Chapter XI: A Symposium on the Relation Between Money and General Prices (3)

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

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

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

THE TESTIMONY OF RICARDO

[78]Let us suppose that the circulation of all countries were carried on by the precious metals only, and that the proportion which England possessed were one million; let us further suppose, that, at once, half of the currencies of all countries, excepting that of England, were suddenly annihilated, would it be possible for England to continue to retain the million which she before possessed? Would not her currency become relatively excessive compared with that of other countries? If a quarter of wheat, for example, had been both in France and England of the same value as an ounce of coined gold, would not half an ounce now purchase it in France, whilst in England it continued of the same value as one ounce? Could we by any laws, under such circumstances, prevent wheat or some other commodity (for all would be equally affected) from being imported into England, and gold coin from being exported? If ... the exportation of bullion were free, gold might rise 100 per cent.; and for the same reason, if 35 Flemish schillings in Hamburgh had before been of equal value with a pound sterling, 17-1/2 schillings would now attain that value. If the currency of England only had been doubled, the effects would have been precisely the same.

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

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

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

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

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

FOOTNOTES:

[43] _The Purchasing Power of Money_, pp. 14-71. The Macmillan Company. New York. 1911.

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

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

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

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

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

[49] This fact is apparently overlooked by Laughlin when he argues that there is not "any reason for limiting the amount of the deposit currency, or the assumption of an absolute scarcity of specie reserves." See _Principles of Money_, p. 127.

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

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

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

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

[54] _Causes of the Changes in Prices since 1896._ Bulletin of the American Economic Association, Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 27-36.

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

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

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

[58] _Ibid._, pp. 52-61.

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

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

[61] Kemmerer, _Money and Credit Instruments_, pp. 9-18, 74-82.

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

[63] _Ibid._, p. 9. [See Fisher: _Purchasing Power of Money_, pp. 175-180.]

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

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

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

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

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

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

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

[71] _Ibid._, pp. 61-63.

[72] _Ibid._, p. 64.

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

[74] _Ibid._, pp. 64-65.

[75] _Ibid._, pp. 65-67.

[76] _Ibid._, pp. 67-69.

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

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

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