Money

Front matter

Ho

' CORNELL UNIVERSI'i,^^

I.IBRARY

Introduction To The Series

The Theory of Economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions. It is not difiBcult ia the sense in which mathematical and scientific techniques are difficult; but the fact that its modes of expression are much less precise than these, renders decidedly difficult the task of conveying it correctly to the minds of learners.

Before Adam Smith this apparatus of thought scarcely existed. Between his time and this it has been steadily enlarged and improved. Nor is there any branch of knowledge in the formation of which Englishmen can claim a more predominant part. It is not complete yet, but important improvements in its elements are becoming rare. The maia task of the professional economist now consists, either in obtaining a wide knowledge of relevant facts and exercising skill in the application of economic principles to them, or in expounding the elements of his method in a lucid, accurate and illuminating way, so that, through his instruction, the number of those who can think for themselves may be increased.

This Series is directed towards the latter aim. It is intended to convey to the ordinary reader and to the uninitiated student some conception of the general vi INTRODUCTION TO THE SERIES

principles of thought which economists now apply to economic problems. The writers are not concerned to make original contributions to knowledge, or even to attempt a complete summary of all the principles of the subject. They have been more anxious to avoid obscure forms of expression than difficult ideas; and their object has been to expound to intelligent readers, previously unfamiliar with the subject, the most significant elements of economic method. Most of the omissions of matter often treated in textbooks are intentional; for as a subject develops, it is important, especially in books meant to be introductory, to discard the marks of the chrysalid stage before thought had wings.

Even on matters of principle there is not yet a complete unanimity of opinion amongst professors. Generally speaking, the writers of these volumes believe themselves to be orthodox members of the Cambridge School of Economics. At any rate, most of their ideas about the subject, and even their prejudices, are traceable to the contact they have enjoyed with the writings and lectures of the two economists who have chiefly influenced Cambridge thought for the past fifty years. Dr. Marshall and Professor Pigou.

J. M. Keynes.

Preface

§ 1. This book is intended to be a more or less selfcontained unit: but it is also the second volume of a series. Its connection with its predecessor — Mr. Henderson's Supply and Demand — is to be found in the emphasis laid on the theory of money as a special case of the general theory of value. Its bearing upon the remaj nderof the series is to be found m the conclusion to which the booFteads Up, that Mo H6y is af ter alTa," 'fundament ally unimportant su bject, In the sense that 'TTPitiWIJtTp rnnst revolutionajxjjoi' the ~^sounc^t^^ monetary policy can be expected to provide jjreniedy •-f OTTKbse stra ins and disharmonies whose roots lie deep -■ in the presenfstnro tBre;:MJBdustryrartd"perEaps in the veryjoature^ofman himself.

attempt hasbeen made to steer a middle course between the bare recapitulation of eternal platitudes, and excessive preoccupation with topical and transitory events. But at a time of rapid change the task is not an easy one. The plan of the book was laid in the summer of 1920, and though an effort has been made to keep it up-to-date, there are perhaps some things in it already, and there will be more by the time it is published, which would be the better for a change in emphasis and even perhaps in tense. But there is a point beyond which eleventh-hour revision ceases to be worth while; and where there is any doubt, and especially in connection with Chapter VIII, §§ 1-5, such viii PREFACE

words as "now" and "present" should be taken to refer to the date at the foot of this preface. § 2. This is a work of exposition, and in no sense of orginality or research. I have therefore availed myself freely, and (except on a few rather special points) without detailed acknowledgment, of the ideas and the labors of others. Among published works, I desire to acknowledge my special indebtedness to the standard writings of Prof. Pigou, Prof. Cassel, Prof. Irving Fisher, Mr. R. G. Hawtrey, and Mr. Hartley Withers. For the rest, it is still an almost pardonable exaggeration to say that "monetary theory, in its most accurate form, has become in England a matter of oral tradition." ^ It has been my great good fortune to imbibe that tradition, at one remove from Dr. Marshall, and directly from Professor Pigou and Mr. J. M. Keynes. To the counsel and revision of Mr. Keynes, as welL.as to consultation with Mr. Henderson and other Cambridge colleagues, this book owes much of whatever merit it may possess. But the path of true doctrine is not always plainly marked: and for my strayings into the fields of error I must accept full blame.

D. H. R.

Cambridge,

' Economic Journal, 1911, p. 393.

Chapter I The Merits And Drawbacks Of Money Page

§ 1. Intkoditctobt . 1

§ 2. A Definition of Money ..... 2

§ 3. The Advantage of Monet to the Consumer. . 4

§ 4. The Advantage op Monet to the Phodttcer. . 6 § 5. The Dangerous Ease op Borrowing and Lending

§ 6. The Evil Effects op Monetart Instability on

THE Distribution of Wealth . .11

§ 7.. The Evil Effects op Monetart Instabilitt on the

Creation of Wealth .... 13

Chapter II The Value Of Money

I. What is Meant bt the Value op Money

§ 1. A Definition of the Value of Monet ... 17

§ 2. Changes in the Value of Money ... 18

§ 3. Difficulties of Measurement .... 20

§ 4. Provisional Solution 24

II. How THE Value op Money is Determined

§ 5. Resemblances between Monet and other Things . 28

§ 6. Differences between Monet and other Things . 30

§ 7. Monet in Existence and Money Available . . 34

§ 8. Two Peoblems fob Solution .... 37

is s CONTENTS

Chapter III

I. The Kinds of Money page

5 1. Bank Monet and Common Monet: Legal Tender,

Optional and StrssiDiART Monet ... 39

} 2. CONVEKTIBLE AND STANDARD MoNEY ... 42

j 3. Token and Full-bodied Monet ... 44

II. The QuANTrtT op Bank Monet

1 4. The Relation op Checks to Deposits ... 47 ) 5. The Relation of Deposits to Reserves op Common Monet . . . . 50 i 6. The Magnitude op Bank Reserves ... 53 t 7. The Relation op Deposits to Common Monet outside Bank Reserves . . . . 57

III. The Quantitt op Common Money

i 8. The Relation op Convertible Common Monet

to Standard Monet ... 59

i 9. The Quantity op Standard Monet . 62

1 10. The Meaning op a Gold Standard . . 66

1 11. The Quantitt of Monet and the Cost of Pro-

duction of Gold ..... 68

1 12. The Gold Exchange Standard .... 71

Chapter IV Bank Money And The Price-level

1. Prima Facie Objections to Bank Loans . . 74

2. A Provisional Justification op Bank Loans . 76

3. Interest on Bank Loans .... 79 • 4. The Possible Stagnation op the Banking Ststem 82 I 5. The Case for the Creation op Additional BInk

Loans 84

CONTENTS xi

PAGE

§ 6. Dangers Involved in Additional Bank Loans 87 § 7. The Inherent Tendency of the Banking System

TO Excessive Creation op Money ... 91

§ 8. English Banking Policy .... 94

Chapter V

§ 1. Output and the Price-Level .... 98

§ 2. Gold Migration and the Price-Level . . . 100

§ 3. The War Debt and the Price-Level . 102 § 4. Treasury Bills, Ways and Means Advances and

the Price-Level ...... 105

§ 5. Bank Loans and Treasury Notes .... 109

§ 6. Treasury Notes and the Price-Level . . Ill § 7. Cause and Effect in Relation to Money and the

Price-Level .114

Chapter VI

§ 1. The Case for a Price-Level varying inversely

with Productive Power . . 118

§ 2. The Case for a gently rising Price-Level . 122

§ 3. The Case against the Gold Standard . . 125

§ 4. The Case for the Gold Standard . . . 128

§ 6. An Improved Standard 131

Chapter VII The Foreign Exchanges

§1. The Normal Rates op Exchange . . . . 135

§ 2. Price Movements and the Exchanges . . . 138

§ 3. Other Influences on the Exchanges . . . 141

§ 4. Some Fallacies about Exchange .... 144 xii CONTENTS

PAGE

§ 5. Exchange under an International Token Monet . 147 § 6. Exchange under a Gold Standard . . . 150 §7. The Degrees OF Gold Standard .... 153

Chapter VIII Monetary Policy

1 1. The Causes op Palling Prices

i 2. The Effects op Falling Prices .

( 3. Falling Prices and Trade Depression

i 4. The English and American Price-Levels

i 5. Revaluation op the Pound Sterling .

( 6. The Manipulation op the Rate op Interest

i 7. The Rationing op Bank Loans

1 8. Conclusion

Chapter I The Merits And Drawbacks Of Money

"Crabs and all sorts of things," said the Sheep: "plenty of choice, only make up your mind. Now what do you want to buy?" Through the Looking-glass.

§ 1. Introdudory. ^ney i s_aot_siiclLaL-Yital subject, a s is oft en supBosedj nevertheless, it is an interesting and important branch of the study of economics. It is necessary for the economic student to try from the start to pierce the monetary veil in which most business transactions are shrouded, and to see what is happeniag in terms of real goods and services; indeed so far as possible he must try to penetrate further, and to see what is happening in terms of real sacrifices and satisfactions. But having done this he must return and examine the effects exercised upon the creation and distribution of real economic welfare by the twin facts that we do use the mechanism of money, and that we have learnt so imperfectly to control it.

And this is specially necessary at a time when the money systems of the world have ceased to work with the comparative ease and smoothness to which we had become accustomed, and are indeed for the most part thoroughly out 9f order. Almost everybody is directly affected by, and acutely conscious of, the violent changes which have taken place in the purchasing power of money over the things which he wishes to buy; and most people are also, though less vividly, aware of the violent changes which have taken place in the purchasing power of the money of their own covmtry over the money of other countries. This disorganization of the world's monetary apparatus has become a breeding-ground of real dangers and disharmonies, and to some extent also of illusory hopes and aspirations. It is necessary, therefore, to explore it thoroughly, if only to clear the approach to those more vital questions of the creation and apportiojunent of real wealth with which the later volumes of this series will be concerned. A monetary system is like some internal organ; it should not be allowed to take up very much of our thoughts when it goes right, but it needs a deal of attention when it goes wrong.

§ 2. A Definition of Money. It is clearly desirable to arrive at an early imderstanding of what we mean by money. There is no very general agreement upon this point; but as with so many other economic terms, it does not matter very much what meaning we adopt as long as we stick to it, or at any rate do not change it without being aware that we are doing so. In this book, the term mon ey wiU be_used to_denote_anything which is widely accepted in payment for goods, or in discharge oT other kinds of business obllgatipn. If things which are intended to be money — the notes of certain Governments, for instance — cease to be widely accepted in discharge of obligations, they cease to function as money, and, from the point of view of the student at any rate, to be money. On the other hand, if things which have not been hitherto considered as money, such as tobacco or cattle or tins of bully-beef, become widely accepted in discharge of obligations, they become, in our present sense, money. ^

This praperlamfJ aeing widely ^acceptable generally^^

thou gh not always imgolyes-^^^anoIEerT^ namely the

projiert y nf being expressed in units, in term sjafjaihicE" it is common to reckon the.Afahie-o£all thos e goods an d services which men- are in the h abit ot exchanging_mth .one another. This is what the textbooks on money mean to convey when they say that money is not only a "medimn of exchange" but a "standard of value." But that statement as it stands does not quite fit in with the definition of money which we have chosen. It is not necessary that everything which is used as a medium of exchange should itself be also a standard of value, but only that it should be expressed in terms of something which is a standard of value. For instance, John Smith's checks may be widely accepted in discharge of his obligations, and are therefore rightly regarded, according to the definition which we have chosen, as money: and Bank of England five-pound notes are universally accepted in the United Kingdom in discharge of obligations, and are certainly money. But nobody reckons his income or conducts his business dealings in terms of John Smith's checks or even of

' Of the beer in -which in effect wages were partly paid in the Staffordshire coal-mines in the middle of the nineteenth century, a recent historian remarks: "This currency was very popular and highly liquid, but it was issued to excess and difficult to store," Fay, Life and Labor in the Nineteenth Century, p. 197.

Bank of England notes: people reckon their incomes and conduct their transactions in terms of the pounds sterling of which John Smith's checks and Bank of England notes are expressed as multiples.

Money then is anything which is widely acceptable in discharge of obligations: but a thing will not as a rule be widely acceptable for this purpose unless it is expressed as a multiple of some unit which is regarded as a measure or standard of the value of things in general. This conception of a "standard of value" raises some difficulties, to which we must return later: and we must also postpone for the present a consideration of the different kinds of money which exist, and of the ways in which various money systems are built up out of them. Meanwhile what there is to be said applies to all money, defined as we have defined it.

§ 3. The Advantage of Money to the Consumer. The next question for our consideration is "What is the point of using money?" We have become so accustomed to the use of money that it requires a little exercise of imagination to realize how much we owe to it. But over large parts of the world to-day people have been deprived of the advantages of a sound system of money, and are finding out how inconvenient and even paralyzing the consequences may be.

The first_grgat achiev ement-of -_monayL is that it enables roauas consiuner jto^generaKze his purchasing power, and jto^iakgj iis claim s on socieiyLJn the form whicETsuits him best.. If there were no money, people would have to be paid for their services in kind; and whether they were strictly rationed, or whether they were allowed to help themselves to an unlimited extent, in either case there would be waste. For in the former case they would be encouraged to take more of certain goods and services, and forced to take less of others, than they really require; and in the latter case they would be tempted to be extravagant all round. The existence of a monetary economy helps society to discover what people want and how much they want it, and so to decide what shall be produced and in what quantities, and to make the best use of its limited productive power. And it helps each member of society to insure that the means of enjoyment to which he has access yield him the greatest amount of actual enjoyment which is within his reach — it gives him the chance of not surfeiting himself with car rides, or stinting himself unduly of the countenance of Charlie Chaplin.

How fully he avails himself of this opportunity depends on his aptitude for judging accurately of the relative amounts of enjoyment which different ways of spending a penny or a dollar would afford him, and on his strength of mind in acting on his judgment. Some people exploit to the full this opportunity of "making the most of their income": others settle down to a comfortable habit of customary expenditure, and regard immunity from excessive brain-wear about the spending of money, and from the keeping of meticulous accounts, as worth some leakage of material enjoyment. To waste satisfaction by "going on the burst" may even be itself a source of satisfaction. But in any case man values highly this privilege of spending his money income, that is of taking his real income, as he pleases — how highly you may see if you read the story of the fight against the truck system of paying wages, or watch the faces of an engaged couple as they open the parcel containing their seventeenth writing-case.

There are indeed some services, such as the use of the roads, which we all of us receive without making specific payment. Further, in some callings, such as the army or domestic service, a more extensive pajmient in kind is generally recognized to be for the convenience of everybody concerned: and those who have given rein to their fancy in delineating the ideal economic society of the future have often contemplated some system of doles or rationing for the distribution of those staple commodities of which all human beings stand in need. But since even such an ideal society would not be likely to be infinitely rich, the total claim which any individual could make upon it would still have to be limited: and since individual tastes and requirements would presumably continue to differ, people would still have to be given a certain amount of latitude and discretion with regard to the form in which they presented part at any rate of their claims. In other words, money of some kind — certificates, that is to say, of a general title to real income, to be interpreted and particularized by the individual — would have to persist. The need for money then seems to be fundamental, if a given volume of productive power — a given poise of mankind in his relations with nature — is to be made to yield the greatest harvest of individual satisfaction which it is capable of yielding.

§ 4. The Advantage of Money to the Producer. The second great achievement of money is that it enables man as producer to concentrate his attention on his own jobj and so to add more effectively to the general flow of goods and services which constitutes the real income of society. Historically, the process of "commutation" of payments in kind into payments in money is found to be very closely bound up with the process of "differentiation" of various crafts and occupations: and logically the intimate connection between the two is not difficult to understand. The specialization and division of labor on which our economic structure is founded would be impossible if every man had to spend a large part of his time and energies in bartering his products for the materials of his industiy and the goods v/hich he requires for his own consumption.

This is especially true of the system of large-scale '.'capitalistic" production which is dominant to-day. The various forms which this system takes must be discussed in more detail in a future volume: but for our present pm-poses it is sufficiently accurate to describe it as one under which a large number of workmen work for wages imder the orders of a "capitalist," who is responsible for the disposal of their joint product, and who allocates a share of the proceeds to the individual workmen. Now it would as a rule be intolerable from a business point of view if every large "capitalist" — say an ironmaster or the managing director of a railway company — had to lay in a store of all the things his workmen are likely to want and to dole them out to them. In certain conditions indeed, as experience shows, a partial arrangement of this kind m^ay be put Into force, either because it is a source of illicit profit to the "capitalist" (as under the old truck system), or because it fTimishes a special incentive to the workman (as in the case of the special butter wages allowed in 1919 to coal miners in Germany), or because (as in domestic service) it is manifestly to the convenience of both parties. But speaking generally it is far simpler, and is indeed the only practicable course, for the "capitalist" to pay his workmen money wages, which they accept in the confident expectation of being able to obtain with them the things which they reqidre. The existence of money then seems to be a necessa^^" condition for any great development of the division of labor not merely as between those who foUow different crafts, but as between those who plan and initiate and control and those who do the day-work of the world. Whether this is a thing for money to be proud of is of coiu^e another matter: aJl that is urged here is that in so far as the capitalistic system of industry- has been an indispensable instrument of material progress, money has been so too.

The third great achievement of money is closely allied to the second. It consists in this, that money immensely facilitates the making of loans and paj-ments in advance of all kinds. Wage payments, which have been mentioned above, are in essence one form of such payment in advance. The " capitalist " will not be able to dispose finally of his product till it is in a finished state: but the workmen engaged on the preliminary stages must be enabled to Uve meanwhile, and money facilitates arrangements being made for this. The making of advances by one kind of business man to another is also rendered much easier by tiie existence of money : so is the investment or loaning of its sa\-iL^s by the general public. Saving, and the lending of savings by one person to another, means in the last resort the saving and lending of real things, and it may exist without money: but so long at any rate as we rely for it upon individuals, it would be very cumbrous and difHcult to arrange on a large scale without the aid of money. So for this reason too the existence of money seems to be essential to our modern system of production, which rests so largely upon the willingness of one man to transfer command over goods to another, in the expectation of being repaid either by that other or by some third party at a future date.

§ 5. The Dangerous Ease of Borroiving and Lending Money. But this third great achievement of a monetary economy is also one of its two great drawbacks and dangers. For it makes it so fatally easy to lend and tfl, borrow — or t o appear~to lend ^md to borrow — things . which are not really in e xistence at all, or even likely to c^einto e xistence .^ How this happens we shall see inore clearly when we come to examiae in detail the structure of modern monetary systems: but it may be convenient to give here one or two preliminary illustrations of what is meant. In the early days of the war the British Government wanted in effect to borrow from private citizens various things — lumps of steel and cloth and hay and such-like — for the prosecution of the war. But all it could do in fact was to borrow money, because that is the only thing which people are used to lending: and with the money so obtained it expected, with a touching confidence bom of long years of the smooth working of a monetary economy, to be able to obtain everything it wanted. But it soon found that it could not do so, and that it would have to make special and elaborate ordinances in order to obtain the things which it wanted, and even in some cases itself to undertake their production.

Our second illustration is from the ordinary conduct of industry. When there is a "boom" in the constructional trades — steel, shipbuilding, engineering and the rest — "capitalists" in these trades bid for the services of workpeople by offering them plentiful money wages. As was explained above, these wages are really in the nature of an advance, backed by the estimates made by the " capitalists " of the value which society will set on the buildings and ships and so forth which are in process of production. But what the workman wants these money advances for is to obtain the necessaries and conventional comforts of his life: and under a money-system there is no guarantee that these are being turned out as fast as the money wages are being handed over. Hence we may get a state of affairs when industry is active and wages high, but the necessaries of life are scarce; and then there is outcry and imrest: which is broadly what was happening during the two years after the armistice. If every business man had to make arrangements himself for feeding and clothing and amusing his employees before he embarked on any venture, as he might have to do if he were building a railway, say over the Andes, hundreds of miles from civilizacion, such maladjustments would not occur; but of course industrial progress would be very slow and difficult. As it is, the ease with which advances of every kind can be made in money oils the wheels of material progress: but the result is that people tend to confuse the pieces of money, which are mere certificates of a right to draw goods which may not even exist, with the goods themselves, and to lay up all sorts of trouble and disillusionment for themselves. Adam Smith once compared money to a road, over which all the produce of a district passes to market, but which does not itself produce a single blade of anything. Nobody would be so foolish as to expect to eat a road : yet man is always being surprised afresh by the discovery that he cannot eat money, as the Turks are said to be surprised afresh each year by the advent of winter. He is so pleased with his ingenious invention that he is always expecting too much of it.

§ 6. The Evil Effects of Monetary Instability on the Distribution of Wealth. Tha:S££Qnd.gre at disadv aiitageof money is one of which everybody to-day is acu tely

We^hall have to examine more carefully in a moment

what we mean by this phrase, " the value of money: " for

the present we may define it provisionally as the power

of money to purchase the things people want. Now all

of us, from landowner to laborer, are enabled to live

because other people want our services, if we take that

word in an extended sense to include the use of our

possessions: and if the power of other people's money

to buy our services always varied in exactly the same

degree as the power of our money to buy other people's

services, there is no reason why these variations in the

purchasing power of money should matter to any of us.

But in fact that is not the way things happen. Some people sell their services on conditions which are fixed, by legal contract or by the force of custom, for a long time ahead in terms of money: other people are easily enabled or forced, as the case may be, to bring about alterations in the prices of the services they sell. The former group of people are clearly benefited by a rise and injured by a fall in the value of money: for in the former case they receive a greater and in the latter case a smaller power of command than they expected over the things which they require. The latter group of people tend to gain by a fall and to lose by a rise in the value of money: for they make use, whether for purposes of further production or for their own enjoyment, of the services of people whose money rewards are fixed, while their own money rewards are variable. Any change therefore, however slight, in the value of money, so long as it is not perfectly foreseen, leads to a certain redistribution of the real income of society between these two groups of persons.

A few years ago it was possible to lay down fairly definitely the classes of which each of these two groups was composed. Broadly spealdng, the former comprised wage-earners, professional people (such as Government oflJcials and schoolmasters), and those who had made loans, whether to Governments or to industrial companies, at a fixed rate of money interest. The latter group comprised the "business classes," those, that is, who derived an income from venturing and planning and controlling the production and sale of goods: for their money expenses for the hire of labor and capital remained relatively fixed, while their money incomes fluctuated with the prices of the things they sold. At the present day this generalization is still partially true, but the situation has been greatly complicated by the increased power of certain sections of Labor and by the piecemeal interventions of the State. The violent fall ia the value of money between 1914 and 1920 led to a great and often arbitrary redistribution of income not only between different social and industrial classes, but between the members of different callings in the same class. The reader, however, will probably recognize without much difficulty to which group he belongs. If he is a railway shareholder or an elementary school teacher or a certain type of skilled artisan, he will probably hold that he was "hit" by the fall in the value of money: if he is a shipowner or a railway porter he will probably admit to himself, though not to the world, that things did not work out so badly.