Chapter XIII…

Chapter XIII

THE VOLUME OF MONEY AND THE VOLUME OF TRADE--TRADE AND SPECULATION

In proving that an increase of money must proportionately increase prices, it is necessary to prove that the volume of trade is independent of the quantity of money and credit instruments by means of which trade is carried on. Money on the one hand, and quantity of goods to be exchanged on the other, are the two great independent magnitudes, whose equilibration mechanically fixes the average of prices. This notion, as to the essence of the quantity theory, finds expression in Taussig,[225] "The statement of a quantity theory in relation to prices assumes two independent variables: total money or purchasing power on the one hand, total supply of goods or volume of transactions on the other." Taussig, though he would maintain that this independence holds, so far as money and trade are concerned, admits that it breaks down so far as trade and elastic bank credit, bank-notes and deposits, are concerned. Trade and elastic bank-credit are largely _inter_dependent.[226] This concession on Taussig's part means virtually giving up the quantity theory for Western Europe and the United States and Canada, though Taussig still sees something left of the quantity theory tendency in view of the "irregular and uncertain" connection which he finds between money and bank-credit.[227] Fisher, however, makes no such surrender. He is quite as uncompromising as to the independence of deposits and trade as he is with reference to the independence of money and trade. He does, indeed, make the concession that increasing trade tends to increase deposits indirectly, by increasing the ratio of M' to M, by modifying the habits of the people as to the use of checks as compared with cash (p. 165),[228] but he denies stoutly that there is any direct relation between them. (P. 168.) Trade acts only via a modification of the ratio between M and M', and M still remains controlled, not by trade, but by quantity of money. As to any control over T by M', he repudiates it explicitly, (P. 163.) Increasing M', either through an increase of M, or through an increase in the normal ratio between M and M', will have no effect on T,--or, for that matter, on the V's. The introduction of credit, therefore, leaves the quantity theory intact: an increase of M, increasing M' proportionately, leaving the V's unchanged, and having no effect on T, must exhaust its influence on P, raising P proportionately, if the equation of exchange is to remain valid.

The argument set forth to prove that T is not influenced by M or M' is as follows: "An inflation of the currency cannot increase the products of farms or factories, nor the speed of freight trains or ships. The stream of business depends on natural resources and technical conditions, not on the quantity of money. The whole machinery of production, transportation and sale is a matter of physical capacities and technique, none of which depend on the quantity of money. The only way in which quantities of trade appear to be affected by the quantity of money is by influencing trades accessory to the creation of money and to the money metal.... From a practical or statistical point of view they amount to nothing, for they could not add to nor subtract one-tenth of 1% from the general aggregate of trade." (Loc. cit. p. 155. Italics mine.) Something similar is said on p. 62, where "transitional" influences of M on T are being discussed: "But the amount of trade is dependent, almost entirely, on other things than the quantity of currency, so that an increase of currency cannot, even temporarily, very greatly increase trade. In ordinarily good times practically the whole community is engaged in labor, producing, transporting, and exchanging goods. The increase of currency of a "boom" period cannot, of itself, increase the population, extend invention, or increase the efficiency of labor.[229] These factors pretty definitely limit the amount of trade that can reasonably be carried on. So, although the gains of the enterpriser-borrower may exert a psychological stimulus on trade, though a few unemployed may be employed, and some others in a few lines induced to work overtime, and although there may be some additional buying and selling which is speculative, yet almost the entire effect of an increase in deposits must be seen in a change in prices. Normally the entire effect would so express itself, but transitionally there will be also some increase in the Q's." (Pp. 62-63. Italics mine.)

Fisher is here exceedingly uncompromising, even where transitional periods are concerned, and it is not necessary, in order to do his position full justice, to make much distinction between "normal" and "transitional" effects in my counter-argument. I shall, however, take account of the distinction as I proceed, in justice to other, more moderate, quantity theorists.

It is a familiar doctrine that the quantity of money is irrelevant, that things go on in much the same way whether money is abundant or scarce, the only difference being that in the one case prices are high and in the other, low; that, in particular, it is a gross fallacy to connect the rate of interest with the amount of money, since (as many writers would put it) the rate of interest depends on the amount of capital rather than money. At the opposite extreme, we have writers like Brooks Adams (Law of Civilization and Decay), who see the fate of nations and the progress of civilization resting on the abundance or scarcity of money. Fisher takes the first position in its extremest form.[230]

The truth, I think, is intermediate. The effects of the New World discoveries of gold and silver after the voyage of Columbus on trade and industry were tremendous. Trade was enormously increased. Walker, in his _Inter__national Bimetallism_,[231] asking, from the standpoint of a quantity theorist, why prices only increased 200% while money increased 470%, admits that the chief reason was the increase in trade, due in large part to the very increase in money itself. Sombart, in his Der Moderne Kapitalismus,[232] finds in this influx of money a tremendous source of capitalistic accumulations, (a) for the Conquistadores, (b) for the handicraftsmen whose prices rose faster than their costs, (c) for tenants whose rents were fixed in money, (d) for landowners, whose rents were fixed in kind [a point not obviously true], and (e) for bankers, as the Fugger. An increase of capital, savings that would otherwise not have been made, must have profoundly modified the whole industrial system, and greatly increased both industry and commerce. If it be objected that effects of this sort are not usual, that they came in a world which had been starved for money, and which, by means of the enormous increase in money was able to pass from a "natural" to a money economy, I reply that the difference between such a case and the usual effects of an increase of money are in degree rather than in kind. The world of Columbus' day was in part on a money economy, and the world to-day, despite Professor Fisher's emphatic denial,[233] still employs a great deal of barter, or equivalents of barter. I shall revert to this point later. But even this consideration would not rob Sombart's points of their significance for modern conditions. Further, we have an even more striking case, on Walker's own showing, in the effects of the Californian and Australian[234] gold discoveries in the 19th Century on trade, industry, and speculation.[235]

Nor is the tremendous agitation over bimetallism, involving a literature so great that no man could dream of reading it all, involving great political movements, Presidential campaigns, great Congressional debates, repeated legislation, international conferences, etc., for twenty years, to be explained on any other ground than that the world felt practical, important, and unpleasant effects on industry and trade from the inadequacy of the money supply.

The view of Hartley Withers[236] is interesting here. He says: "any such great addition to currency and credit would have a great effect in stimulating production, and so would lead to a great addition to the number of real goods which humanity desires and consumes when it can get them.... Trade would be more active." On p. 23 he speaks of the enormous expansion of trade made possible by paper representatives of gold. On p. 83 he speaks of the attitude of the money-market toward gold, which the orthodox economist is apt to think of as a survival of Mercantilism. Withers thinks that the money market is right in a large degree.

As illustrating Withers' statement about the views of "practical men" on this point, the following extract from a recent address by Theodore Price, quoted with approval in a "market letter," written by Byron W. Holt,[237] is interesting: "The fact seems to be that the exigencies of war in Europe are leading to an extension of credit such as would not have been possible in peace, because the hesitant conservatism of bankers would have then prevented it, and we are finding that instead of working harm it is doing good, because huge masses of fixed capital are thereby made productive, and are circulating with the increased velocity that always quickens enterprise and accelerates the wheels of industry.... All the precedents of history indicate that accelerated activity will come with peace and continue until the exuberance of success has led men to build faster than the world has grown and to demand credit upon the basis of future rather than of present values."

What is the essential causation in the matter? Well, viewed merely as a matter of mechanical equilibration, the quantity theory view is not strictly true, by any means. For a given country--and Fisher's quantity theory is always a theory for a given country, and, indeed, for any separate market, even a single city[238]--an increase of banking credit means an increase in non-monetary capital, because, to a greater or less extent it dispenses with the use of gold, which goes abroad, bringing back wealth in other forms in exchange. Adam Smith saw this clearly, and phrased it strikingly, likening gold and silver coins to the wagon-roads of Scotland, which are necessary for transportation, but which none the less prevent the use of the roadways for raising grain; whereas bank credit is like a wagon-road through the air, which restores the roadbeds to cultivation. Increased non-monetary capital, other things equal, should mean increased trade.

But, more fundamentally, an increase in gold itself within the country, if not bought by the export of an equivalent amount of other goods, is an increase of capital. Not all capital is money, but standard coin is capital. Money is a tool of exchange, and exchange is part of the productive process. More money means more exchanging. That is what money is for. Part of the mechanism is in the money rates, which go down as money becomes more abundant, making it profitable to effect exchanges which would not have been profitable had the money rates been higher. Granted that the money-rates and the general rate of interest tend, in the long run, to keep--I will not say at the same figure[239]--a certain fairly definite relation to one another, it still does not follow that the new "normal" equilibrium will give us an interest rate which is the same as the general rate of interest was before the influx of gold. On the strictest static theory, this is not to be expected. Because the total amount of capital in the country is increased, and this means a lowered interest rate all around, in the marginal employment of capital. The margin of the use of capital will be lowered everywhere, including the margin for the use of money. This means permanently lowered money rates in the country, even though the permanent level be higher than the initial money rates immediately following the access of new gold. I have put the argument in terms that suggest the productivity theory of interest, because it is more simply stated that way. I do not accept the productivity theory, as a fundamental explanation of interest, but for many purposes, the results to be obtained by it coincide with the psychological time theories,--which also, in their present form, seem to me imperfectly developed. I need not try to construct a theory of interest here, however, as the familiar theories lead to no trouble at this point. It is enough to point out that the increased amount of capital, meaning better provision for present wants--wants concerned with gold in the arts and with money for productive exchanges, as well as goods generally since part of the new gold will be exported for other things--will lessen the pressure of present as compared with future wants, and so lessen the rate of interest on the time-preference theory. The final outcome will be an extension of the marginal use of money, and a greater volume of exchanges. Of course, the increase in the supply of any kind of capital good, apart from a prior increase in the demand for its services, will, on the mechanical view of economic causation, necessarily lead to some fall in its capital value. Gold money will be no exception to this rule. As to how much the increase in its quantity will lead its capital value to fall, however, we are unable to say. For the quantity theory, the fall will be in proportion to the increase. For the theory just outlined, the fall will depend on the elasticity of demand for gold in the arts, and on the elasticity of "demand" for money, meaning by demand for money simply the demand for the short-time use of money as a tool of exchange, a demand which governs directly, not the capital value of money, but rather the "money-rates." The relation between the money rates and the capital value of money will best be discussed at another point.[240] We have no reason at all to suppose that either of these demands[241] exhibits the tendency to obey the law of proportional variation which the quantity theory requires of money.

It is further important to note that as a country gets more abundant capital, there seems to be a tendency to extend the use of money rather more than the use of many other capital goods. Where the interest rate is 10 and 12%, as in Arizona and New Mexico, money, even when brought in, tends to leave in large degree to bring in other forms of capital which the situation calls for more imperatively. The early American colonies, needing money pressingly, and making shift with a great variety of substitutes for good metallic money, thoroughly acquainted with the advantages of a money-economy from their European experience, and having "habits" as to the carrying and using of money which they had brought with them from Europe, still found it impossible to keep a great deal of metallic money, in view of the still greater importance of other forms of capital. It is in the most highly developed commercial communities, commercial centres, and par excellence, in the speculative centres, that the demand for the money-service is most elastic.[242] A country where the rate of interest is low, loses other forms of capital, and gains money, in the process of reequilibration, as compared with a new and undeveloped section, although the new section also extends the margin of the money service, in effecting a greater number of exchanges, when money is increased.

And this leads to a vital distinction, which quantity theorists almost always lose: the distinction between the volume of production, and the volume of trade. Even in the mechanical system of causation which they describe, it is true only of production and transportation that technical and physical[243] factors are of primary significance, and that money is of minor significance. For trade and commerce, money is always highly important. To the extent that a region is primarily given over to the primary productive activities, mining, and agriculture, such trading as is necessary can be done by means of a small amount of money, supplemented by barter and long-time book-credit. A region or a city whose chief business is commerce, however, needs a large part of its capital in the form of money, and of banking capital, which is largely invested in money for banking reserves. Trade, as distinguished from industry (and it is after all trade that is under discussion), is helped or hindered as its tools are more or less abundant. These considerations would suggest that the elasticity of the demand for the use of money is greater than the elasticity of demand for the use of capital in almost any other form. Production is, indeed, limited by labor supply and natural resources, in considerable degree. Trade,[244] however, even from the standpoint of mechanical causation, is limited chiefly by the relation between the profits to be made in commercial transactions, and the "price" that must be paid for the money and credit that are required to put them through. There are enormous numbers of transfers that could be made to advantage if there were no cost at all involved. They are not made, because exchanging requires pecuniary capital. Let the pecuniary capital increase, however, and sub-marginal exchanges become worth while, the general margin is lowered. Commerce is the most highly flexible and elastic portion of the whole productive process. The elasticity of demand for commercial capital is, thus, greater than the elasticity of demand for any other form of capital.

How widely the volume of trade differs from the volume of production, and how great is the element of speculative transactions in trade, will best appear, I think, from an analysis of the figures which Fisher gives[245] for the volume of trade in the United States. His figure for the volume of trade in the year 1909 is $387,000,000,000.00, three hundred and eighty-seven billions of dollars! This figure is reached by equating the figures he has reached for MV plus M'V' to PT, and assuming P to be one dollar, by making the "unit" of T, arbitrarily, a dollar's worth of each sort of commodity, at the prices of 1909. I have already commented on the legitimacy of this method of summarizing T,[246] and need not say more here, beyond calling attention to the fact that "volume of trade," as commonly used, does in fact mean, not T alone, but PT. Fisher for years other than 1909, however, makes use of a different method of getting at T: he takes certain indicia of relative amounts of trade, compares them with the same indicia for 1909, and estimates the trade for other years as being such a percentage of the trade for 1909 as their indicia are of the indicia of 1909. The indicia chosen are: (1) quantities of certain commodities, cotton, fruit, cattle, etc., received at principal cities of the United States, taken as typical of the variations of the internal commerce of the United States; (2) quantities of 23 articles of import and 25 articles of export, for each year, taken as typical of variations in the foreign trade of the United States; (3) sales of stocks. These three indicia, weighted in a manner to be described in a moment, are then averaged. There is a second element in the index, made up by taking the figures for railroad tonnage, and the figures for receipts on first class mail, which are averaged. The first average and the second average are then combined into a third average, which is the final index. The relation between this index for every year other than 1909 and the same index for the year 1909 determines the amount of T for each year--the two indicia, together with the figure, $387,000,000,000.00, giving the required amount by the "rule of three." I shall not go into details with the method of constructing these averages, but I wish to make clear the comparative weight given to each element in the final index: The first three elements count twice as heavily as the last two, and so constitute the biggest factor. In the first average, based on the first three elements, the item taken as typical of internal trade is weighted by 20, the item taken as typical of foreign trade is weighted by 3, and sale of stocks by 1. It appears from Fisher's figures (p. 479), that the one really big variable among all the indicia is the sale of stocks, but the weight given it is so small that it makes virtually no difference in the final result. Thus, as between 1898 and 1899, stock sales increased over 50%, but total trade, as shown by Fisher, increased only 5%. In the following year, stock sales decreased over 21%, but total trade, on Fisher's figures, increased. The following year, 1901, stock sales virtually doubled, but Fisher's final figure shows only an increase around 13%. Two years later, in 1903, stock sales fell off about 40%, from the figures for 1901, but again, as compared with 1901, total trade on Fisher's figures shows an appreciable gain. The influence of stock sales on Fisher's index is, virtually, negligible. The dominating factor is the receipts of selected staples, cattle, cotton, rice, pig iron, etc., in the principal cities of the United States. There is not a single year in which his final figure for T does not move in harmony with this factor (p. 479). He gets, thus, for the volume of trade through the fourteen years under consideration, a surprising steadiness, and a pretty uniform progressive development.

In defence[247] of his method of weighting, Fisher says, simply: "These weights are, of course, merely matters of opinion, but, as is well known, wide differences in systems of weighting make only slight differences in the final averages." (Italics mine.)[248]

Are these figures valid? Well, first one is struck with the absolute magnitude assigned to T. The figures seem vastly greater than would have been anticipated. The method of calculating it, for 1909, I shall discuss in detail in the chapter on "Statistical Demonstrations of the Quantity Theory." For the present, it is enough to note that the absolute magnitude is derived from figures collected by Dean David Kinley for the National Monetary Commission,[249] of deposits, exclusive of deposits made by one bank in another, made in about 12,000 banks (out of 25,000) on March 16, 1909. These deposits were classified as (1) money (with subdivisions) and (2) checks and other credit instruments. A cross-classification divided them into (1) retail deposits; (2) wholesale deposits; (3) all other deposits. Kinley's object was to determine the extent to which checks are used, as compared with money, in payments, particularly in wholesale and retail business. Fisher's total, briefly, was obtained as follows: Kinley's figures, for the one day, were increased to make an allowance for the non-reporting banks; they were further increased on the assumption that March 16 was below the average for the year; the figure finally obtained for the day was then multiplied by 303, assumed as the number of banking days in the year, and the product, 399 billions, was taken as representing the total circulation of money and checks in trade. For some reason not made clear, this total was subsequently reduced to 387 billions. Counting the average price, P, as $1, T was considered to be 387 billions.[250]

In the statistical chapter to follow, it will be shown that this estimate is a very decided exaggeration. Deposits made in banks greatly overcount trade. Very many payments represent duplications, loans and repayments, taxes, etc., and are in no sense trade. This is true of all classes of deposits, wholesale and retail, as well as "all other." But for the present, I am concerned with the question, not of the absolute magnitude of the volume of trade, but rather, the questions of its character, of the elements that enter into it, and, above all, of the extent to which it is physically determined by technical conditions of production, and the extent to which it is flexible, a matter of speculation, etc.

We may approach this question from the angle of several bodies of statistical information. First, the question may be raised: what is there in the country which could be bought and sold enough in the course of a year to give us anything like so great a total? The subtractions which we shall find it necessary to make will still leave us an enormous total.

The United States Census Bureau[251] in 1904 reached the conclusion that the total wealth of the country was only $107,000,000,000. Of this, over $62,000,000,000 was in real estate; $11,000,000,000 in railroads; street railways, over $2,000,000,000; telephone, telegraph, water and light, and similar enterprises total nearly $3,000,000,000 more. None of these things enter into ordinary wholesale and retail trade. The items that one would ordinarily think of are agricultural products, $1,900,000,000; manufactured products, $7,400,000,000; mining products, $400,000,000. Can these things be exchanged often enough in the course of a year to account for $387,000,000,000!

These figures are for 1904,[252] whereas Fisher's figures are for 1909. If the Census Bureau had taken an inventory in 1909, the figures would doubtless be larger. The inventory for 1912 made by the Census Bureau does show a very considerable increase, the largest item being due to a rise in real estate values. The figures for agricultural, manufacturing, and mining products are, also, figures for a given time rather than for total production through the year. But, making all the allowance one pleases, it is quite incredible that one should reach a figure of $387,000,000,000 by taking only the exchanges necessary to bring raw materials through the various stages of production to the consumer. The greater part of the $387,000,000,000 is to be explained in another way!

A detailed analysis of Kinley's figures, on which the estimate of total trade is based, leads clearly to the same conclusion. Kinley's figures for the banks that reported on March 16, 1909, are as follows:

Retail deposits 60 millions Wholesale deposits 124 millions "All other" deposits 502 millions

The "all other deposits" are vastly greater than retail and wholesale deposits combined! Notice, too, with reference to the question as to how often goods need to be turned over in getting to the consumer: wholesale trade uses only about twice as much money and checks as does retail trade. Goods are not, if these figures are in any way typical of actual trade, turned over many times in the process of reaching the consumer. The "necessary," or "physically determined" number of exchanges, in the routine of trade, is small, per item.

Retail deposits of 60 millions make up less than one-eleventh of the total. Retail and wholesale deposits together make up about three-elevenths. What is the other eight-elevenths, represented by the "all other deposits"? It will help if we see where these "all other" deposits are located. If we find them scattered evenly throughout the country, in rural regions as well as in cities, we might be at a loss. If, however, we find them bunched in the big speculative centres, we may conclude that speculation accounts for a large part of them. We do in fact find this.

The following figures show the different classes of deposits (1) in the South Atlantic States; (2) in reserve cities; (3) in New York City alone:

South Atlantic States: Per Cent.

Retail deposits $ 3,300,000 19.0 Wholesale deposits 4,900,000 29.0 "All other" deposits 8,900,000 52.0

Reserve Cities (including New York City):

Retail deposits $ 24,000,000 5.6 Wholesale deposits 78,000,000 18.2 "All other" deposits 326,000,000 76.1

New York City:

Retail deposits 9,000,000 3.7 Wholesale deposits 34,000,000 14.0 "All other" deposits 198,000,000 82.2

It is difficult, with Kinley's figures, to get figures which exclude returns from cities of substantial size, except for a State like Nevada, where the mining and divorce industries complicate the figures. As near an approach as can be made, perhaps, is to take the State of Louisiana, excluding New Orleans from the totals. Even here, however, we include five cities of over ten thousand, among them Shrevesport, with 28,000 people. The following figures are for the State and national banks in Louisiana, exclusive of New Orleans:

Retail deposits $179,915 24.1 Wholesale deposits 246,647 33.1 "All other" deposits 318,915 42.8

We cannot tell, in these figures for Louisiana, how many banks are represented, or what the average figures per bank are. For the whole State of Arkansas, however, including five cities of over 10,000, with two over 20,000, and one of 45,000, we can get an average for ninety reporting banks. Even here we do not know where these banks are located within the State; though it is probable that they are in the larger places, and so exceed the average deposits for the banks in the State as a whole, to say nothing of the average for the smaller places. The ninety banks are almost wholly State and national banks.

Arkansas: Per Cent.

Retail deposits $232,017 25+ Wholesale deposits 231,614 25+ "All other" deposits 456,544 49+

The average for all deposits, per bank, in Arkansas is $10,224; the average for all the 11,492 banks reporting for the whole country is, approximately, $60,000; the average for the 659 banks reporting from New York State is $502,136; the average for the banks in New York City alone is doubtless much higher, but cannot be stated, as Kinley's figures do not tell how many banks reported by cities.[253]

The "all other deposits" in Arkansas are 27.8% cash, and 72.2% checks; the "all other" deposits in the country as a whole are only 4.1% cash, with 95.9% checks; the "all other deposits" of New York City are only 1% cash, with 98.9% checks.

Several facts are very clear from these comparisons: (1) the proportion of "all other deposits" increases very rapidly as we get closer to the great centres of speculation, and is lowest in rural regions; (2) the great bulk of all the deposits is in the cities. The average for Arkansas banks, for example, is only one-sixth the average of the whole country, and is only one-fiftieth the average for the banks of New York State. It is a much smaller fraction of the average for New York City, but we cannot give an exact figure. The totals reported from the rural regions are trifling, as compared with the totals reported from the big cities. This, as will be made clear in the chapter on "Statistical Demonstrations of the Quantity Theory," is not because the country reports were less complete that the city reports. New York was probably less complete than the country as a whole. It is simply because the activity of country accounts is small, the amount of trading in the country districts small, and (as shown) the average for country banks is small. (3) The character of the "all other" deposits in Arkansas differs substantially from that of the "all other" deposits in New York City, as indicated by the fact that the proportion of cash is high in Arkansas--substantially higher, in fact, for the "all other" deposits in Arkansas than for all deposits, or even for retail deposits, in the country as a whole. The percentage of checks in total retail deposits in the United States, in Kinley's figures, was 73.2; the percentage of checks in the "all other" deposits in Arkansas was 72.2. We may count these Arkansas "all other" deposits as, in considerable degree, deposits made by farmers. What were the "all other deposits" made in New York City?

Dean Kinley's list of the miscellaneous elements that enter into the "all other deposits," given on p. 151, contains only two that might be expected to bulk large in New York without appearing in Arkansas. These are: brokers, and stock and bond financial corporations. Of course, theatres, hotels, publishing houses, railroads, public funds, "those who have no specific business," and rich churches, will all be absolutely much larger in New York City than in Arkansas. But these things may be found in many places, scattered throughout the cities of the country, without making anything like such "all other" deposits as New York shows. It is not New York's foreign commerce that does it, because that is represented in New York's "wholesale deposits," which make up only 14% of New York City's total deposits for the day. It cannot be the supposed "clearing house" function of New York City,[254] whereby banks in different parts of the country pay their balances due one another in New York exchange, because such transactions would appear in New York chiefly in the figures for deposits made by one bank in another, and these figures are excluded from Kinley's totals. It cannot be the deposits of the "idle rich" for current expenses that swell New York's "all other deposits" so greatly--these could not equal the total retail deposits of the city, which are only 3.7% of the total in New York. Moreover, similar deposits are made in many other cities, without, in proportion to population, making any such totals. Figures, moreover, for the aggregate yearly income of the United States, and for the distribution of that income between rich and poor, make it clear that any such items must be bagatelles in comparison with these enormous figures. The only explanation that will really explain is the speculative and investment and financial transactions that centre in New York, and, in less degree, in the other great financial cities of the country.

This is Dean Kinley's opinion. In the "all other" deposits he makes a 50% allowance for speculative transactions. "A large proportion of deposits in this 'all others' class undoubtedly represents speculative transactions, all of which, or practically all of which, are settled with credit paper."[255] It is also the opinion of General Francis A. Walker, expressed concerning similar figures from earlier inquiries.[256]

Various kinds of evidence converge toward this conclusion. Thus, the evidence of clearings, total items presented by banks to the clearing houses of the country. New York clearings are usually nearly twice as great as total clearings for the rest of the country. New York clearings fluctuate in general harmony with transactions on the New York Stock Exchange. This has been commented on many times. The extent to which it holds has recently been carefully measured by Mr. N. J. Silberling, whose results appear in the Annalist for August 14, 1916, under the title, "The Mystery of Clearings." Mr. Silberling applies the "coefficient of correlation" to the problem, getting in one significant figure a measure of the extent to which two variables, as share sales on the New York Stock Exchange and New York clearings, vary together. This coefficient has been used enough by economists not to require detailed explanation here. It is a figure always between +1 and -1. +1 indicates that the two variables in question are perfectly correlated, whereas 0 indicates no correlation whatever. -1 indicates an inverse correlation, such that two variables vary exactly and inversely with reference to one another.[257]

Mr. Silberling's studies show the following correlations: New York share sales (numbers of shares, not values) to New York clearings, using weekly figures, for the years 1909-10, r = .628. This is a high correlation. Limiting the observations to the middle weeks of the month for the same period, he gets r = .731(46). The reason for taking only middle weeks in the month is that thereby the disturbing factor of monthly settlements is avoided. The monthly settlements may be for stock transactions, or may be for other things, but as they are not dependent on the stock transactions of the week in which they occur, their effect is to lessen the evident degree of connection between stock sales and clearings. Thus the middle weeks show a closer correlation between the two variables than do all the weeks taken as they come. If figures for the month were taken, this complication would be smoothed out, and a fairer result might be expected to appear. The middle weeks, eliminating monthly settlements, probably eliminate more other things than they do share sales (which are in large degree paid for in 24 hours[258]), and so exaggerate somewhat the relation between shares and clearings. Monthly figures avoid both complications, though they lose something of the concrete causation. An intermediate figure might be expected for the monthly correlation, and this we find: r = .718(23).

A striking single fact in connection with these figures, giving them point as less extreme variations could not do, is found in the behavior of clearings when the Stock Exchange was closed, during the crisis of 1914. At that time, New York clearings, which had been about twice as great as country clearings, fell suddenly below country clearings. When the Stock Exchange was opened, the old proportions suddenly reappeared.

That speculation spreads far beyond New York, New York being the centre for dealings in securities, etc., which involve the whole country, is, of course, well known. The extent of this Mr. Silberling seeks to measure by correlating clearings outside New York with New York share sales. His weekly correlation for these two variables for 1909-10 gives r = .368(103), and the correlation for the mid-weeks gives a higher figure, r = .424(46). The monthly correlation shows r = .257(23), a lower figure, "which is perhaps due in part to the fact that the bulk of the outside monthly clearings show relatively moderate fluctuations, because of their diverse composition, and are less sensitive than the periods of shorter length."

Seeking an index of the variations of that trade which is, in Professor Fisher's phrase, governed by "physical capacities and technique"--a law which Professor Fisher,[259] as we have seen, would apply to the great total of 387 billions which he has constructed--Mr. Silberling chooses the gross earnings of the principal railways as the best available test. Railways deal with all manner of other enterprises. He correlates this with clearings outside New York. "The question might arise at once whether changes in traffic are strictly concomitant with changes in payments involved by it, and therefore with the clearings resulting. The preliminary hypothesis that a 'lag' ensued between traffic and the bulk of the payments was first tested by correlating the railway figures with clearings of one month[260] and two months later, but no correlation was obtained. The direct month-to-month correlation yielded, however, a result r = .524(23)." This suggests that outside clearings are, in substantial degree, an index of physical trade, but Mr. Silberling calls attention to certain chance agreements between railway traffic and speculation in cotton and produce and grain, speculation in the crops which are in current movement, and regularly recurring concomitances between traffic and speculation in March, when the railway traffic revives after the February lull, and when there is a large mass of dealing in Spring deliveries in Chicago. In view of the facts later to be developed, with reference to the small actual value of the necessary physical exchanges (partially covered already) as compared with clearings, this query is well put. We may easily have here a "spurious" correlation. Taking it at its face value, however, and taking the correlation as indicating the influence of physical trade on bank transactions, we get the following results, when total clearings for the country are compared with (a) New York share sales, and (b) with railway gross earnings: (a) r = .607(23); (b) r = .356(23). "Physically determined trade" is at best a minor factor in that total "trade" represented by bank transactions!

Mr. Silberling has buttressed his results with a consideration of various alternative possibilities which might give them a different interpretation. I need not, for present purposes, go further into his figures.[261] Taken in conjunction with the other data presented, and to be presented, together with the theoretical discussion of the nature of trade, and its relations to money and credit, which the present volume contains, they give the present writer abundant confidence in the thesis that the great bulk of trade in the United States is SPECULATION, rather than that sort of trade which is determined "by physical capacities and technique."

The figures given above, of the inventory of wealth at a given moment of time, by the Bureau of the Census, show only trifling magnitudes, as compared with the estimated 387 billions of deposits made in 1909, of items which could enter into ordinary trade, as distinguished from speculation and dynamic readjustments. An effort to calculate ordinary trade on the basis of figures running through the year may throw further light on the problem. Railway, gross receipts for the year ending June 30, 1909, were less than two and a half billions. This is six-tenths of 1% of the total. Receipts of the Western Union Telegraph Company were $30,451,073--less than one-hundredth of 1%. The Post Office in the fiscal year ending in 1909 took in $203,562,383. This is something over one twentieth of 1%. These are gigantic sums. But they are insignificant indeed in this computation. Millions of smaller items simply do not count at all--ten million items of $387 each would give only 1%. The total net income of the United States, as estimated by W. I. King for 1910, including all forms of income, dividends, interest, wages, rents, profits, salaries, etc., is $30,500,000,000[262]--around 7% of the 387 billions.

Let us sum up the major items of ordinary trade. From Kinley's figures, we may get some idea of the proportions of wholesale and retail trade to the total for 1909, assuming that the deposit figures indicate that total. Retail deposits make up less than one-eleventh of the total, and wholesale deposits about two-elevenths. The figures were: retail, 60 millions, wholesale, 124 millions, and "all other," 502 millions. But the "all other" deposits were lower than normal. New York City was, in the first place, probably less complete than the rest of the country, in the figures returned, and, in the second place, New York City, as shown by the clearings of March 17 (the next day, when checks deposited in New York would get into the clearings) was 28% below normal. The rest of the country was within 3% of normal.[263] Not to refine matters too much, we shall, on the assumption that the variable element in New York deposits is connected with the Stock Exchange (as shown by Mr. Silberling's correlations and other considerations), and on the assumption that deposits connected with the stock market appear in the "all other" deposits, add a little over 20% of New York's total of 198 millions, or 40 millions, to the "all other" deposits for the country, leaving the wholesale and retail deposits unchanged. What error there is in this is favorable to the wholesale and retail deposits. Our proportions, then, are: retail, 60, wholesale, 124, "all other," 542, total, 726. If the retail deposits correctly represented retail trade, we could then say that retail trade was a little less than one-twelfth of the whole, and wholesale trade about one-sixth. But there are many speculative transactions engaged in by wholesalers, and a good many by retailers. The writer knows a small delicatessen dealer on Amsterdam Avenue, in New York, who frequently speculates in eggs and canned goods. A colleague in the Harvard Graduate School of Business Administration is authority for the statement that speculation in canned goods and some other things is quite common among retailers, particularly "hedging" by the use of "futures," in canned goods. Speculation among wholesalers is very extensive. The same is true of manufacturers. The same authority cited some cotton manufacturers whose profits from cotton speculation are greater than their profits from manufacturing. We shall see reason to suppose that a very substantial part of manufacturers' deposits were included in the wholesale deposits. That the figures for retailers' deposits exaggerate the retail trade may appear from several considerations: (1) The proportion of checks to cash reported is too high: 73.2%. Dean Kinley allows 5% of the checks deposited to be "accommodation checks,"[264] cashed for customers, rather than taken in in trade. (2) If retail deposits are taken as exactly representative of retail trade, we should get a retail trade for the year of over 32 billions (1/12 of 387 billions), which would exceed the total income of the country as calculated by King for 1910. Dean Kinley reached the conclusion that the retail deposits reported in 1896 also exceeded the probable retail expenditures.[265] Of course, not all of retail trade is in consumption goods. Hardware stores, lumber stores, and some other retail establishments sell, not only to householders for domestic use, but also things which enter into further production, and so do not come out of annual income. If we include in retail trade various items which were not included there in Kinley's figures, such as hotels, theatres, newspaper receipts from subscription and street sales, physicians' fees, etc.--all those items which enter into the domestic budget, including domestic service, we should still not be justified in reaching a total as great as the total income of society, since there would then be no allowance for savings, which we should not count in trade, or for life insurance, which we shall count separately. The items sold at retail which enter into further production cannot make a great total, since large producers buy such things at wholesale. Total retail trade, therefore, and, in addition all the other items in the domestic budget, must be held below the figure for total national income. Suppose, to be very liberal, we allow 29 billions[266] for all these items, under the general head of "retail trade."

For wholesale trade, if we take the figures at face value, the estimate would be 65-3/4 billions (124/726 of 387 billions, or 17% of 387 billions). But we have seen that there is a great deal of speculation among wholesalers. Not all of their deposits, by any means, represent receipts from ordinary business. Moreover, there is much overcounting here, several checks being used for one transaction, especially where wholesalers have branch houses, and checks connected with loans and repayments, and transfers of funds from one bank to another. How much we should subtract for this there is no way to tell. In the case of retail figures, we have the additional check of the figures for total net income, but there is no such check here. We shall, therefore, make no subtraction, but shall content ourselves with pointing out that we are allowing many billions[267] to "ordinary trade" to which it is not entitled, which will much more than offset errors in the opposite direction which the reader may find in our computations.

Do manufacturers' receipts from first sales belong in the wholesale deposits, or must they be counted as a separate item? Dean Kinley does not say. In his list of items, as reported by banks, that go in the "all other" deposits,[268] he does not mention manufacturers, and the item is far too important not to have been mentioned by so careful a writer had he supposed that it belonged there. If manufacturers' first receipts belong, not in the wholesale deposits, but in the "all other" deposits, then we should expect manufacturing cities to show a high percentage of "all other" deposits as compared with wholesale deposits. The city of Pittsburg should be a good test case. The figures there, for State and national banks and trust companies, are:

Per Cent. Retail deposits $1,061,420 9.6 Wholesale deposits 3,368,004 29.7 "All other" deposits 6,672,378 60.6

For Pittsburg, the percentage of "all other" deposits is lower decidedly than the percentage for the country as a whole (about 75%), much lower than for cities where there is active speculation, as Chicago and St. Louis, to say nothing of New York, and is closer to the percentage of the South Atlantic States, 52%, than to the average for the country. The wholesale deposits of Pittsburg, however, rise to 29.7%, as against an average for the country of 17%. There is nothing in these figures to suggest that manufacturers' first receipts are exclusively in the "all other" deposits. I should think it safe to hold that a substantial part of them were included in wholesale deposits, and so already accounted for in our estimate. The total value of products manufactured in 1909 was $20,672,051,870. I shall allow $5,672,051,870 of this to have been already accounted for in our estimate of wholesale trade, and count 15 billions of it as a separate item. If there is an error here, it is very much more than offset by our failure to subtract anything from the wholesale figures for speculation. I think it probable that much more of the figures for manufactures should be assigned to the wholesale figures than I have assigned.

To these figures, we may add a number of other items, absolutely great, but insignificant, in comparison with the 387 billions not only, but also with the figures for retail and wholesale trade already reached. These are: total farm value of farm products (not nearly all of which is sold off the farm) $8,760,000,000; total mineral products, $1,886,772,843; total mill value of lumber, $684,479,859; total life insurance premiums (much of which is savings, and in no proper sense trade), $748,027,892; total fire, marine, casualty and miscellaneous insurance, $362,555,850; total wages and salaries, $14,303,000,000; total land rent, $2,673,000,000;[269] and the items for railway gross receipts, post office, telegraph, already mentioned. The total of these items, together with retail and wholesale trade and manufactures, is $141,860,618,000. This is only 36.6% of the total of 387 billions. It leaves over 245 billions unexplained. What can the 245 billions represent? There is really no way in which ordinary trade can make up more than a very few more billions, so far as I can see. There remain no items as big as 1% of the total, and, as we have seen, small items, of hundreds of dollars each, are like "infinitesimals of the second order"--they simply do not count at all when such staggering figures are involved.[270]

There remains, then, a total of 245 billions of check and money payments which are for something other than the ordinary trade of the country. What do these payments represent? Much of this total represents overcounting and duplications of various kinds, which we shall consider in a later chapter. Much of it also represents speculation and dealings other than speculative in securities. When we seek to find actual figures of transactions in any field, retail, wholesale, or speculative markets, or anything else, it is exceedingly difficult to find anything that approaches the amounts indicated by the banking transactions connected. I do not think that a record of all sales would show retail sales or wholesale sales anything like so great as the figures as we have allowed for them on the basis of the retail and wholesale deposits. When we look at the recorded figures of transactions on the speculative exchanges (or at estimates which competent observers make when records are not available), the figures, though very large, do not begin to equal the banking figures with which we have to deal. The New York Stock Exchange in 1909 showed sales, recorded on the ticker, of nearly 215 million shares of stock, with an approximate value of over 19 billions[271] of dollars. This was not an extraordinary year. In 1901 nearly 266 million shares were sold, in 1905, over 263 millions, in 1906, over 284 millions. A number of other years have approached the figures for 1909. If stock sales be a good index of general speculation, 1909 is a very satisfactory year from which to have got figures, as showing neither extreme speculation, nor extreme dullness--which latter was the case in 1896 when Kinley's other big investigation was made. The figures for shares sold, however, do not exhaust the business done at the New York Stock Exchange. "Odd lots," i. e., sales of less than 100 shares, are not recorded on the ticker. Mr. Byron W. Holt estimates that from 25 to 30% would be added if they were counted. DeCoppet and Doremus, of New York, who handle at least as much of the "odd lot" business as any other New York house, have given me the following information about the "odd lot" business: (1) the volume of odd lot sales is, roughly, from 20 to 25% of the volume of hundred share sales; (2) the odd lot business fluctuates in conformity to the hundred share market; (3) the odd lot speculator is just as likely to be a "bear" as is the hundred share speculator, and, in general, odd lot business is like the hundred share business. If we take the figure on which these two estimates agree, 25%, we may add 53-3/4 million shares to our 215, getting 268-3/4 million shares for 1909, with a value of about 24 billions. Bond sales recorded would add about 1 billion more. There are, further, some unrecorded sales, indeterminate in amount, but sometimes very substantial, when brokers have a number of "stop loss" orders. They match these before the market opens, and, if the prices are reached in the actual trading, these sales become effective automatically, without getting on the ticker. How extensive this is cannot be stated. It may sometimes add very substantially.[272] Thus, on the floor of the New York Stock Exchange we have dealings in excess of 25 billions for 1909. This is nearly as large as the figure we have assigned, on the basis of the bank figures, to total retail trade of the country, and it may well exceed the retail trade in fact. Recorded sales on other stock exchanges do not, in the aggregate for the country, bulk very large. For 1910, when New York shares reached 164 millions, the total for Boston, Philadelphia, Chicago, and Baltimore was something over 21 million shares.[273] The New York Curb has had "million share" days, but the average value of shares is low. But the dealings on the floors on the exchanges and "curbs" are far from all of the dealings in securities! Only securities which have been admitted by the authorities are dealt in on the exchanges. The volume of unlisted securities is enormous. Moreover, not all, by any means, of the sales of listed securities take place on the floors of the exchanges. The bond expert of a large banking house in Boston informs me that the "over-the-counter" business in Boston, both for stocks and for bonds, much exceeds the business in the Boston Stock Exchange, and others among Boston brokers have expressed the same opinion. The statement has been repeatedly made in the financial press that of the bonds listed on the New York Stock Exchange, ten are sold over the counter for one sold on the floor. Evidence on this point is not to be had in definite figures, of course, but I have found no one in Wall Street who regards it as extravagant. A single big bank in New York sold $550,000,000 in bonds in 1911--more than half the recorded bond sales on the Stock Exchange.[274] I should not know how to estimate the volume of outside dealings within many billions of "probable error." If ten billions of listed bonds are sold over the counter in New York alone, we may well suppose that the volume of over-the-counter sales of listed and unlisted securities at least is not smaller than the recorded sales on the floors of the exchanges. But this is all guess work. There are no definite data.

For produce, cotton, and grain speculation we have, in general, estimates rather than records. For the Board of Trade, in Chicago, there is one quite striking piece of information. That is that the Federal War Tax of 1 cent per hundred dollars on grain and provision futures on the exchanges produced $2,000,000 in Chicago alone in 1915.[275] For the purposes of the tax, deliveries within thirty days were counted, not as futures, but as "spot" transactions. The tax was collected almost wholly on grain. If the above figure is correct, then it is clear that dealings in these futures of over thirty days aggregated 20 billions of dollars worth. This gives no estimate of spot transactions, which are, however, very great. All this trading involved less than 400,000,000 bushels of grain received at Chicago--a little over a billion bushels were received at all primary markets. The grain received at Chicago was, thus, (at 80 c. per bushel), sold sixty-two times over in these futures, and an unknown number of times in spot transactions. There are further enormous spot transactions in provisions of various kinds at Chicago.

Chicago is the great centre, of course, for this kind of speculation in the United States. It may well be the world's chief market, so far as futures are concerned, though evidence to establish such a thesis is not at hand. London and Liverpool are gigantic centres of commodity speculation. But we have numerous cities in the United States where such speculation is very great. St. Louis, Kansas City, Minneapolis, New Orleans, and other cities are active speculative centres. New York, while small in its volume of grain and produce speculation as compared with Chicago, is the world's centre for cotton speculation, and the world's centre for futures in coffee, though yielding precedence to Havre, Santos and Hamburg,[276] ordinarily, in the volume of spot coffee transactions, and though handling only a very small amount of spot cotton. The volume of cotton sold in an ordinary year in New York is 50,000,000 bales,[277] though only about 160,000 bales are ordinarily received there, in a year.[278] In the five years preceding 1909, the sales on the New York Coffee Exchange averaged over 16 million bags of 250 pounds each.[279] In 1915, 32 million dollars were deposited as margins in connection with this speculation in coffee, and in ordinary years this runs from 25 to 30 millions, according to the Treasurer of the Exchange. The relation between the margins put up and the total pecuniary volume of trading is not indicated, but in most exchanges the actual depositing of margins is a small fraction of the pecuniary magnitude of the turnovers. Both the Cotton and the Coffee Exchanges are international centres. The Coffee Exchange now handles large transactions in sugar, also.

Contacts between the organized exchanges and ordinary business are very numerous. Producers in every line who can do so protect themselves by "hedging" in the exchanges which deal in their raw materials. This is a commonplace, so far as millers are concerned. The writer has found millers in a town off the main lines of the railroads in Missouri who regularly sell short a bushel of wheat on the St. Louis Merchants' Exchange for every bushel they buy to grind. The business man who does not sometime take a "flier" in the market for other than hedging purposes is rare! But, apart from the organized markets there is an immense volume of speculation. If a wholesaler buys only what he can sell to retailers, it is not speculation. But if he buys in excess of the anticipated demands of his retailers, expecting to sell the excess at an advance to other wholesalers, he is speculating. If a farmer buys cattle to feed, he is not speculating, but if he buys them thinking to sell them at an advance in a short time, and does so, the transactions are speculative. The line is not easy to draw, in practice. Intention is shifting and uncertain. There is chance in every industrial, commercial, and agricultural operation. But for the point at hand, the test is simple: do more exchanges take place than are necessary, under the existing division of labor, to advance the materials of industry through the stages of production, and get things finally to the consumer? If so, the excess of exchanges is speculative. Trading between men in the same stage of production is speculation. It represents trading to smooth out dynamic changes, to bring about readjustments which would have been unnecessary had conditions really been static, and had the initial plans of enterprisers been adequate. Trading in anticipation of further trading with men in the same stage of production is speculative. This sort of thing, in the wholesale business, especially, is exceedingly common. This has been noted by Professor Taussig, and made by him an important point in the theory of crises. Dean Kinley[280] called attention to it as a matter of importance in connection with his investigation in 1896. The coming of cold storage, and the development of the canning industry have, I am informed by a colleague in the Harvard Business School, enormously increased this speculation among both wholesalers and retailers, and it is very important in most wholesale lines. There is short-selling in materials for construction purposes, and in metals, apart from organized exchanges, and, where possible, contractors in the building trade often protect themselves by means of future contracts with speculators who are selling short.

Land speculation, in varying volume, is found in every part of the country. There is speculation in leases, in options on real estate, and in options on leases.[281] It may be noticed, too, that sales of "rights," of puts and calls and straddles, and other contract rights, are regular factors in the organized exchanges. Wherever profits are to be made by leveling values as between different places or different times, speculation arises, and, with dynamic change, this means everywhere, in every business, and all the time! The shifting of labor and capital from industry to industry, leveling returns to capital and labor, involves an enormous amount of trading that would not occur in a "normal equilibrium." Much of this the Stock Exchange does. That is what it is for. But much of it has to do with unincorporated industry, and a vast deal of speculative exchanging takes place to this end apart from the organized exchanges.

Speculation in bills and notes, by note-brokers and particularly by dealers in foreign exchange, occurs on a large scale, and accounts for a great deal of the banking figures. This has nothing to do with physically determined trade. From the standpoint of Professor Fisher's "equation of exchange," it must be barred, if the contention that "trade" is determined by "physical capacities and technique" is to be adhered to. Speculation in demand finance bills is barred in any case, since "money against checks," and "checks against checks," are excluded by his definition.[282] But as an explanation of no small part of our unexplained 245 billions of dollars, these items must be brought in. They are "double counting" from the standpoint of Professor Fisher's equation. They are, however, speculation. An official in a great New York banking house, in charge of the foreign exchange department, writes that in times when exchange rates are fluctuating, enormous quantities of drafts on Europe will be bought and sold, during a period of a couple of weeks or months, whereas under other conditions such transactions might amount to little with the same volume of imports and exports. The part of this which is between banks, a very big item, would not count in the 245 billions, but to the extent that foreign exchange brokers outside the banks participate, their activity helps to explain our 245 billions.

If it be true that speculation, including all manner of readjustment to dynamic changes, makes up the overwhelming bulk of trade in the country, then Fisher's indicia of variation in trade, weighted as they are, are totally misleading. The same is true of Kemmerer's indicia of "growth of business."[283] These are: population, tonnage entered and cleared, exports and imports of merchandise, postal revenues, gross earnings of railways, freights carried by railways, receipts of the Western Union Co., consumption of pig iron, bituminous coal retained for consumption, consumption of wheat, consumption of corn, consumption of cotton, consumption of wool, consumption of wines and liquors, market values of reported sales on the New York Stock Exchange. Only the last of these is in any sense an index of speculation. It is swallowed up by being put on a par with the other fourteen items. Its influence on the final index, made by averaging the others is, as inspection shows, virtually nil. Out of the twenty-six years his figures cover, the general index moves counter to the share sales 14 times! Utterly random figures would have come nearer to the facts in the case. It is particularly striking that Professor Kemmerer, whose total figures, as Professor Fisher's, rest for their absolute magnitude on Kinley's investigation,[284] should assign 89% of his estimated trade (183 billions in 1890) to wholesale commodities,[285] (with 3% to wages, and 8% to securities), when Kinley's figures show that wholesale deposits are a minor fraction of the total!

The constancy in the figures of these two writers for trade from year to year, a general steady, upward growth, does indeed suggest that trade is determined "by physical capacities and technique," and that it does stand as a great, independent, inflexible factor, independent of money and deposits, constituting a real causal coefficient with them in determining prices. If, however, speculation is as big a factor as our analysis would indicate, then trade is a highly flexible thing, varying enormously from year to year, moved by a multiplicity of causes, among them fluctuations in particular prices, and the ease and tightness in the money market--the quantity of money and deposits.

But quite apart from speculation, it is not true that trade is a mere matter of physical capacities and technique, a passive function of production. Rather, one would almost have to reverse the relation. Production waits on trade!

Production, as now carried on, is primarily conducted in the expectation of sale, and of profitable sale. Trade does not go of itself, automatically. Rather, it is a highly difficult matter, calling for the highest order of ability, and the labor of innumerable men. In general, I think it safe to say that in ordinary times, the manufacturer loses vastly more sleep over the question of how he shall market his output, than he does over the question of how he shall produce it. A clerk in the Westinghouse Air Brake Company, engaged in the accounting department, spoke recently to the writer of the "productive end" of the business. On inquiry, it developed that he meant the selling department! He stated that the manufacturing department also, in the language of the employees, in that corporation, would also be termed "productive," but that the selling department was the productive department.

If one reflects a little as to the proportion of "costs" that go into selling, as compared with technical "production," I think my point will be clearer. Advertising has developed so enormously that it needs little discussion. It has been stated that the "Sapolio" people once tried, after their reputation seemed thoroughly established, to stop advertising, with such disastrous results that very extraordinary efforts were required to reestablish the brand. Number 2 wheat is not advertised, in the great magazines, but innumerable brands of flour get newspaper and magazine advertising,--some of them in such a periodical as the Saturday Evening Post, and even those which are locally consumed are commonly advertised in the local press. Nor is it only finished products, of the sort that must be sold to the fickle public, that involve these heavy selling costs. The writer has in mind a corporation producing a high-grade type of glazed retort, in the production of which it has virtually a monopoly, since the clay with which it is made does not coexist with the skill to make it in any other place. The particular product is an indispensable part of many important technical processes. Substitutes made of other clays, and by other companies, are known by the trade to be unsatisfactory. The buyers are all highly trained business men. Here, if anywhere, selling costs should be slight. But the chief selling agent of the corporation has found it necessary, in order to keep the business going, to incur huge expenses for entertaining his customers, finds it necessary to incur great travelling expenses, to use only the most expensive hotels, and, incidentally, to drink a great deal more than his personal inclinations would call for, in keeping the business for his house. I waive discussion of the extraordinary fees which a trust promotor makes, in effecting a consolidation of big business units,--a process of exchange. I am speaking now of the ordinary costs involved in ordinary trade. The army of travelling salesmen, the body of stenographers, who write letters, with various "follow-ups," in the effort to get more business, the growing complexities of such letter writing, in which all suspicion of "circularizing" must be allayed, one-cent stamps being absolutely taboo!--these things are the commonplaces of business. They are in the primers in the "commercial colleges" and "schools of commerce." Only the orthodox economist, with his doctrine of the impossibility of general overproduction, is ignorant of them!

This feature of modern business has been much elaborated in a recent book which has not received the attention it merits--though its strength is rather in criticism than in constructive doctrine. I refer to Dibblee, The Laws of Supply and Demand.[286] Dibblee makes an interesting contrast between commercial and manufacturing cities, maintaining that the former necessarily outgrow the latter--a contention which London, New York, Chicago and other places strikingly illustrate. He presents a truly remarkable fact about London:[287] a recent report of the Commission on London Traffic states that there were in London 638 factories registered as coming under the Factory Acts, with an average horse-power of 54. The total power employed within the London area under the Factory Acts, chiefly used in newspaper printing, was 34,750 horse-power--just one-half of what is required for the steamship, Mauretania! This is the greatest city in the world. What do its millions do for a living?[288] The town of Oldham,[289] he asserts, with 100,000 inhabitants, has spindle capacity enough to supply more than the regular needs of the whole of Europe in the common counts of yarn. To market the output of Lancashire, "the merchants and warehousemen of Manchester and Liverpool, not to mention the marketing organization contained in other Lancashire towns, have a greater capital employed than that required in all the manufacturing industries of the cotton trade." Accurate estimates of the proportion of "selling costs" to costs of technical production are doubtless impossible, for the general field of trade, and precision is unnecessary for my purposes. Dibblee's conclusion, after contrasting retail and wholesale prices, and analyzing the expenses incurred in selling prior to the wholesale stage, is that the cost of marketing is at least equal to "real cost of production," occasionally only slightly below it, and often far above it (62).[290] If one considers how large the item of "good will" often bulks in the value of "going concerns"[291]--good will being in large degree often just a capitalization of prior costs of this nature--Dibblee's estimate need not be exaggerated. Trade connections, trade-marks that have reputation, etc., often represent enormous output in thought, work, and expense. Selling costs may, like other costs, be divided into "prime" and "overhead" costs. Some of the latter lead to long-time consequences, pay for themselves only in the long run. These may be "capitalized" in "good will."[292] Of course, not all good will is got at a cost. Much of it is adventitious.

In the light of the doctrine that trade is independent of money and credit, one wonders why it should be thought necessary to extend branches of American banks to the South American markets which we are now reaching out toward. And why have Americans, from the beginning, been constantly increasing commercial banks?[293] It is easy to sneer at the efforts of the successive frontiers in our history to provide themselves with banks of issue as based on a delusion, the delusion that bank-notes are "capital," and to say that their real need was, not more bank-credit, but more real capital. They needed more tools and live-stock, doubtless, but is that the whole story? And were their banks of no assistance in getting the additional capital of various sorts? And was it a matter of no consequence that they had an abundant medium of exchange? It seems almost childish to put such questions, but the quantity theory has as its logical corollary that to multiply banks is quite useless and wasteful, since the only result is to raise prices. If increasing bank-credit cannot increase trade or production, this corollary is inevitable. Indeed, the case may be more strongly stated. Quite apart from the wasted labor of bank-clerks and the waste of banking capital, the effect of increasing bank-development, on quantity theory reasoning, is harmful. If increasing bank-credit is to raise prices without increasing trade, then, on quantity theory reasoning, it must depress business. The reason is that rising prices in a given region make that region a bad place to buy in, and so curtail its exports. This is, indeed, the quantity theory explanation of international trade, to which attention is later to be given. The country which is expanding its banking facilities most rapidly will suffer most in competition in the world markets. This is why the United States have so little foreign trade! It also explains the rapid strides that China and Central Africa have recently made in capturing the world's markets. I submit that there is no flaw in this argument, if the premise of the independence of volume of trade and volume of bank-credit be granted. It follows from the quantity theory. That it is no caricature of Fisher's argument will appear, I think, from the following quotation,[294] which very nearly states what I have just been saying, though it does not draw the conclusion that banking is a bad thing: "The invention of banking has made deposit currency possible, and its adoption has undoubtedly led to a great increase in deposits and consequent rise in prices. Even in the last decade the extension in the United States of deposit banking has been an exceedingly powerful influence in that direction. In Europe deposit banking is in its infancy."[295] Happy Europe, troubled only by war! It is greatly to be hoped, in the interests of American agriculture, that the efforts to increase agricultural credit facilities will fail!

We are driven to one of the most fundamental contrasts in economic theory, which appears under various guises and in different forms: statics vs. dynamics; transition vs. equilibrium, theory of prosperity vs. theory of goods; normal tendency vs. "friction."[296] Perhaps Professor Fisher, and the quantity theorist in general, would dismiss many of these considerations as not applicable to the general principle, which is a "normal" or "static" or "long run" law, not subject to considerations of this sort. It is scarcely open to Fisher to defend himself this way, because of his exceedingly uncompromising statement regarding even "transitional" relations between volume of trade and money and credit. I shall not reply to anyone who offers such an objection by a general tirade against "static economics." I believe thoroughly in the method of economic abstraction, and in reaching general principles by ignoring, provisionally, in thought the "friction" and "disturbing tendencies" which often make the first approximations look somewhat unreal. But I raise this question: to what feature of our economic order do we chiefly owe it that we can make such abstractions? By virtue of what does friction disappear? What is it that makes our abstract picture of economic life, as a fluid equilibrium, with its nice marginal adjustments, its timeless logical relations, correspond as closely as it does to reality? The answer is: MONEY and CREDIT.[297]

It is the business, the function, of money and credit, as instruments of exchange, to bring about the fluid market, to overcome friction, to effect rapid readjustments, to give verisimilitude to the static theory, to make the assumptions of the static theory come true. Where exchange is easy and friction slight, there will not be two prices for the same good in the same market. Speculators, seeking profits of fractions of a point, will prevent that. By multiplying exchanges, they will level off values and prices. Because money and credit have done their work so thoroughly in the "great market," it is possible for men to talk about static theory, and to work out economic laws in abstraction from friction, transitions, and the like.

In the static state, all speculation is banished. There are no price-fluctuations to be smoothed out, no new prospects to be "discounted," no uncertainties to be guarded against by "hedging." Seasonal goods will, of course, have to be carried over from one season to the next, but this will involve merely warehousing and the use of capital--"time speculation," involving many sales, does not come in. One sale to the capitalist who carries the seasonal goods, with a sale by him to the man who means to use them, will suffice. It has been shown before that the great bulk of trade is speculation. But speculation is banished from the static state. Speculation is a function of dynamic change, waxing and waning with the degree of uncertainty that exists, the new conditions to which readjustments have to be made, the "transitions" that have to be effected. In other words, the laws governing the volume of trade are dynamic laws, laws of "transition periods," and so the whole notion which underlies the quantity theory, of "normal periods," "static" relations, etc., is here irrelevant. Volume of trade, as distinguished from volume of production, is controlled by the number and extent of the "transitions" that have to be made. The chief work of money and credit is done in, and because of, "transition periods." Assume a normal equilibrium accomplished, and you have little trading left to do. It will still be necessary, if you have the division of labor, and private enterprise, for goods to pass through as many different hands as there are different independent enterprisers in the stages of production, and on, through merchants, to the consumer. It will still be necessary to pay wages, rents, dividends and interest. But there will be no selling of lands, of houses, of factories, of railroads, or of securities representing these. By hypothesis these are already in the hands best qualified to hold them. The "static equilibrium" presents "mobility without motion, fluidity without flow."[298] The static picture is a picture of completed adjustment, where no one has an incentive to change his work, or his investments, because he has already done the best that he can for himself. It is, therefore, a picture of a situation where there is little incentive for those exchanges which make up the great bulk of the volume of trade in real life.

Hence the curious phenomenon that very much of static theory has been developed in abstraction from money and credit. Mill's theory of international values, for example, abstracts from money. "Since all trade is in reality barter, money being a mere instrument for exchanging things against one another, we will, for simplicity, begin by supposing the international trade to be in form, what it is in reality, an actual trucking of one commodity against another. So far as we have hitherto proceeded, we have found the laws of interchange to be essentially the same, whether money is used or not; money never governing, but always obeying, those general laws."[299] Other writers have similarly held that money is a mere cloak, covering up the reality of the economic process. Schumpeter, for example, holds that money is, in the static analysis, merely a "Schleier," and that "man nichts Wesentliches uebersicht, wenn man davon abstrahiert."[300] On the static assumptions, of the fluid market, with friction, etc., banished, money is, indeed, anomalous and inexplicable. It is a cloak, a complication, a vexatious "epi-phenomenon." There is nothing for it to do, and there can be, consequently, no "functional theory" developed for it. Static theory may be ungracious in ignoring its own foundation. But static theory is grotesque when it seeks to support its own foundation! Static theory is possible only on the assumption that the work of money and credit has been done. What, then, shall we say of static theory which seeks to explain the work of money and credit? Yet precisely this is what is undertaken by the quantity theory, with its "normal" or "static" laws of money and credit. A functional theory of money and credit must be a dynamic theory. To talk about the laws of money, "after the transition is completed" is to talk about the work money will do after it has finished working. For a functional theory of money and credit, we must study the obstacles that exist to prevent the fluid market. We must study friction, transitions, dynamic phenomena.

To this problem we shall come in Part III. For the present, I am content to have disproved the quantity theory contention that the volume of trade is independent of the quantity of money and credit.

APPENDIX TO CHAPTER XIII

THE RELATION OF FOREIGN TO DOMESTIC TRADE IN THE UNITED STATES[301]

The word, "trade," as used in connection with statistics of foreign and domestic trade has been irritatingly ambiguous. Few writers, in speaking of domestic trade, have meant the same thing by trade that they have meant by the word when speaking of foreign trade, and hence we have had many pointless efforts to institute comparisons between the two, and some very misleading statements about the matter. Thus, figures have been offered which would show that the foreign trade of the United States is only a fraction of 1% of the domestic trade. This conclusion is reached by taking the figures for banking transactions discussed in Chapters XIII and XIX as representative of domestic trade, and comparing them with the annual figures for exports and imports. This procedure is fallacious for several reasons:[302] the figures thus reached for domestic trade exceed even the total trading within the country, as shown in Chapter XIX. In the second place, as shown in Chapter XIII, the bulk even of these deposits which do represent real trading grow chiefly out of speculation. Even in ordinary trade, goods are counted several times before reaching the final consumer. It is clear, therefore, that even an accurate figure for total trading within the country would have little relevance when we are seeking a figure to compare with exports and imports. Nor, if a comparison of the actual trading in which foreigners participate with the trading exclusively between Americans is sought, can we take the export and import figures as representative of the foreign trading--they do not include a multitude of highly important transactions in which foreigners participate. Very much of the business of the New York Cotton Exchange, the New York Stock Exchange, the Chicago Board of Trade, and other speculative markets represents foreign buying and selling, especially arbitraging transactions, and the other "invisible items" of foreign trade need merely to be mentioned for the economist to recognize the fallacy of a comparison which omits them.

What figures are relevant when we wish to compare foreign and domestic trade? First we must make clear the purpose for which the comparison is to be made. If we are concerned with the calls made by foreign and domestic trade on the money market, we should make use of a different method of comparison than that which will be here employed. The purpose of the comparison here undertaken is to determine how much of our American labor, land and capital is at work producing for the foreign consumer, as compared with the land, labor and capital in America producing for the American consumer. The comparison here undertaken is concerned with the question which is usually uppermost in the minds of those who undertake such a comparison, namely, how important is our foreign market to us? Obviously, for such a comparison as this, we should not count a given case of eggs twelve times merely because it changed ownership twelve times in getting from farm to breakfast table. Items of export and import count only once in the figures for export and import. We must find a figure for domestic "trade" in which items count only once, allowing no turnovers of the same goods to swell the total, if we wish to make our figures comparable.

The method proposed for making this comparison, for a long series of years, is a modification of the method used by the writer in an article in the Annalist of Feb. 7, 1916. A figure based on the bank deposits of retail merchants in Kinley's 1909 investigation was there taken as properly comparable with the export and import figures. The final sale to consumer by retailer is "the one far off divine event" toward which the whole productive process moves. Everything else in production and exchange looks forward to this. Ultimately, from the demand of the final consumer comes all the demand that is directed toward the agencies of production, even though the laborer sees his immediate market in the person of the employer, and the capitalist or landlord sees his immediate market in the person of the active business man. The figure reached for retail trade by the method then employed was $34,500,000,000 for 1909. This figure was too high, as shown in Chapter XIII above, and the figure reached now for retail deposits by the same method is $32,000,000,000. Even this figure is too high, however, as I there concluded, to represent retail trade, and I shall use it only as a check on King's figure for the total income of the United States in 1910, which I shall use as a base figure instead of my own. King's figure for the total income of the United States in 1910 is $30,500,000,000.[303] I take this figure as including all that the American people spend for consumption, with retailers, physicians, hotels, theatres, etc., and also their net savings for the year. Part of this they spent for foreign products. The rest they spent at home. This residue spent at home gives us a figure which we may properly compare with the amount the foreigner spends in America, as indicating the ratio of foreign to domestic trade for the purpose in hand. We subtract, in other words, from the figure for total income the figure for imports. Then we compare the residue with the figure for exports, and get our ratio of foreign to domestic trade. The export and import figures must first, however, be reduced to a retail basis. That is, assuming that wholesale prices are two-thirds of retail prices, we add 50% to the figures for exports and imports (which are wholesale figures) before making the subtraction and the comparison. The ultimate consumer, both in Europe and America, pays for imports and exports on a retail basis.[304] This method, applied to the figures for 1910, gives us a ratio of about 10:1 for domestic to foreign trade--the lowest percentage for foreign trade which we shall find for any year in the period investigated, 1890-1916.

This comparison is still unfavorable to foreign trade. Domestic trade, in our figures, includes savings and investments, including investments made by Americans abroad. Import figures are marred by undervaluations, exports are not all counted, and the figures for exports and imports do not include foreign investments in America. American investments abroad should not be counted as part of domestic trade. Moreover, our figures take no account of travellers' expenditures, or of services performed by professional men of one country for men in another, or of certain other "invisible items." But while this makes our percentage for foreign trade too low for all years, it probably does not greatly upset the results for yearly variations in the ratio except for the year 1916, when the figure for domestic trade is left decidedly too high, and the ratio for foreign trade is too low, as compared with previous years.

For years other than 1910, indirect calculations must be resorted to for domestic trade. I have substantial confidence in the rough accuracy of the figure chosen for 1910 in view of the convergence of two widely different sets of data. My figure for retail deposits in 1909 is $32,000,000,000. King's figure for total income is $30,500,000,000 for 1910. King's figure seems to me a better figure to use for the purpose in hand. I use my own merely as a rough check on his. For years other than 1910, the figure for net income is calculated as a percentage of King's figure for 1910, by means of an "index of variation." It is assumed that the net income of 1905, for example, bears the same relation to the index for 1905 that the absolute figure for net income of 1910 bears to the index for 1910, and net income for 1905 is then computed by "the rule of three." The index of variation chosen is railway gross receipts weighted by wholesale prices. I think that railway gross receipts are, on the whole, the most dependable and easily manageable index of physical volume of production that we have, though recognizing difficulties, later to be discussed, in using them for the purpose in hand. Railroads touch virtually every kind of business in the country. Variations in the pecuniary volume of production and consumption, however, if due to rising or falling prices, rather than to changing physical volume, would not be indicated by changes in railway gross receipts. The same volume of transportation might represent widely varying pecuniary values of goods transported. Railway rates do not vary from year to year with prices of goods, even though high-priced goods are normally charged higher rates than low-priced goods. The index, therefore, must include prices as well as physical volume of transportation. For 1910, therefore, railway gross receipts and an index of prices are multiplied together, and counted as 100%. The same thing is done for railway gross receipts and prices for other years, and the results reduced to percentages of the result for 1910. The figure for net income in any other year is then readily computed as a percentage of the figure for 1910. The results, for the years 1890-1916, appear in the tables below.[305]

It may be noticed that my figures for net income in 1900 and 1890 do not correspond very closely with the figures for the same years as independently estimated by King. My figure for 1900 is $12,900,000,000, where his is $17,965,000,000; for 1890, my figure is $9,300,000,000, where his is $12,082,000,000. I am inclined to the view that the figures in my tables come closer to the facts for these years than do his figures, assuming that his figure for 1910 is correct. It will be noticed that on his figures there was an increase of about 50% from 1890 to 1900, and an increase of only about 66% in the decade following. This seems to be an unlikely relation. One would expect a much greater rate of increase for the decade 1900-10, as compared with the preceding decade, than King's figures show. The period from 1890 to 1900 included the terrible panic of 1893 and the prolonged depression ensuing. The panic in 1907 was trifling in comparison, and recovery, as shown by our index numbers in the tables below, was very much quicker. Moreover, falling prices characterized much of the earlier decade. The highest prices of the whole ten years were in 1891. The period from 1900 to 1910 is a period of rapidly rising prices, on the whole. On the basis of our general knowledge of the two periods, one would expect a greater percentage gain by far for the second decade, and I therefore trust the results of the index of variation here chosen, which show that. Similar results are obtained by applying to the base figure for 1910 an index of variation derived from Kemmerer's and Fisher's figures for trade[306] and prices. My figure for 1890 may, moreover, be checked by comparison with the figure given by C. B. Spahr in The Present Distribution of Wealth in the United States (p. 105) for the net income of the country for that year: $10,800,000,000. It may be that my figure for 1890 is too low, but I have not sought to "doctor" it by an arbitrary "correction factor" to make it correspond more closely than it does with the other estimates. It is striking enough that a figure derived from an index of variation, twenty years away from its base, should come as close as this to figures calculated from wholly different data.

One brief comment may be made on the significance of these figures. It may be questioned if figures showing the proportions of our industry devoted to supplying goods for the foreign market correctly indicate the importance of the foreign market to us. It may be urged that if we should lose our foreign market, we should merely turn to producing more for the domestic market, and that the loss would not be the whole of our receipts from foreign trade, but merely the cost of transition, and the loss that comes from shifting to production to which we are less suited. This is, doubtless, true. But the loss reckoned this way may well be greater than the loss reckoned on the basis of my figures! It is equally true, moreover, that our domestic trade is not important to the extent indicated by my figures, since if we lose part of our domestic trade, our producers will turn to supplying more for the foreign market. But one must not regard the cost of transition as a negligible matter! The cost may easily be prolonged depression. Certain parts of our foreign trade are really vital to us, both on the import and (to a less degree) on the export side. The most important practical use to which the figures here given may be put are in connection with short-run problems. Foreign trade is so important to us that any sudden alteration in its amount may bring great adversity or great prosperity--as the course of the present War abundantly testifies.[307]

An application of our method to the years 1850 and 1860 gives a percentage for foreign trade of 12.7 in 1850, and 16.0 in 1860.[308]

Certain other cautions are needed in presenting these figures. For one thing, variations in railway rates will make a given volume of gross earnings mean different things in different years as to the physical volume of traffic. In the writer's opinion, which is confirmed by Professor W. Z. Ripley, there is no possible way of making allowance for this, as the cross-currents affecting railway rates are altogether too numerous and obscure. Nor has any effort been made to allow for variations in the proportions of freight and passenger receipts, or of different classes of freight traffic.

Again, the proportions of railway traffic connected with foreign trade may vary greatly, and it may happen that a big increase in railway gross receipts is due to increasing foreign trade, primarily. There is reason to suppose that much of the increase of 1916 is to be explained that way. This makes our comparison for 1916 particularly adverse to foreign trade, since we count as domestic trade what is really foreign trade. The figures, however, are presented as they stand. Moreover, for 1916, the great increase in foreign trade is in exports. Merchandise imports are not much greater than in previous years.[309] Our exports have been chiefly paid for by "invisible items," gold and securities, and short term credits. These do not appear anywhere in our figures. A substantial source of error appears from this cause in our 1916 figure. I should think it safe to put the ratio for foreign trade to domestic trade for 1916 at above 20%, instead of the 17.9% our table shows.

The reader will wish to know for a given year how much of the increase or decrease is due to physical growth of business, as represented by railway gross receipts, and how much is due to changes in prices. To give this information, and to make it easy for a critic to check the results, a table showing the index numbers from which the figures for net income are computed is subjoined.[310]

TABLE I[311]

1 2 3 4 Ratio of Domestic Trade of Foreign Trade of Foreign Calendar Net Income United States = United States = to Years of the Net Income minus Exports at Retail Domestic United Imports at Retail Prices Trade States Prices

1890 $ 9,300,000,000 $ 8,100,000,000 $1,300,000,000 16.1% 1891 10,400,000,000 9,200,000,000 1,400,000,000 15.2% 1892 10,000,000,000 8,700,000,000 1,400,000,000 16.1% 1893 10,100,000,000 8,900,000,000 1,300,000,000 14.6% 1894 8,300,000,000 7,300,000,000 1,200,000,000 16.5% 1895 8,400,000,000 7,200,000,000 1,200,000,000 16.7% 1896 7,900,000,000 6,900,000,000 1,500,000,000 21.8% 1897 8,000,000,000 6,900,000,000 1,600,000,000 23.2% 1898 9,100,000,000 8,200,000,000 1,900,000,000 23.2% 1899 10,900,000,000 9,700,000,000 1,900,000,000 19.6% 1900 12,900,000,000 11,700,000,000 2,200,000,000 18.8% 1901 14,600,000,000 13,300,000,000 2,200,000,000 16.5% 1902 15,600,000,000 14,200,000,000 2,000,000,000 14.1% 1903 17,700,000,000 16,200,000,000 2,200,000,000 13.6% 1904 18,000,000,000 16,500,000,000 2,200,000,000 13.3% 1905 19,600,000,000 17,800,000,000 2,400,000,000 13.5% 1906 21,500,000,000 19,500,000,000 2,700,000,000 13.8% 1907 26,600,000,000 24,500,000,000 2,900,000,000 11.8% 1908 23,000,000,000 21,300,000,000 2,600,000,000 12.2% 1909 27,600,000,000 25,400,000,060 2,600,000,000 10.2% 1910 30,500,000,000 28,200,000,060 2,800,000,000 9.9% 1911 29,600,000,000 27,300,000,000 3,100,000,000 11.4% 1912 33,800,000,000 31,100,000,000 3,600,000,000 11.6% 1913 34,800,000,000 32,100,000,000 3,700,000,000 11.5% 1914 32,600,000,000 29,900,000,000 3,200,000,000 10.7% 1915 35,400,000,000 32,700,000,000 5,300,000,000 16.4% 1916 49,200,000,000 45,800,000,000 8,200,000,000 17.9%

TABLE II. INDEX NUMBERS FROM WHICH THE FIGURES FOR NET INCOME ARE DERIVED

1 2 3 4 Composite Net Income[312] Dun's Prices R. R. Gross Index, R. R. Gr. of the United Calendar with base Receipts, Rcts. multiplied States in Years in 1910 reduced to by Prices. billions of base of (Column 1 x dollars: 1910 column 2.) 100:30.5::(3):$

1890 76.5 39.8 30.8 $ 9.3 billions 1891 81.5 42.0 34.2 10.4 1892 75.6 43.5 32.8 10.0 1893 77.3 42.9 33.2 10.1 1894 71.5 38.1 27.2 8.3 1895 68.0 40.7 27.8 8.4 1896 63.8 40.6 25.9 7.9 1897 62.2 42.4 26.4 8.0 1898 66.4 45.1 29.9 9.1 1899 72.3 49.6 35.8 10.9 1900 78.1 54.0 42.1 12.9 1901 80.6 59.4 47.8 14.6 1902 84.0 62.6 51.3 15.6 1903 83.1 70.1 58.2 17.7 1904 84.0 70.3 59.0 18.0 1905 84.0 76.4 64.2 19.6 1906 88.1 85.0 70.5 21.5 1907 94.0 92.9 86.3 26.6 1908 92.4 81.8 75.6 23.0 1909 99.0 91.7 91.0 27.6 1910 100.0 100.0 100.0 30.5 1911 98.1 99.0 97.0 29.6 1912 104.1 106.9 111.0 33.8 1913 101.7 112.5 114.0 34.8 1914 102.5 104.5 107.0 32.6 1915 106.0 110.0 116.0 35.4 1916 125.0 129.0 161.2 49.2

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Chapter XIV

THE VOLUME OF TRADE AND THE VOLUME OF MONEY AND CREDIT

In the argument so far I have said nothing of the reverse relationship, the dependence of the volume of money and the volume of credit on trade. The two are indeed _inter_dependent. Interdependence suggests circular theory, and is often a phrase to cover circular reasoning.[313] In the case of the relation under discussion, however, I have, I trust, already abundantly protected myself against the charge of circular reasoning by denying that either volume of money and credit on the one hand, or volume of trade on the other hand, is a true cause at all. Both are mere abstract names, designating highly heterogeneous individual occurrences, which, individually are cause or effect. In general, both volume of money and credit, on the one hand, and volume of trade on the other hand, are results of common causes, which are the verae causae of economic phenomena--values, psychological phenomena. The whole thing is to be explained immediately and primarily in terms of social relationships and mental processes,--in terms of social values.

To show that increasing trade tends to increase money and credit is not difficult. If one may venture a hypothetical illustration--and the sort of hypothetical illustrations, like the dodo-bone case, of which quantity theorists are fond make one hesitate to do so--let us assume a communistic community, isolated from other markets, with a developed system of production, including an extensive use of gold in the arts. Let the communistic regime gradually pass over to an individualistic regime. Assume that the inhabitants are acquainted with the use of gold as money, and that their government is willing to coin it freely. As individualism spreads, and trade grows, will not more and more gold be taken to the mints? I am not here concerned with the principles determining the apportionment of gold between the money employment and the arts. It is enough to show that expanding trade tends to increase the volume of money.

Assume that the money supply meets difficulties in its expansion. Is there not at once an incentive to extend credit? The seller finds his customers unwilling to buy for cash, in amounts as great as before. In order to sell as much as before (assuming that the use of credit is known, to avoid trouble with historical origins), he extends credit,--which, when practiced generally, lightens the strain on the money supply.

I have so far said nothing of the case where there are stocks of the money metal to be got from outside markets. But if a country is expanding its trade, does not money come in? The quantity theorists would, indeed, admit this, in general, though their reason is a bad one, namely: that expanding trade lowers prices, and lower prices make the market attractive to foreign buyers, who then send in money for the goods. I shall later discuss this aspect of the theory.[314] For the present, I merely interject the question as to the probability of an expansion of trade when prices are falling. Increasing stocks of particular goods may well mean lower prices for these goods and if they be articles of export the lower prices may well increase the export trade, and bring money in. But this increase in stocks of articles of export is very different from total trade within the country; and lower prices in articles of export are very different from a generally lower price-level.[315]

Will expanding trade in a country increase credit? I come here to one of the striking features of Fisher's doctrine--a feature in which I think he is fundamentally true to the quantity theory. He finds no way in which expanding trade can directly increase credit. Expanding trade can increase credit, (a) only by changing the habits of the people, so as to alter the ratio, M to M', or (b) by reducing the price-level, and so bringing in money from abroad, whence, as M is now increased, M' rises proportionately. "An increase in the volume of trade in any one country, say the United States, ultimately increases the money in circulation (M). In no other way could there be avoided a depression in the price-level in the United States as compared with foreign countries. [He should say, from the standpoint of his theory, that increasing trade will cause a fall in the price-level, and so bring in more money.] The increase in M brings about a proportionate increase in M'.[316] Besides this effect, the increase in trade undoubtedly has some effect in modifying the habits of the community with regard to the proportion of check and cash transactions, and so tends somewhat to increase M' relatively to M; as a country grows more commercial the need for the use of checks is more strikingly felt."[317] In a footnote to this paragraph, he defines the issue still more sharply. "This is very far from asserting as Laughlin does that 'The limit to the increase in legitimate credit operations is always expansible with the increase in the actual movement of goods'; see Principles of Money,[318] New York (Scribner), 1903, p. 82. We have seen, in Chapter IV, that deposit currency is proportional to the amount of money; a change in trade may indirectly, i. e., by changing the habits of the community, influence the proportion, but, except for transition periods, it cannot influence it directly."[319]

My own explanation of the causal sequence whereby expanding trade brings money into a country would be radically different from that given by Fisher in the first quotation. I should expect, first, that rising prices would encourage rising trade; I should then expect the rising volume of trade, with higher prices, to lead borrowers to need, and secure, larger loans from the banks, with, as loans and deposits rise in proportion to reserves, some slight increase in "money-rates," just enough to draw to the country the extra gold which bankers felt desirable to add to their reserves. I should expect the causal sequence to be the exact reverse of that which Fisher indicates. With falling prices, or waning volume of trade--which would usually come together,[320]--I should expect loans to be reduced, deposits to be reduced, money-rates to fall, and gold then to leave the country again. I should expect this sort of thing to happen normally, and not infrequently, and I should expect gold to come in and go out many times in the course of a business cycle. This would seem to be the sort of explanation which our modern theory of elastic bank-credit would give in connection with this problem. I shall not here go into details with the theory of elastic bank-credit. The theory has been too well established in the debates between the "Currency School" and the "Banking School"[321] in regard to bank-notes to need elaboration and defence here, and the essential identity of deposits and elastic bank-notes from this angle is one of the commonplaces of the literature of banking. What I am here concerned with is the highly significant fact that Fisher's "normal" theory finds no place for this highly important phenomenon. The quantity theory has no explanation of elasticity to give. On the basis of the quantity theory, and for all that the quantity theory can say, the Currency School was right! Fisher offers us, virtually, a "currency theory" of deposits. "Suppose, as has actually been the case in recent years, that the ratio of M' to M increases in the United States. If the magnitudes in the equations of exchange in other countries with which the United States is connected by trade are constant, the ultimate effect on M is to make it less than what it would otherwise have been, by increasing the exports of gold from the United States or reducing the imports. In no other way can the price-level of the United States be prevented from rising above that of other nations in which we have assumed this level and the other magnitudes in the equation of exchange to be quiescent." (P. 162.) If "bank-notes" be substituted for "M'", in this quotation, we have here a perfect statement of the position of the "Currency School" in that great debate. Must this old issue be fought all over again? And yet, I defy any consistent quantity theorist to find any flaw in Fisher's argument on this point. There is no place for a theory of elastic bank-credit within the confines of the quantity theory. Fisher's recognition of this seems full and complete. He relegates all mention of elastic bank-credit to "transitions." The footnote quoted above, in which Laughlin's (somewhat extreme) doctrine based on the theory of elasticity is stated, denies categorically that there is any validity in it, except for transition periods. There is nowhere in the book any explanation of the theory of elasticity.[322] The references to it are few and grudging, and always in connection with the notion of transitions. The most important statement regarding elasticity (less than a page long) is on page 161, where again transitional influences are under discussion. What is a theory of money worth which can offer no explanation of so fundamental, important, and notorious a feature of modern money and banking?

There is a further, related, feature of banking for which the quantity theory can find no explanation. Among the items in a bank's balance sheet, the quantity theorist seizes upon reserves on the assets side, and deposits on the liability side, and builds his theory on the supposed close relation between them. We have seen that this close relation does not, in fact, exist. The range of variation is enormous.[323] But there is one close relation in the balance sheet of the bank concerning which the quantity theory is silent, and that is the relation between deposits and loans. For individual banks and for banks in the aggregate, for long run periods and for short run periods, for reasons that are clear and inevitable, these two magnitudes (or for banks of issue on the Continent of Europe, notes and loans), vary closely together. The relationship between them is the only relationship which does stand out as clearly beyond dispute, among all the items in the banking balance sheet. No assumptions of a "static state" are needed for its demonstration! The relation varies, of course. As banks increase or reduce their capital, as their reserve-percentages rise or fall, as they increase or decrease their holdings of bonds, we find reasons which alter the proportion between deposits and loans. But, despite this, the variation, as shown by figures for the United States, is slight. Assume, for example, a statement showing "loans and discounts" of $1,000,000, deposits, $1,000,000, cash reserve, $200,000. Reserves are then 20% of deposits, and loans are 100% of deposits. If reserves be increased by $100,000 and loans and discounts reduced, to compensate, by $100,000, we have a 50% variation in the ratio of reserves to deposits, with only a 10% variation in the ratio of loans and discounts to deposits. Since cash reserve is much the smaller item, almost always, the same absolute variation in it will affect it, in percentage, vastly more than it will affect loans and discounts. It is strange that a theory should seize on this highly variable ratio of reserves to deposits, and ignore the much more constant ratio[324] of loans and discounts to deposits.

That this close relation between deposits and loans should obtain follows naturally from the theory of elastic bank-credit. The two are built up together. When there are expanding business and rising prices, men borrow more from the banks; as they borrow, they receive deposit credits; the individual who receives the deposit credit may check against it, but it is redeposited by another man, and so, while the deposits of one bank need not grow out of its loans, still, for banks in general, deposits are large because loans are large. For a given bank, the relation holds closely, because the bank lends, in general, to active business men, who will have income as well as outgo, and whose income will, on the average, at least balance their outgo. Thus, through loans, deposits are linked with volume of trade and prices. Trade and deposits wax and wane together.[325] On the other hand, in the absence of rising prices and increasing trade, reserves may increase greatly without forcing an increase in deposits. Loans cannot increase without an increase in deposits. The linkage between deposits and trade is definite, causal, positive, statistically demonstrable. The linkage between reserves and deposits is, at most, negative--if reserves get too low, deposits and loans may be checked in their expansion. But this--to the extent that it is true, which we leave, for detailed analysis, for Part III--gives a very much looser relation indeed than the direct relation between loans and deposits.

The quantity theory has offered no explanation of this relation between loans and deposits. What explanation could a theory offer, which rests in the notion that volume of trade on the one hand, and volume of money and bank-credit on the other hand, are independent magnitudes?[326] I do not mean that quantity theorists are silent regarding the relation of loans and deposits. I mean that they do not attempt, in any discussion I have found, to apply the quantity theory to the explanation of that relation. What shall we say of a theory which, ignoring these easily proved, easily explained, and vital facts regarding bank-credit, offers as its sole explanation of volume of bank-credit a theory so untenable as that of a fixed ratio between volume of bank-credit and volume of money in circulation, with causation running from money to deposits?

Professor Fisher says little about bills of exchange. Here, surely, we have a credit instrument which grows directly out of trade, in general, and whose volume expands and contracts with trade. When banks discount bills of exchange, and issue notes, or grant deposit credits, against such discounted bills, the connection of bank-credit and volume of trade is obvious. The same thing holds largely, however, when promissory notes are discounted. Such notes are usually given by those who plan to use the credits granted in commercial or speculative transactions. The bill of exchange differs from the promissory note in practice, however, in that it itself is often a medium of exchange, without going into the bank's portfolio. "The bill of exchange, therefore, before it gets to the bank usually[327] performs a series of monetary transfers, for the small dealer naturally prefers to pass on the bill, if possible, in making a payment, instead of handing it over to his bank, which would either deduct a certain percentage in the way of discount, or else accept the bill at its face value, crediting the customer with the amount on the date of maturity, while business men (other than bankers) are in the habit of taking bills of exchange as they would cash."[328] This quotation describes conditions in Germany. The same authorities (p. 176) give figures showing a rapid development in the volume of bills of exchange, rising from about 13 billions of marks in 1872 to about 31 billions in 1907. These figures show that bills of exchange are a big factor in German business life,--a conclusion that is strengthened when they are compared with the figures for giro-transfers on pp. 188-189 of the same article, or with the figures for note issue on p. 209.[329] In the United States, of course, the use of bills of exchange has become comparatively unimportant in domestic commerce,[330] though there is a movement to revive them, since the new Federal Reserve system has come in. Their chief importance is in connection with foreign trade. Is it possible that Professor Fisher's reason for wishing to minimize foreign trade[331] is the unconscious desire to get rid of the annoying bills of exchange, which so obviously tend to make bank-credit and volume of trade interdependent, and which further spoil the quantity theory by serving as a flexible substitute for both money and deposits?

I regret the necessity for this elementary exposition of familiar things. But Fisher's theory has no place for these familiar things--and Fisher has merely made very explicit the logic of the quantity theory!

As applied to modern conditions, the quantity theory is obliged to assert--and Fisher does assert:

(a) that there is a causal dependence of bank-credit on money, and "normally" a fixed ratio between them;

(b) that velocity of circulation of money and credit instruments are independent of quantity of money and credit instruments;

(c) that, in general, money and volume of credit (taken together), velocities, and trade, are independent magnitudes, each governed by separate laws, though Fisher concedes some reaction of trade on velocities;

(d) in particular, that volume of money and credit has no influence on trade, and that trade has no direct influence on volume of credit.

All these doctrines are necessary if the contention that an increase of money will proportionately raise prices is to be maintained, or if it is to be maintained that a decrease in trade will proportionately raise prices. I have analyzed each of these contentions, and I find justification for none of them.

Not yet, however, have we reached the least tenable aspect of the quantity theory. There remains the contention that prices are passive, that a change, originating in prices, and involving a change in the average price, or the general price-level, cannot maintain itself--that P is a passive function of the other five magnitudes of the equation of exchange. To this central fortress of the quantity theory we shall devote the next chapter.

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XV. THE QUANTITY THEORY: THE "PASSIVENESS OF PRICES"

Is the price-level passive? Is it true that while change may occur from causes outside the equation of exchange in volume of money, volume of trade, and velocities of circulation, a change in the price-level from causes outside the equation is impossible? Must the average of prices be a passive function of M, the V's, M' and T? Such is the general contention of the quantity theory, and such, very explicitly, is Fisher's contention. The price-level is always effect, and never cause (with slight modifications of the doctrine for transition periods) in its relations to the other magnitudes in the equation of exchange.

Now in one sense, it is my own contention that the price-level can never be a cause of anything. The price-level is an average. Averages may be indicia of causation, but they are not themselves causes. They are not, in reality, anything at all. Causation is a matter which pertains to the particulars of which the average is made. But this is not the doctrine of the quantity theory. The quantity theory does, in certain connections, assign causal influence to the level of prices, particularly in the theory of foreign exchange, where the explanation of international gold movements rests on the doctrine that a price-level in one country, higher than the price-level of another country, drives money away.[332] It will be seen, in a moment, that Fisher relies on this principle to prove that the price-level of a country cannot rise without an increase of money--if it did so rise, it would drive out the money, and so be forced down again. The point at issue may be stated in terms of particular prices. The quantity theory is that, while particular prices may rise from causes affecting them, as compared with other prices, without a change in money, velocities, etc., still there cannot be a rise in the general average, because other prices will be obliged to go down to compensate. The issue is as to the possibility of a rise in particular prices, uncompensated by a corresponding fall in other particular prices, without a prior increase in money, or velocities, or decrease in trade. I take up the issue in this form. I shall maintain that particular prices can, and do, rise, without a prior increase in money or bank-deposits, or change in the volume of trade, or in velocity of money or deposits and also without compensating fall in other particular prices. Putting it in terms of Fisher's equation, I shall maintain, as against Fisher, that P can rise through the direct action of factors outside the equation of exchange, that as a consequence of such rise the other factors readjust themselves, and that a new equilibrium is reached which, in the absence of new disturbances from causes outside the equation, tends to be as permanent and stable as the old equilibrium was.

In the argument which follows, I shall respect thoroughly the distinction between "normal" and "transitional" effects. I do not think that this distinction is properly drawn by Fisher. In my discussion of the relation between the volume of bank-credit and the volume of trade, and in other connections, I have shown that Fisher leaves out of his normal theory most of the concrete factors which do affect both the concrete magnitudes, and the long run averages, of the factors in his own equation. But for the present, I shall meet him on his own ground, give his distinctions their fullest weight, and carry my argument through the "transition" to a point where no further change among the factors in the equation can be expected as a consequence of the initial change assumed.

Fisher's argument to show the passiveness of prices takes the form of a reductio ad absurdum. "To show the untenability of such an idea let us grant for the sake of argument that--in some other way than as effect of changes in M, M', V, V', and the Q's--the prices in (say) the United States are changed to (say) double the original level, and let us see what effect this will produce on the other magnitudes in the equation."[333] Then, if the equation of exchange is to be maintained, either M or M' or their velocities must be increased, or trade must be reduced. But he holds that none of these is possible. (1) Money will be reduced. High prices drive money away to other countries. Nor can gold come in via the mints. "No one will take bullion to the mints when he thereby loses half its value."[334] On the contrary, men will melt down coin. Nor will high prices stimulate mining. Rather, by raising the expenses of mining, they will discourage mining. (2) Bank-deposits cannot increase. Bank-deposits depend on the amount of money, and as that is reduced, they must be reduced, to keep their normal ratio to the volume of money. (3) The appeal to velocities is no more satisfactory. These have been already adjusted to individual convenience.[335] (4) Nor can trade be decreased. Since the average person will not only pay, but also receive, high prices, there is no reason why he should reduce his purchases. "The price-level is normally the one absolutely passive element in the equation of exchange."[336]

"But though it is a fallacy to think that the price-level in one community can, in the long run, affect the money in that community, it is true that the price-level in one community may affect the money in another community. This proposition has been repeatedly made use of in our discussion, and should be clearly distinguished from the fallacy above mentioned. The price-level in an outside community is an influence outside the equation of exchange of that community, and operates by affecting its money in circulation and not by directly affecting its price-level. The price-level outside New York City, for instance, affects the price-level in New York City only via changes in the money in New York City."[337]...

"Were it not for the fanatical refusal of some economists to admit that the price-level is in ultimate analysis effect and not cause, we should not be at so great pains to prove it beyond cavil." To explain this "fanatical refusal," Fisher alludes to the "fallacious idea" that the equation of exchange cannot determine the price-level, because the price-level has already been determined by other causes, usually alluded to as "supply and demand." He urges, however, that supply and demand, cost of production, etc., relate, not to the price-level, but only to particular prices: that the price-level is a factor prior to, and independent of, the particular prices, and is presupposed by theories like supply and demand, cost of production, etc.[338]

The reductio ad absurdum, at first blush, looks impressive. One obvious criticism suggests itself, however, and it will be found to give a clue to a much more fundamental criticism: is it reasonable to assume a doubling of all prices? Above all, must the assumption involve the doubling of the price of gold bullion? Part of the argument to show that gold bullion would not be minted rests on that assumption. But, more fundamental, for such an all round doubling of prices, no cause could be assigned. Of course the hypothesis of an increase in prices without any cause is absurd, and Fisher easily disposes of it. But suppose we assign some concrete causes, outside the equation of exchange, which might affect prices, and see how the thing works then!

Fisher states on p. 95 that "other elements in the equation of exchange than money and commodities[339] cannot be transported from one place to another." And in the passage quoted above he maintains that price-levels in one country can influence price-levels in another country, or even price-levels in one city can influence price-levels in another city, only via changes in money, in the second country or city. But other elements in the equation are directly transferable, in fact. Deposits, e. g., in London, to the credit of New York bankers, may be transferred to Paris, directly, by cable or by letter, and prices are constantly being directly passed from one country or market to another by the same media. Let us suppose a strong case, to put our principle in relief. Assume an island, which produces a staple widely used, whose chief centre of production is outside the island. Assume that this staple, an agricultural product, rises greatly in price, owing to a blight, which promises to be permanent, in the main producing region. The blight does not affect the island, however. Let this product be the main product of our island, which we shall assume to be small. Let the island have communication with the outside world by boat only once in three months. Let it be, however, in constant communication by cable. Word comes by cable of the rise in the price in the staple. The staple at once rises in the island. No new money has come in to cause it. Will this be a rise in the price-level? Will there be compensating reductions in the prices of other things to leave the price-level unchanged? What prices can fall? Not the prices of goods that have been imported to the island, surely. They will rather tend to rise, because everybody on the island will feel richer than before, and will be disposed to buy more freely. Meanwhile, merchants and bankers on the island will be more ready to extend credit than before, so that they will be able to buy more freely. What else can fall? Not the prices of the land! Rather, the land will rise in price greatly, because the increased price of the staple, expected to be permanent, will promise bigger rents, and the price of the land, being a capitalization of the annual rental, will rise very much more than anything else--it will rise to the extent of the capitalized price of the increase in the rents. Wages, likewise, will rise, since the price of the product of labor has risen. And the capital instruments in use in producing the staple will also rise, though not so much as land and wages, inasmuch as they can be brought in from outside at the end of three months. What is there that can fall--except, perhaps, such goods as are exclusively designed for the construction of poorhouses! A significant particular price rises--that is the first step; then, from causes familiar to all students of economics, other related prices rise; there is a general sympathetic rise in prices, the price-level has risen independently, from causes outside the equation of exchange. But now, can this rise sustain itself? Well, what can bring it down? When the ship comes, at the end of three months, it will bring in additional supplies of the articles of import, and they will go down to their old level. Will they go any lower than the old level? What is there to cause them to do so? The outside price-level should be higher now, rather than lower, since the stock of the staple in question is reduced, and nothing else increased to compensate. Nor can any reason be assigned why other prices on the island: the staple in question, lands, wages, etc., should fall at all from the level they reached when the news first came.

Incidentally, our ship may also bring in more gold. The bankers, finding their deposits expanding, may feel it well to cable orders for more gold to increase their reserves, especially as they have been subject to somewhat unusual calls for cash for hand to hand circulation--though this last need they might well have been meeting by expanding their note issue.

Is there anything else to be said? Is not the new equilibrium stable? And is not the causal sequence precisely the reverse of that assigned by the quantity theory? First. a rise in prices; second, an expansion of credit, book-credit, notes and deposits; third, money comes in. If anyone is particularly anxious about the equation of exchange in this process, he may add to my expansion of credit an increase in velocities to keep it straight!

I may add that I see nothing in the "transition" I have described to cause trade to be reduced. Rather, I should expect the rising prices to make trade more active--or better, I should expect the rising values of goods, etc., of which rising prices are the symptom, to make trade more active, particularly as there would be an increase in speculation to bring about readjustments, and to "discount" the prosperity. Nor can I find any reason why trade should be reduced below the old level in the new normal equilibrium. It would make no difference, however, if trade were reduced either transitionally or normally, since the point at issue is the possibility of a rise in prices originating from causes outside the equation of exchange, and compelling a readjustment of a permanent character in the other factors of the equation. The quantity theorist is at liberty to make this readjustment in any way he pleases. My point is made if he has to make the readjustment, and if the price-level stays up!

I have put my illustration in an extreme form to throw the whole thing in relief, and to make the demonstration free from a host of complexities. But is not the causal process essentially the same if we substitute, say, the Southern States for our island, and cotton for our staple? So long as the telegraph bringing news of the ruin of cotton production in India and Egypt, with the higher price of cotton, can come in ahead of the money that the quantity theorist might imagine rushing in a race with it on the train to be offered for the cotton, my point is made. In point of fact, there would be a general rise in prices and wages in the South, which, leading to an expansion of credit, would only gradually and in no definite ratio lead to an increase in money drawn from outside. Buyers outside would pay, not with money, but with checks drawn on New York, and Southern bankers would use their discretion as to how much actual cash they would bring in. With the elastic note issue of our Federal Reserve system, I see no reason to anticipate that money would be drawn to the South in an amount proportionate to the increase in prices. Even if it were, the causation would not run from money to prices, and that is the point at issue. If rising prices can cause increasing money, the whole quantity theory is upset, whatever the proportions involved.

It will be noted that my illustration might be put partly in the form of the supply and demand argument. Increasing demand for cotton in the South leads to higher price of cotton; higher price of cotton makes cotton-growers richer, and enables them to increase their demand for imported goods, for land, and for labor. Supply and demand comes into conflict with the quantity theory, and does not suffer in the conflict! Supply and demand determine particular prices, and particular prices determine the price-level!

Now I wish to generalize this point. I shall show that the quantity theory conflicts with most of our doctrines of prices, as worked out in our systems of economics. I shall show that, in important cases, the quantity theory conflicts with the law of supply and demand, with the doctrine of cost of production, with the capitalization theory, and with the doctrine of imputation as worked out by the Austrians, whereby the prices of labor, land, and other agents of production rise or fall with the prices of the consumption goods which they produce. I shall show the conflict in important cases, and shall show also, in those cases, that it is not the quantity theory which can be sustained.

The general form of the conflict may be stated for all these theories. They are theories of the relations of particular prices, concerned with showing that individual prices are so related that they tend to vary together. A rise in one price, according to these theories, tends to bring about rises in others, and vice versa. The quantity theory, on the other hand, asserts a relation among individual prices such that a rise in one tends to bring about a fall in others--it requires a compensatory fall at one point, if there has been a rise somewhere else.

Let us take some cases. I shall take, first, the conflict between the quantity theory and the capitalization theory, as I can use the illustration just given in connection with it. I have, in a preceding chapter, given a statement of the capitalization theory. It is a theory concerned with the prices of long-time goods and income-bearers, as lands, houses, capital goods of various sorts that give forth their services through a series of years, stocks, bonds, etc. The prices of things of this sort, according to the capitalization[340] theory, depend on two factors: one, the money income expected from the income-bearer, the other, the prevailing rate of interest. This money income, except in the case of bonds, commonly depends on the prices of the products of the income-bearer, or (in the case of stocks) of the products of the concrete capital-goods to which the income-bearer gives title. If we may follow the Austrian division of goods into higher and lower "orders," or "ranks," we may say that the prices of the goods of higher ranks are the capitalizations of the prices of the goods of lower ranks specifically produced by them. Thus, concretely, if the price of wheat rises, we may expect the prices of land to rise, if the rate of interest remains the same. If the price of steel rises, we may expect the stocks of the U. S. Steel corporation to rise, also. If the prices of smokeless powder, and other war munitions soar, we may expect the prices of the stocks of the corporations involved to do precisely what they have done in the recent course of the stock market. All this, on the assumption that the rate of interest does not change, and that the risk factor remains constant. If these factors vary, the results will not present the mathematical exactitude that the formula calls for, but the general tendency will remain the same. On the other hand, if the incomes remain unchanged, but the rate of interest rises, then we may expect the capitalized prices to fall, and if the rate of interest falls, we may expect the capitalized prices to rise. From the standpoint of the present discussion, I suppose it might be fairest and best to state the capitalization theory on this point as Fisher himself states it. In his Elementary Principles of Economics (ed. 1912) after giving a table showing in figures the difference made in different capital prices by different rates of interest (p. 125) he states (126): "If the value of the benefits derivable from these various articles continues in each case uniform, but the rate of interest is suddenly cut down from 5% to 2-1/2%, there will result a general increase in the capital values, but a very different increase for the different articles. The more enduring ones will be affected the most." And in his book, The Rate of Interest: "The orchard whose yield of apples should increase from $1,000 worth to $2,000 worth would itself correspondingly increase in value from, say, $20,000 to something like $40,000 and the ratio of the income to the capital value, would remain about as before, namely, 5%." (P. 15.) On the next page, he generalizes his notion: "One cannot escape this conclusion (as has sometimes been attempted) by supposing the increasing productivity to be universal. It has been asserted, in substance, that though an increase in the productivity of one orchard would not affect the total productivity of capital, and hence would not appreciably affect the rate of interest, yet, if the productivity of all the capital in the world could be doubled, the rate of interest would be doubled. It is true that doubling the productivity of the world's capital would not be entirely without effect upon the rate of interest; but this effect would not be in the simple direct ratio supposed. Indeed, an increase of the productivity of capital would probably result in a decrease, instead of an increase, of the rate of interest. To double the productivity of capital might more than double the value of the capital." (Rate of Interest, p. 16.)[341] Fisher reiterates this doctrine in his reply to Seager, in the American Economic Review, Sept. 1913, pp. 614-615.

Now my concern here is not with the points at issue as between Fisher and Seager: the "impatience" vs. the "productivity" theories of interest. For the present, I shall accept Fisher's doctrine on that point as true.[342] I am here interested in Fisher's doctrine that a doubling of the general productivity of capital would double, or more than double, the prices of capital instruments, including land. How is such a general rise in prices possible, if the quantity theory be true? Is not this a rise in general prices from causes outside the equation of exchange? That Fisher means the money-prices of capital goods when he speaks of capital-values is perfectly clear. In the second quotation, he speaks of "capital-value of $40,000", and in general, his definition of value runs in terms of price (e. g., Purchasing Power of Money, pp. 3-4, and Elementary Principles, p. 17). Fisher has no absolute value concept in his system. We have in the passages cited two doctrines, both of which contradict the quantity theory: (1) that a reduction in the rate of interest will raise capital-prices (which are the largest factor by far in the price-level), and (2) that an increase in the product of capital goods means, not only more money paid for the products, but also more money paid for the production-goods. Incidentally, the general imputation theory would call for more money paid to laborers as well. How can all this be, on the quantity theory? And what can the poor equation of exchange do in such a case, if money does not increase, if bank-credit is limited by money, if velocities of circulation are fixed by individual habits and convenience, if trade increases as a consequence of the increased number of goods produced, and if prices rise? It will not help much to assume that the productivity of gold mines is doubled also. The quantity of money does not depend very much on the annual production of gold. Besides, money need not, from the standpoint of the quantity theory, be made of gold. It might be irredeemable Greenbacks, fixed in quantity by law, or even dodo-bones! Would not the capitalization theory apply in the Greenback Period? I shall not try to solve the riddle. I am not responsible for it!

The conflict between the capitalization theory and the quantity theory may be more simply stated. Assume that the prices of consumers' goods and services rise, quantity of money and volume of exchanges remaining unchanged. On the quantity theory, other prices, the prices of producers' goods and services, lands, and securities, would have to come down enough to compensate, in order that the price-level might remain unchanged. For the capitalization theory, however, the prices of lands, securities, and long time capital goods in general would have to rise, since the incomes on which they are based have risen. Wages of labor engaged in making consumers' goods would also have to rise, on the general imputation theory.

The quantity theory conflicts with the capitalization theory. The quantity theory as presented by Fisher conflicts with the capitalization theory as presented by Fisher. Which theory is true? Would prices rise thus, or would they be held down in some way by the limitations on the quantity of money? I hold that I have already proved, in the reasoning given in connection with my hypothetical island, and in the case of the South with its cotton, that the capitalization theory tendency would prevail. The prices of products rise, and then the prices of the labor, land, and other capital goods which have produced them, rise, the rise in the prices of the capital goods behaving in accordance with the laws of the capitalization theory, and all of the rises after the initial rise in products being in accordance with the imputation theory of the Austrians.

This conflict suggests an interesting point. Various elements in our economic theory, added from time to time by different writers, have necessarily come from different philosophical and sociological view-points, and have behind them different philosophical, psychological, and sociological assumptions. The quantity theory, developing, as shown in the chapter on "Supply and Demand and the Value of Money," largely in isolation from the general body of economic theory, has a background of psychological and sociological assumptions quite different from that of many other doctrines. In the chapter on "Dodo-Bones," I stated these assumptions. The quantity theory rests in a psychology of blind habit. It assumes a rigidity in the social system such that it might be likened to a machine, with a hopper into which money is poured, which grinds out prices at the other end. I set this in contrast with the psychological assumptions underlying the commodity theory of money. That theory rests on the "banker's psychology." It assumes a highly reflective and calculating attitude on the part of economic men, with the disposition to look behind appearances for the security, to test things out, to get to bedrock in business affairs. Now the capitalization theory likewise assumes this banker's psychology. In its refinements, as represented by the mathematical formulae in the appendices of Fisher's Rate of Interest, it assumes a degree of precision in business calculation which few experts in bond departments apply, and which the highly fluid and alert dealers in Wall Street certainly have not time for, even if they had that degree of mathematical knowledge! In practice, it need not be said, particularly in the case of the prices of lands, the capitalization theory finds its predictions very imperfectly realized! But the two theories, resting in such divergent psychological assumptions, may be expected, a priori, to conflict. That they do conflict is not remarkable.

I shall show a similar conflict between the quantity theory and the law of costs. In general, the quantity theorist thinks that he has reconciled his theory with cost theory by pointing out that reduced costs manifest themselves in increasing production, which means increasing trade, which should, on the quantity theory, mean lower prices.[343] I need not, for my purposes, analyze this doctrine in detail, though I am disposed to consider it an accident that the two theories converge at this point. For the present, I shall analyze a case where reducing costs actually come as a consequence of the reduction in the volume of trade, and inquire whether such a case will lead, as the cost theory would assert, to lowered general prices, or, as the quantity theory would assert, to higher general prices. The case is that where by improved methods of handling goods, it is possible to dispense with middlemen. Concretely, assume that retailers of milk get in direct touch with dairymen, so that middlemen are eliminated, and that as a consequence the price of milk is reduced two cents a quart. What of the general price-level? T (trade) is reduced. There are less exchanges. Volume of trade does not mean volume of goods produced, but volume of exchanges. With a reduced trade, the quantity theory must assert that prices of commodities other than milk must, on the average, rise, not merely enough to compensate for the fall in milk, but more than that, enough to compensate for the reduced trade as well. But how can the other prices rise? Well, a point comes up obviously: the buyers of milk save two cents a quart. They can spend it for something else. This will raise the prices of other things. But, on the other hand, the middlemen now have less to spend. They have exactly as much less as the others have more, the extra money that milk buyers have being, in fact, the money that the middlemen would otherwise have had. The one offsets the other. There is, then, no reason for the average of other prices to rise. Suppose we carry the process one step further. After a while, the middleman will find other work to do. Then they will have incomes again to spend. But in going to work again, they will be engaged in production, and so will, in general, be increasing the volume of trade. The quantity theorist could not expect a rise in prices from this!

And here we are given a clue to a fundamental confusion in the quantity theory, a confusion which, accepted by the reader, gives the quantity theory much of its plausibility. I refer to the confusion between volume of money, and volume of money-income.[344] The two need not be the same. The two generally are not the same. In the case I have described, the one has changed without a change in the other. Now if one wishes to view the process of price-causation from the standpoint of money offered for goods,--an essentially superficial,[345] but frequently useful, view-point--it is clearly money-income, rather than mere quantity of money in the country that is important. Into the determination of volume of money-income, however, come factors of a high degree of complexity, among them, prices for which there is no possible place within the confines of so simple and mechanical a doctrine as the quantity theory.

In passing, I notice a point to which I called attention in discussing Fisher's factors in the equation of exchange. I refer to his definition of velocity of circulation as the average of "person-turnovers" of money.[346] In the illustration given, there is no reason to suppose that this average is changed. The middlemen simply drop out of the average. They have no money to turn over! But velocity of circulation, defined as "coin-transfer," (cf. supra, p. 204) has clearly changed. The course of money has been short-circuited. It goes through fewer hands in the course of a given period. This last concept of velocity of circulation is clearly the one that must be used, if the equation of exchange is to be kept straight. But this fact should make it clear that velocity of circulation, instead of being the inflexible thing that Fisher has described, resting in individual habits and practices, a true causal factor in the price making process, is really a highly flexible thing, in large degree a passive function of trade and prices.

With this distinction between volume of money and volume of money-income[347] clearly held, we are prepared to go further in our attack on the quantity theory, granting the quantity theorist all his most rigorous assumptions, and still demonstrating that prices can vary independently, without prior change in quantity of money, volume of trade, or velocity of money. Let us assume the extreme case of the quantity theory: a closed market; no credit; no barter; a fixed supply of money; a fixed volume of trade; a fixed set of habits affecting velocity, namely, that everyone spends, in the course of the month, all that he has accumulated by the first of the month. The quantity theorist could not ask a more iron-clad set of assumptions than this! If the quantity theory is not valid here, if the price-level is not absolutely fixed, helpless to change, with these assumptions, then the quantity theory, even as a minor tendency, must be surrendered, and the quantity theorist must admit that the whole line of thought has been fallacious. But is the price-level passive? Suppose we assume a combination of employers of maid-servants, which forces down the wages of maid-servants from $20 to $10 per month. Assume further that there is no alternative employment for the maid-servants, so that they all remain at work.[348] So far, we have made a change in one price, the price of domestic service. What of the general average of prices, the price-level? Well, so far, the price-level is down. If nothing else takes place, we have reduced the price-level by reducing one price. What else can take place? Two things: (1) the masters now have $10 per month each more to spend for other things than before. That tends to raise prices in their other channels of expenditure. (2) The maid-servants now have $10 each less to spend,--the same ten dollars! That lessens prices in the lines of their expenditure. These last two changes exactly neutralize one another. The first change, in the price of domestic service, remains unneutralized. The general price-level is, then, lowered--by a cause acting from outside the equation of exchange, directly on prices. The first change comes in one price. In the final adjustment, that change remains unneutralized. How is this possible? Is the equation of exchange still valid? As a mathematical formula, yes. As expressing a causal theory, in which prices are effect, and money, trade, and velocity causes, no. The equation is kept straight by a reduction in velocity. Because the wages of maid-servants are reduced, less money goes through their hands; $10 per month per maid are short-circuited. But the cause is with the prices. The price-level, even under these absolutely rigorous assumptions, is not passive.

In general, I conclude that the price-level, under the laws governing particular prices, supply and demand, cost of production, the capitalization theory, the imputation theory, etc., can vary of its own initiative, independently of prior changes in the quantity of money, or of volume of trade, or other factors that the quantity theory stresses; and that these changes in the price-level (or in the particular prices which govern the price-level) can maintain themselves, and compel a readjustment in trade, credit, money and velocities, to correspond. This conclusion strikes at the very heart of the quantity theory, and, if valid, leaves the quantity theory disproved. More fundamentally, I should put it, prices can change because of changes in the psychological values of goods. These values are social values, and are to be explained only by a social psychology. But for the present it has seemed best to me, as a means of attracting sympathetic attention from a wider circle of economists, to make use of the less debated doctrines of the science in attacking the quantity theory. It is not necessary to rest the case on my own special theory of value. Supply and demand, cost of production, the capitalization theory, the imputation theory--the general laws of the concatenations and interrelations of prices--are quite adequate for the confutation of the quantity theory. They are laws concerned with particular prices, and the price-level is nothing but the average of particular prices. Whatever explains, really explains, the particular prices, also explains the price-level.

Fisher, as we have seen, is not of this opinion. Although he has defined the price-level as an average of particular prices[349] he none the less exalts this average into a causal entity, prior to and master of the particular prices out of which it is derived, of which it is a mere average.[350] This average, he maintains, is presupposed in the determination of all particular prices.[351] This seems to me a wholly untenable position. Ex nihilo nihil fit. There cannot be more in the average than there is in the particulars from which it is derived. In point of fact, there is necessarily vastly less. All the concrete causation is lost. The average, in itself, is nothing but a statement, a summary of results. I know nothing more metaphysical in the history of economic theory than this hypostasis of an average.[352]

I reject Fisher's notion that the average of prices is an independent entity. But I do not consider that the idea lying behind this untenable doctrine is absurd. Cost of production, supply and demand, and the other price theories do presuppose something more fundamental. They do presuppose money, and the value of money, as has been shown at length in Part I. The trouble with Fisher's notion comes in his definition of the value of money in purely relative terms as the reciprocal of the price-level, and his contention that the study of the value of money is identical with the study of price-levels.[353] Value is not a mere exchange relation.[354] Rather, every exchange relation involves two values, the values of the two objects exchanged. These two values causally determine that exchange relation. In the case of particular prices, then, we must consider not only the value of goods, but also the value of money. And the causes determining the general price-level will therefore include not alone the values of goods, but also the value of money. In the foregoing arguments by which I have shown that the price-level can vary independently of the other factors in the quantity theory scheme, I have been concerned only with changes in the values of goods, measured by a constant unit of value. If the value of money should also be varying, the concrete results on the price-level would have been different. On the face of things, there was nothing in the cases I discussed to require us to suppose that the value of money would also vary. The argument ran on the assumption of a fixed value of money. I have shown, in earlier chapters, that the assumption of a fixed value of money is fundamental to the laws of supply and demand, cost of production, and the capitalization theory. In point of fact, this assumption is rarely true--never strictly true. For causes which are in considerable degree independent of the causes governing the values of goods (as the causes governing their values are in considerable degree independent of one another), the value of money varies, now in the same direction as the values of goods in general, now in an opposite direction. Further, money itself does not escape the general laws of concatenation of values. The value of money has causes which are bound up with the values of other goods. Thus, when prices are rising and trade expanding, there is a tendency--commonly a minor tendency--for money also to rise in value, and so prices do not go quite as high as they would have gone had money remained constant. This tendency arises from the fact that there is more work for money to do in a period of active trade and rising prices. Gold also tends to rise in value in the arts, with prosperity. The reverse tendency manifests itself when prices are falling: money tends, in some measure, to fall in value with the goods,[355] and so prices do not fall as far as they would fall if money remained constant. But in general, the causes governing the values of goods, and the causes governing the value of money, are sufficiently independent to justify us in studying each separately, in abstraction, on the assumption that the other is unchanged. Hence, supply and demand, cost of production, and the other price theories, which assume a fixed value of money, are proper tools of thought for the study of the prices of goods.

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XVI. THE QUANTITY THEORY AND INTERNATIONAL GOLD MOVEMENTS

The quantity theory explanation of international gold movements is as follows: if money comes into a country, it raises prices. If the price-level of the country is raised more rapidly than the price-levels of other countries are rising, then the country becomes a bad place in which to buy and a good place in which to sell; its exports fall off, its imports increase, and finally the inflow of money is checked, and, perhaps, money flows out again. The equilibrium of the gold supplies of different countries is thus dependent on the price-levels of the countries involved. The quantity of gold in a country determines its price-level, and no more gold can stay in a country, on this theory, than that amount which keeps its price-level in proper relation to the price-levels of other countries. It is not necessarily asserted that the price-levels of all countries must be equal--the facts too obviously contradict that. But when this precise statement is not made, the substitute statement of some "normal" relation between the price-level of one country and that of another becomes a very vague one, and the theory becomes pretty indefinite.

I am here concerned chiefly with one contention: the price-level, the average of prices, is not a cause of anything--not of gold movements or anything else. It is a mere summary of many concrete prices. Some of these concrete prices have highly important influence on international gold movements, tending, if they are low, to bring gold in, and if they are high, to repel gold. Others work in the opposite direction, tending if they are low to attract less gold than if they are high. Finally, among all the prices affecting international gold movements, the one which is most significant is commonly not included in the price-level at all: I refer to the "price of money," the short-time interest rate.

Let me elaborate each point. First, it is true that high prices of articles which enter easily into international trade tend to repel gold from the country--meaning by "high prices" prices that are higher than the prices of the same goods abroad. This relates, however, not to the general price-level, but only to a comparatively small set of prices. Most prices in a country are not prices of articles of international trade. High wages may, indeed, draw in immigrants. But high land rents, and high prices of land cannot bring in land. Nor do high land prices send away much gold to other countries for the purchase of land there. Indeed, within a single country, the differences in the relation between land yield and capital value of land are enormous. The following figures are taken from an article by J. E. Pope:[356] In Yazoo Co., Mississippi, farm lands are sold at $10 to $25 per acre. The average gross income per acre is $28. In Cass Co., Iowa, the land prices are from $100 to $125 per acre while the gross income amounts to only $11 per acre, if only crops and dairy products are taken into account, and to $20 if the sales of live stock are included. In Oglethorpe Co., Georgia, the average price is from $10 to $25 per acre, and the average income $10. In Paulding Co., Ohio, land is sold at from $75 to $100 per acre, and the average income per acre, including returns from live stock sold, is $15. Why should not landowners in Cass County, Iowa, sell their comparatively unproductive land, at a high price, and go, with their money, to Yazoo County, Mississippi? The answer is simply, that they would have to go with their money, and they prefer to stay at home! Absentee landlordism is not generally popular with men who are seeking paying investments. Land stands at one extreme. But then land is the very biggest item in an inventory of wealth, and, while not as land, actively bought and sold,[357] it is a big element in the values of many active securities. The principle holds in less degree of many other things, however. The securities of a local corporation, say a gas plant, find their best market at home, as a rule, unless the city be large. If they are held by foreign capitalists, they still find a very restricted market in the foreign country. Only those who have investigated at first hand will feel free in buying them--unless, indeed, they are guaranteed in some way by a big and well-known house. Prices of personal and professional services vary enormously in different sections of the same country, to say nothing of variations between different countries, and there is a very slow movement indeed toward bringing about higher salaries for rural preachers in Kansas because the salaries of London preachers have risen, or because of increased demand for preachers in Germany. Great numbers of commodities are too bulky to move far. Their prices vary with little relation to similar prices elsewhere. But the principle needs no more elaboration. If the reasoning be simply that men tend to buy where things are cheap, and to sell where things are dear, it is clear that that establishes a very loose relation indeed between the price-levels of different countries.

The second point is that some prices, by rising, actually bring in gold from abroad, while by falling they tend to release gold. I am not here referring to the case discussed in the chapter on "Supply and Demand," where a commodity, cotton, with an inelastic demand, is doubled, the doubled quantity selling for a less aggregate price, and so bringing in less money from abroad. That case would bear considerable generalization. I am referring here to the case where credit is built on the value of long time goods, as lands, or railroads. Concretely, let us suppose an increase in railroad rates allowed by the Public Service Commission of Missouri. This is, in itself a rise in prices. It will, further, on the capitalization theory, make the prices of stocks of the roads operating in the State rise also, and give a margin of additional security for bond-issues. This will make it possible for these roads to float foreign loans (or would have done so before the War), and so will tend to turn the exchanges in our favor. Gold will tend to come in, not to go out. Similarly if the prices of dairy products, or truck gardens, or orchards, or orange groves rise, leading to a rise in the prices of the lands involved, foreign capital will tend to come in as loans--i. e., the exchanges will turn more favorable to us, and the gold movement tend to turn our way. I suppose, by the way, that something of a point could be made against the Single Tax at this point: destroying land values would lessen the security which a community could offer outside lenders. The Single Tax would, thus, hamper the development of countries which need capital from outside. Men who wish to use their own capital, under their own management, might, as the Single Taxers claim, be tempted to come in, if they could be free from taxation on the capital they bring with them; but lenders, who wish a good margin of security, would find less inducement to lend.[358] This is a digression, but one feature of it is pertinent: though the foreigner does not care to migrate from his high-priced land to low-priced land elsewhere, he is often willing to trust a loan to the owner of high-priced land elsewhere. I will not venture the generalization that high-priced land necessarily attracts loans, and tends to turn the gold movements in favor of the country where prices are high. The point has been made that if lands are being exchanged frequently, the new buyer tends to exhaust his credit resources in paying for the land: i. e., puts so large a mortgage on it that he has little margin of security to offer for working capital.[359] I shall not here undertake to determine how far as a matter of fact, in different places, the one tendency outweighs the other. It is enough to point out that in many cases, where this factor is absent (as in the case of the railroads cited), rising prices attract, and do not repel, foreign gold, and that for none of these cases is the consequence of rising prices for the gold movements to be explained in the simple way that the quantity theory doctrine would require.

Finally, the international movements of gold[360] are enormously moved by the short-time rate of interest. The raising of the Bank Rate in England, supplemented, when necessary, by "borrowing from the market" by the Bank of England, as a means of making the Bank Rate effective, quickly turns the course of the exchanges. This is, as has been pointed out, a more effective device when used by the English money-market than when used by borrowing countries, since the borrower, by offering higher rates, is not always able to borrow more, whereas the lender, by demanding higher rates, is usually able to reduce his loans. But the difference is one of degree, and in point of fact a rise in the short time rates in New York City is commonly an effective means of bringing in gold from abroad. It is true that this is not the only factor. I have been at pains to point out how other factors work. I am as far as possible from denying the powerful influence of the "balance of trade" as treated by the older economists on international gold movements, when both visible and invisible items are included. But my point is, first, that these invisible items are numerous and flexible, and that a big factor in their determination is the short time rate of interest; and second, that the balance of physical items, even, depends, not on the price-level as a whole, but merely on the prices of those particular goods which enter into foreign trade. It is perfectly possible, and, indeed, is very common, for rising prices in a country to lead to expanding trade and expanding bank-credit, which causes bankers to wish to expand their reserves, which leads them to raise their rates on short time loans, which leads gold to come in from abroad. More simply still, the bankers may merely offer an attractive rate to the foreign bankers, and establish credits abroad, against which they draw "finance bills," which influence the gold movements in the desired manner.

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XVII. THE QUANTITY THEORY vs. GRESHAM'S LAW

There is a pretty obvious conflict between the quantity theory and Gresham's Law. The latter is, essentially, a "quality" theory of money. For the quantity theory, dodo-bones, or anything else will do. "It is the number, and not the weight, that is essential"![361] For Gresham's Law, the weight makes all the difference in the world, if it is a question as between full weight and light weight coins, and, in general, the value of the thing of which money is made, considered in its commodity aspect, is the starting point of that doctrine.

The quantity theorist seeks, indeed, to harmonize the two. His theory is that Gresham's Law manifests itself only when there is a redundancy of the currency due to the issue of paper money, or overvalued metal. In such a case, prices rise, he holds, and then the undervalued metal, or the metallic currency, which count no more than the paper or the overvalued metal in circulation, tend to leave the country, to another country where prices are lower, or tend to leave the money use for the arts. But the quantity theorist must maintain that it is only via increased issue, with consequent rising prices, that Gresham's Law comes into operation. If there are a million dollars of gold in circulation, and a half million of irredeemable paper is added, then only half a million of the gold (or rather a little less than half) will leave. If more than that left, prices would fall, because of the scarcity of money, and then the gold would come back, because it would be worth more in concurrent circulation with the paper than it would be worth as money abroad, or in the arts. On the quantity theory, there can be no difference in the value of gold and paper, in such a case, after enough gold has left to balance the paper that has been issued. Falling prices would prevent it.

But Gresham's Law is not held by any such fetters! And the facts of monetary history, in important cases, show Gresham's Law controlling, despite the quantity theory. I will refer briefly to two such cases.

The first centres about the suspension of specie payments by the Northern banks and the Federal Treasury on January 1, 1862. This suspension was not accompanied by any increase of money. Rather, there was a decrease,[362] shortly following, in the amount of paper money. The banks in New York, and certain other States, were bound so strictly by their charters, and by the State laws, that they dared not leave their notes unredeemed. Speculators, buying notes at a discount--for virtually all bank-notes fell to a discount--were able to present them to the banks in these States and demand gold, which led to a very profitable business. The banks protected their gold by ceasing to issue notes, or by reducing the volume of note issue. Certified checks were used to a considerable extent instead. There was certainly no increase, and probably a reduction, a considerable reduction, in the volume of bank-notes in circulation. The only other paper money in circulation was the Demand Notes of the Federal Government, which were not increased after the date of the suspension, and which were in any case small in volume as compared with the total amount of money. On the quantity theory version of Gresham's Law, there was nothing to drive gold out. Gold was not pushed out by redundant currency. Rather, it left, leaving a monetary vacuum behind. Coincidently, strangely enough, prices rose. The vacuum in the money supply was so serious, that the subsequent first issue of the Greenbacks brought a welcome relief. Throughout the whole of the first year of the suspension, the volume of money was less than it had been in the preceding year. None the less, the gold stayed out of general circulation. It did not come back from abroad. And prices rose.[363]

A similar episode, the obverse of this, occurred when the Bank of England resumed specie payments in the early '20's. Then gold came back, the currency was increased, and, coincidently, prices fell.[364]

I conclude that the conflict between Gresham's Law and the quantity theory is real and fundamental, and that in cases where different qualities of money are in concurrent circulation, the undervalued money will leave, regardless of the question of quantity.

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XVII. THE QUANTITY THEORY AND "WORLD PRICES"

Some writers, who would call themselves quantity theorists, would repudiate many of the doctrines for which Fisher stands, and which the historical quantity theory involves. The recognition which Fisher's book has received from quantity theorists generally, justifies me in treating his book as the "official" exposition of the modern quantity theory, and, indeed, it is easy to show that Fisher is fundamentally true to the quantity theory tradition. With many writers, the disagreement with Fisher would be a mere matter of degree; they would hold that Fisher has set forth the central principle, that his qualitative reasoning is correct, but that the relations among the factors in his equation are less rigid than he maintains. As I reject even the qualitative reasoning by which Fisher defends his doctrine, and reject even the qualitative tendency which he maintains, my criticisms will apply as well to the position of this group of writers, though I should have less practical differences with them, to the extent that they admit qualifications and exceptions to Fisher's doctrine.

There is, however, a group of writers who seem to feel that the quantity theory remains sufficiently vindicated if it can be shown that an increase in gold production tends to raise prices throughout the world, while a check on gold production tends to lower prices, and who rest their case on the necessity which bankers find of keeping reserves in some sort of relation to the expansions of bank-credit.

A view of this sort is presented by J. S. Nicholson, whose statement of the application of the quantity theory to the modern world differs almost toto coelo from his original statement in the dodo-bone illustration already discussed. Nicholson[365] declares that in our modern society "the quantity of standard money, other things remaining the same, determines the general level of prices, whilst, on the other hand, the quantity of token money is determined by the general level of prices." Nicholson's reasoning is, substantially, as follows: Although the bulk of exchanging is carried on by means of credit devices, there is still a certain part of exchanging, especially in the matter of paying balances, for which standard money only can be used. He regards the whole credit system as based on standard money, and says that for any given level of prices there is a minimum amount of standard money, absolutely demanded. If the volume of standard money falls below this minimum, the price-level will fall to such a point that the volume of standard money is again adequate. He takes, moreover, a world-wide view, declaring that it is the relation between the volume of gold money throughout the world and the demand for standard money throughout the world which determines the relative values of money and commodities. "The measure of values or the general level of prices throughout the world will be so adjusted that the metals used as currency, or as the basis of substitutes for currency, will be just sufficient for the purpose. We see then, that the value of gold is determined in precisely the same manner as that of any other commodity, according to the equation between supply and demand."

In the consideration of this doctrine, let us note several points in which it differs fundamentally from the quantity theory proper, and from the situation assumed in the dodo-bone illustration. First, it is not a quantity theory of money. Money is not regarded as a homogeneous thing, each element having the same influence on prices. Rather, token money is the child of prices. This doctrine would in no way fit in with the logic of the equation of exchange, as presented by Fisher. Further, the dodo-bone idea is entirely gone. Gold, a commodity with value in non-monetary employments, is under discussion, and it is the quantity of gold that is counted significant. This recognizes, if not the need, at least the existence, of a commodity standard. Nicholson definitely avows the necessity for the redemption of representative money, even going so far as to say that "all credit rests on a gold basis,"[366] that all instruments of exchange derive their value from the volume of standard money which supports them, and that if this basis were cut away the whole structure would fall. Nicholson recognizes, further, that gold has value independent of its use as money.[367]

In evaluating Nicholson's doctrine, I wish to point out, first, the inaccuracy of the statement that all credit rests on a gold basis. It is true that credit instruments are commonly drawn in terms of standard money, which is commonly gold. International credit instruments may even specify gold, and the same thing happens at times within a country. But commonly, in this connection, gold functions, not as the value basis lying behind the credit instrument, the existence of which justifies the extension of the credit, but rather as the standard of deferred payments, by means of which the credit instrument may be made definite. The real basis of the value of a mortgage is not a particular sum of gold, but rather the value of the farm, expressed in terms of gold. The basis of a bill of exchange is not a particular sum of gold, but rather is the value of the goods which changed hands when the bill of exchange was drawn,[368] supplemented by the other possessions of drawer, drawee, and the endorsers through whose hands it has gone. Even a note unsecured by a mortgage, or not given in payment for a particular purchase, is based, in general, on the value of the general property of the man who gives it, and on the value of his anticipated income.[369] So throughout. Credit transactions, for the most part, originate in exchanges, and carry their own basis of security in the goods and securities which change hands, not in that small fraction of the world's wealth, the stock of gold, which could, Coin Harvey asserted in the middle '90's, be put in the Chicago grain-pit! And now let me extend this idea. Although coin made from the standard of value is a great convenience, there is yet no vital need, in theory, for a single dollar, pound or franc made from the standard of value. If gold should cease entirely to be used as a medium of exchange, or in bank or government reserves, if the gold dollar should become a mere formula, so many grains of gold, without there being any coins made of it, still, so long as that number of grains had a definite, ascertainable value, commensurate with the value of some other commodity which could be used as a means of paying balances and redeeming representative money, the gold dollar could still serve as a measure and standard of values. In the situation I have assumed, silver bullion, at the market ratio, could perform all the exchange and reserve functions now performed by gold, even though not so conveniently.[370] Nicholson's description of the use of gold as a reserve, while calling attention to an important fact, has led him into the error of supposing that what may be true of gold, the medium of exchange, and reserve for credit operations is necessarily true of the standard of value as such.

Nicholson is correct, however, in looking to the standard of value for part of the explanation of changes in prices. And, since it so happens that a considerable part of the value of the standard of value comes from its employment as medium of exchange and reserve, he is correct in looking to its use as money as part of the explanation of its value. His error comes, however, in failing to see that independent changes in the values of goods may also change the price-level, and that variations in the demand for gold as a commodity may also change the value of gold, and so change the price-level.

Further, in so far as Nicholson clings to the notion of prices as depending on a mechanical equilibration of physical quantities, he is subject to the criticisms given before of the general quantity theory, and in so far as he clings to the identity of the value of gold with the reciprocal of the price-level,--the relative conception of value--he is subject to the criticisms already urged.

Again, even for a single country, the connection between volume of reserves and volume of credit is very loose and shifting. A thousand factors besides volume of standard money in a country determine the expansions and contractions of credit, and the long run average of credit. For the whole world, this connection is even looser. To assume a fixed ratio between them for the whole world, one would have to assume that all the world was simultaneously, and normally, straining its possibility of credit expansion to the utmost, so that the minimum ratio--a notion which is far from precise[371]--should also be the normal maximum, and so that no country, in expanding its credit, could draw in new reserves from other countries which had more quiescent business conditions.

Nicholson's notion of the world price-level, moreover, is subject to the criticisms I have made in the chapter on "The Quantity Theory and International Gold Movements." How can the world level have a close connection with the volume of gold, if different elements in the world price-level, the price-levels of different countries, can vary so widely and divergently as compared with one another? Even granting--which I do not grant, and which I maintain I have disproved--that the price-level in one country has a close connection with its stock of gold, would it not be true that the average price-level for the world would vary greatly, with the same world stock of gold, depending on which countries had the gold?

There is nothing in Nicholson's doctrine which seems to me to justify in any degree the doctrine that prices, in a single country, or in the world at large, show any tendency to proportional variation with the quantity of money, or with the world's stock of gold.

Is it not true, then, that there is some sort of relation between gold production and world prices? It is. Gold is like other commodities. Its value tends to sink as its quantity is increased. As its value sinks, prices tend to rise. As to the elasticity in the value-curve for gold, I think it will be best to reserve discussion till a later chapter,[372] in Part III. We shall there find reason for thinking that gold has much greater elasticity in this respect than most other commodities. That its value should fall proportionately with an increase in its quantity, I should not at all conclude. Even if its value did sink proportionately with an increase, prices would rise proportionately only if the values of goods remained unchanged.

But why do we need a quantity theory of money, with all its artificial assumptions, and its law of strict proportionality, to enable us to assert the simple fact that gold, like other commodities, has a value not independent of its quantity? What theory of money would deny it? Surely not the commodity or bullionist theory. For that theory, which seeks the explanation of the value of money in the value of gold in the arts, it would go without saying that an increase in the supply of gold for the arts would lower its value there and consequently, its value as money. Surely the theory which I shall maintain in Part III of this book will not deny that increased gold production tends to lower the value of money, and consequently to raise prices. With the "quantity theorist" who is content with this conclusion, I have no quarrel--unless he claims this obvious truth as the unique possession of the quantity theory!

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