standard because England, its enemy, has the gold standard also. We know, of course, that in time of war, the gold standard is often temporarily abandoned in favor of a paper standard; and the new proposal would not escape such a difficulty. This, however, would not be due to the international character of the plan, but to the exigencies of war.

6. "The multiple standard is not ideal. Especially is it faulty when the cause of price movements is entirely a matter of the abundance or scarcity of goods in general." Those who hold this objection point out that an ideal standard would not be one which always smooths out the price level but one which discriminates and leaves unchanged such rises and falls as are due to general scarcity and abundance of goods. There is much to be said in favor of such discrimination as an ideal. It must be admitted that the compensated dollar plan would not discriminate between changes in the price level due to the scarcity or abundance of goods in general and those due to changes in money and credit. It must be further admitted that a theoretically ideal standard would take some account of this distinction. But the compensated dollar plan does not claim to be ideal. The plan would simply correct the gold standard to make it conform to a multiple commodity standard. It does not pretend to correct the multiple commodity standard to make it conform to some "absolute" standard of value.

Such an ideal standard is as unattainable as is absolute space. Changes in relative value indicate change in absolute value, either of goods or of money; but it is not possible for us to know, except in a general way, how much of the absolute change is in goods and how much in the dollar. On general principles we may be assured that the absolute change is wholly or mostly in the dollar. We economists in our measurements of value are in much the same predicament as the astronomers. Our economical "fixed stars" are fixed only in a relative sense. We cannot measure the empty spaces of absolute value, but can only express values in terms of visible goods, the general average of which is the nearest approach to absolute invariability we can, in practice, reach.

But if it were possible to measure absolute values to our universal satisfaction, in terms, say, of "marginal utility," or of "disutility of labor," or of anything else, there are no statistics by which we can realize such a standard in practice. The only readily available statistics by which we can correct our present standard are price statistics from the great markets. We can, by index numbers based on these price statistics, translate from gold into commodities, but as yet we cannot translate from commodities into any ideal or absolute standard.

If I were treating of the problem of an ideal standard of value, I think I should be inclined to agree with Professor Marshall that a standard that represents a gradually descending scale of prices to keep pace with the "real" cheapening improvements in industrial processes is better than one which represents an absolute constancy of prices. But it would be quite impracticable to discover the exact rate of fall of prices which would correctly register the improvement going on in industry, and, moreover, it would, I believe, be so small as not to depart much from the mutiple standard. This I infer is also the opinion of Professor Marshall.

Professor Kinley makes the very interesting suggestion that we can suppose a more ideal standard than the tabular by making our unit a definite percentage of the national annual dividend. This appeals to me as a rough and ready way of fixing a unit more nearly ideal than that fixed by the tabular standard. But it would certainly not be practicable. It would not even be quite ideal. But if Professor Kinley will measure his standard, the compensated dollar plan will be able to take care of it.

In fact, if we could find a more absolute standard than the tabular standard and could accurately measure it in statistics, precisely the same method of compensating the dollar could be employed to keep the dollar in tune with that standard as with the tabular standard. The only difference would be that the guiding index would be different. The plan for compensating the dollar does not in essence consist in selecting the multiple or any other standard. It consists in a method of making the monetary unit conform to any standard chosen. But there is convincing evidence that the multiple standard is usually near enough to the ideal for all practical purposes and infinitely nearer than the gold standard. While individual goods may vary greatly in absolute value, the general mass of goods will vary comparatively little and seldom. There may be some absolute change in the general mass of commodities, but it must usually be extremely small in comparison with changes in any one commodity like gold. It is clear from the theory of chances that this must be the case. The odds are hundreds to one that the variations in absolute value in several hundred commodities will offset each other to a large degree. We very seldom have world feasts or world famines. If the corn crop is short in some places it is abundant in others. If it is short everywhere the crop of wheat or barley or something else is practically certain not to be. We cannot expect that everything will usually move in one and the same direction. If there is a war in Japan, it is not likely that there will also be a war in India. A world war or even anything as near to a world war as the present conflict in Europe is a most unusual thing.

A standard composed of several hundred commodities must therefore be, in all human probability, more stable than a standard based, as is our present gold standard, on one commodity. Bimetallists made much of this point when claiming that two metals joined together were steadier than one, just as two tipsy men walk more steadily arm in arm than separately. Still more steady is the average of a hundred commodities just as a line of a hundred tipsy men abreast and holding each other's arms will march even more steadily than two. This is because it is wholly unlikely that every man in the line will lurch in the same direction at the same instant. The lurching of some in one direction can always be depended on to offset almost entirely the lurching of others in the other direction. This theory of probabilities in its application to the present rise of prices is, I believe, borne out by the facts.

After a careful study of all available evidence, I am convinced that the present general rise in prices beginning in 1896, cannot be traced to any simultaneous scarcity of goods. I refer the reader to Why Is the Dollar Shrinking? where I have given the summary of the evidence. I think the facts are equally clear that the great fall in prices from 1873 to 1896 can not be laid, wholly at least, to the increasing plentifulness of goods.

Finally, even if we could measure and apply an absolute standard, it is doubtful if, in practice, it would be of any more service in regulating contracts, than a multiple standard. For after all, as I have tried to show in Appreciation and Interest what we want in a contract is something that is dependable rather than something that is absolutely constant; and the multiple standard gives dependability in terms of the ordinary staple necessities of life. If we could know that the dollar always means a definite collection of goods, we could know that the bondholder or the salaried man who gets a stated income of $100 a month, would have the same command over actual goods, and such knowledge would be of great service. This whole subject I have discussed in Chapter X of my Purchasing Power of Money.

7. "It would be inadequate to check rapid and large changes of the price level." Owing to the narrow limits, e. g., 1 per cent. as stated, imposed on the monthly adjustments, it is quite true that a sudden and strong tendency of prices to rise or fall could not be completely checked. If prices were to rise 8 per cent. per annum and the plan permitted no more rapid shift than 6 per cent. per annum, this would leave only 2 per cent. per annum uncorrected, or only one-fourth the rate at which prices would rise if wholly uncorrected. But half (or in this illustration three-quarters of) a loaf is better than no bread. Moreover, such extreme cases are rare and when they occur there is all the keener need for mitigation even if it be somewhat inadequate. Ultimately, of course, after the rapid spurt has abated, the counterpoise, in its relentless pursuit, would overtake the escaped price level and bring it back to par.

8. "The correction always comes too late." It is objected that the plan does not make any correction until actual deviation has occurred, and so the remedy always lags behind the disease. It is true that the corrections follow the deviations. They could not precede them unless we foreknew what the deviations were to be; and we could not afford to entrust the work of guessing to government officials. In this respect, as in others, the plan does not attain perfection; yet it is infinitely better than the present plan, which leaves the standard haphazard. It is also pointed out that after the correction is applied it may happen that prices will take the opposite turn, in which case the remedy actually aggravates the disease. But, taking the extremely fitful course of prices since 1896 and correcting it according to the plan, month by month, as shown in the Quarterly Journal of Economics diagram, we find that in nine cases out of ten the opposite is true. Even in the few remaining cases the deflections were very slight and were, of course, soon corrected immediately after the following adjustments. If the corrections are sufficiently frequent, it is impossible not to maintain, in general, an extremely steady adjustment.

When steering an automobile the chauffeur can only correct the deviation from its intended course after the deviation has occurred; yet, by making these corrections sufficiently frequent, he can keep his course so steady that the aberrations are scarcely perceptible. There seems no reason why the monetary automobile cannot be driven almost equally straight.

9. "The plan assumes that a 1 per cent. fluctuation can be exactly corrected by a 1 per cent. adjustment of the dollar's weight." Owing, I fear, to my own fault of phrasing, I have found that several people have acquired the mistaken impression that the plan requires, to be made at each adjustment, an increase of 1 per cent. in the weight of the dollar for every 1 per cent. increase of the index number since the last adjustment; whereas actually the plan requires, to be made at each adjustment, an increase of 1 per cent. in the weight of the dollar for every 1 per cent. excess of the index above par then outstanding.

From this mistaken premise it has naturally been inferred that, in order that the plan should work correctly, a 1 per cent. loading of the dollar would always have to exactly correct a 1 per cent. change in the index number, and, very properly, the critics doubted the truth of this. But since the premise was mistaken the objection based on it disappears.

10. "The plan would be sure to create dissatisfaction and quarrelling." This fear is, I believe, wholly imaginary. There would be some ground for it if the proposal were to adopt the old "tabular standard" by correcting money payments through the addition to or subtraction from the debt of a certain number of dollars. Under these circumstances the extra dollars paid or the dollars from which the debtors were excused would stand out definitely and would be a subject for debate and dispute, but if the tabular standard were merged in the actual money of the country the ordinary debtor and creditor would be as unaware of how his interests had been affected as he is now unaware of how his interests are affected by gold appreciation. It would still be true that to the ordinary man "a dollar is a dollar."

If we cannot get the ordinary man to-day really excited over the fact that his monetary standard has affected him to the tune of some 50 per cent. of his principal of fifteen years ago, it does not seem likely that he could get excited because some one tells him that the index number used in the "compensated dollar" plan robbed him of 1 or 5 per cent. as compared with some other possible system.

The debtor class favored in large measure bimetallism, or free silver, as a means of helping them pay debts, while the creditor class opposed it. But this was a question of changing the standard, not of keeping it unchanged. If it were proposed to shorten the yardstick, undoubtedly many who would profit in the outstanding contracts would and ought to oppose it. But there is and can be no contest over efforts to keep the yardstick from changing.

11. "It has never been tried." True; but the proposal is, in mechanism, almost identical with the gold exchange device introduced by Great Britain to maintain the Indian currency at par with gold. The system here proposed would really be to-day less of an innovation in principle than was the Indian system when introduced and developed between 1893 and 1900, while the evils it would correct are similar to, but vastly greater than, the evils for which the Indian system was devised.

The truth is, unless I am greatly mistaken, that the last named is the only strong objection to the plan in the minds of most of its critics; it is the constitutional objection to any change of the status quo. It is simply the temperamental opposition to anything new. As Bunty well says in the play, "anything new is scandalous." The conservative temperament dislikes experiment because it is experiment. Accordingly it is not surprising that we find many of the objectors saying, "let well enough alone," "let us 'rather bear those ills we have than fly to others that we know not of.'" These people seldom give assent to untried experiments; yet after the new plan has been tried and established they invariably turn about and become its most staunch supporters. This fact has been often illustrated in our monetary and banking system. Nothing short of the shock of civil war was required to divert us from a state system of banking to a national one. In spite of the intolerable evils of the former, it was easy to find many arguments in its favor. After the change these arguments never reappeared. The same was true of slavery.

But conservatism always yields gradually to pressure. Its resistance is strong but has no resiliency. It is not like the resistance of a steel spring (which, when pushed in one direction, will bend back), but a mass of dough or putty which, though it resists impact strongly, yet when it is moved stays inert and does not return. Under these circumstances, even if progress is made an inch at a time, it seems to me worth while to try to make it. The two steps first necessary have been taken, namely, the perfecting of the plan and the running the gauntlet of criticism.

It is not impossible, judging from the many and authoritative endorsements of the plan, that it may be pushed rapidly toward realization. All depends on the opening up of opportunities. After the present war, for instance, it may be that "internationalism" will come into a new vogue and that some special opportunity will be afforded to bring the plan with its endorsements to the serious attention of the world's administrative officials.

* * * * *

[88]It must be admitted at the outset that the plan, if carried out with iron consistency for a considerable stretch of time, would achieve the result mainly had in view--the prevention of a long-continued and considerable rise in prices. It might not achieve that result as smoothly and evenly as its proposer expects; and the qualifications just stated--that it must be carried out unflinchingly for a long period--should be borne in mind. No one who holds to the doctrine that the general range of prices is determined by the relation between the quantity of commodities and the volume of the circulating medium, and that the volume of the circulating medium in the end depends, ceteris paribus, on the amount of coined money, can do otherwise than admit the logical soundness of the scheme. He who maintains that the rise in prices during the last fifteen years is due to the greater gold supply must admit that a restriction of the monetary supply of gold will check the rise. The plan proposed is in essence one for a regulation in the monetary supply of gold. Its effects must be the same in kind as those of a cessation of free coinage, with an apportioned limited coinage....

The question arises whether it would be feasible for one country alone to adopt the plan. It would be feasible, in the same sense that it would be feasible for all countries together to adopt it. One country alone, carrying it out with unflinching consistency, might secure the desired result, subject to the qualifications which have already been indicated. But that any one country would in fact adopt it alone seems to me in the highest degree improbable.

Consider for a moment the mode in which the scheme would work in detail if adopted by a single country. Though the immediate effect upon general prices within the country would be unpredictable, the effect upon certain kinds of prices would be certain, predictable, almost instantaneous. Exported commodities would feel the effect at once. Their prices are determined, to use the current expression, by the foreign market. It would be more accurate to say that their prices are determined by the total market, domestic as well as foreign. But it is clear that their prices must be the same (due allowance being made for transportation charges and the like) within the country as without. Now the immediate effect of a seigniorage would be, as Professor Fisher points out, a readjustment of the par of foreign exchange. The exporter would find the par of exchange lessened, and in terms of domestic money (compensated dollars) he would receive less than he got before. All commodities of export would fall in price at once, or fail to rise, to the extent of the seigniorage. Other commodities probably would be unaffected for the moment. In the long run, no doubt, these other commodities (we may call them domestic commodities) would also be affected. But, to repeat, the rapidity and extent of the change in general prices is impossible of prediction. The exporters, none the less, would feel an immediate and unmistakable effect. Beyond question they would be as hotly indignant with the plan as if an excise tax had been imposed on their commodities without any possibility of their raising the price of their products. Consider for a moment what would be the state of mind in our cotton-exporting South. Is it to be supposed that any set of legislators could resist the political pressure from the various exporting sections, and carry out the scheme unflinchingly? Can we imagine a Congressman telling his constituents that they need only wait a while, until all money incomes and all prices had adjusted themselves to the new conditions? that then nobody would be worse off or better off than before? To ask this sort of question is to answer it. The very proposal of the scheme in the halls of Congress would invite the hot opposition of the exporting sections and industries. Its immediate consequences for them would be seen quickly enough, and no promise of ultimate adjustment would lessen their hostility....

Professor Fisher has predicted that prices will rise further. He is disposed to believe that there will be not only a rise, but that there will be a considerable rise. I hesitate very greatly to enter the domain of prediction. I am inclined to believe that the rise in prices will not cease for the next decade; but whether it will be considerable or moderate or negligible in extent, I should not venture to say. Predictions concerning the output from the mines are to be taken with the greatest caution. We all recall the predictions which Suess made in 1892. The distinguished geologist believed that the prospects of an increased production of gold were of the slightest, and that the world must fall back on the use of both metals. How different the course of events has been from that which he predicted! There are those who believe that the output of gold, so far from continuing to increase, has reached, or is approaching, its maximum. For myself, I should not be surprised if there were a cessation in growth, and should certainly be surprised if there were not a relaxation in the rate of growth.

Further: it deserves to be borne in mind that the total supply of the precious metals is now so much greater than it was twenty years ago that the same annual increment will have much less effect on prices. This is the familiar consequence of the durability of the precious metals....

Finally, a circumstance should be borne in mind which bears not only upon the intrinsic desirability of a regulative plan, but also upon the attitude of the general public and the consequent political and industrial possibilities. Economists are familiar with the difference between the phrase which they use in describing the new conditions, and that which is current in popular discussion. The economists speak of the "rise in prices"; the general public speaks of the "high cost of living." The difference in phraseology is not due simply to variation of the point of view. It results from the fact that very different phenomena are had in mind by the two sets of persons. The economist is thinking and reasoning about the change which has been of special interest for him--the general rise in prices. The man on the street is thinking about the exceptional rise in the prices of one important set of commodities. Any one who will examine with care the index numbers of our Bureau of Labor will see what a marked rise, much beyond that of the general index number, has appeared in the prices of farm products, and especially in the prices of meat. That special advance has taken place within the last three or four years. It is precisely within this period that general attention has been turned to rising prices. What the public has had chiefly in mind has been the commodities of wide consumption. This, I believe, is the main cause of labor unrest....

Whatever be the particular causes that have led to the high prices of food, economists agree that these causes will operate irrespective of any compensated dollar plan. This would simply serve, at its best, to keep general prices where they are, leaving each particular group of commodities subject to its own particular set of causes. If the compensated dollar plan were to be adopted, and if the prices of food should continue to mount, there would be disappointment for the general public, but nothing to surprise the economist. And conversely, it is entirely possible that the rise in the cost of living, that is, the special rise in the prices of foodstuffs, will reach its end irrespective of any monetary change whatever. The general rise in prices and money incomes ... is not unwelcome to the great majority of people. Its incidental consequences are perceived and debated chiefly by the economists; such as the effects on the creditor class and the slowness of so-called fixed incomes to rise correspondingly. The general public is concerned chiefly with the conspicuous rise in the prices of foodstuffs, which is ascribable to causes very different from those that bring the general rise, and can be reached only by remedies very different....

FOOTNOTES:

[87] Adapted from Irving Fisher, Objections to a Compensated Dollar Answered, reprint from The American Economic Review, Vol. IV, No. 4, December, 1914.

[88] F. W. Taussig, The Plan for a Compensated Dollar, The Quarterly Journal of Economics, Vol. 27, May, 1913, pp. 401-416.

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XIV. MONETARY SYSTEMS OF FOREIGN COUNTRIES

ENGLAND[89]

[90]The monetary unit is the pound, or sovereign, equal to $4.8665, divided into 20 shillings of 12 pence each, each penny equal to 4 farthings. Originally the pound was a Troy pound of silver, .925 fine. Under the law of 1816 gold was made the standard and silver subsidiary. The coinage of gold is free, and to avoid delay the Bank of England is required to buy all gold and pay for the same at once at the [minimum] rate of L3 17_s._ 9_d._ per ounce, a [maximum] charge of 1-1/2_d._ being imposed for the accommodation. Silver is only coined on government account and the coinage ratio is 14.29 to one.

They have the gold sovereign (containing 113.001 grains pure gold), the unit of their currency, also half-sovereigns, crowns (5_s._), double florins, (4_s._), half-crowns, florins, shillings, six and three pence pieces, four pence (groat), two pence and penny, all in silver, also penny, half-penny, and farthing in bronze. A few English banks, operating under old charters, issue notes to a limited extent, which circulate as money. Otherwise the paper currency of England and Wales consists wholly of notes of the Bank of England....

Extraordinary measures were resorted to by the British government in the early stages of the European war of 1914; with the close of the war currency conditions will doubtless go back to normal, as described above.

The Government, also, under date of August 6, authorized an issue of currency notes, in denominations of L1 and 10 shillings....

These notes, which were first issued to the public August 7, were deposited with the Bank of England for account of the British government, as the practical way of getting them into use; they were used for various purposes, including advances to banks at 5 per cent. per annum, up to 20 per cent. of their deposits; the volume outstanding December 30, 1914, was L38,478,164; the amount outstanding on June 23, 1915, was L46,199,705. These notes were protected in part by securities and by an increasingly large gold reserve, exceeding 75 per cent. in March, 1915.

Postal orders were made legal tender and so remained until February 4, 1915....

CANADA

In 1857 the legislature of Upper and Lower Canada formally adopted dollars and cents as the money in which public accounts should be kept. The Confederation in 1867 adopted the same for the Dominion, retaining, however, the sovereign.

In 1871 the Currency Act prescribed the same for all accounts, providing also that the gold coins of the United States of America should be legal tender along with British sovereigns, the latter at a rating of $4.86 2/3.

The silver and bronze tokens (including pieces of 50, 25, 20, 10, 5, and 1 cents) had been supplied from the London Mint, or from Birmingham on its behalf, from 1856 to 1907. After the Confederation no more coins were issued for the separate Provinces. The twenty-cent piece (though still retained by Newfoundland) has not been struck for Canada since 1864.

From January 2, 1908, the whole supply of British and Canadian coins was undertaken by the Ottawa Mint. By the Ottawa Mint Act the Dominion Parliament undertook the support of a branch of the Royal Mint in Ottawa, the administration to be in the hands of the British Treasury. This system (the same as that of the Australian Branch Mints, Sydney, Melbourne, Perth) was preferred to the plan of an independent Dominion Mint because that was the only way of procuring the privilege of coining British sovereigns.

A royal proclamation published on November 2, 1907, duly established a branch of the Royal Mint at Ottawa, and authorized the coinage of British sterling gold coins from dies prepared in England, such coins to rank with those struck in London. The depositor of gold bullion has the right to demand British sovereigns in exchange....

The British sovereign (or pound) is legal tender in Canada at $4.8666. The American gold coins are also legal tender. Canadian silver coins are 925 parts fine, and have a slightly less amount of fine silver than United States of America silver coins of similar circulating values. The dollar, though sanctioned, has not yet been struck.

Paper currency consists of legal-tender Dominion notes and bank-notes issued against the credit of the banks; there were at the end of 1914, 22 banks, with 3,130 branches in the Dominion, 20 in Newfoundland and 72 in the United States and other foreign countries....

On July 31, 1914, just before the war, Dominion notes were issuable without limit, providing the amount over $30,000,000 was covered by gold. The volume at that time was $112,821,618.53 and the gold held amounted to $90,292,833.28. As a consequence of the war the limit beyond which Dominion notes may not ordinarily be issued without being entirely covered by gold was by an Act passed in August increased from $30,000,000 to $50,000,000....

BRITISH COLONIES

The British West Indies, as also Guiana, make British gold legal tender. United States gold also circulates freely. There are a few banks with limited note-issuing power, and minor coins are similar to those of England. There is a growing use of United States currency.

British Honduras has a dollar unit, identical with that of the United States.

British India has ... adopted the gold [-exchange] standard and India has for some years been largely absorbing gold; the pound is the unit--the metallic currency, mainly silver, is maintained at parity with gold by an arbitrary valuation or rate of exchange. The principal coin is the rupee, equal to $0.3244; by a fixed government rating 15 rupees equal L1. There is a gold [-exchange] standard reserve for India, amounting, March 13, 1915, to L25,627,393, about one-half held in India and one-half in London; it consists of gold and investments.... Paper money is issued only by the Government and is covered by gold, silver largely, and securities to some extent.

The Straits Settlements have a dollar currency, divided into 100 cents; the value of the dollar was fixed by the Government at 2_s._ 4_d._, on January 29, 1909, and has since been maintained at approximately that rate, a gold [-exchange] standard reserve being accumulated for that purpose. The system is copied after that of India.

Hong Kong, silver standard, is the exchange point between gold and silver countries, and hence important. The British dollar of 416 grains is the principal coin. It fluctuates in value with the value of silver bullion.

Australia and New Zealand have the British system of banking. There are many banks, some with British charters, and many branches; they issue notes covered by gold. Gold in large quantities has been produced in these states since 1851.

British Africa and other minor Eastern possessions have the British system, modified in various respects.

Egypt having recently been formally annexed by Great Britain, her monetary system will naturally be closely identified with that of England in the future. The English sovereign has been for many years the gold coin of common use.

LATIN UNION

The Latin Union consists of France, Italy, Belgium, Switzerland and Greece; they are bimetallic, both gold and silver being full legal tender, and the coinage ratio being 15-1/2 to 1; they have identical systems, and formed a union to maintain the parity of silver and gold, at the above ratio, by accepting each other's silver coins; while their systems are bimetallic in law, silver is now coined only in small denominations and on government account. The general adoption of the gold standard by other countries has embarrassed the efforts of the Union to preserve the parity and also the interchangeability of silver coins between these nations.

FRANCE

France has the franc, equal to $0.193, as the monetary unit; the principal gold coin is the louis, equal to 20 francs. The paper currency of France is issued wholly by the Bank of France, a private corporation, privately owned, but whose chief officers are appointed by the Government, which thereby obtains a general control of policy and administration; the maximum amount of note-issue is fixed by law, arbitrarily, and by occasional increase is kept well ahead of the country's necessities; no fixed legal reserve is required, but the total note-issue must be covered by gold, silver, securities, and commercial paper; as a matter of fact it carries very large metallic reserves, and since it may lawfully pay its obligations in either gold or silver, it can always conserve its gold holdings by requiring a premium for the same, or withhold gold payment altogether.

It has over 400 branches and the same rate of discount obtains in all branches on the same day; it thus regulates and controls the interest rate throughout France, in the interest of uniformity and fairness; it may do business with banks or individuals and has many very small loans; its notes are a legal tender; the power to issue currency is one of its chief elements of banking power....

BELGIUM

Belgium is bimetallic and its coins are the same as those of France and have unlimited lawful currency; bank-notes are issued only by one bank, privately owned; the Government receives a share of the dividends in excess of 6 per cent., and imposes a tax upon the note-issues; demand liabilities, including notes, must be protected by a coin reserve of 33-1/3 per cent. and the notes must be covered by cash, commercial paper and securities.

ITALY

Italy has the lira, equal to $0.193, and divided into 100 centesimi; her coins correspond to those of France; the Bank of Italy largely, and two other banks to a lesser extent, issue notes against their credit, limited, however, to three times their capital, unless covered by gold; the issue may be increased, but comes in for a tax of 1 per cent. per annum and must be protected by a 33-1/3 per cent. reserve in coin and foreign exchange....

SWITZERLAND

Switzerland's coinage system duplicates that of France, and her Federal Bank is very similar to the Bank of France....

GREECE

Greece ... has for its monetary unit the drachma, equal to $0.193. Her coinage follows the Latin Union agreement. Paper currency is issued both by the Government and by banks, and both are depreciated. Greece had to resort to emergency measures during the Balkan War, which may have an influence upon her currency for some time.

SPAIN

Spain ... has the peseta, equal to $0.193 United States, as her unit. The Bank of Spain has the sole right to issue notes, which may equal five times its capital and must be protected by a 25 per cent. coin reserve. Gold commands a premium. Silver is coined only on Government account....

GERMANY

Germany, gold standard, has for her currency unit the mark, of 100 pfennig, equal to $0.238; the 5-mark piece contains the same amount of pure silver as the 5-franc piece and two United States half-dollars.... Silver is legal tender to the amount of 20 marks. The coins for her colonies are varied to suit local needs.

AUSTRIA-HUNGARY

Austria-Hungary, gold standard, has as its unit the krone, equal to $0.2026; 20-krone and 10-krone pieces are coined in gold, also gold ducats, worth $2.288; silver coins are of various fineness....

PORTUGAL

The Portuguese Government, by decree of May 22, 1911, adopted a new monetary system and the coins will be placed in circulation as soon as possible. The unit of the system, excepting for her possessions in India, is the gold escudo,... equal to $1.08 American gold. The escudo is divided into 100 equal parts called centavos.... Multiples are 2, 5, and 10 escudos. Divisions of the escudo are of silver, with values of 50, 20, and 10 centavos; subsidiary coins consist of bronze and nickel pieces. Her currency is not maintained at a parity with gold.

NETHERLANDS

... The unit is the florin or guilder of 100 cents, equal to $0.402. The 10-florin piece is the principal gold coin; the ryksdaalder (2-1/2 florins), the florin and half-florin in silver are legal tender, as well as all gold coins; silver is maintained at parity with gold by law; coinage of silver is only on Government account; paper money is issued by a central bank and 40 per cent. metallic (gold and silver) reserve is required against deposits as well as notes; the balance of the notes are covered by negotiable instruments. The central bank was organized in 1814. Banking in the Netherlands is excellently managed.

SWEDEN--NORWAY--DENMARK (SCANDINAVIAN UNION)

These have the gold standard and have for their unit the krone, equal to $0.268 United States currency; their subsidiary silver has various fineness; paper currency of Sweden is issued by the Royal Bank, owned by the Government; notes are legal tender and may be issued to a fixed amount in excess of gold on hand or in foreign banks, but must at all times have gold to the extent of at least 10,000,000 kroner.

Norway has a single bank of issue, controlled by the State, which owns a majority of the stock; notes are legal tender and may be issued to twice the amount of gold on hand and in foreign banks.

Denmark's paper money is issued by a privately owned bank, but under strict control by the Government; the notes are legal tender and may be issued to a sum 30,000,000 kroner in excess of the gold on hand.

RUSSIA

Russia is on a gold basis and has for its unit the ruble, of 100 kopecks, equal to $0.51456 in United States currency; the silver coins in common use are the ruble, one-half and one-fourth ruble; paper money is issued by the Imperial Bank, which is owned by the Government and managed as part of its finance department; the law requires the coin reserve to equal two-thirds of the note issue....

JAPAN

Japan maintains the gold standard and its unit is the yen, equal to $0.498; the yen is divided into 100 sen, the sen into 10 rin. The yen equals 11.574 grains of pure gold.

The Bank of Japan may issue notes to the extent of $120,000,000 upon securities, any amount upon specie, and also may issue further sums in excess of specie, subject to a tax of 5 per cent. The stock of the bank is all privately owned. Japan first copied the national banking system of the United States and after trial abandoned the same for a central bank. She has managed her finances and her banking with wonderful ability and great success. Besides the Bank of Japan, there are many strong private banks, notably the Yokohama Specie Bank.

CHINA

China, silver basis, had for its unit the tael, divided into 1000 cash; there are said to be sixteen different kinds of tael in the different states of China; the most valuable is the "Haikwan," or "customs tael," the one in which customs dues are reckoned, and this equalled $0.664 United States currency, October 1, 1914. The cash is of base metal, with a square hole punched in the centre and is worth less than a mill in our currency.

In the last years of the Empire a new system of coinage was established and since continued by the Republic. The unit is the yuan of silver, worth $0.477, but varies with the price of silver; one-half, one-fifth, and one-tenth yuan are also coined in silver and smaller coins in copper and brass....

PHILIPPINES

The unit of value is the peso, equal to $0.50 in United States currency. The fiscal affairs are administered by the United States and the currency is safe and maintained on [essentially] a gold basis.

ARGENTINA

At a time when the cultivation and development of trade relations with South America seem most alluring, we find a principal embarrassment in the currency and credit conditions which obtain in most South American States, but Argentina, one of the most favored of South American States, has a stable and sound currency system. Her unit is the peso, of 100 centavos. The gold peso is equal to $0.9647 in United States money. In 1889 the Government took measures to acquire gold and fixed the relation of paper to gold at 227.27 per cent., and it has since been maintained at that level without fluctuation. This made the paper peso equal to about $0.44 gold. They have a very large gold reserve in their caja de conversion, 262,000,000 pesos gold, which protects the paper money and gives it stability. Gold payments were suspended temporarily at the commencement of the European war (1914), but paper money seems to have remained at par....

BRAZIL

Brazil was formerly a colony of Portugal, and naturally copies the parent country in her currency system. Her unit is the milreis, of 1000 reis. Nominally the gold standard prevails, but depreciated paper is the currency of her commerce. The milreis contains 12.686 grains of pure gold and is worth in United States currency $0.546.

In 1898 the Government assumed the sole power to issue paper money, and strove to bring the same to a parity with gold; the arbitrary valuation put upon the milreis by the Government was 15_d._ or $0.30.

On December 20, 1910, the value of a milreis was raised to 16_d._ The Government accumulated a conversion fund, understood to be $60,000,000 to $70,000,000, but owing to crises at home and abroad it has not yet been able to make gold and paper notes interconvertible.

Brazil possesses an enormous area, and is wonderfully rich in undeveloped resources. Her coffee and rubber are especially valuable and should take care of her international trade balances. In the near future her currency should become stable and free from fluctuation. Brazilians receive important service from foreign banks and bankers.

CHILI

Chili has the gold standard, but her paper currency is not maintained at a parity with gold; her unit is the peso, of 100 centavos, of the value of 18_d._...

FOOTNOTES:

[89] The following table, from The Monetary Systems of the Principal Countries of the World, compiled in the office of the Director of the Mint, Washington, 1912, gives the weight, fineness, etc., of the coins of Great Britain:

GOLD -----------------+-------+------------+-------+--------+--------+-------- | | | | | Pure |Value in Denominations. |Weight.| Fineness. | Fine | Weight.|gold or | United | | |weight.| |silver. |States |Grams. |Thousandths.|Grams. |Grains. |Grains. | money. -----------------+-------+------------+-------+--------+--------+-------- 5 pounds |39.9410| 916-2/3 |36.6125|616.3720|565.0080|$24.3325 2 pounds |15.9764| 916-2/3 |14.6450|246.5488|226.0032| 9.7330 Sovereign | 7.9881| 916-2/3 | 7.3225|123.2744|113.0016| 4.8665 Half sovereign | 3.9941| 916-2/3 | 3.6612| 61.6372| 56.5008| 2.4332 -----------------+-------+------------+-------+--------+--------+-------- SILVER -----------------+-------+------------+-------+--------+--------+-------- Half crown |14.1379| 925 |13.0775|218.1760|201.8119| $0.6083 Florin |11.3103| 925 |10.4620|174.5405|161.4495| .4866 Shilling | 5.6551| 925 | 5.2309| 87.2695| 80.7232| .2433 Sixpence | 2.8275| 925 | 2.6154| 43.6339| 40.3008| .1216 Fourpence (groat)| 1.8850| 925 | 1.7436| 29.0893| 26.9071| .0811 Threepence | 1.4137| 925 | 1.3076| 21.8162| 20.1788| .0608 Twopence | .9425| 925 | .8718| 14.5446| 13.4536| .0405 Penny | .4712| 925 | .4358| 7.2715| 6.7252| .0202 -----------------+-------+------------+-------+--------+--------+--------

[90] A. Barton Hepburn, A History of Currency in the United States, pp. 450-473. The Macmillan Company. New York. 1915.

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