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THE VALUE OF MONEY
BY
B. M. ANDERSON, JR., PH. D. ASSISTANT PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY AUTHOR OF "SOCIAL VALUE"
New York THE MACMILLAN COMPANY 1917
All rights reserved
COPYRIGHT, 1917 BY THE MACMILLAN COMPANY Set up and electrotyped. Published May, 1917.
To
B. M. A., III AND J. C. A.
WHO OFTEN INTERRUPTED THE WORK BUT NONE THE LESS INSPIRED IT
Preface
The following pages have as their central problem the value of money. But the value of money cannot be studied successfully as an isolated problem, and in order to reach conclusions upon this topic, it has been necessary to consider virtually the whole range of economic theory; the general theory of value; the role of money in economic theory and the functions of money in economic life; the theory of the values of stocks and bonds, of "good will," established trade connections, trade-marks, and other "intangibles"; the theory of credit; the causes governing the volume of trade, and particularly the place of speculation in the volume of trade; the relation of "static" economic theory to "dynamic" economic theory.
"Dynamic economics" is concerned with change and readjustment in economic life. A distinctive doctrine of the present book is that the great bulk of exchanging grows out of dynamic change, and that speculation, in particular, constitutes by far the major part of all trade. From this it follows that the main work of money and credit, as instruments of exchange, is done in the process of dynamic readjustment, and, consequently, that the theory of money and credit must be a dynamic theory. It follows, further, that a theory like the "quantity theory of money," which rests in the notions of "static equilibrium" and "normal adjustment," abstracting from the "transitional process of readjustment," touches the real problems of money and credit not at all.
This thesis has seemed to require statistical verification, and the effort has been made to measure the elements in trade, to assign proportions for retail trade and for wholesale trade, to obtain indicia of the extent and variation of speculation in securities, grain, and other things on the organized exchanges, and to indicate something of the extent of less organized speculation running through the whole of business. The ratio of foreign to domestic trade has been studied, for the years, 1890-1916.
The effort has also been made to determine the magnitudes of banking transactions, and the relation of banking transactions to the volume of trade. The conclusion has been reached that the overwhelming bulk of banking transactions occur in connection with speculation. The effort has been made to interpret bank clearings, both in New York and in the country outside, with a view to determining quantitatively the major factors that give rise to them.
In general, the inductive study would show that modern business and banking centre about the stock market to a much greater degree than most students have recognized. The analysis of banking assets would go to show that the main function of modern bank credit is in the direct or indirect financing of corporate and unincorporated industry. "Commercial paper" is no longer the chief banking asset.
It is not concluded from this, however, that commerce in the ordinary sense is being robbed by modern tendencies of its proper banking accommodation, or that the banks are engaged in dangerous practices. On the contrary it is maintained that the ability of the banks to aid ordinary commerce is increased by the intimate connection of the banks with the stock market. The thesis is advanced--though with a recognition of the political difficulties involved--that the Federal Reserve Banks should not be forbidden to rediscount loans on stock exchange collateral, if they are to perform their best services for the country.
The quantity theory of money is examined in detail, in various formulations, and the conclusion is reached that the quantity theory is utterly invalid.
The theory of value set forth in Chapter I, and presupposed in the positive argument of the book, is that first set forth in an earlier book by the present writer, Social Value, published in 1911. That book grew out of earlier studies in the theory of money, in the course of which the writer reached the conclusion that the problem of money could not be solved until an adequate general theory of value should be developed. The present book thus represents investigations which run through a good many years, and to which the major part of the past six years has been given. On the basis of this general theory of value, and a dynamic theory of money and exchange, our positive conclusions regarding the value of money are reached. On the same basis, a psychological theory of credit is developed, in which the laws of credit are assimilated to the general laws of value.
In a final section, the constructive theory of the book is made the basis for a "reconciliation" of "statics" and "dynamics" in economic theory--an effort to bring together the abstract theory of price (i. e., "statics") which has hitherto chiefly busied economists, and the more realistic studies of economic change (i. e. "dynamics") to which a smaller number of economists have given their attention. These two bodies of doctrine have hitherto had little connection, and the science of economics has suffered as a consequence.
This book was not written with the college student primarily in mind. None the less, I incline to the view that the book, with the exception of the chapter on "Marginal Utility," is suitable for use as a text with juniors and seniors in money and banking, if supplemented by some general descriptive and historical book on the subject, and that the whole book may very well be used with such students in advanced courses in economic theory. I think that bankers, brokers, and other business men who are interested in the general problems of money, trade, speculation and credit, will find the book of use. Naturally, however, it is my hope that the special student of money and banking, and the special student of economic theory will find the book of interest. The book may interest also certain students of philosophy and sociology, who are concerned with the applications of philosophy and social philosophy to concrete problems.
My obligations to others, running through a good many years, are very great. With Professor E. E. Agger, I talked over very many of the problems here discussed, in the course of two years of close association at Columbia University, and gained very much from his suggestions and criticisms. Professor E. R. A. Seligman has read portions of the manuscript, and given valuable advice. Professor H. J. Davenport has given the first draft an exceedingly careful reading, and his criticisms have been especially helpful. Professor Jesse E. Pope supervised my investigations in the quantity theory of money in 1904-5, in his seminar at the University of Missouri, and gave me invaluable guidance in the general theory of money and credit then. More recently, his intimate first hand knowledge of European and American conditions, both in agricultural credit and in general banking, has been of great service to me. Mr. N. J. Silberling, of the Department of Economics at Harvard University, has been helpful in various ways, particularly by making certain statistical investigations, to which reference will be made in the text, at my request. Various bankers, brokers, and others closely in touch with the subjects here discussed have been more than generous in supplying needed information. Among these may be especially mentioned Mr. Byron W. Holt, of New York, Mr. Osmund Phillips, Editor of the Annalist and Financial Editor of the New York Times, Messrs. L. H. Parkhurst and W. B. Donham, of the Old Colony Trust Company in Boston, various gentlemen in the offices of Charles Head & Co., and Pearmain and Brooks, in Boston, Mr. B. F. Smith, of the Cambridge Trust Company, Mr. W. H. Aborn, Coffee Broker, New York, Mr. Burton Thompson, Real Estate Broker, New York, Mr. Jas. H. Taylor, Treasurer of the New York Coffee Exchange, Mr. J. C. T. Merrill, Secretary of the Chicago Board of Trade, DeCoppet and Doremus, New York, and Mr. F. I. Kent, Vice President of the Bankers Trust Company, New York. My greatest obligations are to two colleagues at Harvard University. Professor F. W. Taussig has given the manuscript very careful consideration, from the standpoint of style as well as of doctrine, and has discussed many problems with me in detail. Professor O. M. W. Sprague has placed freely at my service his rich store of practical knowledge of virtually every phase of modern money and banking, and has read critically every page of the manuscript. None of these gentlemen, of course, is to be held responsible for my mistakes. I also make grateful acknowledgment of the aid and sympathy of my wife.
In the course of the discussion, frequent criticisms are directed against the doctrines of Professors E. W. Kemmerer and Irving Fisher, particularly the latter, as the chief representatives of the present day formulation of the quantity theory. Both their theories and their statistics are fundamentally criticised. I find myself in radical dissent on all the main theses of Professor Fisher's Purchasing Power of Money, and at very many points of detail. To a less degree, I find myself unable to concur with Professor Kemmerer. But I should be sorry if the reader should feel that I fail to recognize the distinguished services which both of these writers have performed for the scientific study of money and banking, or should feel that dissent precludes admiration. I acknowledge my own indebtedness to both, not alone for the gain which comes from having an opposing view clearly defined and ably presented, but also for much information and many new ideas. My general doctrinal obligations in the theory of money and credit are far too numerous to mention in a preface. My greatest debt in general economic theory is to Professor J. B. Clark.
B. M. ANDERSON, JR.
HARVARD UNIVERSITY, March 31, 1917.
ANALYTICAL TABLE OF CONTENTS
PART I. THE VALUE OF MONEY AND THE GENERAL THEORY OF VALUE
Chapter I
ECONOMIC VALUE PAGE Problem of value of money special case of general theory of value; present chapter concerned with general theory 1
Formal and logical aspects of value: value as quality; value as quantity; value and wealth 5-6
Absolute vs. relative conceptions of value: value of money vs. "reciprocal of price-level"; value prior to exchange; value and exchangeability; do prices correctly express values? 6-12
Doctrine so far in accord with main current of economic opinion 12-14
Causal theory of value new: marginal utility, labor theory, etc., rejected 14-16
Social explanation required: "individual" a social product, both in history of individual and in history of race 16-19
And above individual impersonal psychic forces, law, public opinion, morality, economic values 19-20
Three types of theory have dealt with these: theory of extra-human objective forces; extreme individualism; social value theory 20-21
Illustrated in jurisprudence, ethics, and economic theory 21-26
Law, morals, and economic values generically alike, but have differentiae 26-28
But not differentiated on basis of states of consciousness of individual immediately moved by them, because many minds in organic interplay involved 28-33
Economic social value (a) of consumers' goods and services: "utility" and scarcity; "marginal utility"; social explanation of marginal utility; marginal utilities the conscious focus of economic values of consumers' goods; but only minor part of these values; individuals, classes and institutions heavily weighted by legal, moral, and other social values, in power over economic values of consumers' goods 33-38
Economic social value (b) of labor, land, stocks, bonds, "good will," etc.; based only in part on values of consumers' goods; partially independent, directly influenced by contagion, and centers of power and prestige 38-41
Pragmatic character of theory 41-43
Relation of social values to individual values 43-45
II. SUPPLY AND DEMAND, AND THE VALUE OF MONEY
Hiatus between general theory of value and theory of value of money 46-47
Partly because former has been developed by different writers from those who have developed latter 47-49
But chiefly because supply and demand, cost of production, etc., assume fixed value of money, and are theories of price, rather than value 49
Supply and demand useful but superficial formula, common property of many value theories 49-50
Crude and unanalyzed in Smith and Ricardo; first made precise by J. S. Mill, who gives essentials of modern doctrine 49-51
Boehm-Bawerk's pseudo-psychology spoils Mill's clean-cut doctrine 51-52
Supply and demand assumes fixed value of money-unit, and hence inapplicable to money itself 52-56
But supply and demand does not assume fixed price-level 56-57
Cairnes vs. Mill 57-58
Mill's unsuccessful effort to apply supply and demand to money 59-62
Walker's attempt 62
Supply and demand in the "money market" 62-63
III. COST OF PRODUCTION AND THE VALUE OF MONEY
Types of cost theory: modern cost doctrine is "money costs" doctrine, and inapplicable to value of money 64
Labor cost: Smith; Ricardo; Ricardo's confession of failure; "real costs" in Senior and Cairnes; Mill's "money-outlay" cost doctrine, and Cairnes' criticism; but "money-cost" has survived 64-67
Because "real cost" doctrine does not square with facts 67-69
"Money-cost" of producing money-metal 69-70
Austrian cost doctrine runs still in money terms, assuming value, money, and fixed value of money 70-71
"Negative social values" as "real costs" note, 71
IV. THE CAPITALIZATION THEORY AND THE VALUE OF MONEY
Money as "capital good," and "money-rates" as rentals 72-73
Capitalization theory; formula; capital value passive resultant of annual income and rate of discount 73-74
But in case of money, rental and rate of discount not independent variables 74-76
And in case of money, capital value not passive shadow, but active cause of income 76
Capitalization theory assumes money, and fixed value of money 76-77
Assumed fixed value of money absolute, and not relative 77-78
Capitalization theory, in current formulation, inapplicable to value of money 78-79
V. MARGINAL UTILITY AND THE VALUE OF MONEY
Marginal utility theory usually thinly disguised version of supply and demand, and hence inapplicable to money 80
View that money is unique in having no utility per se 81-83
Marginal utility and "commodity theory" of money-value 81-82
Quantity theorists and marginal utility of money 81-82
Money an instrumental good, and marginal utility no less applicable here than elsewhere; marginal utility invalid as general theory of value, hence invalid when applied to money 82-120
Wieser's theory of value of money 83-88
A circle in reasoning 88-90
Schumpeter's similar circle 100
But Schumpeter's general utility theory, though inapplicable to value of money, in form avoids a causal circle 90-98
Schumpeter's conspectus; different from Boehm-Bawerk and most utility theorists 90-92, 113-120
Defects and limitations of Schumpeter's general theory 90-98
Schumpeter's substitutes for social value concept 98-99
Von Mises sees circle of Wieser and Schumpeter 100
Seeks to avoid it by construing utility theory as historical, instead of static, theory 101
But this departs from fundamentals of utility theory; other difficulties 101-110
Kinley's doctrine 110-111
General criticism of utility theory 111-115
Davenport, Wicksteed, Fisher, Perry 113-120
PART II. THE QUANTITY THEORY
VI. THE QUANTITY THEORY OF PRICES. INTRODUCTION
Preliminary statement of quantity theory, and of critical theses to be developed in following chapters. Virtually every contention and every assumption of quantity theory to be challenged 123-129
VII. DODO-BONES
Quantity theory doctrine that valueless objects can serve as money; Nicholson's assumption: money made of dodo-bones 130-131
Fisher's view also 130
And Ricardo's 131-132
Will dodo-bones circulate? Dodo-bones and poker chips; circular reasoning 132
Both medium of exchange and standard of value must be valuable 133
Is inconvertible paper an exception? 133-134
Doctrine that money gives legal claim to things in general 134
Kemmerer's assumptions; money made of commodity, once valuable, now used only as money 135
Commodity theory requires present commodity value 135
Historical vs. cross-section view: possibility that such money would circulate 135-136
Value not tied up with marginal utility or commodities: social value theory; derived values often become independent of original presuppositions, in economic as well as legal and moral spheres 136-139
But this no basis for quantity theory: social psychology, not mechanics 139
"Banker's psychology" vs. psychology of blind habit: India, Austria, United States; monetary phenomena of war times; "credit theory" of Greenbacks 139-142
Question-begging definitions 142-143
Assumptions of quantity theory: blind habit and fluid prices 143-144
Extreme commodity theory denies that money-use adds to value of money; usually not true; analysis of money-functions 144-150
Hypothetical case in which whole value of money comes from commodity value 150-152
Money must have value apart from monetary employments, but, in general, gains additional value from employment as money 152-153
VIII. THE "EQUATION OF EXCHANGE"
Fisher leading, most consistent, most uncompromising quantity theorist: wide acceptance of his views 154
Taussig vs. Fisher 155
Fisher and dodo-bone doctrine: logical part of quantity theory; Fisher's value concept 155-156
"Equation of exchange": analysis of Fisher's version, typical of all 156-171
In what sense equality between two sides of equation? Meaning of "T" 158-161
No "goods side" to equation; both sides sums of money; equal because identical; equation meaningless 161-162
All factors in equation highly abstract 162-163
"P" and "T" cannot both be given independent definitions: P defined as weighted average, with T in denominator; and must be changed from year to year, as elements in T change, even though no prices change 164-166
This makes circular theory: problem defined in terms of explanation 165-166
Causal theory associated with equation of exchange 166
Equation amplified to include credit; not acceptable to Nicholson or Walker, and caricature of conditions in Germany and France 166-170
Book-credit, bills of exchange, etc., excluded 167-170
Why a one-year period? 170-171
IX. THE VOLUME OF MONEY AND THE VOLUME OF CREDIT
Mill thought credit acts on prices like money, and that this reduces quantity theory tendency to indeterminate degree; Fisher holds volume of money in circulation governs volume of credit, so that quantity theory stands 172
Fisher's arguments for fixed ratio, money to bank-deposits 172-173
Argument a non-sequitur, even if contentions true 173-177
Contentions untrue: no fixed ratio between reserves and deposits, or reserves and demand liabilities, either in America or Europe 177-182
Taussig's views; virtually surrender of quantity theory in modern conditions 182-185
Bulk of quantity theorists in between Fisher and Taussig, but nearer to Fisher's view than to Taussig's 185
Chapter X
"NORMAL" VS. "TRANSITIONAL" TENDENCIES
Quantity theory qualified by distinction between "normal" and "transitional" effects of change in quantity of money, etc. 186
Meaning of distinction, and extent of qualification hard to determine: is "normal period" real period in time? How long is "transitional period"? Is it realistic, or hypothetical? Is equation of exchange realistic? Concrete vs. hypothetical price-levels 186-189
Legitimate and illegitimate abstraction 189-190
Causation and temporal order 190-191
Fisher admits very slight qualification of "normal theory" 192
Mill's quantity theory "short run" theory; Taussig's "long run" theory; radically different logic in the two 192-193
Fisher's theory sometimes "long run" and sometimes "short run" 194-195
XI. BARTER
Quantity theory spoiled if resort to barter possible and important 196
Extent of barter and other flexible substitutes for money and bank-credit; simple barter; different methods of corporate consolidations; flexibility, with state of money-market; clearing-house arrangements in speculative exchanges; offsetting book-credits 197-200
Barter made easier under money economy, by measure of value function of money 201
Bills of exchange; foreign trade 201
XII. VELOCITY OF CIRCULATION
Velocity conceived by quantity theory as causal entity, independent of quantity of money and prices; necessary assumption for law of proportionality 203
"Coin-transfer" vs. "person-turnover" concepts 203-204
Velocity really non-essential by-product, meaningless average 204-205
Doctrine that velocity independent of money; habit and convenience; hoarding; hoarding by banks 205-209
Velocity and volume of trade; vary together 209-214
Value of money causally governs velocity 214-215
Chapter XIII
THE VOLUME OF MONEY AND THE VOLUME OF TRADE--TRADE AND SPECULATION
Quantity theory doctrine that volume of trade, and volume of money (and credit), are independent; trade governed by physical and technical conditions, not money 216-219
View that quantity of money vitally affects production and trade 219
Walker, Sombart, Withers, Price, Holt 219-222
Increase of money increases trade, even on static theory: increase of money increase of capital; lowered margin in exchanges; money-rates and interest; money tool of exchange; elasticity of demand for money-service; in Arizona and New York City 222-225
Trade distinguished from production and from stock 225-226
Trade chiefly speculation; Fisher's $387,000,000,000 of trade in U. S. in 1909 analyzed; index of variation in trade; figure based on Kinley's returns from 12,000 banks; double-counting 227-230
Figure largely represents speculation; statistics of total wealth of U. S.; small role of wholesale and retail deposits; "all other deposits" bunched in speculative centers, especially New York; trifling "deposits" in country banks; evidence of bank-clearings: clearings and stock speculation; clearings and ordinary business 230-241
Measurement of "ordinary trade" 241-248
Volume of stock speculation 248-251
Commodity speculation 251-252
Unorganized speculation 252-254
Bill and note speculation 255
Fisher's and Kemmerer's indicia of trade variation wholly misleading 255-257
Production waits on trade; selling costs vs. "cost of production"; "good will"; are banks useless? 257-262
"Normal vs. transitional": statics vs. dynamics; money and credit make static assumptions possible; very little trade in "normal equilibrium" or static state; volume of trade depends on transitions and dynamic changes; functional theory of money and credit must be dynamic theory; abstraction from money by static theory; no static theory of money and credit possible; quantity theory misses whole point of money-functions 262-266
APPENDIX TO CHAPTER XIII
THE RELATION OF FOREIGN TO DOMESTIC TRADE IN THE UNITED STATES
Ambiguity of "domestic trade": figures comparable with export and import figures cannot include turnovers; net income of United States, minus imports on retail basis, counted as domestic trade; exports on retail basis counted as foreign trade; net income for 1910; index of variation for other years; cautions and qualifications; ratio of foreign to domestic trade, 1890-1916 267-278
Chapter XIV
THE VOLUME OF TRADE AND THE VOLUME OF MONEY AND CREDIT
Interdependence of trade, and money (and credit); increasing trade causes increase of money and credit 279-281
Quantity theory doctrine: Fisher vs. Laughlin 281-282
Quantity theory has no explanation of elastic bank credit: "Currency Theory" of deposits 282-285
Loans and deposits 285-288
Bills of exchange 288-290
Summary of quantity theory doctrine 290-291
XV. THE QUANTITY THEORY: THE "PASSIVENESS OF PRICES"
Heart of quantity theory: price-level cannot change without prior change in money, deposits, trade, or velocities: independently rising price-level, unable to alter trade or velocities, would drive money away, and so be unable to sustain itself; individual prices can rise independently, but other prices must fall to compensate 292-295
Criticism: argument impressive only because it assumes an uncaused rise in general price-level; when causes assigned, prices can independently rise, compelling modification in other factors in "equation of exchange"; "transitional" and "normal" effects: instances 295-299
Quantity theory conflicts with supply and demand: supply and demand holds good: particular prices and price-level 299-300
Generalization of conflict to include cost of production, capitalization theory, imputation theory 300
Capitalization theory vs. quantity theory; different psychological assumptions of the two theories 300-306
Cost of production vs. quantity theory; money-income vs. quantity of money 306-308
Quantity theory false, granting all its assumptions 308-310
Doctrine that price-level independent of particular prices, and presupposed by them, false; absolute value of money, not price-level, presupposed; price-level may change with value of money constant, through changes in absolute values of goods 310-314
XVI. THE QUANTITY THEORY AND INTERNATIONAL GOLD MOVEMENTS
Quantity theory holds that gold movements depend on price-levels; but price-level mere average, cause of nothing 315-316
Some prices, rising, tend to repel gold, but most prices have no such effect 316-317
Some prices, rising, bring in gold 317-319
Gold movements and money-rates 319-320
XVIII. THE QUANTITY THEORY AND "WORLD PRICES"
Types of quantity theory: world's volume of gold vs. quantity of money in given country; standard vs. token money; abandonment of dodo-bone theory and "equation of exchange" 324-326
Credit does not rest on money: measure of values vs. reserves; loans and wealth; value of money vs. price-level 326-328
Loose relation of reserves and credit in world as whole; no proportionality of quantity of gold to value of gold; no quantity theory needed to assert that value of gold related to its quantity 328-330
Chapter XIX
STATISTICAL DEMONSTRATIONS OF THE QUANTITY THEORY--THE REDISCOVERY OF A BURIED CITY
Criticism of quantity theory statistics yields constructive conclusions; Mitchell and Greenbacks; Kemmerer's and Fisher's statistics of "equation of exchange"; Kemmerer's criticism of earlier statistics 331-335
Kemmerer's and Fisher's figures all wrong except for volume of money and deposits, and prices in base year; if correct, would not prove quantity theory 335-337
Fisher's statistics, resting on Kemmerer's, chiefly studied: their relation to Kinley's "deposits" figures 337-338
M'V' calculated: errors in calculation; New York very incomplete in Kinley's figures; private banks and trust companies; clearings and "deposits," in New York and outside; "total transactions" and clearings; Fisher exaggerates country checks by at least 116 billions, for 1909; major part of all "check deposits" in New York City 348-353
New York as "clearing house" for United States: extent of, and influence of on New York clearings, much overestimated; bulk of New York clearings and New York "deposits" grow out of New York business 353-361
Index of variation for M'V' wrongly weighted; V' wrongly calculated for all years; which upsets calculation of V 361-363
Volume of trade: greatly exaggerated by bank transactions, which include vast deal of duplications in checks, loans and repayments, etc. 363-368
Fisher's reply; _under_counting offsets _over_counting 368-369
Main items of undercounting in clearing houses of speculative exchanges; measurement of, in New York Stock Exchange, and Chicago Board of Trade; swamped by call loan transactions, which exceed security sales 369-381
Price-indexes of Kemmerer and Fisher, dominated by wholesale prices, have no relevance to their "equations of exchange" 381-383
In general, their figures bury speculation and New York City 383
XX. RECAPITULATION OF POSITIVE DOCTRINE
Recapitulation of constructive theses of Parts I and II, and program of Parts III and IV 387-396
XXI. THE ORIGIN OF MONEY, AND THE VALUE OF GOLD
Problem stated 397-401
Value vs. saleability: degrees of saleability; theory of saleability; "buying price" vs. "selling price"; indirect exchange in barter economy; development of commodity of superior saleability into money 401-406
Money never unique 406-407
Origin of gold money: ornament; store of value; social prestige of prodigality and of ornament; love of approbation, sex-impulse, and competitive display; elastic value-curve of gold; industrial employments of gold 407-413
Distribution of wealth and power, and value of gold 413-416
XXII. THE FUNCTIONS OF MONEY AND THE VALUE OF MONEY
Classification 417-418
Measure of values (standard of value) distinguished from medium of exchange; former does not add value to money metal, latter does 418-424
Reserve function 424
Money as "bearer of options"; distinguished from store of value; the dynamic function of money par excellence; explanation of low rates on call loans, and short loans, and low yield of high grade bonds, which share "bearer of options" function; "pure rate" of interest vs. "money rates": Austria; the New York money market 424-432
Legal tender; the Staatliche Theorie 432-436
Standard of deferred payments; which functions add to value of money metal? 436
Relation of money rates to capital value of money 436-442
Agio when coinage is restricted: India vs. Western World 442-450
Equilibrium of gold in arts and gold as money: difficulties of marginal analysis; the money-market phenomena 450-458
XXIII. CREDIT
Analysis rather than definition: "futurity" not essence of credit; credit part of general value system; stocks as credit instruments; juridical and accounting phases 459-462
Confidence; involved in general value phenomena as well as credit; social psychology of confidence; contagions; influence of centers of prestige; nothing unique in credit; selling vs. borrowing 462-469
Definition of credit; credit vs. credit transaction; credit and exchange; bulk of credit grows out of dynamic conditions 469-474
Functions of credit; increasing saleability of non-pecuniary wealth; corporate organization; limits of credit expansion 475-478
Consideration of objections: that personal loans do not rest on wealth; public loans; that value behind loan would not exist if loan were not made 478-484
Schumpeter's "heresies"; his view of the function of the banker: "dynamic credit"; America vs. Continental Europe 484-488
Peculiarities and functions of bank credit; technique of banking: capital; assets; reserves; "liquidity"; money market 488-496
XXIV. CREDIT--BANK ASSETS AND BANK RESERVES
Traditional view that liquid commercial loans normal and dominant type of bank asset disproved; cannot exceed 11-1/2 per cent of assets of American banks; analysis of bank assets: "other loans and discounts"; stock collateral loans; loans on "other collateral security"; stocks and bonds held by banks; classes of banks; various combinations; excluding real estate loans, more than half of credit extended by State and national banks and trust companies is to stock market; rapid development of stock collateral loans: New York; Europe 498-512
Activity of different types of loans: banking assets get liquidity chiefly from stock market, and from produce speculators 512-516
Credit extended to Wall Street not at expense of ordinary commerce; country banks and Wall Street 516-518
Federal Reserve Banks should rediscount stock collateral loans; "Money Trust" a trust in financing corporations, not ordinary commerce; panics and Federal Reserve System 520
Quantity theory, putting all exchanges on a par, grotesque: volume of trade and prices in the stock market 520-523
Direct and indirect financing of corporations by banks; "margin dealer" as "banker" 523-526
Adam Smith's view of banker's functions, and of safe bank loans 526
Correct on basis of facts of his day, but corporate organization and organized stock market have made smelting house as liquid as consumers' goods 527
Division of labor in banking: America vs. Germany 527-528
Agriculture in money market 528-529
Reserve problem: special case of problem of liquid assets; many flexible substitutes for cash 529-532
Causal relation runs from deposits to reserves; gold production and reserve-ratio 532-535
No static law or "normal ratio" possible; reserve function entirely dynamic function; reserve not needed in "static state"; illustrated by London money market; "ideal credit economy" 536-544
PART IV. THE RECONCILIATION OF STATICS AND DYNAMICS
XXV. THE RECONCILIATION OF STATICS AND DYNAMICS
Theory of money as focus of general economic theory, exhibiting interdependence of doctrines; basis of further unification of statics and dynamics in higher synthesis 547-548
Statics vs. dynamics, normal vs. transitional, and related contrasts; illustrations; divergent lines of doctrine: tariffs, wars, overproduction, extravagance, etc. 548-552
Statics quantitative; dynamics qualitative 552-553
Statics and dynamics both abstract 553-554
Dynamics and "friction" 554-555
"Theory of prosperity" and dynamics 555-556
Statics and cross-section analysis; statics as price-theory; dynamics as value-theory 556-560
Generalization of statics: price-theory applied to dynamic phenomena: capitalization; costs; "taxonomy;" "discounting" dynamic changes; money the static measuring-rod: wide scope of money-measure; measurement of non-economic values 560-569
Generalization of dynamics: all values, whether of wheat or "good will," have social psychological explanation; technological and biological factors, and the static equilibrium; business cycles 569-575
Business man vs. economic theorist, and value-theory; manipulation of values and prices 575-578
Statics and time 578-580
Immaterial capital 580-582
Statics and dynamics have not different subject-matter 583-586
Equilibrium of all social values: statics and dynamics of the law: social forces and social control 586-589
Summary of Part IV 589-591
I. THE VALUE OF MONEY AND THE GENERAL THEORY OF VALUE
THE VALUE OF MONEY
I. ECONOMIC VALUE
The problem of the value of money is a special case of the general problem of economic value. The present chapter is concerned with the general theory of value, while the rest of the book will consider the numerous peculiarities and complications which make money a special case. The main proof of the theory here presented is to be found in a previous book[1] by the present writer. A number of periodical articles by several writers which have since appeared, in criticism or in further development of the theory, have at various points led to shifting emphasis and clearer understanding on the author's part, and the present exposition, without seeking explicitly to meet many of these criticisms, or to embody the new developments, will none the less be different because of them. To one writer in particular, Professor C. H. Cooley, the theory is indebted for restatement, amplification, and important additions.[2] On the whole, however, the theory presented in this chapter is substantially the theory presented in the earlier book. The theory is set forth in the present chapter with sufficient fullness to make the present volume independent of the earlier book.
Value has long been recognized as the fundamental economic concept. There have been many and divergent definitions of value, and many different theories as to its origin. It is the belief of the present writer--not shared by all his critics!--that the definition of value which follows, and the conception of the function of value in economic theory involved in it, conform to the actual use of the term in the main body of economic literature. The theory of the causes of value here advanced is new, but the definition of value, and the conception of the relation of value to wealth, to price, to exchange, and to other economic ideas, seem to the present writer to conform to what is implied, and often expressed, in the general usage of economists.[3]
It is important to separate sharply two questions: one, the theory of the causes of value, and the other, the definition of value, or the question of the formal and logical aspects of the value concept. The two questions cannot be wholly divorced, but clarity is promoted by considering them separately. We shall take up the formal and logical aspects of the matter first.
Value is the common quality of wealth. Wealth in most of its aspects is highly heterogeneous: hay and milk, iron and corn-land, cows and calico, human services and gold watches, dollars and doughnuts, pig-pens and pearls--all these things, diverse though they be in their physical attributes, have one quality in common: Economic Value.[4] By virtue of this common or generic quality, it is possible to add wealth together to get a sum, to compare items of wealth with one another, to see which is greater, to get ratios of exchange between items of wealth, to speak of one item of wealth, say a crop of wheat, as being a percentage of another, say the land which produced it, etc. This common quality, value, is also a quantity. It belongs to that class of qualities which can be greater or less, can mount or descend a scale, without ceasing to be the same quality,--like heat or weight or length. Such qualities are quantities. There is nothing novel in the statement that a quality is also a quantity. It is implied in every day speech. We say that a man is tall, or heavy, or that the room is hot--qualitative statements; or we may say exactly how tall, or how heavy, or how hot--quantitative statements. The distinction between qualitative analysis and quantitative analysis in chemistry implies the same idea. Thus we may speak of a piece of wealth as having a definite quantity of value, or say that the value of the piece of wealth is a definite quantity. We may then work out mathematical relations among the different quantities of value, sums, ratios, percentages, etc.
Ratios of Exchange are ratios between two quantities of value, the values of the units of the two kinds of wealth exchanged.[5] A good many economists, particularly in their chapters on definition, have defined value as a ratio of exchange. This is inaccurate. The ratio of exchange presupposes two values, which are the terms of the ratio. The ratio is not between milk and wheat in all their attributes. It is between milk and wheat with respect to one particular attribute. Compare them on the basis of weight, or cubic contents, and you would get ratios quite different from the ratio which actually is the ratio of exchange. The ratio is between their values.
In the diagram above, something of what is to follow is anticipated, since the cause of value is indicated. Wheat is shown to be exerting an influence on milk, and milk exerts an influence on wheat. The comparative strength of these two influences determines the ratio of exchange between them. But these two influences are not ultimate. The ratio of exchange is a relation, a reciprocal relation. It works both ways. But behind this relativity, this scheme of relations between values, there lie two values which are absolute. These values rest in the pull exerted on wheat and on milk by the human factor which is fundamental, which in our diagram we have called the "social mind." Values lie behind ratios of exchange, and causally determine them. The important thing for present purposes is merely to note that value is prior to exchange relations, that it is an absolute quantity, and not, as many economists have put it, purely relative. The ratio of exchange is relative, but there must be absolutes behind relations.
A price is merely one particular kind of ratio of exchange, namely, a ratio of exchange in which one of the terms is the value of the money unit.[6] In modern life, prices are the chief form of ratio of exchange, but it is important for some purposes to remember that they are not the only form.
Values may simultaneously rise and fall. There may be an increase or decrease in the sum total of values. Ratios of exchange cannot all rise or fall. A rise in the ratio of the value of wheat to the value of milk means a fall in the ratio of the value of milk to the value of wheat. Both may have fallen in absolute value, but both cannot simultaneously rise or fall with reference to one another. This is the truism regarding ratios of exchange which many economists have inaccurately applied to value itself in the doctrine that there cannot be a simultaneous rise or fall of values. There can be a simultaneous rise or fall of values, but not a simultaneous rise or fall of ratios of exchange.
There can be a general rise or fall of prices. Goods in general, other than money, may rise in value, while money remains constant in value. This would mean a rise in prices. Or, money may fall in value while goods in general are stationary in value. This would also mean a rise in prices. In either case, more money would be given for other goods, and the ratio between the value of the money unit and the value of other goods would have altered adversely to money. There are writers to whom the term, value of money, means merely the average of prices (or the reciprocal of the average of prices). For them, a rise in the average of prices is, ipso facto, a fall in the value of money. This view will receive repeated attention in later chapters. The view maintained in the present book is that the value of money is a quality of money, that quality which money shares with other forms of wealth, which lies behind, and causally explains, the exchange relations into which money enters. Every price implies two values, the value of the money-unit and the value of the unit of the good in question.
Value is prior to exchange. Value is not to be defined as "power in exchange." Certain writers[7] who see the need of a quantitative value, which can be attributed to goods as a quality, still cling to the notion that value is relative, that two goods must exist before one value can exist, and that value is "power in exchange," or "purchasing power." The power is conceived of as something more than the fact of exchange, and as a cause of the exchange relations, but is, none the less, defined in terms of exchange. This position, however, does not really advance the analysis. It is a verbal solution of difficulties merely. To say that goods command a price because they have power in exchange is like saying that opium puts men to sleep because it has a dormitive power. Physicians now recognize that this is no solution of difficulties, that it is merely a repetition of the problem in other words. If we wish to explain exchange, we must seek the explanation in something anterior to exchange. If value is to be distinguished from ratio of exchange at all, it cannot be defined as "power in exchange."
To seek to confine value to exchange relations, moreover, makes it impossible to speak of the value of such things as the Capitol at Washington City, or the value of an entailed estate, or of values as existing between exchanges. Nor can we make the price which a good would command at a given moment the test of its value, except in the case of the highly organized, fluid market. Land, at forced sale, notoriously often brings prices which do not correctly express its value. Moreover, even for wheat in the grain pit, the exchange test is valid only on the assumption that a comparatively small amount is to be sold. If very much is put on the market, the situation is changed, and the value falls. In other words, if "bulls" cease to be "bulls," and shift to the other side of the market, the very elements which were sustaining the value of the wheat have been weakened, and of course its value falls. "Power in exchange" is a function of two factors, (1) value and (2) saleability. A copper cent has high saleability, with little value, while land has high value with little saleability.[8] Some things have value with no saleability at all. In a socialistic community, where all lands, houses, tools, machines, etc., are owned by the state, and where such "prices" as exist are authoritatively prescribed, value and exchange would have no necessary connection. Values would remain, however, guiding the economic activity of the socialistic community, directing labor now here, now there, determining the employment of lands now in this sort of production, now in that. Exchange is only one of the manifestations of value. More fundamental, and more general, including "power in exchange," but not exhausted by it, is the power which objects of value have over the economic activities of men. This is the fundamental function of values. The entailed estate, which cannot be sold, still has power over the actions of men. The care which is taken of it, the amount of insurance which an insurance company will write on it, etc., are manifestations and measures of its value. The same may be said of the Capitol at Washington.[9]
In the fluid market, prices correctly express values. Assuming that the money-unit is fixed in value, variations in prices in the fluid market correctly indicate variations in values. The great bulk of our economic theory, the laws of supply and demand, cost of production, the capitalization theory, etc., do assume the fluid market, and a fixed value of the dollar.[10] Our economic theory is static theory, in general, and abstracts from the time factor and from "friction." In fact, values change first, and then, more or less rapidly, and more or less completely, prices respond. In the active wholesale and speculative markets, where the overwhelming bulk of exchanging takes place, the prices respond quickly. Static theory is thus adequate for the explanation of these prices, for most practical purposes, so long as the changes in prices are due to changing values of goods, rather than to changing value of the money-unit. Moreover, the distinction between value and price is, in a fluid market, where the value of money is changing slowly, often not important. In the assumption of money, and of a fixed value of money, the absolute value concept is already assumed. No harm is done, however, if the economist does not explicitly refer to this, but goes on merely talking about money-prices. Very many economic problems indeed may be solved that way. This is why the inadequate character of the conceptions of value as "ratio of exchange" or "purchasing power" has not prevented these notions from being serviceable tools in the hands of many writers. But there are many problems for which these conceptions are not adequate, because the implicit assumption of a fixed value of money cannot be made. Among these problems is the problem of the value of money itself, which constitutes the subject of this book. For that problem, an absolute value concept is vital.
If, in our diagram above, we substitute for "social mind" the more general expression, "human factor," we should find that our value concept is the common property of many writers. We should find it fitting in with the absolute value notion of Adam Smith and of Ricardo.[11] The "human factor" which explains the absolute value is, for them, labor. We should find it fitting in with the "socially necessary labor time" of Marx: the value of a bushel of wheat is the amount of labor time which, on the average, is required to produce a bushel of wheat. It is an absolute value. It is a causal coefficient with the absolute value, similarly explained, of the bushel of corn, in explaining the wheat-price of corn. Our concept will fit in exactly with the "social use-value" of Carl Knies, according to whom the economic value of a good in society is an average of its varying use-values to different individuals in the market. This average is an absolute quantity. The absolute values of units of two goods, thus explained, causally fix the exchange ratio between the goods. Knies' value-theory, it may be noticed, is explicitly modeled on that of Marx, to whom he refers, the difference being that Knies takes an average of individual use-values, while Marx takes an average of individual labor-times, as the causal explanation.[12] Our value concept will fit perfectly with Professor J. B. Clark's "social marginal utility" theory of value. Indeed, the present writer gratefully acknowledges that the concept is Professor Clark's rather than his own, and that all that is necessary for its explanation has been set forth by Professor Clark.[13] Professor Clark's causal theory of value, his explanation of this absolute quantity of value as a sum of individual marginal utilities, we have elsewhere[14] criticised as involving circular reasoning, like all marginal utility theories, in so far as they offer causal explanations. But his statement of the logical character of value, of the relation of value to wealth, of value to price, of value to exchange, of the functions of the value concept in economic theory, and of the functions of value in economic life,--Clark's doctrines on these points we have accepted bodily, and in so far as the present writer has added anything to them it has been by way of elaboration and defence.
The concept of value here developed is explicitly adopted by T. S. Adams, David Kinley, W. A. Scott, W. G. L. Taylor, L. S. Merriam, and A. S. Johnson, among American writers, to name no others. All of these writers would concur in the formal and logical considerations[15] as to the nature of value here presented, whatever differences might appear among them as to the causal explanation of value.
The value concept here presented performs the same logical functions as the "inner objective value" of Karl Menger, Ludwig von Mises, and Karl Helfferich, discussed in our chapter on "Marginal Utility," below, and is, in its formal and logical aspects, to be identified with that notion. It is essentially like Wieser's "public economic value," discussed in the same chapter.[16] That there should remain critics[17] who consider the present writer a daring innovator, who is thrusting a personal idiosyncracy in terminology upon economic theory, is striking evidence that men often talk about books which they have not read! The reader who accepts, provisionally, the doctrine so far presented, as a tool of thought which will aid us in the further progress of the argument, may do so with the full assurance that he is accepting a tried and tested concept, which has seemed necessary to very many indeed of the great masters of the science.[18]
So far, the writer feels himself in accord with the main current of economic thought. When we come to a causal explanation of the value quantity, however, earlier theories appear unsatisfactory. The labor theory of value has long since broken down, and has been generally abandoned. The reasons for this will appear in the chapter on "Cost of Production." The effort to explain value by marginal utility, by the satisfactions which individuals derive from the last increment consumed of a commodity, has likewise broken down, as will appear in the chapter on "Marginal Utility." In general, it may be said that the effort to pick out feeling magnitudes,[19] either of pleasure or pain, in the minds of individuals, and combine them into a social quantity, leads to circular reasoning. Thus, the utility theory: It is not alone the intensity of a man's marginal desire for a good which determines his influence on the market. If he has no money, he may desire a thing ever so intensely without giving it value. If he is rich, a slight desire counts for a great deal. In other words, utility, backed by value, gives a commodity value. But this is to explain value by value, which is circular. So with the theory of average labor time. How shall we average labor time? The problem is easy if we confine ourselves, say, to wheat. If one bushel of wheat is produced with ten hours' labor, a second with eight hours' labor and a third with six hours' labor, the average is eight hours, and we may fix the value of the bushel of wheat according. But suppose we wish to compare the labor engaged in making hats with the labor engaged in raising wheat. How can such labor be compared? Hats are, in their physical aspects, incommensurable with wheat. The one quality which they have in common, relevant to the present interest, is value. Given the value of the wheat and the value of the hats, you may compare and average out the labor engaged in producing them. But if value must be employed as a means of averaging labor, it is clear that average labor can be no explanation of value. This is not the only flaw in the labor-time theory, but it illustrates a vice which it has in common with all those theories which start with individual elements, and seek to combine them into a social quantity. The whole method of approach is wrong. It makes two abstractions, neither of which is legitimate: first, it abstracts the individual from his vital and organic connections with his fellows, and then, second, it takes from the individual, thus abstracted, only a small part, that part immediately concerned with the consumption or production of wealth. In this process of abstraction, very much of the explanation of value is left out. The whole man, in his social relations, must be taken into account before we can get an adequate theory of value. We turn, then, to a brief discussion of society and the individual, and to a discussion of those individual activities and social relations which are most significant in the explanation of economic value.
* * * * *
All mental processes are in the minds of individual men. There is no social "oversoul" which transcends individual minds, and there is no social "consciousness" which stands outside of and above the consciousnesses of individuals. So much by way of emphatic concurrence with those critics of the social value theory[20] who persist in foisting upon the theory the notion that there is a social oversoul, or that the "social organism" is some so far unclassified biological specimen. To say that economic value is a social value, the product of many minds in organic interplay, is not to say that economic value is independent of processes in the minds of individual men, or that it results from any mysterious behavior of a social oversoul.
The human animal is born with certain innate instincts and capacities. Human animals of different races and different strains are in highly important points different in their instincts and capacities. But the human animal is not born with a human mind. Nor could the human animal, apart from association with his fellows, ever develop a human mind. "The human mind is what happens to the human animal in a social situation."[21] Of course, without the care of adults, the infant would, in general, promptly perish. But, more fundamental for our purposes, is the fact that all the important stimuli which play upon the child during his first two years, when the human mind is being developed, are social stimuli. So true is this, that the child's commerce with physical things runs in social terms. The child interprets the physical objects about him personally, attributes life and human attributes to them, holds conversation with them, praises and blames them, makes companions of them. This animism of the child, so puzzling to an old-fashioned psychology, is readily explained by social psychology. It is a social interpretation of the universe. It follows naturally from the principle of apperception: the interpretation of the unknown in terms of the known; the extension of accumulated experience to the interpretation of new experiences. The first experiences of the human animal are social experiences.
In the history of human society, a similar generalization is possible. The human individual is found, not in primitive life, but late in the scale of social evolution. Individuality is a social product. The savage is not a free, self-conscious person, who can set himself off against the group, and feel himself an isolated centre of power. His life is wrapped up in the group life. In the great barbarian states like Ancient Egypt or China, the life of the individual was so controlled by social tradition, and innovation was so ruthlessly crushed out that individuality had little scope. Greece and Judea gave larger scope to individual variation, but the individual still felt himself bound up with his group, and was stoned, given hemlock, or crucified if he challenged the existing social order too seriously. The break-up of the Greek city states, as independent sovereignties, and their subjection to the universal sway of Rome, made it possible for the cultured Greek to set himself up in opposition to the State; the coming of Christianity, substituting personal relations with deity, for the communal worship which had preceded it, gave the individual a vital interest apart from the life of the group about him, so that he could still further feel independent of his immediate social environment. The development by the Roman lawyers of the Jus Gentium, the law which is common to all nations as distinguished from the particular law of a given group, emphasized the doctrine of the Christian religion and of the Stoic philosophy of a humanity which transcends the limits of a given state,[22]--a notion which tended to free the individual from dependence on his immediate associates. But note that in all this we have merely a widening and multiplying of social relationships, and that the individual gains freedom from one set of social relationships only by coming into others. The Christian gains freedom from his immediate surroundings because he feels himself in communion with "angels and archangels and all the glorious company of Heaven." Francis Bacon could survive his degradation in the England of his day because he could leave his "name and memory ... to foreign nations and to the next age."
Bagehot, in his Physics and Politics, Tarde, and Baldwin, to name no others,[23] have shown how tremendously responsive human beings are to suggestion, how wide is the sway of imitation in human life, how fashion, mode, custom, etc., make and mold the individual. Cooley,[24] with an improved psychology, has amplified the analysis, tracing the development of the individual mind in interaction with the minds of those about him, making still clearer the sweep and pervasiveness of social factors in framing the very self of the individual. In what follows, I assume the results of these investigations. They constitute the starting point from which we set out on the quest of a theory of economic value.
So much for the individual. He is a social product. But what of society? Objective, external, constraining and impelling forces, which are not physical, which are seemingly not the products of the will of other individuals with whom the individual holds converse, meet the individual on every hand. There is the Moral Law, sacred and majestic, which stands above him, demanding the sacrifice of many of his impulses and desires. There is the Law, external to him and to his fellows, in seeming, failure to obey which may ruin his life. There is Public Opinion, which presents itself to him as an opaque, impersonal force, before which he must bow, and which he feels quite powerless to change. There are Economic Values ruling in the market place, directing industry in its changing from one sort of production to another, bringing prosperity to one individual and bankruptcy to another, not with the caprice of an individual will, but with the remorseless impersonality of wind and tide. He who conforms to them, who anticipates their mutations, gains great wealth--but no business man dare set his personal values against them. There are great Institutions, Church and State and Courts and Professions and giant Corporations and Political Parties, and multitudinous other less formal or smaller institutions, which go on in continuous life, though the men who act within them pass and change. Their Life seems an independent life, and the individual who tries to change their course finds that his efforts mean little indeed, as a rule. There is a realm of Social Objectivity, a realm of organization, activity, purpose and power, not physical in character, not mechanical in nature, which is set in opposition to individual will, purpose, power, and activity. How is the individual related to this objective social world?
Three main types of theory have sought to answer this question. On the one hand, there is a type of theory, doubtless the oldest type, a type which arises easily in a period when social changes are slow, which sees in the objective social world something really separate and distinct from individual life, having a non-human origin, and deriving its power from something other than the human will. On the other hand, there is an extreme individualism, which emphasizes individual separateness, which posits as a datum the individuality which we have seen to be a social product, and thinks of the objective social realm as a mere mechanical, mathematical summing up of individual factors, or as a something which individuals have consciously made, by contract or agreement, or what not. Finally, there is a type of theory, to which the present writer would adhere, which finds a false antithesis in the contrast thus sharply made between society and individual, which holds that the individual is not, in his psychological activity, so much set off from the activities of his fellows as the contrast would indicate, but rather shares in the give and take of a larger mental life. This larger mental life is completely accounted for when all the individuals are completely accounted for, but it cannot be accounted for by considering the individuals separately. No individual is completely, or primarily, accounted for until his relations to the rest of the group are analyzed. Thinkers who start out with the individuals separately conceived, and then seek to combine them in some arithmetical way, abstract from those organic social relations which constitute the very heart of the phenomenon we are seeking to explain. The parts are in the whole, but the whole is not the sum of the parts. The relationships are not arithmetical, additive, mechanical, but are vital and organic. Men's minds function together, in an organic unity.[25]
The first two of these types of theory (perhaps because individuals are physically sharply marked off from one another, and go on in biological functioning in obvious separateness) have falsely accentuated the self-dependence and separateness of individual minds. The second type of theory, which has sought to work out the whole thing on the basis of this false conception of the individual, has largely failed to see the objective social realities, or has, with methodological rigor, denied their existence. This second type of thinking has especially characterized a good deal of economic theory, which rests on the philosophy and psychology of David Hume.[26] We will set our doctrine in clearer light if we contrast three parallel types of theory which have appeared with reference to the nature of morality, of law, and of economic value. For each of these phenomena, we have theories which represent all three of the types of social thinking to which we have referred.
In the theory of morals, we have, at one extreme, doctrines like those of Kant and Fichte, according to whom morality is a matter of obligation, independent of the human will, independent of consequences, inherent in the nature of things. Man's mind can find out what the moral law is, but man's mind has nothing to do with the making of the moral law. The same notion is involved in the ideas of "natural rights," "justice though the heavens fall," and the like. The conception is strikingly brought out in the question about which old theologians sometimes debated: is Right right because God enjoins it, or does God enjoin Right because it is Right? Whether or not Right is supreme over God, these old theologians never questioned that Right is supreme over all human wishes and desires, and in no sense an outcome of them. At the other extreme, we have the moral doctrine of the Sophists, for whom each man's will was right for him--a doctrine which reappears in every individualistic and anarchistic age. For this doctrine, there are no valid social standards of right and wrong. There is nothing binding on the moral agent but his own will. In between, is the moral doctrine of such thinkers as Friedrich Paulsen, or John Dewey, who represent the reigning type of moral theory to-day. For them, morality is a purely human matter. It grows out of the needs and interests of men. What is good at one time and place is not necessarily good at another time and place. There are no immutable moral principles, valid throughout the ages. None the less, morality is not a private matter, about which men may do as they please. Morality is the product of an organic society, the product of the interplay of many minds. To a given individual, the moral law is, indeed, an external constraining and impelling force. It is the will of the rest of the group. It may be his own will too, but if it is not, it overrides his personal preference, He, on the other hand, is part of the group which constrains and guides every other individual. There are, in fact, many sets of moral values: on the one hand, the social moral values par excellence, which the group will enforce in various ways; and then, for each individual, his own moral values, which may correspond qualitatively more or less with the group values, or may antagonize them. But the Moral Law is the will of the group. It is no simple composite of the moral values of individuals. It has its organic interrelations with all phases of social life. Economic changes modify it, legal changes modify it, religious values modify it, all phases of social life are expressed in it.
In legal theory, we find these three types of doctrine also. The first type is clearly indicated in the general attitude of American and English courts, especially toward the common law, though it influences their interpretation of all law. The law is something which the mind of man may find out, but may not make. If a new situation arises, the court "finds" the law--in theory the principle "discovered" by the court was in the common law at the beginning. Of course, we know that the judge invents the rule he makes, to fit a novel case, but the judge himself will not admit it. The theory of the law and the theory of morality have developed in close connection, and the notion of "natural right" is a juristic as well as a moral idea. At the other extreme, we have from certain recent students of law the doctrine that "The Law" is a myth, that there is nothing but the particular opinion of a particular judge at a particular time. Individualism cannot go so far in legal theory as to give every individual in society a chance to put his oar in, and have a separate law for himself! The social and institutional character of law is too obvious to permit that. But individualism has gone so far in legal theory as to deny all objectivity to law except in a given decision in a particular case. In between these two extreme views, appear the views of writers like Savigny, or Professor Munroe Smith, for whom the law is a changing product of social psychology, volitional[27] rather than intellectual in character, objective enough to the individual who violates it, or the judge who seeks to pervert it, but none the less not outside the minds and interests of men. In Professor Munroe Smith's phrase, law is "that part of the social order which by virtue of the social will may be supported by physical force."[28] I venture to describe this type of legal theory as the "social value" theory of the law. In the chapter on "The Reconciliation of Statics and Dynamics," infra, I have cited certain opinions of Mr. Justice Holmes which apply it, and even bring into it the notions of the marginal analysis.
There are, similarly, three types of economic theory. At the one extreme we have theories of "intrinsic" value, which would place economic value outside the wills of men. The mediaeval discussions of "just price" often illustrate this notion. It creeps not infrequently into judicial opinions,--to which such notions are essentially congenial! The working economist of our own day has found little use for it, but in periods when economic change was slow it suggested itself not unnaturally to men, as an explanation of the seeming impersonality of market phenomena, and as a practical idea for combatting extortion and injustice. Something of the idea is involved in a sentence of Shakspere's:[29]
"But value dwells not in particular will; It holds his estimate and dignity As well wherein 'tis precious of itself As in the prizer."
At the opposite extreme would be those economists, as Professor Davenport and Jevons, who find no value for a good except in the minds of individual men, so that there may be as many different values as there are different men. That something social and objective exists in the market place can hardly be denied, but when pressed for an account of it, these writers reduce it to a bare, abstract, mathematical ratio.[30] Each individual mind is shut up within its own limits, inscrutable to other minds, and there can be no psychological phenomena which include activities in many minds, for this view. In between these two extremes, is the social value theory of the present writer. Economic value is not intrinsic in goods, independent of the minds of men. But it is a fact which is in large degree independent of the mind of any given man. To a given individual in the market, the economic value of a good is a fact as external, as objective, as opaque and stubborn, as is the weight of the object, or the law against murder. There are individual values, marginal utilities, of goods which may differ in magnitude and in quality from man to man, but there is, over and above these, influenced by them in part, influencing them much more than they influence it, a social value for each commodity, a product of a complex social psychology, which includes the individual values, but includes very much more as well. Our theory puts law, moral values, and economic values in the same general class, species of the genus, social value, alike in their psychological "stuff" and character, to be explained by the same general principles, even though differentiated in their functions, and in the extent to which they depend on various factors in the social situation. They are parts of a social system of motivation and control. They are the social forces, which govern, in a social scheme, the actions of men.
It may be well to suggest rough differentiae which mark off these values from one another. Legal values are social values which will be enforced, if need be, by the organized physical force of the group, through the government. Moral values are social values which the group enforces by approbation and disapprobation, by cold shoulders and ostracism or by honor and praise. Economic values are values which the group enforces under a system of free enterprise, by means of profits and losses, by riches or bankruptcy. The group may, under a communistic or socialistic system, rely in whole or in part upon the machinery of the law; in which case economic values appear not in their own form as immediately guiding production, but as "presuppositions" of some of the legal values.
The differentiation of these types of social value may also run in terms of their functions,[31] though it is not so easy to mark them off here, since their functions overlap. The function of economic values is to guide and control the economic activities of men, to send labor from one industry to another, to cause one sort of thing to be produced or another, to supply the motive force which impels industry. Legal and moral values also directly affect industry, often working to check the results which the economic values alone would lead to--as when the law forbids the production and sale of liquor, or checks child labor, etc. The law, on the other hand, does not, primarily, in its influence on industry, seek positively to determine its direction. The law forbids the production of liquor, but does not decree the production of bread. The law may seek to affect industry positively, by protective tariffs, for example, which aim at the building up of certain industries, but its effects are here indirect, reached through modifications in the economic values. Economic values, on the other hand, do not primarily aim at the regulation of the conduct of men outside the market place, or the shop or the farm, etc. Economic values are not primarily concerned with making men be good husbands or good neighbors, or brave soldiers. Economic values may be used, in part, for these purposes, as when a father-in-law uses his wealth as a lever to make his son-in-law behave--or, indeed, as a bait to get a son-in-law! It is hard to find a phase of social life which is not touched by all types of social values, but it is possible, roughly, to mark off those phases of social life which are subject to primary regulation by one or the other sort of social value.
The differentiation is easier when we look at the social institutions which have to do primarily with the one or the other sort of value. Courts and legislatures are easily marked off from stock exchanges and banking houses. There is not so clearly an institutional nucleus for moral values, since the church has lost its control over the moral situation.
When we view the matter from the standpoint of the objects of value, differentiae also appear. The main type of object of moral value is modes of conduct; the "type object" of economic value is physical things which men eat, wear, drink, etc., even though quantitatively the major part of the sum total of economic values attach to other things, instrumental goods, lands, labor, and social relations, like franchise rights, good will, which in the main reflect the values of consumers' goods;[32] objects of legal value are in large degree the same as objects of moral value, namely, modes of conduct, but moral values attach to a wider group of objects, and legal values attach to certain forms of conduct which are morally indifferent.
It is not so easy to make the differentiation when we view the thing from the standpoint of the consciousness of men who are at the centre of the situation, to whose consciousness the social values are presented. We may put at the very forefront of the economic value of oranges the gustatory feelings or desires of those who consume them; at the forefront of the moral value of a heroic rescue by a fireman the thrill that runs through the onlookers. Qualitatively, these psychological states are different, as those who have experienced both will know. But it is difficult indeed to put the difference into words. When it comes to a legal value, say the legal value of a given contract right which a man seeks to enforce in court, it is not easy to find any particular emotion or state of consciousness which is peculiar or appropriate to it. The value is so highly institutionalized and impersonal, that it seems to the court and lawyers and even the litigants to be merely a question of fact to be intellectually analyzed. Its roots are deep in human emotions, but not in the emotions, primarily, of those who are handling the transaction. Perhaps the jurist has states of consciousness we know not of. There may be a distinctively legal emotion. It seems to crop out at times when one questions, in conversation with a judge or lawyer, the infallibility of the courts. But the law does not derive its power therefrom! Rather, the law derives its power from the general consent and acquiescence and support of the mass of men, who turn over to experts the details of administering it, and who support The Law in general, rather than the rule of the corpus delicti, with their emotional sanction.
I think that we have here a clue to a vital point for our theory. We need not expect to find the major part of the explanation of any of these social values in the conscious emotions of those who are moved by them. In the case of the orange or the heroic act, we are, indeed, close to pretty simple human feelings and desires. In general, in the case of moral values, the individual emotion and the social value are qualitatively comparable, since moral values rarely take on a highly institutional character. They are more free from class or institutional control than other social values. This need not be true. Thus, the plantation negro need not feel any personal shame in the moral delinquency which he none the less hides from the "white folks" whose values he must more or less conform to. But, on the whole, moral values are much more "participation values,"[33] shared by the whole group in common, than are economic values or legal values. When we pass beyond the simple case of a consumption good, and get into the realm of the more institutional economic values, we lose all guidance from the clue of satisfactions in consumption. Just what emotion, for example, is appropriate in the presence of the four and a half per cent convertible bond of the Chesapeake and Ohio Railway Co.? If it be answered that ultimately that bond represents satisfactions in consumption, since the owner of it may spend the income for consumers' goods, or since the railroad in question carries coal which goes to Italy to be used in a cruiser which will sink an Austrian warship, thereby giving consumers' satisfactions to individuals in Italy, so that the value of the bond is ultimately reducible to specific satisfactions of given individuals, we may still hold that those satisfactions do not constitute the value of the bond, as such. Moreover, the same is true of the legal values. Ultimately, very specific human emotions are affected by the rule of the corpus delicti, or the rule governing pleas in estoppel. Both in legal and in economic values we have an elaborate and complex system of social psychological character, which can by no means be reduced to elementary desires or feelings of individuals, even though when the whole story is told, no part of the system will be found outside the minds of individual men. The point has been well put by Professor C. H. Cooley: "It would be as reasonable to attempt to explain the theology of St. Thomas Aquinas, or the Institutes of Calvin, by the immediate working of religious instinct as to explain the market values of the present time by the immediate working of natural wants."[34] I think that any attempt to differentiate the various kinds of social value on the basis of the type of emotion in the minds of those who have most immediately to do with them, or to explain them primarily by those emotions, is foredoomed. The law does not get its power from the emotion of the judge who gives a decision, nor does the value of a rare painting rest chiefly in the intensity of desire of the few rich connoisseurs who compete for it. Back of the judge, giving validity to his decision, stands the will of the group; back of the rich connoisseurs stand the legal and other social values concerned with the distribution of wealth, by virtue of which they are able to make their wants felt in the market. Both judge and connoisseur are focal points, through which stream the social forces affecting the values in question. Both are important. But the emotions and ideas of neither exhaust the psychological causation involved in the values.
This is very much more apparent when we consider the values that arise in the great speculative markets, say in the wheat pit, or the stock exchange. Those who buy and sell are primarily interpreters, students, of impersonal, social forces, seeking to adjust themselves to them, to forecast them, in such a way as to derive profit from them. Their choices and decisions are also factors. Indeed, it is possible to view the matter in such a way as to make their decisions the whole story. In the same way, it is possible to make the mind of the judge the final explanation of the legal value. But the speculators themselves are under no such illusion. They know very well that if they run counter to the facts they will lose money. And the judge knows very well that the range of arbitrary choice which he can exercise without impeachment, or at least without reversal by a higher court, is very limited. Nor is even a Supreme Court of the United States free to do its arbitrary will. Just because it is so conspicuous, and because its doings are so important, it has manifested more respect for judicial tradition, and more responsiveness to the tides of public sentiment, than any other court in the Federal Judiciary.[35]
The head of a great banking house makes a decision regarding an underwriting operation. On his decision depends the question of whether or not the securities are issued. On the issue of the new securities depends, in part, the values of the existing securities of the corporation in question, and the nature of the future employment of thousands of men and great quantities of land and capital. Tremendous power is concentrated in the hands of this banker. But it is not his power! He cannot exercise it in an arbitrary or capricious way. He approaches his problem in much the same spirit that the judge approaches a disputed question of law. He analyzes the factors involved. He considers the condition of the money-market, the question of the probable ease or difficulty of marketing the new securities to investors, the prospects of the business of the corporation in question, the probable future demand for its products, the stability of that demand, the personnel of the management of the corporation, the attitude of the government toward it, the nature of its other outstanding securities, with special reference to the proportion of bonds to stocks, and the amount of "fixed charges" against its earnings. He may also take into account other enterprises of similar character which he has connections with, and the question of whether or not building up the corporation in question may injure other corporations to which he has responsibilities. He looks far into the future, seeking to conserve his prestige, and unwilling to assume responsibility for an issue which investors will later lose faith in. Proximately, his decision is tremendously important, and his thoughts and feelings are of immense significance, but ultimately, they are determined by all manner of social considerations, and always, the degree to which they count in determining values depends on his weight in the economic situation, which rests (1) on his prestige, i. e., the massing of beliefs and hopes of many men, (2) on his wealth, which rests in the legal and moral values governing distribution, and (3) on his institutional relationships, which again are psychological facts, partly legal in character. He is as much a social instrument as is the judge. Both may abuse their power. Both do at times abuse their power. But the significant point is that the power both have is social power, and is in no sense proportional to the intensity of their own emotions. It arises from the emotional power in the minds of many men.
It would be easy to elaborate the points in which morals, laws, and economic values are alike, and to show in detail that the theory of economic value is merely a special case of the general theory of social value. For our present purposes, however, it is enough to have illustrated the general doctrine, and to have set up the economic values as true social forces. It may be noticed that the effort to differentiate the different kinds of value is not altogether successful. They are not in watertight compartments in social life. It is a commonplace among students of ethics that moral values grow, in greater or less degree, out of economic factors. Indeed, the "economic interpretation of history" has as its central theme the doctrine that morality, law, and ideal values in general are governed by the economic situation. This is a one-sided view. Moral and legal values are influenced and modified by economic forces. Legal and moral values do, in part, derive their power from economic values. But on the other hand, economic values likewise derive part of their power from legal and moral values. The "social mind" is an organic whole, in which no factors exist "pure," and in which there is constant give and take. The effort to explain moral values by a single principle, as sympathy, legal values by another simple principle, as fear, and economic values by a different simple principle, as utility, is foredoomed. It has been given up by the students of law and morals, and should be abandoned by the students of economics.
Let us consider more narrowly the main factors affecting and explaining economic social values. Let us take, first, the simplest case, that of goods and services which minister directly to human wants, goods and services "of the first order." Goods of this sort would be oranges, bread, clothing, jewels. Services of this sort would be the services of the barber, the valet, the physician, the preacher, the teacher, the actor. I abstract, in discussing these values, from the complications that grow out of the friction in retail trade, and the existence of many customary prices, and prices fixed by other than economic values, in the case of teachers, or preachers. I shall concentrate attention upon such things as oranges, bread, clothing, and jewels. The focus of the values of these things, and an essential condition of their existence, is their utility, that is to say, their power to satisfy human wants. Utility as used in economics does not mean usefulness in any moral sense. From the standpoint of the economist, whiskey and opium are as useful as bread, if they satisfy wants equally intense. And the economist is not concerned with the general utility of things considered in their totality. Air is more useful than jewels, but a carat of air is not as useful as a one-carat diamond. Air exists in such abundance that it does not need to be economized. Scarcity with reference to the extent of the wants involved is also essential to economic value. A combination of the ideas of utility and scarcity gives us the simple notion for which the formidable name of "marginal utility" has been devised. The marginal utility of a good to a man is the power the last, or "marginal," unit of the good which the man consumes has to give him satisfaction, or, viewed from the standpoint of the man, is the intensity of his desire[36] for, or of his satisfaction in, the final unit consumed. So far, our account of the value of the orange will seem perfectly acceptable to those accustomed to traditional discussions of the problem in the text-books. The difference is that many text-books stop at this point, leaving the impression that with the definition of marginal utility the whole value problem has been solved. For the social value theory, the conception of marginal utility is barely a starting point. Indeed, it is not even a starting point. We shall have to look both in front of it and behind it. Recognizing that marginal utilities to individuals are essential to economic values of consumption goods, we shall have to point out other things which are also essential, and we shall have to explain the factors determining these marginal utilities themselves.
The last point may be considered first. Men's desires are socially determined. Even the simplest, most instinctive, wants of human nature are, in their concrete manifestations, the product of social culture in overwhelming degree. Consider sex and hunger. We do not enjoy our food when our neighbors pick their teeth with their forks. This would not trouble a chimpanzee, whose instinctive equipment in the matter of hunger is vastly more like that of a man than is the actual hunger impulse of a highly civilized man like that of a savage. Civilized men will often starve rather than eat human flesh. Even when moral scruples are overcome, actual physical revulsion may prevent it. Men of different times and places wish food of special sorts, served in special ways. They wish to eat in the company of their fellows, but only of those fellows who can know and obey the ritual that is appropriate to the time and place. This is true of humble folk as of those who "dress for dinner." The ritual differs for the two sorts of people. But there is a spirit, a type of conversation, a code of etiquette, which prevails at the mealtime of virtually all men, and too serious digressions therefrom will take away the appetites of all. About the mealtime and the festal board have gathered a great host of traditions, ideals, and social activities, till they have become in verity an institution, and not the least important, by any means, of social institutions. Out of the simple instinct of sex, we have evolved many of the most precious things of our civilization, and between the sex impulse of the animal and the sex impulse of the gentleman who is seeking to marry the one woman in all the world, there is a difference so great that comparison between the two is difficult.
Here we have wants which grow out of the most elementary things in human nature, wants which are intense and universal, but which vary, in their concrete manifestations, enormously from age to age and from place to place. When we come to the wants which change more quickly, the fact that social factors dominate needs no arguing. Fashion, mode, custom, obviously account for the concrete wants that exist in clothing, ornamentation, amusement, housing, etc. If we wish to know what women will be wanting to wear six months hence, we do not go to women individually and ask them. We could not find out that way. They would not know. We go rather to the theatre, and study the stage and the boxes, to the famous designers of women's dress, to the metropolitan centres of various sorts, to the "radiant points of social control"[37] from which emanate the suggestions which pass in imitative waves through the women of the country in the next few months. The laws of imitation have been elaborately developed by Bagehot, Tarde, Baldwin, Ross, LeBon, Cooley, and others, and I content myself here with referring to their writings. The wants of women--and men--are socially given, grow out of a give and take, a social process. And in this social process, it is not true that each man counts one! Rather, a few lead, and many follow. There are centres of prestige which count overwhelmingly.
Certain wants are competitive.[38] Where social status depends on having as good a house as one's neighbors, and where social leadership depends on having a better house than one's neighbors, there is no limit to men's desires for better houses. With each improvement which one introduces, each feels the desire to improve, however contented he might have been had the other not made the improvement. To this we shall recur in our discussion of the origin of money, in explaining the value of gold.
So much for the human wants which stand as the focus of economic values in the case of articles of immediate consumption.
But, given these wants, and given their marginal intensities, we are only at the beginning of our explanation of the economic values of the consumption goods. It is again not a case of each want counting one, to the extent of its intensity. There are again, by virtue of the legal and moral values governing the distribution of wealth, centres of power. The wants of some men count for nothing, however intense they may be. The pauper, the prisoner, the beggar--popular proverb about "beggars and horses" understands them, however much the "marginal utilitarian" may forget that their wants count for nothing.[39] The slightest whim, on the other hand, of the man who has inherited millions may count heavily in giving values to goods. For the explanation of the values of consumption goods, then, we need both the socially determined marginal utilities of individuals, and the socially determined weight which these individuals have in our economic system. This weight would involve a very elaborate explanation. Many factors affect it. We call attention here, however, especially to the fact that it rests in large part on the legal and moral values and institutions concerned with the distribution of wealth. Changes in the distribution of wealth are as important as changes in the wants themselves in giving the explanation of changes in values. The economic social values of consumption goods include not merely the values of those goods to the individuals who consume them, but also the values of the individuals themselves in the social scheme of things.
What of the values of instrumental goods, of goods of "higher orders," of labor, of stocks and bonds, of lands, of franchise rights and good will?
It is the one great contribution of the Austrian economists to have shown that the causation in value runs, primarily, from consumption goods to the goods of higher "orders" which are concerned with their production, and that these values of instrumental goods, etc., are derived and secondary values. The value of wheat is based on the value of bread, the value of land on the value of wheat. The value of the stock of United States Steel rests in part on the value of iron lands, which rests on the value of ore, which rests on the value of pig iron, which rests on the value of steel rails, which rests on the value of the service of transporting building materials, which rests on the value of a building, which rests on the value of the services which a dentist performs in an office in the building. This is the main line of causation. This is the first approximation which gives us a clue, without which we should find problems insoluble. But is it not clear that this cannot be the whole story? At every step complications enter. The whole thing cannot be got out of the value of the dentist's services, and the other consumers' goods and services, which are indirectly aided by the property to which title is given by ownership of U.S. Steel stock; nor is the value of the stock to be fully explained by the value of the property to which it gives title.
At every step, we meet the complication that men must estimate and calculate, for one thing. And rarely indeed can men see all the steps, the end from the beginning. Take first a very simple case, wheat land. The value of the wheat land of to-day rests on the value of wheat, but it is the wheat of to-morrow and for many years to come; the wheat of to-morrow rests for its value on the value of the bread of the day after to-morrow. Sometimes the differential between goods at two consecutive steps in the productive process is pretty constant. Wheat and flour vary pretty closely together. The differential is not strictly fixed even there. But bread and wheat land have a much looser connection in their variations. If land could produce no wheat or corn or other good that would satisfy human wants, and if it could not itself satisfy human wants, it would ordinarily have no value.[40] But the connection between the value of the bread and the value of the land is loose and uncertain, while the connection between the value of the land and the intensity of the wants actually satisfied by the bread produced from it, is absolutely nil. Whether the bread saves a starving man or feeds the pet pigeons of a millionaire, is a matter of indifference so far as the value of the land (or of the bread) is concerned.
We take the values of consumption goods, and break them up, attributing part to the labor that immediately produced them, part to the raw materials that entered into them, part to the machine that fashioned them, and so on. We then break up the value attributed to the raw material, attributing part to the labor that worked in producing it immediately, part to the machine that fashioned it, part to the rawer material of which it was made. And so with the values of the machines. Ultimately we get back to the values of labor, or of land, or of securities giving title to complexes of lands, machines, etc.--values which we do not further break up. But at every step, we find additional factors. We find these derived values becoming independent, substantial, standing in their own right. Moral and legal values affect them directly, as in the case of patriotic support of government securities, moral antagonism to the securities of the Distillers' Securities Corporation, or the influence of court decisions, legislation and elections on security values. Such values rest, in large degree, on the massing of beliefs and hopes, not concerned with specific satisfactions of wants, but with the existence of future economic values. These beliefs and hopes again have their social explanation. It is not a case where each man counts one. There are centres of prestige and power, bankers and financial magnates, whose opinions and decisions count heavily, and waves of optimism and pessimism, which affect the whole group. We shall discuss these matters more fully in connection with the analysis of credit, at a later point of our study. For the present, it is enough to point out that the whole thing cannot be explained on the basis of the values of consumers' goods, and that the values of consumers' goods are only in small part explained by the intensities of the wants they serve.
In summary: Economic value is the common quality of wealth, by virtue of which it is possible to compare divers kinds of wealth, and treat wealth quantitatively, getting ratios of exchange, sums of wealth, etc. Value is a quantity, i. e., a quality which has degrees of intensity. Ratios of exchange are ratios between values. Price is a particular sort of ratio of exchange, namely, a ratio in which one of the terms is the value of the money-unit. Prices correctly express values on the assumption of the fluid market, and on the assumption that the value of the money-unit does not vary.
The value quality is psychological in character. It rests in human minds. But not in the minds of individuals thought of separately. It is a complex of many individual mental activities, highly institutionalized, and including legal and moral values, hopes and beliefs and expectations, as well as the immediate intensities of men's wants for consumption goods.
The ultimate test of scientific theory must be practice. If a theory aids in manipulating facts, if it leads to the discovery of ways of doing things which are better than old ways, if it solves problems which have hitherto remained unsolved, or carries the solution of problems farther than has hitherto been the case, it is a good theory. It need not be the best possible theory. It need not be a final theory. The chief claim for the present theory of value is that it not only unlocks all the doors that earlier theories have unlocked, but also others which have resisted the old keys. The man who goes into the modern stock market armed with marginal utility and the quantity theory is like the man who would fight Hindenburg with bows and arrows. Bows and arrows are effective in the hands of expert archers, and the great figures in the history of economics have done wonderful things with marginal utility, "real costs," and the quantity theory. But the social value theory is offered as a better weapon.
The writer believes that the problem of the value of money has not been solved by the older theories of value. He believes that the social value theory will solve it. He proposes on the basis of the social value theory to make clearer the nature of credit phenomena, and to assimilate the laws of credit to the general laws of value. He proposes with the social value theory to bring together in a higher synthesis two divergent types of economic theory, the "static" and the "dynamic." He thinks that a rigorous and consistent application of the absolute concept of value will clarify confusions at various points in the general body of price theory, as the laws of supply and demand, etc.
He offers the social value theory as the only way of giving a psychological explanation to the demand-curve, and a marginal value explanation of marginal demand-price. Demand-curves are social value curves, on the assumption of the fixed social value of the dollar. The utility theory, as will appear in the chapter on "Marginal Utility," has failed to give psychological magnitudes corresponding to any point on the demand-curve. In general, he offers the social value notion as the justification for the assumption of a quantitative value which, as we shall see, underlies the whole of our current price analysis.
The theory here outlined has been, as stated, developed and defended more fully in a previous book. For the rest, the author would have it judged by its usefulness or failure as a tool of thought in the investigations which follow.
NOTE. It has seemed best not to break the main course of the argument of this chapter for the elaboration of one point on which there has appeared to some critics to be vagueness in the exposition of the social value theory in my earlier volume, namely, the relation of social values to the individual values of those who are moved by the social values. Social values have as their function the guidance and control of the activities of men. But men are also moved by their own individual feelings, interests, and desires.
What is the relation between these two sets of factors? In what has gone before, it has been made clear that social values present themselves to the individual as opaque, objective facts, largely beyond his control, to which he must adjust himself. They represent the minds of other men, acting in corporate and organic ways, putting pressure on him, or offering him lures. Now the individual reckons with these social values in the same way that he reckons with any other of the facts affecting the economy of his life. He must adjust himself to them in the same way that he must, if he is a blacksmith, adjust himself to the technical qualities of the iron he is manipulating. This does not mean that he is passive before them, any more than he is passive before the iron. He rather seeks to carry out his personal purposes and desires by actively adapting himself to objective facts, whatever they be. This means that different individuals will react in different ways to the same social value. The fear of the law will keep one man from burning dead leaves in the street where it will not keep another man from murder. A given degree of social pressure will make one man crease his trousers, while another man will not even know that the pressure to crease one's trousers exists! There are great individual variations in responsiveness and sensitiveness to social pressure. In part, these variations are due to inborn qualities. In larger part, they are due to social education, and to social status. Thus, the fact that one man will work all day in a ditch in response to the lure of a dollar and a half, while another will not work in the ditch for a hundred dollars a day, may rest in slight degree on the greater inborn sensitiveness of the latter to the physical pain of labor, but rests primarily on the fact that the latter doesn't need the money, and has a social standard, growing out of his class-associations and education, which would make him ashamed to be seen in the ditch. Indeed, we may think of the social standard in question as a social value acting on him, rather than in him. He fears ridicule. The same degree of social power, luring men toward the ditch, exists in the dollar in each case, but the response is very different in the two cases.
Later formulations of the utility theory and the labor cost theory, as represented by the theory of Schumpeter, which we shall discuss in the chapter on "Marginal Utility," give us, in a scheme of purely static equilibrium, a picture of the adjustment of the individual values to the social values. As we shall see, they give us no account whatever of the social values. They do not explain causation at all. But they do show that there is a tendency for the individual marginal utilities of consumption to become proportional to the social values of the goods consumed by each individual; and for the individual marginal disutilities in production to become proportional to the social values of the rewards that come to producers. The scheme is highly unrealistic. It has been emphatically repudiated by Boehm-Bawerk, so far as the disutility equilibrium is concerned. ("Ultimate Standard of Value," Annals of the American Academy, Vol. V, pp. 149-209.) But it is worth something, not as explaining social values or market prices, but rather, as showing how individuals conform to social values and market prices. Cf. Social Value, pp. 43-44, n. 2, and 148.
The theory that individual marginal utilities and disutilities are proportional to market values is unrealistic enough, in the light of the analysis of individual utilities which we have given, even for the utilities. It is quite impossible to make anything of importance of it from the side of individual disutilities. The length of the working day is not fixed for each worker by a comparison of his own labor pain with the satisfactions he expects from his wages. It is fixed by conditions largely external to him, and the whole group works the same number of hours, with the machine. The law may limit the working day. Trades-union effort may do it. Opportunities for alternative employment may do it, for the labor force of a factory as a whole. But the theory, which really must rest in the notion that each individual has many options, and that the working period is flexible, cannot mean much. The prosperity of the laborer does more to limit the working day than does his suffering!
The reactions of individuals as consumers or producers on the social values modify the social values. But, as we have shown, the primary explanation of the social values is not to be found in the individual utilities and disutilities of those who react to them. Utilities and labor pains are parts, but minor parts, in the explanation of social values.
II. SUPPLY AND DEMAND, AND THE VALUE OF MONEY
The theory of the value of money is a special case of the general theory of economic value. To the layman, this would seem to go without saying. To the student of the literature of the subject, however, who has noticed the wide divergence between the method of approach to the general problem of value and the method of approach to the problem of the value of money, in most treatises which include both these topics, the proposition will sound unusual if not heretical. Most text-books in English to-day will offer the marginal utility theory as the general theory of value. The same books commonly present the quantity theory of the value of money. Whether or not the two theories are consistent may wait for later discussion, but that the quantity theory of money is a deduction from the utility theory of value, and a special case of the utility theory of value, will not, I believe, be contended by anyone. Certainly in its origin, the quantity theory is much the older theory. The same is true for those writers who seek to explain value in general on the basis of cost of production, and who at the same time offer the quantity theory to explain the value of money. The two theories may or may not be consistent, but in any case, they are logically and historically independent, neither being a deduction from the other. Older writers (as Walker and Mill), whose treatment of the general theory of value runs in terms of "supply and demand," have stated that the quantity theory is merely a special case of the law of supply and demand, and the statement is occasionally met in present-day writings, though one of the most recent and best known of the expositions of the quantity theory, Professor Fisher's Purchasing Power of Money, very explicitly repudiates this doctrine.[41] But it may be easily shown, and will be shown later, that the quantity theory, and the present-day formulation of the law of supply and demand, are in no way logically dependent upon each other. This lack of connection between two bodies of doctrine which should be in a most intimate and essential way related to each other, may well throw suspicion on the current treatments of both topics. In any case the lack of connection raises a problem, and calls for explanation.
Part of the explanation may be sought in the fact that the writers who have developed the general theory of value have not been, in general, the writers who have most elaborated the theory of the value of money. The theory of money has been for a long time a more or less isolated discipline. In Ricardo, we have an elaboration of the labor theory of value, and we also have the quantity theory of money. But it is not clear that Ricardo added anything to the quantity theory. He found it, in much the form in which he used it, in the writings of predecessors, among them Locke and Hume. Ricardo makes large use of the quantity theory as a premise, but apparently feels the theory to be so self-evident that it needs little exposition or defence at his hands. John Stuart Mill is a clear exception to the general statement. Cairnes, likewise, did treat both topics in considerable detail, but while his interest in the general theory of value was that of the theorist, his treatment of money was primarily in the spirit of the publicist, and his interest was less in the justification of the theory--which he again seems to feel needs little defence--as in its application. A similar statement may be made with reference to Jevons. He worked out his general theory of value for its own sake; his utterances on the theory of the value of money must be sought scattered through his practical writings on money. Alfred Marshall's Principles (Vol. I) says almost nothing about the theory of money; his opinions on that subject are to be found in some ex cathedra replies to questions from a Parliamentary Commission. The most important discussions in England of the value of money are to be found in the long polemic between the Currency and the Banking Schools, by writers who would not be listed among the makers of the general theory of value. In the United States to-day, with the exceptions of Professors Fisher and Taussig, the writers who have been interested in the general field of economic theory have done comparatively little with the value of money (e. g., Professors Clark and Fetter), and the writers who have been most interested in the value of money have usually not written largely on the general theory of value (e. g., Professors Laughlin, Scott, Kinley). Professor Kemmerer might well be included as an illustration of this last statement. His primary interest is in money, rather than general theory, even though he does precede his theory of the value of money with an exposition of the utility theory of value. In German, a similar situation obtains. Boehm-Bawerk has touched the theory of money scarcely at all. Menger has written an important article on "Geld" in the Handwoerterbuch der Staatswissenschaften, but the important thing about this article is the theory of the origin of money, and the reader will find little on the problem of the value of money. Wieser has recently taken up the value of money (in articles published in 1904 and 1909), but no trace of his views has as yet manifested itself in the English literature on money, and the writer may here express the opinion that Wieser's contributions to the theory of money are not likely to be very influential, or to add to his reputation.[42] Austrian writers on the value of money, as Wieser and von Mises, have recognized more clearly than anyone in America or England, the essential dependence of the theory of the value of money on the general theory of value. The German writer on money who has attracted most attention recently, however, G. F. Knapp, troubles himself about the general theory of value not at all.
But the main explanation of the hiatus between the two bodies of literature and doctrine is to be sought in something more fundamental. Neither utility nor costs nor supply and demand furnishes an adequate basis from which the quantity theory, or any other theory of the value of money can be deduced. The cost theory, and the supply and demand theory, in their present-day formulation, are really not theories of value at all, but are theories of prices, theories which presuppose value, and money, and a fixed value of money. And the utility theory, as usually presented, is either a theory of barter relations, or else (more commonly) speedily settles down into the grooves of supply and demand, leaping by means of a confusion of utility curves and demand-curves (or sometimes by a deliberate identification of them, e. g., Flux and Taussig[43]) to the treatment of market prices. I shall take up these points in order.
A historical summary of the development of the notions of supply and demand will aid the exposition. It may be noticed, first of all, that supply and demand is really a very superficial formula even though an exceedingly useful one. By virtue of its superficial character, it antagonizes few other theories, and it has been the common property of almost all schools of value theory. Cost theories and utility theories, labor theories, or social value theories, all find use for it, in one form or another. It is really quite neutral and colorless, so far as the ultimate questions of value-causation are concerned. The more fundamental causal factors offered by one theory or another are commonly supposed to operate through supply or demand, in price-determination. Adam Smith seems to see this more clearly than does Ricardo. Ricardo, indeed, sometimes thought of demand and supply as forces antithetical to the forces of labor-costs which he was considering. In ch. xxx of his Principles of Political Economy and Taxation (ed. McCulloch, pp. 232ff.) he holds that his natural value ultimately rules, except (p. 234) in the case of monopolized articles. Supply and demand govern the prices of monopolized articles and of all articles in the short run. I do not find in Ricardo any clear statement to the effect that cost of production operates through influence on supply. Neither Adam Smith nor Ricardo felt the need of very much precision in the definition of supply and demand. Smith does, indeed, distinguish "effectual" from "absolute" demand, in a well-known passage (ed. Cannan, I, p. 58), defining effectual demand as the demand of the effectual demanders, i. e., these who are willing to pay the "natural price" of the commodity. The term "supply" he does not use in this passage, but speaks of the "quantity which is actually brought to market," and gives as the law of market price that it is determined by the "proportion" between this quantity and the effectual demand. That much is wanting in this analysis will be sufficiently clear when the views of J. S. Mill and Cairnes are considered. Ricardo offers even less than Smith in the way of definition. The reader may compare the pages in Ricardo's Works cited above, and the discussion of the demand for labor on p. 241 in the same volume.
In J.S. Mill, a clean-cut notion first appears. The doctrine that price is determined by a ratio between effectual demand (i. e., the wish to possess combined with the power to purchase) and supply (i. e., the quantity available in the market), is sharply criticised. How have a ratio between two things not of the same denomination? "What ratio can there be between a quantity and a desire, or even a desire combined with a power?" To make supply and demand comparable, demand must be defined as "quantity demanded," and then the difficulty arises that the quantity demanded will vary with the price, which seems to present a case of circular reasoning if demand is to be a determinant of price. The solution which Mill develops for this difficulty really gives us our modern conception, virtually complete except that Mill does not present it in the useful diagrammatic form and does not whisper the magic word, "margin." There is a demand-schedule, which, plotted, would give a demand-curve. At such and such prices, such and such quantities are demanded, or will be purchased. There is a supply schedule, presenting a supply situation of similar character (though not so clearly indicated). The price reached is that price which equalizes amount demanded and amount supplied. A higher price will lead to competition among sellers, forcing down the price, a lower price will lead to competition among buyers, forcing up the price. The notion of a ratio between supply and demand is replaced by the notion of an equation between them. The present writer wishes to remark, in this connection, that Boehm-Bawerk's elaborate analysis, with his "marginal pairs," etc., has not advanced one step beyond this conception of Mill's, that it is really less satisfactory than Mill's analysis, because of the impedimenta of pseudo-psychology it has to carry, and because of its confusion of utility schedules with demand schedules.[44] In our present-day expositions, as presented in the diagrams, we are accustomed to say that price is fixed when marginal supply-price and marginal demand-price are equal, putting the stress on the ordinate, rather than on the abscissa, on the identity of the dollars paid or received, rather than on the identity of the goods given or received. But this is merely another way of stating the same equilibrium which Mill perceived--when marginal demand and supply prices are equal, amount supplied and amount demanded will be equal, and conversely.
One point is to be added, making explicit what is implicit in the modern theory of supply and demand. Supply and demand doctrine assumes money, and a fixed value of money. That there should be a given schedule of money-prices for varying quantities of a good, is possible only if there be a given value of the money-unit.
That the modern doctrine of supply and demand necessarily involves the assumptions of value, of money, and of a fixed value of money, may be proved by the following considerations:
Supply-situation, represented by the supply-curve, and demand-situation, represented by the demand-curve, are conceived of as antithetical and independent causal forces, whose equilibrium determines both "supply and demand" (in the sense of quantities supplied and demanded) and price. Mill's doctrine that supply and demand determine price gets out of the circle that demand (amount demanded) is itself dependent on price, only by making both demand in this sense and price results, rather than causes, and by putting the causation back into the more complex factors which I call "supply-situation" and "demand-situation." The two independent causes, then, are summed up in the supply-curve and the demand-curve. But, first, these curves are expressed in money. And second, a change in the value of money would affect both of them proportionately. But a theory which is concerned with supply and demand as independent and antithetical must abstract from factors which give them a common movement, without modifying their relation to each other. A change in the value of money would lead the supply-curve to move to the right, and the demand-curve to move to the left, the change in each being proportionate, and the amount supplied, and amount demanded, would remain unchanged. Changes in the value of money must, therefore, be abstracted from.
Again, we must precise the notion of an increase in demand, or of supply. Increase in demand may mean mere increase in amount demanded, consequent upon a lower price, consequent, i. e., upon a lowering of the supply schedule. In this sense, increase in demand is a passive fact, a result rather than a cause. On the other hand, if the increase in demand is an increase in the amount demanded at the same price, if it means a change in the demand-situation, represented by the moving to the right of the demand-curve, we have a causal factor in increase in demand, a factor which raises the price and compels new supply to come into the market. We may distinguish these two meanings as increase in demand in the active and in the passive senses. Mutatis mutandis, we may speak of increase of supply in the active and passive senses. These distinctions have been made before, but it has not been clearly seen that these distinctions, and the connected doctrines, involve the assumption of a fixed value of money. But consider: it is the current doctrine that increase in demand in the active sense, the demanding of a greater amount at the same price, the moving of the demand-curve to the right, not only raises the price, but also tends to increase the supply. But this is true only if the cause of the increase in demand is not a cause which simultaneously works on supply, neutralizing that tendency. If the increase in amount demanded at a given price be due to a lowered value of money, then the same lowered value of money will reduce the supply available at that price pro tanto, and the new equilibrium, caeteris paribus, will be at a higher price, to be sure, but with the same amount supplied and demanded. "Demand" is a term which carries the connotation of motivating power in economic theory. Through demand run the forces which regulate production and supply. The function of increased demand is to induce increased supply. But the value concept, and the assumption of a fixed value of money, are needed to preserve this part of the doctrine. Without them we have no way of distinguishing a real increase in demand in the active sense, which does modify the adjustments in production, and alter the proportions of different supplies, from a nominal increase in demand in the active sense, which merely raises a money-price, without affecting supply.[45]
Another approach will lead to the same conclusion. Demand and supply-curves are not to be understood merely in terms of brute, physical quantities. They are rather curves expressing economic significances, manifesting psychological forces which lie behind them. No considerations of mere physical quantity will explain why one demand-curve should be "elastic" and another inelastic,--each curve has its own peculiarities, which are not mechanical in their nature. Demand-curves express the diminishing economic significance of goods as their quantity is increased. How economic significance is to be interpreted need not be argued here. I have elsewhere undertaken to show that the utility theory of value does not explain the economic significance which demand-curves express--that demand-curves are not utility curves. My own theory is that demand-curves are to be explained only in terms of a social psychology, that demand-curves are social-value curves. But my argument at this point does not rest on the particular type of causal theory of value one chooses. It is enough that the demand-curve be recognized as expressing economic significance, and diminishing economic significance.[46] But for the demand-curve to express variation in economic significance of a good, there is need for a unit in which to express that variation. That unit is the economic significance of the dollar, itself assumed to be invariable--as all measures must be assumed to be invariable if measurement is to mean anything. If the unit chosen vary in the course of a given investigation, the curve tells you nothing at all.
Another way of reaching the same conclusion is to say that an increase in demand in the active sense will lead to an increase in supply only if there be no corresponding increase in demand for the alternative employments of the sources of that supply, that, e. g., an increased demand for wheat will lead to increased production of wheat only if there be not a corresponding increase in the demands for corn and other crops which can be raised on land and with labor and capital that would otherwise produce wheat. This is only another phase of the argument that went before, that an increase in demand due to a falling value of money would lead to a corresponding shift in the supply-curve. It is not quite the same argument, however, because that was an argument concerned with short run tendencies, resting on the assumption that the holders of supply would immediately react to a change in the value of money, whereas the argument just presented rests on the longer adjustments, based on the law of costs, as worked out by the Austrians. This point will be made clearer in the next chapter.
Yet another, and perhaps simpler, approach to the same conclusion is by pointing out that an individual, deciding to buy, must take account of the prices of other things in his budget--that individual demand-schedules would be different if market prices of other things--which depend on the value of money--were different.
The doctrine that supply and demand (and cost of production, the capitalization theory, and other elements in the current price-analysis) presuppose a fixed value of money, must be sharply distinguished from the doctrine of Professor Fisher (Purchasing Power of Money, ch. 8), and others, that a fixed general price level is assumed by supply and demand, etc. I should deny that a fixed general price level is assumed. The point rests in the distinction between value as absolute and value as relative. For my theory, it is perfectly possible for the general price level to rise, with the value of money constant, because of a rise in the values of goods. In a later chapter, on "The Passiveness of Prices," I shall examine the doctrine of Professor Fisher more closely, and set these two views in clearer contrast. For the present, it is enough to point out one vital difference between a rise in prices due to a fall in the value of money and a rise in prices due to a rise in the values of goods, with the absolute value of money unchanged: in the latter case, there is an increase in the psychological stimulus to industry, an increase in economic power in motivation, which energizes and increases production. In the latter case, especially when the fall in the value of money is rapid, and the rise in prices is clearly due to that cause (as in the case of Confederate paper, or the French Assignats), we find a reverse effect on industry. Intermediate cases, where money is falling in value, but where goods are also rising, give us intermediate results.
In what follows, I shall from time to time refer to this distinction. In my own exposition, I shall always use "value of money" in the absolute sense, as distinguished from the mere "reciprocal of the price level,"--a practice which I have sought to justify in the chapter on "Value," and in other places there referred to.[47]
The modern theory of supply and demand, then, assumes money, and a fixed value of money. It is, therefore, obviously unfitted as an instrument to solve the problem of the value of money. If supply and demand concepts are to be applied to this problem, they must be of a different sort. This was pointed out by Cairnes[48] who criticised Mill's formulation, and pointed out that Mill departed from it in three capital doctrines: in the theory of the value of money, in the theory of wages, and in the theory of international values. By the demand for money, Mill means, not the amount of money demanded, but the quantity of goods offered against money--a very different conception. (Mill, Principles, Bk. III, ch. viii, par. 2.) In what sense a quantity of goods can equal a quantity of money, or in what sense there can be a ratio between goods and money, (to recur to Mill's former problem as to the ratio between things not of the same denomination) Mill does not make clear, nor is it defensible to speak of either a ratio or an equation on the basis of Mill's system, since Mill had no absolute value concept. Cairnes seeks to reconstruct the notion of supply and demand, in such fashion as to make it possible to apply it universally, and takes up the question of the comparability of supply conceived as a quantity of goods, and demand, conceived, not as a quantity of goods, but as desire combined with the ability to pay. He concludes that in both supply and demand there is a physical, as well as a mental, element. Demand he defines as the desire for a commodity backed by general purchasing power; supply as the desire for general purchasing power, backed by the offer of a commodity. Thus he thinks he has made the two of the same denomination, so that comparison may be instituted between them, and the ideas of equation, ratio, and proportion made legitimate. By "general purchasing power," Cairnes seems to mean money and the representatives of money. It is not an abstract power, since it is the "physical" element in demand, comparable with, and of the same denomination with, the physical element in supply, a commodity. Cairnes' solution of Mill's difficulty seems to me to be merely verbal, however. First, in what way is the desire for general purchasing power in the mind of one man comparable with the desire for a commodity in the mind of another man? I pass over the supposed difficulty that knowledge of other men's emotions is impossible,[49] and emphasize simply the point that price offer, either by demander or supplier, is no test of the intensity of desire where there are inequalities in the distribution of wealth. But second: in what sense is general purchasing power, money and money-funds, of the same denomination as a commodity? Cairnes emphasizes the physical character of both. But surely they are not comparable on the basis of any physical attributes--weight, bulk, etc. Certainly if we look at the concept of demand here given, the physical aspect is simply irrelevant--gold money goes by weight, but what of paper money and credit instruments? And in what sense is even gold money physically of the same denomination with, say, wheat, or hay or base-ball tickets? Not physical quantities, but economic quantities, are relevant here; not weight or bulk, but value. By means of a concept of value, as the homogeneous quality of wealth, present in each piece of wealth in definite, quantitative degree, could Cairnes bring about comparability between the "physical" elements in supply and demand. But not otherwise. Only significances, values, are relevant here. Supply and demand presuppose value.
It will be interesting to consider the effort to solve the problem of the value of money by means of supply and demand on the lines employed by Mill, where demand for money is defined as quantity of goods to be exchanged, and supply of money as quantity of money times rapidity of circulation, and where physical quantities are treated as the relevant factor, no value concept of the sort here contended for being presupposed. This is, essentially, Mill's method. There is, in this conception, first the difficulty that "quantity of goods to be exchanged" is not a true quantity at all, but is a mere collection of things of different denominations, dozens of eggs, pounds of butter, gallons of milk, etc., incapable of being funded into a quantity.[50] There is, second, the difficulty that increasing the amount of any one of the items in this heterogeneous composite need not increase the "demand" for money, in the sense that it increases the "pull" on money, or tends to increase the supply of money. Yet, under the general doctrine of supply and demand, an increase in demand should be a stimulus to increase in supply. Indeed, it is easy to construct a case where an increase in the quantity of one of the items in this composite, the others remaining unchanged, would actually tend to repel money, to reduce the supply of money. Suppose that one item in America's stock of goods, say cotton, is much increased in quantity, and suppose that cotton has a highly inelastic demand-curve, so that the increased quantity sells for less money than the original quantity.[51] Suppose, too, that cotton is our chief article of export, and that the bulk of our cotton is exported. Would not the "balance of trade" tend to turn against us, so that gold would tend to leave the country, and the supply of money be reduced? There is nothing in the situation assumed to raise the prices of other goods,[52] so that they could exert a counteracting "pull" on money. Europeans, to be sure, having less to pay for cotton, could demand more of other things, and Americans paying less for cotton could demand more of other things. But, on the other hand, American producers of cotton, receiving less for their cotton--receiving precisely as much less as the others had more--could then demand less of other things, exactly as much less as the others are able to demand more. The original tendency for gold to leave the country, and the tendency for gold to leave the money-form and be used in the arts, would remain unneutralized. An "increase of demand for money," in Mill's sense, would in this case present the remarkable phenomenon of driving money away. Physical quantities are irrelevant. Psychological significances are what count.
It is interesting to note, in this connection, that some striking contradictions in quantity theory reasoning on any formulation, whether connected with the notions of supply and demand or not, are involved in this hypothesis. The illustration above gives a case where a lowered price level leads money to flow away from your country. But, on the quantity theory explanation of foreign exchange, it is rising price levels which drive gold away, and falling price levels which attract gold![53]
Mill's effort to apply the notion of demand and supply to the value of money is, then, (1) not an application of his formal doctrine of supply and demand, and (2), is a failure, leads to results contradictory to the general law of supply and demand, as soon as we take account of the peculiarities of individual commodities, and cease to look at commodities in one huge lump. Psychological forces, rather than physical quantities, are what count. Whether or not the supply and demand notion of Cairnes, reinterpreted by putting a quantitative value concept into it, could serve as a means of approach to the value of money, I shall not here argue. No one so far as I know has attempted to do the thing that way, and my own theory is best developed by another method. It is interesting to note, however, another somewhat different effort to apply the supply and demand formula. General Walker does so, including among the factors determining the demand for money, not only the quantity of goods to be exchanged, but also the prices[54] prevailing. Since by value of money Walker means merely the reciprocal of the price-level, this is the clearest possible case of a vicious circle. It would be a circle even if he were trying to explain the absolute value of money, as distinguished from the reciprocal of the price-level, since the former is one of the determinants of the latter. Value of money and values of goods determine prices; prices and quantity of goods determine demand for money; demand and supply of money determine value of money,--a hopeless circle.
I know no sense in which the terms, demand and supply of money, can have relevance to the problem of the value of money. There is one sense in which the terms can be used which fits in with the modern supply and demand-curves, and that is the sense in which they are used in the money market. Demand for money comes from borrowers; supply of money from lenders. The price paid is a money-price, the curves express the short time money-rates, the rental of money, in terms of money, for stated periods of time. There is a relation, later to be investigated, between the rental of money, the money-rate, and the value of money, but the two are in no sense the same. It should be noted, too, that we are here concerned with "money-funds" rather than with money in the strict sense,--distinctions and relations in this connection properly belong at another stage of our inquiry. Whenever the terms, demand and supply of money, appear in the following pages, they will be used in the sense developed in this paragraph.
Demand and supply are superficial formulae. They cannot touch a problem so fundamental as that of the value of money.
III. COST OF PRODUCTION AND THE VALUE OF MONEY
When the cost theory was a labor theory, as with Ricardo, the expression, cost of production of money, could have a definite meaning. It meant the labor-cost of producing the money metal. Even in this form, it is recognized that cost of production has a looser connection with value in the case of money than in the case of most commodities, because the supply of money metal is large and durable, and the annual production affects it slowly. But cost of production theories, in the form of labor theories, or labor-abstinence-risk theories, have little standing in modern economic theory. Ricardo himself saw the break-down of the pure labor theory; and Cairnes, Ultimus Romanorum, so limited and modified the "real costs" doctrine as to leave little validity in it, even on his own showing. The prevalent doctrine of cost of production runs in terms of "money-costs"--and hence is of no use when the problem of the value of money itself is to be solved.
A brief historical sketch of the cost theory will be helpful. Costs are sometimes conceived as a cause of value, and sometimes as a measure of value. Often these two aspects are mixed, and writers shift from one notion to the other. This is particularly true of the labor theory. In Adam Smith the contention sometimes is that labor is unvarying in value, hence an admirable measure of values, and an excellent standard of long-time deferred payments. Smith compares wheat and silver from the standpoint of the constancy of their relation to labor, and concludes that wheat is the better standard in the long run, because it remains more nearly fixed with reference to labor than does silver. Sometimes Smith thinks of labor as a cause of value, and thinks of the labor that enters into the production of a good as the significant thing. At other times, the labor that goods will command or purchase is the significant thing--and here one is not clear whether he thinks of labor as a cause or as a measure. Whether labor is to be funded as labor-pain, or as labor-time, Smith does not state. Sometimes labor seems to be considered as homogeneous in its efficiency. At other times, he makes comparison between different kinds of labor as to their efficiency, and compares the efficiency of labor in different occupations. One can find nearly anything one pleases in Adam Smith on these points. At times he speaks of "labor and expense," rather than labor alone, as governing prices.
Labor-cost to the laborer would take the form of labor-pain or labor-time. To the employer, it would take the form of outlay in wages. Adam Smith never makes any definite statement of point of view here, and shifts back and forth from one to the other. He recognizes variations in labor-pain, in danger, etc., in different kinds of labor when discussing wages.
Ricardo elaborated the labor theory of value, and tried to think it through. He was too keen a logician to shift view-points with Smith's facility, and he tried to make a completed system.[55] There is some shifting from the theory of labor as a cause of value to labor as a measure of value, as in the following passage: "If the state charges a seigniorage for coinage, the coined piece of money will generally exceed the value of the uncoined piece of metal by the whole seigniorage charged, because it will require a greater quantity of labour, or, which is the same thing, the value of the produce of a greater quantity of labour, to procure it." (Works, McCulloch ed., 213.) In general, however, Ricardo developed a causal theory of value, quantity of labor being the basis of the absolute values of goods, their relative values depending on the relative amounts of labor involved in the production of each. I shall not go into the matter fully, but shall call attention to the rock on which the system split, as Ricardo himself admits. A greater or less proportion of capital works with labor in producing different things, and the value of product, in that case, varies not merely with the labor, but also with the amount of capital, and the length of time the capital is employed. How say, then, that labor alone governs value? How reduce labor-cost and capital-cost to homogeneous terms? James Mill tried to do it for him by making capital merely stored up or petrified labor, which gives up its value again in production. But this doesn't meet the difficulty, because there is a surplus value, over and above that explained by all the labor, including the labor which produced the machine, and the labor which produced the raw materials which entered into the machine, etc. The case of wine is a particularly obstinate case. Wine increases in value merely with the passage of time, at a rate which corresponds to the profit on capital. Ricardo finally, in correspondence with McCulloch, definitely abandons the case, stating that there are many exceptions to the proportionality between exchange value and labor-cost. "I sometimes think that if I were to write the chapter on value again which is in my book, I should acknowledge that the relative value of commodities was regulated by two causes instead of one, namely, by the relative quantity of labor necessary to produce the commodities in question, and by the rate of profit for the time that the capital remained dormant." (Davenport, Value and Distribution, p. 41.) But this is a "dualistic" rather than a "monistic" explanation--one element is a money-expense, or at all events a pecuniary item, while the other is a "real cost" item. The two are incommensurate and incommensurable.
Senior seeks to supply the unifying principle. "Abstinence" and labor have pain as a common element, and so are commensurable. Costs, reduced to labor and abstinence, become homogeneous again. Monism is restored. Cairnes completes the doctrine by adding risk to the real cost elements: a triune cost concept, sacrifice being the generic fact in the three manifestations.
With John Stuart Mill, in general, we have an entrepreneur view-point. Money-expenses of production, entrepreneur outlay, plus wages of management, or including wages of management, are the factors with which Mill reckons. He is no longer concerned with psychological ultimates, or real costs. Cairnes criticised Mill sharply for this. No distinction is more fundamental he holds, than that between costs or sacrifice on the one hand, and rewards on the other. Labor, abstinence and risk are sacrifices; wages, interest, profits are rewards. None the less, in cost doctrine, as in supply and demand doctrine, it is Mill's view which has prevailed. Cost as conceived by Mill is a superficial, pecuniary notion. It tells little as to ultimate causation. But it is virtually only as a pecuniary doctrine, costs from the entrepreneur view-point, that the cost doctrine is met in modern theory.
Why is this? Well, first, the real-cost doctrine simply does not square with the facts. The hardest labor does not produce the most valuable goods. Value in fact does not vary either with labor-pain or labor-time. In fact, whatever the explanation, it would seem to be truer that the relation is an inverse relation. Nor does the abstinence that pinches hardest produce the largest amount of capital. And while there is some correlation between risks and profits, the correlation is at best low and is not a correlation between psychological sacrifice and profits. Even "marginal abstinence" for a Rothschild or a Rockefeller causes no pain. It is absurd to seek to find a common element in the "abstinence" of a rich man and the pain of a poor and aged laborer. I pass over the supposed difficulty that abstinence is, in general, suffered by one set of minds, and labor-pain by a different set of minds, and hence, since men cannot compare their own emotions with the emotions of other men, there is no comparability. This subjectivistic psychology would, of course, make it equally impossible to fund labor-pains of different laborers, or to get any common denominator at all.[56] It is enough to point out that differences between rich and poor, between successful and unsuccessful, between efficient and inefficient, (apart from acquired differences which may be smoothed out by the "stored up labor-of-training" principle) make labor-pain, and marginal labor-pain, vary greatly from value, and make labor-pain, abstinence and risk quite incommensurable, and quite without fixed relation to value. Cairnes saw this in part, and developed his doctrine of non-competing groups to deal with it. Labor-pain and value vary together only when we are comparing goods produced by laborers within a competing group. Laborers in one group do not compete with laborers in another group. There is perfect competition in the capital market, however, and so capital costs ("abstinence") are perfectly correlated with value, to the extent that capital enters. Cairnes seems to think that the whole difficulty with his real cost doctrine comes from the failure of competition. In fact, however, it comes also from the inequalities in wealth. And even in his highly competitive capital market it is equally true that abstinence, or even marginal abstinence (a term which Cairnes does not use) has no constant relation to amount of capital accumulated, value produced, or interest received. The cost theory breaks down at every point when it runs in labor-abstinence-risk terms. So generally has this been recognized, that the cost theory has generally given way to the utility theory, and cost doctrine when it appears in modern economics is either the very superficial money-outlay notion of Mill, or else the Austrian cost doctrine, later to be discussed, which is still a pecuniary concept. I have elsewhere undertaken to show (Social Value, chs. 3-7, and the ch. on "Marginal Utility," infra) that these defects of the "real-cost" theory, are just as much in evidence in the utility theory. The failure of the real cost theory of value is by no means a vindication of the utility theory. Both have the same vice--the effort to combine into a homogeneous sum a lot of individual psychological magnitudes measured in money, when the money-measure has a different psychological significance for each individual, and so comparison and addition are impossible. But in any case, the real cost doctrine of the Classical School has failed, and so cannot serve as the basis of the theory of the value of money.
Obviously the money-outlay cost theory of Mill cannot explain the value of money itself. The marginal cost of producing twenty-three and twenty-two hundredths grains of gold will always be a dollar, however the dollar may vary in value. Indeed, in general, the assumption of a constant value of the money-unit is implied in the monetary cost concept. Cost curves are supply-curves and the reasoning already given as to the need for assuming constant value for money in the supply and demand concept will apply here. Costs function in value-determination only by checking supply. Rising costs tend to mean a lessened supply. But if the cost-curve is rising because of a fall in the value of money, then the demand-curve will be rising also, and production will not be checked. The general law as to the relation of cost to demand and supply assumes a fixed value of the unit of cost, the dollar.
To the Austrian economists we owe a rational theory of costs which gives the money-outlay concept more than a merely empirical basis. First, they see in costs not causes, but results. Value causation comes ultimately, not from the side of supply, but from the side of demand. I shall not now undertake a criticism of their explanation of demand. I have elsewhere criticised their confusion of demand-curves and utility-curves, and pointed out that marginal utility gives no explanation of demand. I shall recur to the utility theory of value at a later point. For the present, it is enough to point out that the Austrian theory of costs is independent of their utility vagaries, and rests best on the notion of supply and demand, as expressed in the modern curves, with the assumption of a fixed value of the money-unit. Costs consists of entrepreneur money outlay of various kinds, chiefly wages, interest, and rent. Rent is, for the Austrians, as much a cost as any other item of entrepreneur outlay. But these items of cost are not ultimate data. They are rather reflections of the positive values of the products. Value runs from finished product to agents of production, labor, and instrumental goods, and land. Avoiding needless complications from a discussion of interest as a factor in cost--a doctrine on which the Austrians, say Wieser and Boehm-Bawerk, are not agreed,--it is enough to point out that high wages or high rents, which limit production in any given industry or establishment, are high because the land and labor in question have alternative uses, because other industries, or other competitors in the same industry, bid for them. Cost-curves, then, are reflections of demand-curves. The cost-curve of wheat, e. g., is what it is because of the demand-curve for corn, for cattle, and for every other commodity that could be produced with the same labor and land. Cost doctrine thus becomes part of the general doctrine of supply and demand, and runs in pecuniary terms, assuming money, and a fixed value of money, and hence is incapable of serving as a theory of the value of money itself.
That some vaguer form of cost doctrine, where the unit of cost is, not money, but some composite commodity of things used in the production of the standard money metal, or a unit of abstract value, might be worked out, is doubtless true. Gold production, like other industry, is part of the general economic scheme, and there is some sort of equilibrium reached which draws labor and capital now away from, and now back to, the gold mine. To bring this equilibrium into the general scheme of the modern theory of costs, however, in terms precise enough to make a satisfactory theory of the value of money, is a thing which has not so far been done, and I do not have high hopes of its early accomplishment. In any case, such a theory must rest upon a positive theory of value. Cost doctrine is negative, and can never be fundamental.[57]
IV. THE CAPITALIZATION THEORY AND THE VALUE OF MONEY
Money is capital. A dollar is a capital-good. Money is, moreover, a durable form of capital, which gives forth its services bit by bit, and indeed, in a community where the state bears the burden of wear and tear, never ceases to give forth those services. In any case, from the standpoint of a given individual, so long as there is a limit of tolerance prescribed for legal tender, it is a matter of accident if he ever incurs a loss from the wastage of the capital instrument, money, through wear and tear. Moreover, the fact that money is "fungible," and that its use is to be found in a process which commonly returns to the owner, not the same coin, but a different coin, we may, in general, abstract from the wear and tear of the dollar, and look upon the dollar as a capital instrument which promises its owner, if he chooses to use it as capital, a perpetual annuity. The nature of this money service will be more fully described later. For the present it is sufficient to say that exchange is a productive process, that exchange creates values, in as true a sense as manufacturing does, and that money facilitates exchange in as true a sense as coal facilitates manufacturing. There is, at any given time, a demand-curve for this money service, manifesting itself in the money market, a demand for the short time use of money as a tool of exchange, and the "prices" which come out of the interaction of demand and supply in the money market are the short time "money rates" including the "call rates." These are properly to be conceived, not as pure interest on abstract capital, but as rents[58] which are to be attributed to money as a concrete tool.
Now, in general, when such rents appear, they may be capitalized. And the price of the instrument of production that bears these rents, will be the sum of the rents, discounted at the prevailing rate of interest, with considerations of risk, etc., allowed for. The reasoning of the capitalization theory is really quite simple. Take, for example, a piece of urban site land, which is expected to bring a perpetual annuity of one hundred dollars. The whole economic significance of the land is contained in its services, present and prospective. The possession of land under certain circumstances brings other services, as social prestige, than the services which can be alienated to a lessee. But in this case I am abstracting from considerations of that sort, and also from the factor of risk. The whole value of the piece of land under consideration comes from the value of the one hundred dollars a year. But these annual incomes are not all equally valuable, even though all expressed as one hundred dollars. The first one hundred dollars is due one year hence, the tenth ten years hence, the thousandth, a thousand years hence. The principle of perspective comes in--I abstain from any detailed discussion of the theory of interest, simply stating that in a general way I agree with the contention that time constitutes the essence of the phenomenon, or rather, the tendency to discount the future. The capital price of the land is the sum of an infinite convergent series of the "present worths" of the incomes. The formula is as follows: capital price of land = $100/1.05 + $100/(1.05)^2 + $100/(1.05)^3 ... + $100/(1.05)^n when the rate of interest is 5%. The limit of this series, assuming the series to be infinite, is $2000, and a simple formula for calculating it under the assumptions, is to divide $100, the annual income, by .05, the rate of interest. Given the annual income, given the prevailing rate of interest, the capital price is determined. The relation may be illustrated, roughly, by the figure of a candle, a disk, and the shadow of the disk on the wall. The disk represents the annual income, the shadow on the wall the capital value, and the distance between the flame and the disk the rate of interest. Increase the distance between the flame and the disk, the rate of interest, and the shadow becomes smaller; shorten the distance, and the shadow is increased. Similarly, enlarge the disk, and the shadow is enlarged. The capital value varies directly with the annual income, and inversely with the rate of discount. Now my purpose here does not involve a detailed examination of the validity or limitations of the capitalization theory. For the present, the only question is, has this theory any application at all to the problem of the value of money? It offers itself as a general theory of the values of durable bearers of income. Money is a durable bearer of income.
The capitalization theory, however, is of no use for the purpose in hand. Money does not obey the general law in the relation which the magnitude of the income bears to the rate of interest. In general, the income and the rate of discount are independent variables. Their influence, operating in opposite directions, fixes the capital value, increasing income increasing the capital value, increasing discount rate reducing it. In the case of money, however, the two factors are not independent. The short time money rate is not, to be sure, identical with the long time rate of interest, which is the rate of discount for the purpose in hand. But the two tend to vary together in the long run average in fact, and they are related in the expectation of those who are concerned in the capitalization process.
In our chapter on the "Functions of Money," in Part III, it will be shown that normally there tends to be a difference between the money rates and the long time interest rates, the long time rates tending to be higher than the rates on short loans, the rate on very short loans being lower than the rate on somewhat longer short time loans, and the call loan rate being lowest of all. The explanation of this must be deferred till we have analyzed the functions of money. But the important thing, for present purposes, is that the money rates, though lower than the "pure rate" of interest, tend to vary, in long time averages, with that "pure rate,"[59] and that, consequently, the income from renting money, and the discount rate to be applied in capitalizing that income, are not independent magnitudes, but tend to vary together. They thus tend to neutralize one another. If money rates go up, and if they are expected to stay up long enough to justify (on the ordinary capitalization theory) a rise in the capital value of money, we have a counteracting influence in the long time interest rate, which also rises, and tends to pull down the capital value of money. To recur to our illustration of the candle and the disk, as the disk increases in diameter, the distance between the candle and the disk grows greater, and so the shadow tends to remain the same.
There is a further difficulty, to which attention will be called more fully in later chapters, particularly the chapter on "Dodo Bones," and the chapter on the "Functions of Money." In other cases, in general, the capital value is, as the capitalization theory requires it to be, a true shadow, a passive function of the income and the discount, of the disk and the distance between the candle and the disk. In the case of money, however, the income is causally dependent, in part, upon the capital value. Money can function as money only by virtue of having value. The shadow becomes substance in the case of money. It is the value of money which makes possible the money work. The capitalization theory, thus, if applicable at all, must be radically modified before being applied. We shall subsequently, in the chapters above referred to, take account of this fundamental complication. For the present, we can state it merely as a problem: how can we construe the interaction of the income value of money and the capital value of money in such a way as to avoid a circular theory?
But further, the capitalization theory, as heretofore formulated, like the doctrines of supply and demand and cost of production, assumes money, and a fixed absolute value of money. This assumption must be made if we are to be able to predict, on the basis of the capitalization theory, that a given annual income, at a given rate of discount, will give a specified capital value. This may be shown by the following considerations: If men anticipate that the value of the income, which is a fixed sum of dollars, is to grow less in the future, then the present worth of the bearer of that income will shrink to an extent greater than the "pure rate" of interest would call for. The principle of "appreciation and interest" comes in. The nominal interest, in times of falling value of money, tends to exceed the pure rate by an amount which compensates for the loss in value of future income as the dollar falls in value. We have here, however, a principle different from the principle of time discount. It is not the influence of time, which makes a given value appear smaller as it is further removed in time, but it is an anticipated lessening in the value of the income itself, that counts. In terms of our candle and disk illustration, it is a factor affecting the size of the disk, rather than a factor affecting the distance between the disk and the candle. For the purposes of calculation, the two elements in the nominal rate of interest may be lumped together, and the nominal rate, rather than the pure rate, may be taken as the rate of discount for capitalization purposes. But for theoretical purposes, the two must be kept distinct. The capitalization theory rests on the assumption of a fixed value of the money unit.
That the fixed value of the money unit assumed is an absolute value, and not a mere "reciprocal of the price level," may be proved by some further considerations regarding relations among these same factors. Assume a fall in the rate of interest. Then, on the capitalization theory, prices of lands, stocks and bonds, houses, horses, and all items of wealth which give forth their services through an appreciable period of time, will rise, and with them the average of prices, or the general price level, will rise.[60] If one hold the relative conception of value, according to which the value of money necessarily falls when prices rise, because the two are merely obverse phases of the same thing, then this rise in the price level is, ipso facto, a fall in the value of money. But we have seen that a fall in the value of money means, on the "principle of appreciation and interest," a rise in the interest rate! Hence, we would have proved that a fall in the interest rate causes a rise in the interest rate--which is absurd. If, however, we recognize that prices can rise without a fall in the value of money, if, i. e., we use the absolute conception of value, this difficulty disappears. The capitalization theory and the theory of appreciation and interest can be reconciled only on the basis of the absolute conception of value.
The capitalization theory, then, in its present formulation, assumes money, and a fixed absolute value of money. It is, therefore, inapplicable to the problem of the value of money itself.
In general, none of the polished tools of the economic analysis,--neither cost of production, the capitalization theory,[61] nor the law of supply and demand,--is applicable to the problem of the value of money. The reason is that they get their edge from money itself. The razor does not easily cut the hone. It is to this fact, I think, that we owe the widespread and long continued vogue of a theory so crude and mechanical as the quantity theory. In the next chapter we shall show that the utility theory of value--which we shall not recognize as a polished tool!--has also failed to give us help in explaining the value of money.