The Value of Money Part 5

I shall further maintain, as against the whole spirit of the quant.i.ty theory, that it does not seize hold of essentials in the causes lying behind prices. I shall contend that the factors with which it deals, instead of being independent _foci_ to which converge the causes governing the price-level, and through which causation flows in one direction, are really not true "factors" at all, but rather are blanket names for highly complex and heterogeneous groups of facts concerning which few general statements are possible. Quant.i.ty of goods exchanged, for example, may be in some of its parts caused by rising prices, in others of its parts may be causing falling prices and is chiefly caused by _fluctuating_ prices. The net change in prices in this case is not the result of any one movement from "quant.i.ty of goods" as a whole.

Changes in the price-level are not one result, but rather, are the mathematician's average of many changes, due to a host of causes, in many individual prices. The quant.i.ty theory is an effort to simplify phenomena highly complex. Of course, the simplification of complex phenomena in thought is a laudable scientific goal, but when the simplification goes so far as to group things only superficially related, and to leave out the really vital elements, it is worthless.

Value theory, with all the value left out, is like Hamlet with no actor for the t.i.tle role. Simplification in the explanation of general prices has gone as far as we can legitimately take it when we seek to summarize all the factors involved in the _foci_ of, on the one hand, the value of money, and, on the other hand, the values of the particular goods. The general price-level is an average of many concrete prices. Each of these individual prices has a concrete causal explanation. The _general_ price-level has, not a few simple causes, but an infinite host of causes. Indeed, the general price-level has no real existence. It is a convenient mathematical concept, by means of which we may summarize the mult.i.tude of concrete facts. It is useful as a device for measuring changes in the value of money, on the a.s.sumption that changes in the values of goods neutralize one another. This a.s.sumption is never strictly true, and often is demonstrably false. The general price-level is neither a cause nor a result. Particular prices, in general, are results of two causes, namely, the value of money and the value of the good in question, and particular prices may then become causes, changing the quant.i.ty of money involved in a given set of exchanges. Neither quant.i.ty of money, nor quant.i.ty of goods exchanged, nor rapidity of circulation, nor general price-level is a simple, h.o.m.ogeneous quant.i.ty, obeying definite laws.

I shall also undertake to show that in many important cases the quant.i.ty theory leads to conclusions regarding the price-level which contradict other laws of prices, notably the capitalization theory, the cost of production doctrine, and the law of supply and demand. I have previously pointed out that these three doctrines are inapplicable to the problem of the value of money itself. On the a.s.sumption of a value of money, however,--using value in the absolute sense--they are applicable to the problem of prices, and, since the price-level is merely an average of particular prices, they should be applicable to the problem of the price-level also. It will be shown, in the course of the criticism which follows, first that the quant.i.ty theory contradicts each of these doctrines, in certain situations, and second, that in these cases, the conclusions based on the cost theory, the supply and demand theory, and the capitalization theory are right, and the conclusions based on the quant.i.ty theory are wrong. It has been maintained by certain writers, as Knut Wicksell[106] and Irving Fisher,[107] that cost of production and supply and demand are inapplicable to the problem of the general price-level. I shall maintain the contrary, holding that while these doctrines are inapplicable to the problem of the _value_ of money, they _are_ applicable to the problem of general prices, on the a.s.sumption of a fixed value of money. By the value of money I mean its absolute[108]

value, and not--what the quant.i.ty theorists commonly mean--its "purchasing power," or the "reciprocal of the price-level."

I shall undertake to show that no sound conclusion reached on the basis of quant.i.ty theory reasoning is the peculiar property of the quant.i.ty theory school; that every valid conclusion which may be based on the quant.i.ty theory may also be deduced from the theory maintained in this book, and, indeed, that most of them may be deduced from several other theories of money, notably the commodity or bullionist theory. I shall show a number of false and misleading doctrines which logically spring from the quant.i.ty theory, and shall undertake to show that the quant.i.ty theory fails to give an adequate basis for several important parts of the theory of money, among them Gresham's Law, the theory of international gold movements, and the theory of elastic bank-notes and deposit-currency.

So much for the theses to be maintained. The detailed proof of these contentions will best be given in connection with a critical account of various versions of quant.i.ty theory doctrine. Attention will be given in this summary to the expositions of Nicholson, Mill, Taussig, and Kemmerer, and very special attention to I. Fisher, though some other writers will also be taken into account.

CHAPTER VII

DODO-BONES

Must money have value from some source outside its money-functions? It is a part of the quant.i.ty theory that this is unnecessary. I have cited, in the preceding chapter, Irving Fisher and J. S. Nicholson to this effect. Nicholson's statement is interesting and picturesque, exhibiting the quant.i.ty theory in all the nakedness of its poverty, and I shall present it at some length. "For simplicity," to isolate his phenomenon, he a.s.sumes a hypothetical market, in which the following conditions obtain: (1) No exchanges are to be made unless money (which he a.s.sumes to consist of counters of a certain size made of dodo-bones) actually pa.s.ses from hand to hand. No credit or barter. (2) The money is to be regarded as of no use whatever except to effect exchanges, so that it will not be withheld for h.o.a.rding, _i. e._, will be actually in circulation. (3) There are ten traders in the market, each with one kind of commodity and no money, and one trader with all the money (one hundred pieces), and no commodities. Further, let this moneyed man put an equal estimation on all the commodities. Now let the market be opened according to the rules laid down; then all the money will be offered against all the goods, and, every article being a.s.sumed of equal value, the price given for each article will be ten pieces, and the general level of prices will be ten. It is perfectly clear that, under these suppositions, if the amount of money had been one thousand pieces, the price-level would have been one hundred per article, etc. Under these very rigid a.s.sumptions, then, it is obvious that the value of money varies exactly and inversely with the amount put into circulation.--The rapidity of circulation he regards as coordinate, in fixing the price-level, with the volume of money. To ill.u.s.trate this, he a.s.sumes again his hypothetical market, and "dodo-bones," a.s.suming as before that one merchant has all the money (one hundred pieces), and that ten have commodities of equal value. Instead, however, of the merchant with the money desiring all the commodities equally, he is made to desire only the whole of that of trader one, who in turn desires the whole of number two's stock; and so on to the ninth merchant, who wants the commodity of number ten, _who wants the dodo-bones_. In this case, each article will be exchanged only once, as formerly, but the money will change hands ten times, and the price of each article will be one hundred instead of ten.

"We now see that, under these circ.u.mstances, with the same quant.i.ty of money, and the same volume of transactions, the level of prices is ten times as great as before, and the reason is that every piece of money is used ten times instead of once." Whence he concludes: "The effect on prices must be the same when, in effecting transactions, one piece of money is used ten times as when ten pieces of money are used once."[109]

Ricardo, too, expresses the dodo-bone theory very explicitly. "If the state charges a seigniorage for coinage, the coined piece will generally exceed the value of the uncoined piece of metal by the whole seigniorage, because it will require a greater quant.i.ty of labour, or, which is the same thing, the value of the produce of a greater quant.i.ty of labour, to procure it.

"While the state alone coins, there can be no limit to this charge of seigniorage; for, by limiting the quant.i.ty of the coin, it can be raised to any conceivable value. It is on this principle that paper money circulates; the whole charge for paper money may be considered a seigniorage. Though it has no intrinsic value, yet, by limiting its quant.i.ty, its value is as great as an equal denomination of coin, or of bullion in that coin."[110]

Would the dodo-bones circulate? Nicholson chose the ill.u.s.tration to throw into the sharpest relief the absence of any value from a non-monetary employment. n.o.body has any use for them as dodo-bones. What economic force is there, then, to make them circulate? Nicholson says nothing about an _agreement_ among the traders, _a.s.signing_ a significance[111] to the dodo-bones, so that they might function in the same way that poker chips do--indeed, any such notion would vitiate his ill.u.s.tration, for he proposes to explain an adjustment of prices by natural economic laws. Why then, will any of the traders give up his valuable commodities for the worthless dodo-bones? Will you say that he will take them, not because he wants them himself, but because he knows that others will take them from him? But why would the others want them?

Because they in turn can unload them on still others? But this seems a plain case of the vicious circle. It is, in effect, saying that the dodo-bones will circulate because they will circulate. A will take them because B will take them; B will take them because C will take them, C because ... N will take them; N takes them because A will take them.[112] I do not deny that if the traders used the dodo-bones as counters, agreeing that such dodo-bones should represent some other commodity chosen as a standard of values, that the dodo-bones would circulate. But, in that case, they would be, not primary, self-sustaining money, but merely representative, or token money. And just here let me lay down two general propositions[113] respecting the two main functions of money: to serve as a standard, or common measure, of values, the article chosen must, as such, be valuable. The thing measured must be either a fraction or a multiple of the unit of measurement. But this quant.i.tative relation can exist only between _h.o.m.ogeneous_ things. The standard, or measure, of values, then, must be like the commodities whose values it is to measure, at least to the extent of having _value_.[114] The second proposition is respecting the medium of exchange. The medium of exchange must also have value, or else be a representative of something which has value. There can be no exchange, in the economic sense--I abstract from disguised benevolences, accidents, and frauds--without a _quid pro quo_, without value balancing value, at least roughly, in the process. Now when it is remembered that the intervention of the medium of exchange, taking the place of barter, really breaks up a single exchange under the barter system into two or more independent exchanges, and that the medium of exchange is actually received in exchange for valuable commodities, it follows clearly that the medium of exchange must either have value itself, or else represent that which has value. These two propositions seem almost too obvious to require the statement, but they contradict the quant.i.ty theory, and they are not, on the surface, reconcilable with certain facts in the history of inconvertible paper money. It is necessary, therefore, to state them, and to examine further some of the phenomena which seem to contradict them. If they are true, Nicholson's dodo-bones will perform neither of the primary functions of money. They have no value, _per se_--they cannot, then, measure values; they are neither valuable nor t.i.tles to valuable things--they are not _quid pro quo_ in exchange, and will not circulate.

I shall not pause long to discuss the doctrine that money needs no value itself, because it is really a sort of t.i.tle to, or claim on, or representative of, goods in general. The notion, first, would not pa.s.s a lawyer's scrutiny. There are no such indefinite legal rights. A system of legally fixed prices, with a socialistic organization of society, would be necessary to give it definiteness--and in such a situation there would be no room for a quant.i.ty theory of prices! Economic goods, as distinct from money, are not generally "fungible" to the extent that would make them indifferent objects of legal rights. Besides, whether or not the thing is logically thinkable, it is legally false. Legal factors enter into the economic value of money, as will later be shown, but it is economic, and not legal, value, which makes money circulate.

Helfferich has taken the trouble to give the notion of money as a mere t.i.tle to things in general a somewhat more fundamental a.n.a.lysis, and I would refer the reader who is not satisfied by the foregoing on this point to his discussion.[115]

I wish to make very clear precisely how much I mean by the foregoing argument that circular reasoning is involved in saying that A will take the dodo-bones because B will take them. The same question arises for B, and for the others. The real question is as to the cause for any general practice of the sort. Why should A _suppose_ that B will take them?

What could bring about such a system of social relations that a general expectation of this sort could arise?

Kemmerer undertakes to give an answer in a hypothetical case by the following ingenious a.s.sumption (_Money and Credit Instruments_, p. 11): the money consists of an article which formerly had a high commodity value, which has lately entirely disappeared, but the money continues to circulate, through the influence of custom, and because of the demand for a medium of exchange.

In this ill.u.s.tration Kemmerer recognizes the historical fact that money has originated from some commodity which had value because of its significance as a commodity. Historically, a great many different commodities have served, and gold and silver finally emerged victors for reasons which need not just now concern us. These historical facts, coupled with the idea that value is, essentially, "something physical,"[116] or coupled with the notion that value arises only from marginal utility, or from labor, have been accepted by the Commodity or Metallist School as sufficient proof that standard money is only possible when made of some valuable commodity. Professor Laughlin seems to think of the whole thing as depending on the value of gold bullion, and to recognize the money-employment as a factor in affecting the value of money only in so far as it draws gold away from the arts, and so raises its value there by lessening the supply.[117] If money originated in a commodity, how is it possible for the commodity value to be withdrawn, and for money still to retain its value?

This brings us to a question I have raised before, namely, whether the genetic, or historical account of a social situation, and the cross-section a.n.a.lysis of the same situation, necessarily agree.[118] Is it possible that when a commodity basis was necessary to start the thing, and when even in the modern world gold bullion, interconvertible with gold coin, remains the ultimate basis of the money-systems of all great commercial peoples, that you could withdraw the commodity support and keep money unchanged in value? Or could you even have any value left at all? Now in answer, I propose to admit the possibility of so doing.

The forces which a cross-section a.n.a.lysis reveals are not necessarily identical with those which a theory of origins sets forth. Once the thing is set going, the forces of inertia favor it. A new theory, fixed in the minds of the people, say the quant.i.ty theory itself, might give them such confidence in their money that its value might be maintained.

A fiat of the government, making the money legal tender, supplemented by the loyalty of the people, might keep up its value. I think there is reason to believe that this is a source of no little importance of value for the German paper money to-day, and, to a less extent, of the notes of the _Banque de France_. All these possibilities I admit. Value is not physical, but psychological. And the form of value with which we are here concerned, economic value _par excellence_, is a phenomenon of social, rather than individual psychology. Many and complex are the psychical factors lying behind it. Belief, custom, law, patriotism, particularly a network of legal relations.h.i.+ps growing out of contracts expressed in terms of the money in question, the policy of the state as to receiving the money for public dues, the influence of a set of customary or legally prescribed prices, which tie the value of money to a certain extent to the values of goods--factors of this character can add to the value of money, and can, conceivably, even sustain it when the original source of value is gone. Social economic value does not rest on marginal utility. In general, utility is essential, as one of many conditions, before value can exist, even though the intensity of the marginal want served by a good bears no definite relation to its value. But in the case of the value of a money of the sort here considered, marginal utility is in no sense a cause of the value.

Rather, the marginal utility[119] of such money to an individual is wholly a reflection of its social value, and changes when that social value changes. It is quite consistent with the general theory of economic value which I have set forth in _Social Value_, for me to admit possibilities of this kind. The value of money in such a case has become divorced from its original presuppositions. The paper, originally resting on a commodity basis, or the coins originally valued because they could be transformed into non-monetary objects of value, have become objects of value in themselves. a.n.a.logous phenomena are common enough in the general field of values, and are less common in the field of economic values proper than one might suppose. Thus, most moral values tend to become independent of their presuppositions. Moral values of modes of conduct have commonly arisen because those modes of conduct were, or were supposed to be, advantageous in furthering other ends.

Morality, in its essence, is _teleogical_. Yet so far have the moral ideals become ends in themselves that it is possible to have great thinkers, like Kant and Fichte, setting them up as eternal and unchangeable categorical imperatives, regardless of consequences. Thus Fichte declares, "I would not tell a lie to save the universe from destruction." Older still is the dictum, "_Fiat just.i.tia, ruat coelum._"

Yet truth and justice, in the history of morals, and, in the view of most moral thinkers to-day, are of value primarily because they tend to preserve the universe from destruction, and would never have become morally valuable had they had the other tendency! Legal values manifest this tendency even more--one needs only to point to our vast body of technical rules of procedure in criminal cases, which persist long after their original function is gone, and after they have become highly pernicious from the standpoint of the ends originally aimed at. In the sphere of the individual psychology the phenomenon is very common. The miser's love for money is a cla.s.sical example. The housewife who so exalts the cleanliness of her home that the home becomes an unhappy place in which to live, is an often-described type. The man who retires from business that he may enjoy the gains for the sake of which he entered business often finds that the business has become a thing of value in itself, and longs to be back in the harness, while many men, long after economic activity is no longer necessary, continue the struggle for its own sake. Activities arise to realize values. The value of the activity is derived from the value aimed at. But consciousness is economical, and memory is short. The activities become habits. The habits gather about themselves new psychological reactions. The interruption of habitual activities is distasteful. Life in all its phases tends to go on of its own momentum. The activities tend to become objects of value in themselves, whether or not their original _raison d'etre_ persist. In both the social and the individual sphere, apart from blind inertia and mechanical habit, active interests tend to perpetuate the old activities, whose _raison d'etre_ is gone. The judge who continues to apply the outgrown absurdities of adjective law may do it from timidity or from being too lazy to think out the new problems whose solution must precede readjustment to present social needs, but the criminal lawyer who can free his guilty client by means of these technicalities has an active interest in their perpetuation. The individual who would readjust his conduct in the light of changed interests finds that active opposition is met in the emotional accompaniment of the old habits. The economic society may wish to be free from a money whose original value is gone, but there is a powerful debtor interest which approves of that money, and whose support tends to maintain its value.

All these possibilities I admit. My own theory of value, which finds the roots of economic value ramifying through the total social psychological situation, rather than in utility or labor-pain alone, involves possibilities like these. But--and this is a point I wish especially to stress--we are out of the field of mechanics, and in the field of social psychology, when we undertake to explain the value of money that way. No longer is there any mathematical necessity about the matter. There is no such _a priori_ simplicity as the quant.i.ty theory deals with. Factors like these might maintain the value of money for a time, and then wane.

These factors might vary in intensity from day to day, with changing political or other events, leading the value of money to change from day to day, quite irrespective of changes in its quant.i.ty.[120] In so far as you have a people ignorant of the nature of money and of monetary problems, a people in the bonds of custom, with slightly developed commercial life, whose economic activities run in familiar grooves unreflectively, you will most nearly approximate a situation like that which Professor Kemmerer a.s.sumes. But that means that what might be true in India, or to a less degree in Austria--countries to which the quant.i.ty theorists are accustomed to refer--need not at all be true in the United States. Here everybody was talking about the theory of money in 1896--not necessarily very intelligently!--and here, moreover, such phrases as "good as gold," and propositions like that which came from Mr. J. P. Morgan in his testimony before the Pujo Committee that "gold is money, and nothing else," would seem to indicate that a very great part of our people might utterly distrust such a money as Professor Kemmerer describes. The banker's tendency to look behind for the security, to test things out, to seek to get to bed-rock in business affairs, holds with a great many people. An overemphasis on this is responsible for the doctrine of Scott[121] and Laughlin[122] that the sole source of the value of inconvertible paper money is the prospect of redemption, and that inconvertible paper money differs from gold in value by an amount which exactly equals the discount at the prevailing rate of interest, with allowance for risk, for the period during which people expect the paper money to remain unredeemed. We have not the banker's psychology to any such extent as that. Apart from the fact that the money function adds to the value of money, under certain circ.u.mstances,--a point to be elaborated shortly--other, non-rational factors, contagions of depression and enthusiasm, patriotic support, "gold market" manipulations, etc., entered to break the working of the credit theory of paper money as applied to the American Greenbacks. I may here express the opinion that the credit theory is the fundamental principle in the explanation of the value of the Greenbacks, however.

But we have not the banker's psychology to any such extent as the extreme forms of that theory would a.s.sume. "Uncle Sam's money is good enough for me," is a phrase I have heard from the Populists,--who, by the way, were pretty good quant.i.ty theorists! "The government is behind it." There are plenty of men for whom that a.s.surance would be enough.

Indeed, the general notion that in some way, not specified, perhaps not yet known to anybody, the government will do what is necessary to maintain the value of its money is a ground which might well influence even the most sophisticated banker. I think such a general confidence in the English government has clearly been a factor in the price of Sterling exchange since the balance of trade turned so overwhelmingly against England in the present War.[123] Our monetary history, I may add, has been in considerable measure a struggle between these two opposing psychological reactions on that point. The utter breakdown of the _fiat_ theory came in Rhode Island, and in connection with the Continental Currency, in the days before the Const.i.tution was adopted.

On the other hand, I do not believe that those who put a banker inside every one of us can prove that their principle has been a complete explanation at any stage of our monetary history. But clearly considerations like these take away all mathematical certainty from the matter.

The foregoing a.n.a.lysis makes clear, I trust, that the notion that the money function alone can make an otherwise valueless money circulate is untenable. There must be value from other sources as well. All that is conceded is that there need not be a physical commodity as the basis of the money. Value is not necessarily connected with a physical commodity.

There is a disposition on the part of many quant.i.ty theorists to beg the question at the outset, to a.s.sume money as circulating, without realizing how much this a.s.sumption involves. The a.s.sumption involves the further a.s.sumption that there are _causes_ for the circulation of money.

But the same causes which make money circulate will also be factors in the determination of the _terms_ on which it circulates, _i. e._, the prices. To seek then, by a new principle, the quant.i.ty theory, to explain these prices without reference to these causes, is a remarkable procedure. There is sometimes a disposition to do the thing quite simply indeed: define money as the circulating medium, and, _by definition_, you have it circulating! A rather striking case of this, which is either tautology or circular reasoning, appears in Fisher's _Purchasing Power of Money_ (p. 129): "Take the case, for instance, of paper money. So long as it has the _distinctive characteristic of money,--general acceptability at its legal value_,--and is limited in quant.i.ty, its value will ordinarily be equal to that of its legal equivalent in gold."

(Italics mine.)

It is not quite easy to construct, even ideally, a social psychology which would perfectly fit the quant.i.ty theory. One would have to a.s.sume that money circulates purely from habit, without any present _reason_ at all. The a.s.sumption must be that the economic life runs in steady grooves, so that quant.i.ty of goods exchanged will always be the same, or at least, that it will always be the same proportion of the goods produced--there must be no option of speculative holding out of the market allowed the holder of exchangeable goods. The individuals must have constant habits as to the _proportions_ of the money they receive to be spent and to be held for emergencies. All the factors affecting "velocity" of both money and goods must be constant--Professor Fisher maintains very explicitly that velocities, both of money and of bank-deposits are fixed by habit (_loc. cit._, p. 152),--and, in any case, the a.s.sumption is necessary. A thoroughly mechanical situation must be a.s.sumed, where there is the rule of blind habit. Given such a mechanism, you pour in money at one end, and it grinds out prices at the other end, automatically. But, strangely enough, in this social situation where blind habit rules, prices are perfectly fluid! In India, or in other countries where the a.s.sumptions of the quant.i.ty theorist come most nearly to realization, so far as the general rule of habit is concerned, one finds also many customary prices. In a country completely under the rule of habit, the prices would, as a matter of _psychological_ necessity, be also fixed. What might then be expected to happen in such a country, if an economic experimenter should disturb them in their habitual quant.i.ty of money? Which habits would give way, those relating to prices, or those to velocities, or those relating to quant.i.ties of goods exchanged?[124] I shall not trouble to solve this problem, as it seems to me not the most useful way to approach the problem of the value of money, but I submit it to the consideration of advocates of the quant.i.ty theory. My present purpose is accomplished in pointing out the psychological a.s.sumptions which the quant.i.ty theory makes: a psychology of blind habit, in a situation where the price-level is free from control by customary prices.

Now at another point I wish to mediate between the quant.i.ty theorists and their extreme opponents. Representatives of the Metallist of Commodity School--like Professor Laughlin, and Professor Scott in his earlier writings--seem to deny that the money-employment has any direct effect in increasing the value of money. The money-employment affects the value of money only indirectly, by withdrawing the money metal from the arts, so raising the value of the money metal, and consequently raising the value of the coined metal. The quant.i.ty theory, on the other hand, would utterly divorce the value of money from causal dependence on the stuff of which the money is made. Both these views seem to me extreme. Unless money has value from some source other than the money employment, it cannot be used as money at all. n.o.body will want it. On the other hand, the money use is a valuable use. Exchange is a productive process. Money, as a tool of exchange, enables men to create values. And you can measure the value of the money service very easily at a given time if you look at the short time "money-rates," _i. e._, rates of discount on prime short term paper. These are properly to be considered, not interest on abstract capital, but the rent of a particular capital-good, namely, money. The money is hired for a specific service, namely, to enable a man to get a specific profit in a commercial transaction. Money is not the only good which can be thus employed, and which is paid for for this purpose. Ordinarily a man will pay for money for this purpose. Sometimes, however, one needs the temporary use of something else more than one needs money, and the holder of money pays a premium for the privilege of temporarily holding the other thing. I refer especially here to the practice of "borrowing and carrying" on the stock exchange. The "bear" sells stock which he does not possess, and must deliver the stock before he is ready to close his transaction by buying to "cover." He goes to a "bull" who has more stock than he can easily "carry," and who is glad to "lend" the stock in return for a "loan" of its equivalent in money. Ordinarily the bull is glad to pay a price for the money, as it is of service to him.

Sometimes, however, the situation is reversed, and the service which the temporary loan of the stock performs for the hard-pressed bears is greater than the service which the money performs for the bulls, and the payment is reversed. When the bull pays a premium to the bear, for the use of the money, the amount paid is called "carrying charge," "interest charge for carrying," "contango," (London) or (in Germany) "_Report_."

This is the usual case. But sometimes the bear pays the bull a premium for the use of the stock, and the charge is then called "premium for use," "backwardation," (London) or "_Deport_" (Germany).[125] Money is, thus, not the only thing which has a "use" in addition to the ordinary "uses" which are the primary source of its value.[126] In the case of other things, however, this kind of "use" is unusual. In the case of money it is the primary use. The essence of this use is to be found in the employment of a quantum of _value_ in highly saleable form in facilitating commercial transactions. Commercial transactions, in this sense, are not limited to ordinary buying and selling. I think it best to defer further a.n.a.lysis of the money service to a later chapter, on the functions of money, which will best be preceded by a consideration of the origin of money. For the present, it is enough to note that money has certain characteristics which enable it to facilitate exchanges, and to pay debts, better than anything else, and that this fact makes an addition to its value. It is possible, I think, to measure this addition to value rather precisely in certain cases. Thus, in the case of the American Greenbacks, we find them at a discount, say from the beginning of 1877 on, as compared with the gold dollar in which they were to be redeemed in Jan. 1879. I think it safe to contend that the country was practically free from doubt as to their redemption after the early part of 1877. The discount steadily diminished as the time of redemption approached. Laughlin's theory is thus far beautifully vindicated. The central fact governing the value of the Greenbacks during this period was the prospect of redemption. But, and here I think we see the influence of the money-use, the discount was not as great as would have been called for by the prevailing rate of interest, as measured by the yield on other obligations of the Federal Government, at this time. And the discount completely disappeared some little time before the actual redemption. I see no cause for the absence of a discount in the later months of 1878 except the additional value which came from the money use. This additional value is, ordinarily, not very great. And money is not alone in possessing it. In extraordinary circ.u.mstances it may become quite large. Thus, in 1873, in the midst of the panic, the gold premium fell sharply. At this time the significance of the Greenbacks as a legal tender, a means of final payment of obligations (_Zahlungs_- or _Solutions-mittel_), as distinguished from medium of exchange (_Tauschmittel_), attained an unusual significance. In ordinary times, the marginal value of this function of money sinks to zero, but in emergencies it may become very great. In ordinary times, during the Greenback period, uncoined gold bullion, or gold coin used, not as money, but simply by weight in exchanges, played an important role, competing with the Greenbacks in various employments, particularly as bank reserves, and as secondary bank reserves, and so reducing the marginal value of the money-employment of the Greenbacks themselves.

Gold bullion is not the only thing which can thus serve, however.

To-day, and generally, securities with a wide market, capable of being turned quickly into cash, without loss, or capable of serving as the basis of collateral loans, up to a high percentage of their value, have a much higher value, for a given yield, than have other securities, equally safe, but less well-known and less easily saleable. The "one-house bond" (_i. e._, the bond for which only one banking house offers a ready market) must yield a great deal more to sell at a given price than the bond of equal security which is listed on the exchanges, and has a wide market. Part of this is in ill.u.s.tration of another function of money, the "bearer of options" function, which enables the holder to preserve his wealth, and at the same time keep options for increasing its amount when bargains appear in the market. Foreign exchange performs many of these functions of money in European countries, particularly Austria-Hungary.[127]

The notion that the whole value of gold coin rests on its bullion content arises most easily in a situation where free coinage has long been practiced, and where there are no legal obstacles to the melting down of coin for other uses. Where free coinage is suspended, the peculiar services which only money can perform--or rather, the services which money has a differential advantage in performing--may easily lead to an agio for coined over uncoined metal. The mere fact that coined metal is of a definite fineness well known and attested is often of some consequence, though the attestation of well-known jewelers may give this advantage to metal bars as well, for large transactions. But for smaller transactions, nothing can easily take the place of money. A high premium on small coins, apart from redemption in standard money, may easily arise from the money-use alone. And standard coin may well attain, in greater or less degree, a premium. If it is scarce, as compared with the amount of business to be done, this premium may well be greater than if it is abundant. But that an indefinite premium is possible, or that this premium varies exactly and inversely with the quant.i.ty, I see no reason at all for supposing. If the premium be great enough, men, especially in large transactions, will make use of the uncoined metal--just as they did use gold in this country during the Greenback period. The advantages of money are not absolute. Money is simply more convenient for many purposes than other things. The possibility of a premium is limited by the possibility of subst.i.tutes. It is further limited by the fact that a high premium would awaken a distrust which would bring the premium to destruction, by destroying trade, and so destroying the money-use on which the premium is based.

A detailed discussion of the Indian Rupee since 1893 lies outside the scope of this chapter. I think it may be well, however, to recognize at this point that the limitation in the quant.i.ty of the rupee, through abrogation of free coinage, was a factor in the subsequent rise in its value. It was not the only factor, by any means. But it was a factor. It may be also recognized as a factor in the value of Austrian paper money.

The doctrine just laid down, as to the influence of the money-use in adding to the value of money, is in no sense the same as the quant.i.ty theory. For one thing, it is easily demonstrated that the value-curve for the uses of money is not described by the equation, _xy_ = _c_. This curve expresses, in terms of value, the idea of proportionality which is an essential part of the quant.i.ty theory. Put in terms of the money market, we have a demand-curve for money, not for the long-time possession of money, but for its temporary use--a rental, rather than a capital value, is expressed in the price which this curve helps to determine. This curve is highly elastic. When money-rates are low, transactions will be undertaken which will not be undertaken when the rate is a little higher. In the second place, the method of approach is very different. It is not the whole volume of transactions which must employ money, but only a flexible part. In the third place, the money-use is here conceived of as a source, not of the whole value of money, but only of a differential portion of that value. In the fourth place, the argument runs in terms of the absolute value of money, and not in terms of the level of prices.

It is not the legal peculiarity of money, as legal tender, which is necessarily responsible for this agio when it appears. In the first place, not all money is legal tender. In the second place, we find the same phenomenon in connection with "bank-money" at times--I would refer especially to the premium on the _marc banko_ of the Hamburg Girobank.

(_Cf._ Knapp, _Staatliche Theorie des Geldes_, p. 136.) The legal tender peculiarity may, however, in special circ.u.mstances be a source of a very considerable temporary agio.

It is possible, however, to frame a hypothetical case in which, barring temporary emergencies, the money-use will add nothing to the value of money, and in which the whole value of money will come from the value of the commodity chosen as the standard of values. a.s.sume that the standard of value is defined as a dollar, which is further defined as 23.22 grains of pure gold. a.s.sume, however, that no gold is coined. Let the circulating money be made of paper. Let this paper be redeemable, not in gold, but in silver, at the market ratio, on the day of redemption, of silver to gold. This will mean that varying quant.i.ties of silver will be given by the redeeming agencies for paper, but always just that amount required to procure 23.22 grains of gold. Let us a.s.sume, further, that the government issues paper money freely on receipt of the same amount of silver. a.s.sume, further, that the government bears the charges which the friction of such a system would entail, by opening numerous centres of issue and redemption, by providing insurance against fluctuations in the ratio of silver to gold for a reasonable time before issue and after redemption, meeting transportation charges, brokerage fees, etc. In such a case, the standard of value would not be used as money at all. It would have no greater value than it would if it were not the standard of value--abstracting from the fact that in the one case it might be used in its uncoined form as a subst.i.tute for money more freely than in the other. In any case, it would form no part of the quant.i.ty of money. Its whole value would come from its commodity significance. The value of the paper money, however, would be tied absolutely to the value of gold. As gold rose in value, the paper money would rise in value, and vice versa.

The quant.i.ty of money would be absolutely irrelevant as affecting its value. The quant.i.ty of silver would be likewise irrelevant. The causation as between quant.i.ty of money and value of money would be exactly the reverse of that a.s.serted by the quant.i.ty theory. A high value of money would mean lower prices. With lower prices, less money would be needed to carry on the business of the country. Paper would then be superabundant. But in that case, paper would rapidly be sent in for redemption, and the quant.i.ty of money would be reduced.[128] The value of money would control the quant.i.ty of money. The standard of value, which was not the medium of exchange, would control the value of money, and so the level of prices, in so far as the level of prices is controlled from the money side.

In this hypothetical ill.u.s.tration, we have the extreme case of what the Commodity or Metallist School seems to a.s.sert. In this case, barring temporary emergencies too acute to admit of increasing the money-supply by the method described, their theory that the value of money comes wholly from the commodity value of the standard, would offer a complete explanation. I offer this ill.u.s.tration as the ant.i.thesis of the dodo-bone ill.u.s.tration of Nicholson. That ill.u.s.tration sets forth the extreme claims of the quant.i.ty theory, and purports to be a case in which the quant.i.ty theory would work perfectly. The case ill.u.s.trative of the commodity theory clearly brings out the fact that that theory rests on exclusive attention to the standard of value function of money. The dodo-bone theory gives exclusive attention to, but very imperfect a.n.a.lysis of, the medium of exchange function. But I submit that the extreme case of the commodity theory, in the ill.u.s.tration I have given, is a thinkable and consistent system. It would work--even though not conveniently. Indeed, it resembles in essentials the plan actually proposed by Aneurin Williams, and later by Professor Irving Fisher[129]

for stabilizing the value of money. Subst.i.tute a composite commodity for gold, and gold for silver, in the ill.u.s.tration, and you have the essentials of that plan. The dodo-bone hypothesis, however, as I have been at elaborate pains to show in the foregoing, is unthinkable. It would not work. It is, thus, possible to construct a system for which the commodity theory would offer a complete explanation. It is not possible to do this for the quant.i.ty theory.

But the limiting case for the commodity theory is not the actual case.

Standard money is also commonly a medium of exchange. Standard money is particularly desirable in bank and government reserves. Its employment in these and other ways is a valuable employment, and adds directly to its value both as money and in the arts. There is a marginal equilibrium between its values in the two employments. The notion that the only way in which the money employment adds to the value of money is an indirect one, by withdrawing gold from the arts, so lessening its supply and raising its value there, may be proved erroneous by this consideration: what, in that case, would determine the margin between the two employments? What force would there be to withdraw gold from the arts at all? Why should more rather than less be withdrawn? There must be ascending curves on both sides of the margin. Gold money in small amount has a high significance per unit in the money employment. A greater amount has a smaller significance per unit. The marginal amount of gold put to work as money has a comparatively low significance in that employment--a significance just great enough to secure it from the competing employments in the arts.

We conclude, then, that money must have value to start with, from some source other than the money function, and that there must always be some source of value apart from the money function, if money is to circulate, or to serve as money in other ways. But this is not to a.s.sert the doctrine of the commodity school, that its value must arise from the metal of which it is made, or in which it is expected to be redeemed.

Nor is it to deny that the money function may add to the original value.

On the contrary, the services which money performs are valuable services, and add directly, under conditions which we shall a.n.a.lyze more fully in a later chapter on the functions of money, to the value derived from non-pecuniary sources. Value is not physical, but psychical. And value is not bound up inseparably with labor-pain or marginal utility.

CHAPTER VIII

THE "EQUATION OF EXCHANGE"

In Professor Irving Fisher's _Purchasing Power of Money_[130] we have the most uncompromising and rigorous statement of the quant.i.ty theory to be found in modern economic literature. We have, too, a book which follows the logic of the quant.i.ty theory more consistently than any other work with which I am acquainted. The book deals with the theory more elaborately and with more detail than any other single volume, and sums up most of what other writers have had to say in defence of the quant.i.ty theory. Professor Fisher's book has, moreover, received such enthusiastic recognition from reviewers and others as to justify one in treating it as the "official" exposition of the quant.i.ty theory. Thus, Sir David Barbour cites Professor Fisher as the authority on whom he relies for such justification of the theory as may be needed,[131] while Professor A. C. Whitaker declares that he adopts "without qualification the whole body of general monetary theory" for which Professor Fisher stands.[132] Professor J. H. Hollander has recently referred to Professor Fisher's work on money and prices as a model of that combination of theory and inductive verification which const.i.tutes real science.[133] The _American Economic Review_ presents as an annual feature Professor Fisher's "Equation of Exchange."