expression, cost of production of money, could have a definite meaning.
It meant the labor-cost of producing the money metal. Even in this form,
it is recognized that cost of production has a looser connection with
value in the case of money than in the case of most commodities, because
the supply of money metal is large and durable, and the annual
production affects it slowly. But cost of production theories, in the
form of labor theories, or labor-abstinence-risk theories, have little
standing in modern economic theory. Ricardo himself saw the break-down
of the pure labor theory; and Cairnes, Ultimus Romanorum, so limited and
modified the "real costs" doctrine as to leave little validity in it,
even on his own showing. The prevalent doctrine of cost of production
runs in terms of "money-costs"--and hence is of no use when the problem
of the value of money itself is to be solved.
A brief historical sketch of the cost theory will be helpful. Costs are
sometimes conceived as a cause of value, and sometimes as a measure of
value. Often these two aspects are mixed, and writers shift from one
notion to the other. This is particularly true of the labor theory. In
Adam Smith the contention sometimes is that labor is unvarying in value,
hence an admirable measure of values, and an excellent standard of
long-time deferred payments. Smith compares wheat and silver from the
standpoint of the constancy of their relation to labor, and concludes
that wheat is the better standard in the long run, because it remains
more nearly fixed with reference to labor than does silver. Sometimes
Smith thinks of labor as a cause of value, and thinks of the labor that
enters into the production of a good as the significant thing. At other
times, the labor that goods will command or purchase is the significant
thing--and here one is not clear whether he thinks of labor as a cause
or as a measure. Whether labor is to be funded as labor-pain, or as
labor-time, Smith does not state. Sometimes labor seems to be considered
as homogeneous in its efficiency. At other times, he makes comparison
between different kinds of labor as to their efficiency, and compares
the efficiency of labor in different occupations. One can find nearly
anything one pleases in Adam Smith on these points. At times he speaks
of "labor and expense," rather than labor alone, as governing prices.
Labor-cost to the laborer would take the form of labor-pain or
labor-time. To the employer, it would take the form of outlay in wages.
Adam Smith never makes any definite statement of point of view here, and
shifts back and forth from one to the other. He recognizes variations in
labor-pain, in danger, etc., in different kinds of labor when discussing
wages.
Ricardo elaborated the labor theory of value, and tried to think it
through. He was too keen a logician to shift view-points with Smith's
facility, and he tried to make a completed system.[55] There is some
shifting from the theory of labor as a cause of value to labor as a
measure of value, as in the following passage: "If the state charges a
seigniorage for coinage, the coined piece of money will generally exceed
the value of the uncoined piece of metal by the whole seigniorage
charged, because it will require a greater quantity of labour, or,
which is the same thing, the value of the produce of a greater quantity
of labour, to procure it." (_Works_, McCulloch ed., 213.) In general,
however, Ricardo developed a causal theory of value, quantity of labor
being the basis of the absolute values of goods, their _relative_ values
depending on the relative amounts of labor involved in the production of
each. I shall not go into the matter fully, but shall call attention to
the rock on which the system split, as Ricardo himself admits. A greater
or less proportion of capital works with labor in producing different
things, and the value of product, in that case, varies not merely with
the labor, but also with the amount of capital, and the length of time
the capital is employed. How say, then, that labor alone governs value?
How reduce labor-cost and capital-cost to homogeneous terms? James Mill
tried to do it for him by making capital merely stored up or petrified
labor, which gives up its value again in production. But this doesn't
meet the difficulty, because there is a _surplus_ value, over and above
that explained by all the labor, including the labor which produced the
machine, and the labor which produced the raw materials which entered
into the machine, etc. The case of wine is a particularly obstinate
case. Wine increases in value merely with the passage of time, at a rate
which corresponds to the profit on capital. Ricardo finally, in
correspondence with McCulloch, definitely abandons the case, stating
that there are many exceptions to the proportionality between exchange
value and labor-cost. "I sometimes think that if I were to write the
chapter on value again which is in my book, I should acknowledge that
the relative value of commodities was regulated by two causes instead of
one, namely, by the relative quantity of labor necessary to produce the
commodities in question, and by the rate of profit for the time that the
capital remained dormant." (Davenport, _Value and Distribution_, p.
41.) But this is a "dualistic" rather than a "monistic" explanation--one
element is a money-expense, or at all events a pecuniary item, while the
other is a "real cost" item. The two are incommensurate and
incommensurable.
Senior seeks to supply the unifying principle. "Abstinence" and labor
have pain as a common element, and so are commensurable. Costs, reduced
to labor and abstinence, become homogeneous again. Monism is restored.
Cairnes completes the doctrine by adding risk to the real cost elements:
a triune cost concept, sacrifice being the generic fact in the three
manifestations.
With John Stuart Mill, in general, we have an entrepreneur view-point.
Money-expenses of production, entrepreneur outlay, plus wages of
management, or including wages of management, are the factors with which
Mill reckons. He is no longer concerned with psychological ultimates, or
real costs. Cairnes criticised Mill sharply for this. No distinction is
more fundamental he holds, than that between costs or sacrifice on the
one hand, and rewards on the other. Labor, abstinence and risk are
sacrifices; wages, interest, profits are rewards. None the less, in cost
doctrine, as in supply and demand doctrine, it is Mill's view which has
prevailed. Cost as conceived by Mill is a superficial, pecuniary notion.
It tells little as to ultimate causation. But it is virtually only as a
pecuniary doctrine, costs from the entrepreneur view-point, that the
cost doctrine is met in modern theory.
Why is this? Well, first, the real-cost doctrine simply does not square
with the facts. The hardest labor does not produce the most valuable
goods. Value in fact does not vary either with labor-pain or labor-time.
In fact, whatever the explanation, it would seem to be truer that the
relation is an inverse relation. Nor does the abstinence that pinches
hardest produce the largest amount of capital. And while there is some
correlation between risks and profits, the correlation is at best low
and is not a correlation between psychological sacrifice and profits.
Even "marginal abstinence" for a Rothschild or a Rockefeller causes no
pain. It is absurd to seek to find a common element in the "abstinence"
of a rich man and the pain of a poor and aged laborer. I pass over the
supposed difficulty that abstinence is, in general, suffered by one set
of minds, and labor-pain by a different set of minds, and hence, since
men cannot compare their own emotions with the emotions of other men,
there is no comparability. This subjectivistic psychology would, of
course, make it equally impossible to fund labor-pains of different
laborers, or to get any common denominator at all.[56] It is enough to
point out that differences between rich and poor, between successful and
unsuccessful, between efficient and inefficient, (apart from acquired
differences which may be smoothed out by the "stored up
labor-of-training" principle) make labor-pain, and marginal labor-pain,
vary greatly from value, and make labor-pain, abstinence and risk quite
incommensurable, and quite without fixed relation to value. Cairnes saw
this in part, and developed his doctrine of non-competing groups to deal
with it. Labor-pain and value vary together only when we are comparing
goods produced by laborers within a competing group. Laborers in one
group do not compete with laborers in another group. There is perfect
competition in the capital market, however, and so capital costs
("abstinence") are perfectly correlated with value, to the extent that
capital enters. Cairnes seems to think that the whole difficulty with
his real cost doctrine comes from the failure of competition. In fact,
however, it comes also from the inequalities in wealth. And even in his
highly competitive capital market it is equally true that abstinence, or
even marginal abstinence (a term which Cairnes does not use) has no
constant relation to amount of capital accumulated, value produced, or
interest received. The cost theory breaks down at every point when it
runs in labor-abstinence-risk terms. So generally has this been
recognized, that the cost theory has generally given way to the utility
theory, and cost doctrine when it appears in modern economics is either
the very superficial money-outlay notion of Mill, or else the Austrian
cost doctrine, later to be discussed, which is still a pecuniary
concept. I have elsewhere undertaken to show (_Social Value_, chs. 3-7,
and the ch. on "Marginal Utility," _infra_) that these defects of the
"real-cost" theory, are just as much in evidence in the utility theory.
The failure of the real cost theory of value is by no means a
vindication of the utility theory. Both have the same vice--the effort
to combine into a homogeneous sum a lot of individual psychological
magnitudes measured in money, when the money-measure has a different
psychological significance for each individual, and so comparison and
addition are impossible. But in any case, the real cost doctrine of the
Classical School has failed, and so cannot serve as the basis of the
theory of the value of money.
Obviously the money-outlay cost theory of Mill cannot explain the value
of money itself. The marginal cost of producing twenty-three and
twenty-two hundredths grains of gold will always be a dollar, however
the dollar may vary in value. Indeed, in general, the assumption of a
constant value of the money-unit is implied in the monetary cost
concept. Cost curves are _supply_-curves and the reasoning already given
as to the need for assuming constant value for money in the supply and
demand concept will apply here. Costs function in value-determination
only by checking supply. Rising costs tend to mean a lessened supply.
But if the cost-curve is rising _because_ of a fall in the value of
money, then the demand-curve will be rising also, and production will
not be checked. The general law as to the relation of cost to demand and
supply assumes a fixed value of the unit of cost, the dollar.
To the Austrian economists we owe a rational theory of costs which gives
the money-outlay concept more than a merely empirical basis. First, they
see in costs not causes, but results. Value causation comes ultimately,
not from the side of supply, but from the side of demand. I shall not
now undertake a criticism of their explanation of demand. I have
elsewhere criticised their confusion of demand-curves and
utility-curves, and pointed out that marginal utility gives no
explanation of demand. I shall recur to the utility theory of value at a
later point. For the present, it is enough to point out that the
Austrian theory of costs is independent of their utility vagaries, and
rests best on the notion of supply and demand, as expressed in the
modern curves, with the assumption of a fixed value of the money-unit.
Costs consists of entrepreneur money outlay of various kinds, chiefly
wages, interest, and rent. Rent is, for the Austrians, as much a cost as
any other item of entrepreneur outlay. But these items of cost are not
ultimate data. They are rather reflections of the positive values of the
products. Value runs from finished product to agents of production,
labor, and instrumental goods, and land. Avoiding needless complications
from a discussion of interest as a factor in cost--a doctrine on which
the Austrians, say Wieser and Boehm-Bawerk, are not agreed,--it is enough
to point out that high wages or high rents, which limit production in
any given industry or establishment, are high _because_ the land and
labor in question have _alternative_ uses, because other industries, or
other competitors in the same industry, bid for them. Cost-curves,
then, are reflections of demand-curves. The cost-curve of wheat, _e.
g._, is what it is because of the demand-curve for corn, for cattle, and
for every other commodity that could be produced with the same labor and
land. Cost doctrine thus becomes part of the general doctrine of supply
and demand, and runs in pecuniary terms, assuming money, and a fixed
value of money, and hence is incapable of serving as a theory of the
value of money itself.
That some vaguer form of cost doctrine, where the unit of cost is, not
money, but some composite commodity of things used in the production of
the standard money metal, or a unit of abstract value, might be worked
out, is doubtless true. Gold production, like other industry, is part of
the general economic scheme, and there is some sort of equilibrium
reached which draws labor and capital now away from, and now back to,
the gold mine. To bring this equilibrium into the general scheme of the
modern theory of costs, however, in terms precise enough to make a
satisfactory theory of the value of money, is a thing which has not so
far been done, and I do not have high hopes of its early accomplishment.
In any case, such a theory must rest upon a positive theory of value.
Cost doctrine is negative, and can never be fundamental.[57]
CHAPTER IV
THE CAPITALIZATION THEORY AND THE VALUE OF MONEY
Money is capital. A dollar is a capital-good. Money is, moreover, a
durable form of capital, which gives forth its services bit by bit, and
indeed, in a community where the state bears the burden of wear and
tear, never ceases to give forth those services. In any case, from the
standpoint of a given individual, so long as there is a limit of
tolerance prescribed for legal tender, it is a matter of accident if he
ever incurs a loss from the wastage of the capital instrument, money,
through wear and tear. Moreover, the fact that money is "fungible," and
that its use is to be found in a process which commonly returns to the
owner, not the same coin, but a different coin, we may, in general,
abstract from the wear and tear of the dollar, and look upon the dollar
as a capital instrument which promises its owner, if he chooses to use
it as capital, a perpetual annuity. The nature of this money service
will be more fully described later. For the present it is sufficient to
say that exchange is a productive process, that exchange creates values,
in as true a sense as manufacturing does, and that money facilitates
exchange in as true a sense as coal facilitates manufacturing. There is,
at any given time, a demand-curve for this money service, manifesting
itself in the money market, a demand for the short time use of money as
a tool of exchange, and the "prices" which come out of the interaction
of demand and supply in the money market are the short time "money
rates" including the "call rates." These are properly to be conceived,
not as pure interest on abstract capital, but as rents[58] which are to
be attributed to money as a concrete tool.
Now, in general, when such rents appear, they may be capitalized. And
the price of the instrument of production that bears these rents, will
be the sum of the rents, discounted at the prevailing rate of interest,
with considerations of risk, etc., allowed for. The reasoning of the
capitalization theory is really quite simple. Take, for example, a piece
of urban site land, which is expected to bring a perpetual annuity of
one hundred dollars. The whole economic significance of the land is
contained in its services, present and prospective. The possession of
land under certain circumstances brings other services, as social
prestige, than the services which can be alienated to a lessee. But in
this case I am abstracting from considerations of that sort, and also
from the factor of risk. The whole value of the piece of land under
consideration comes from the value of the one hundred dollars a year.
But these annual incomes are not all equally valuable, even though all
expressed as one hundred dollars. The first one hundred dollars is due
one year hence, the tenth ten years hence, the thousandth, a thousand
years hence. The principle of perspective comes in--I abstain from any
detailed discussion of the theory of interest, simply stating that in a
general way I agree with the contention that _time_ constitutes the
essence of the phenomenon, or rather, the tendency to discount the
future. The capital price of the land is the sum of an infinite
convergent series of the "present worths" of the incomes. The formula
is as follows: capital price of land = $100/1.05 + $100/(1.05)^2 +
$100/(1.05)^3 ... + $100/(1.05)^n when the rate of interest is 5%. The
limit of this series, assuming the series to be infinite, is $2000, and
a simple formula for calculating it under the assumptions, is to divide
$100, the annual income, by .05, the rate of interest. Given the annual
income, given the prevailing rate of interest, the capital price is
determined. The relation may be illustrated, roughly, by the figure of a
candle, a disk, and the shadow of the disk on the wall. The disk
represents the annual income, the shadow on the wall the capital value,
and the distance between the flame and the disk the rate of interest.
Increase the distance between the flame and the disk, the rate of
interest, and the shadow becomes smaller; shorten the distance, and the
shadow is increased. Similarly, enlarge the disk, and the shadow is
enlarged. The capital value varies directly with the annual income, and
inversely with the rate of discount. Now my purpose here does not
involve a detailed examination of the validity or limitations of the
capitalization theory. For the present, the only question is, has this
theory any application at all to the problem of the value of money? It
offers itself as a general theory of the values of durable bearers of
income. Money is a durable bearer of income.
The capitalization theory, however, is of no use for the purpose in
hand. Money does not obey the general law in the relation which the
magnitude of the income bears to the rate of interest. In general, the
income and the rate of discount are independent variables. Their
influence, operating in opposite directions, fixes the capital value,
increasing income increasing the capital value, increasing discount rate
reducing it. In the case of money, however, the two factors are not
independent. The short time money rate is not, to be sure, identical
with the long time rate of interest, which is the rate of discount for
the purpose in hand. But the two tend to vary together in the long run
average in fact, and they are related in the _expectation_ of those who
are concerned in the capitalization process.
In our chapter on the "Functions of Money," in Part III, it will be
shown that normally there tends to be a difference between the money
rates and the long time interest rates, the long time rates tending to
be higher than the rates on short loans, the rate on very short loans
being lower than the rate on somewhat longer short time loans, and the
call loan rate being lowest of all. The explanation of this must be
deferred till we have analyzed the functions of money. But the important
thing, for present purposes, is that the money rates, though lower than
the "pure rate" of interest, tend to vary, in long time averages, with
that "pure rate,"[59] and that, consequently, the income from renting
money, and the discount rate to be applied in capitalizing that income,
are not independent magnitudes, but tend to vary together. They thus
tend to neutralize one another. If money rates go up, and if they are
expected to stay up long enough to justify (on the ordinary
capitalization theory) a rise in the capital value of money, we have a
counteracting influence in the long time interest rate, which also
rises, and tends to pull down the capital value of money. To recur to
our illustration of the candle and the disk, as the disk increases in
diameter, the distance between the candle and the disk grows greater,
and so the _shadow_ tends to remain the same.
There is a further difficulty, to which attention will be called more
fully in later chapters, particularly the chapter on "Dodo Bones," and
the chapter on the "Functions of Money." In other cases, in general, the
capital value is, as the capitalization theory requires it to be, a true
shadow, a passive function of the income and the discount, of the disk
and the distance between the candle and the disk. In the case of money,
however, the income is causally dependent, in part, upon the capital
value. Money can function as money only by virtue of having value. The
shadow becomes substance in the case of money. It is the _value of
money_ which makes possible the _money work_. The capitalization theory,
thus, if applicable at all, must be radically modified before being
applied. We shall subsequently, in the chapters above referred to, take
account of this fundamental complication. For the present, we can state
it merely as a problem: how can we construe the interaction of the
income value of money and the capital value of money in such a way as to
avoid a circular theory?
But further, the capitalization theory, as heretofore formulated, like
the doctrines of supply and demand and cost of production, assumes
_money_, and a _fixed absolute value_ of money. This assumption must be
made if we are to be able to predict, on the basis of the capitalization
theory, that a given annual income, at a given rate of discount, will
give a specified capital value. This may be shown by the following
considerations: If men anticipate that the value of the income, which is
a fixed sum of dollars, is to grow less in the future, then the present
worth of the bearer of that income will shrink to an extent greater than
the "pure rate" of interest would call for. The principle of
"appreciation and interest" comes in. The nominal interest, in times of
falling value of money, tends to exceed the pure rate by an amount which
compensates for the loss in value of future income as the dollar falls
in value. We have here, however, a principle different from the
principle of time discount. It is not the influence of time, which makes
a _given_ value appear smaller as it is further removed in time, but it
is an anticipated lessening in the value of the income itself, that
counts. In terms of our candle and disk illustration, it is a factor
affecting the size of the disk, rather than a factor affecting the
distance between the disk and the candle. For the purposes of
calculation, the two elements in the nominal rate of interest may be
lumped together, and the nominal rate, rather than the pure rate, may be
taken as the rate of discount for capitalization purposes. But for
theoretical purposes, the two must be kept distinct. The capitalization
theory rests on the assumption of a fixed value of the money unit.
That the fixed value of the money unit assumed is an absolute value, and
not a mere "reciprocal of the price level," may be proved by some
further considerations regarding relations among these same factors.
Assume a fall in the rate of interest. Then, on the capitalization
theory, prices of lands, stocks and bonds, houses, horses, and all items
of wealth which give forth their services through an appreciable period
of time, will rise, and with them the average of prices, or the general
price level, will rise.[60] If one hold the _relative_ conception of
value, according to which the value of money necessarily falls when
prices rise, because the two are merely obverse phases of the same
thing, then this rise in the price level is, _ipso facto_, a fall in the
value of money. But we have seen that a fall in the value of money
means, on the "principle of appreciation and interest," a rise in the
interest rate! Hence, we would have proved that a fall in the interest
rate causes a rise in the interest rate--which is absurd. If, however,
we recognize that prices can rise without a fall in the value of money,
if, _i. e._, we use the absolute conception of value, this difficulty
disappears. The capitalization theory and the theory of appreciation and
interest can be reconciled only on the basis of the absolute conception
of value.
The capitalization theory, then, in its present formulation, assumes
money, and a fixed absolute value of money. It is, therefore,
inapplicable to the problem of the value of money itself.
In general, none of the polished tools of the economic
analysis,--neither cost of production, the capitalization theory,[61]
nor the law of supply and demand,--is applicable to the problem of the
value of money. The reason is that they get their edge from money
itself. The razor does not easily cut the hone. It is to this fact, I
think, that we owe the widespread and long continued vogue of a theory
so crude and mechanical as the quantity theory. In the next chapter we
shall show that the utility theory of value--which we shall not
recognize as a polished tool!--has also failed to give us help in
explaining the value of money.
CHAPTER V
MARGINAL UTILITY AND THE VALUE OF MONEY
A good many writers have attempted to apply the marginal utility theory
to the value of money. Among these, I may particularly mention Friedrich
Wieser, Ludwig von Mises, Joseph Schumpeter, and, in America, David
Kinley, and H. J. Davenport.
The marginal utility theory is ordinarily merely a thinly disguised
version of supply and demand doctrine. As usually presented in the
text-books, we have an analysis of the phenomenon of diminishing utility
of a given commodity to a given individual, illustrated by a diagram, in
which the ordinates represent diminishing psychological intensities.
Often a money measure is given to these diminishing intensities, and the
curve is presented as the demand schedule of a given individual. Then,
with little further analysis, a leap is made to the market, and it is
assumed that the market demand-curve, of many individuals, differing in
wealth and character, is a utility-curve, and value in the market is
"explained" by means of marginal utility. I need not here repeat my
criticisms of this procedure.[62] It gives simply a confused statement
of the doctrine of supply and demand. The analysis of utility which
precedes the discussion of market demand is wholly irrelevant, and
merely mixes things up. That such a conception is of no use in solving
the problem of the value of money has been sufficiently indicated in the
chapter on supply and demand.
Sometimes the contention is made that money is unique among goods in
having "no power to satisfy human wants except a power _to purchase_
things which do have such power."[63] This contention, in Professor
Fisher's view, precludes the application of the marginal utility theory
to the problem of the value of money, and he makes no use of marginal
utility in his explanation. Indeed, in the passage from which this
quotation is taken, Professor Fisher says that the quantity theory of
money rests on just this peculiarity of money. Not all writers who
contend that money has no utility _per se_, however, have felt it
necessary to give up the marginal utility theory as a theory of money,
as we shall later see.
On the other hand, writers of the "commodity school" (or "metallist
school"), writers who see the source of the value of money in the metal
of which it is made, can apply the utility theory readily to the value
of money, making the value of money depend on the marginal utility of
gold, or the standard metal, whatever it is. To the writers of this
school, it is incredible that anything which has no utility should
become money. Money must be either valuable itself, or else a
representative of some valuable thing. The value of money comes from the
value of the standard of value, and that value may, so far as the logic
of the situation is concerned, be as well explained by marginal utility
as the value of anything else. Typical of this view is Professor W. A.
Scott's discussion in his _Money and Banking_[64], though the emphasis
there is not on marginal utility as the explanation of the value of the
standard, but on the value (conceived of as an absolute quantity) of the
standard as essential to the existence of money, and the performance of
the money functions. Professor Scott attacks vigorously and effectively
Nicholson's exposition of the quantity theory,[65] where the assumption
is made that money consists of dodo-bones (the most useless thing
Nicholson could think of). Most quantity theorists would share
Nicholson's view that dodo-bones would serve as well as anything else
for money--or, to put the thing less fantastically, that the substance
of which money is made is irrelevant, that the only question is as to
the quantity, rather than the quality, of the money-units, and the
quantity of the money-units, not in pounds or bushels or yards, but in
abstract number merely. For writers who seek the whole explanation of
the value of money in its monetary application, and who see that money,
_qua_ money, cannot administer directly to human wants, the view that
Professor Fisher expresses, namely, that money has no utility, and is
unique among goods in this respect, seems on the surface, to have
justification. On the surface merely, however. Money is not unique among
goods in being wanted only for what it can be traded for. Wheat and corn
and stocks and bonds and everything else that is speculated in is
wanted, by the speculators, only as a means of getting a
profit[66]--they are remoter from the wants of the man who purchases
them than the money profit he anticipates. Ginsing, in America, has
value, though consumed only in China. And there are people, particularly
jewelers, who often want money as a raw material for consumption goods.
The difference is at most a difference of degree--and of slight degree
indeed in the case of such things as bonds, which count on the "goods"
side of the quantity theory price equation, but which really are in all
cases remoter than money itself from human wants. Money really stands,
for the purpose in hand, on the same level as any other instrumental
good.[67] It does not give forth services directly, as a rule. Neither
does a machine, or an acre of wheat land, or goods in a wholesaler's
warehouse. Exchange is a productive process, an essential part of the
present process of production. Money is a tool which enormously
facilitates this process. It has its peculiarities, no doubt. One of
them is--and money is not unique in this as will later appear--that it
must have _value_ from non-monetary sources[68] before it can perform
its own special functions, from some of which it draws an increased
value. But there seems to me to be nothing in the contention quoted from
Professor Fisher, to justify setting money sharply off from all other
things, or to justify the view that marginal utility is inapplicable to
the value of money, if it be applicable to the value of anything at all
that is not destined for immediate consumption. I do not believe that
the marginal utility theory is valid for any class of goods, not even
those for immediate consumption. Where marginal utility theory is,--as
in the conventional text-book expositions--merely another name for
supply and demand theory, it is, as already shown, not applicable to the
value of money, and it is useful in the surface explanation of
market-prices of goods. But where marginal utility theory really seeks
to get at value fundamentals, it is precisely as valid for money as for
goods of other sorts--invalid, in my judgment, in both places, and for
the same reasons in both.
Among the writers who would apply the utility theory to money, while
still insisting that money, as such, has no utility, are Wieser,
Schumpeter--who accepts Wieser's theory in its main outlines--and von
Mises, who develops a notion very different from that of the other two.
Wieser's doctrines are set forth in two expositions, separated by five
years, the second representing a considerable development in his
thought, though resting in part on the first. The first is an address
upon the occasion of his accession to the professorship at the
University of Vienna, in 1904, and is published in the _Zeitschrift fuer
Volkswirtschaft, Sozialpolitik und Verwaltung_, vol. 13 entitled, "Der
Geldwert und seine geschichtlichen Veraenderungen." The second is a
discussion, partly written and partly spoken, "Der Geldwert und seine
Veraenderungen" (written), and "Ueber die Messung der Veraenderungen des
Geldwertes" (spoken), in _Schriften des Vereins fuer Sozialpolitik,
Referate zur Tagung_, no. 132, 1909. For the purpose in hand, a brief
statement of one or two points would suffice to show the futility of
Wieser's effort to get an explanation of the value of money _via_
marginal utility, but I think that readers may be interested in a fuller
account of Wieser's doctrine, just because it is Wieser's, and so shall
undertake to give a more systematic account of it. For brevity, in the
exposition which follows, I shall refer to the first article as "I," and
to the second as "II."[69]
Wieser holds that it is possible to have money wholly apart from a
commodity basis (I, p. 45), citing the Austrian _Staatsnoten_ as a case
in point. The reason for giving them up is that they do not circulate in
foreign trade. Gold fulfills its international money-functions the more
easily because of its various employments, but, after it is thoroughly
historically introduced, as money, it could fulfill its money functions
even if all these employments be thought away (46). Wieser gives no
argument for this contention, and its validity will be examined
later.[70] There are, he says, two sources for the value of gold, the
money use and the arts use, interacting. Money is further removed from
wants, not only than consumption goods, but also than production goods,
which are but consumption goods in the seed. The latter are technically
destined for definite goods. But money may be used to procure whatever
good you please, in exchange. (The absoluteness of this distinction,
also, may be questioned. Pig iron is almost as unspecialized as money in
its relation to wants, since tools enter into the production of almost
every service that human wants require, from surgical operations,
through instrumental music, to wheat and horse-shoes. On the other hand,
money is not the only thing by means of which other things are
purchased. The extent of barter in modern life will wait for later
discussion.[71] I do not think that _any_ sharp distinction between
money and all other things is valid.) Wieser complains of the older
economics which treats money as a commodity. And he contends that as
money and commodities show a contrast in their essence (_Wesen_), they
should also manifest a contrast in the laws of their values, even though
the fundamental general theory of value applies to both (I, 47). He
finds in representatives of money (_Geldsurrogate_) and in velocity of
circulation of money, factors which are lacking in commodities. (Again a
question must be interjected by the writer. Are not corporation
securities essentially like _Geldsurrogate_ from this angle? And do not
goods vary greatly in the number of times they are exchanged? What of
the speculative markets, where more sales are made in an active market,
at times, than there are commodities or securities of the type dealt in
in existence?) The value of money is essentially bound up with the
money-service. Wieser indicates that he is not talking about the
subjective value of money, but its objective value, using the popular
meaning of the term, which, he says, is not strictly logical, but is
useful: the relation of money to all other goods which are exchanged,
the purchasing power of money. This depends on goods as well as on
money. In the second article, Wieser refines and elaborates his
conception of the objective value of money, seeking to get away from the
notion of relativity which is involved in the conception of purchasing
power, and to get an absolute conception, which shall be a causal factor
in the determination of general prices, rather than a mere reflection of
them. It is to be a coefficient with the objective values of goods in
determining prices. A change in general prices may be caused by a change
in the value of money, and may be caused by a change in the values of
goods (II, p. 511). In explaining this objective value concept (which,
in its formal and logical aspects, is in many ways similar to the
absolute social value concept maintained by the present writer, though,
in the present writer's judgment, inadequately accounted for by Wieser,
so far as a psychological causal theory is concerned) Wieser objects to
the term, "objective value" which he had used in the earlier article. He
prefers "volkswirtschaftlicher Wert." (This term is perhaps best
rendered "public economic value," for present purposes, to distinguish
it, on the one hand, from individual or personal value, and, on the
other, from the social economic value concept of the present writer. At
the same time, the connotation of a communistic or authoritive value
must not be read into the term. It is, in its formal and logical
aspects, really the most common of all the value notions, and may, best
of all perhaps, be translated simply "value," or "economic value," or
"absolute value." But for the present discussion, we shall call it
"public economic value.") This public economic value, in the case of
goods, is not a mere objective relation between a good and its
price-equivalent. It is a subjective (psychological) value, like
personal value. If one wishes to call it objective value, one is using
objective in the sense of the general subjective as distinguished from
the personal individual idiosyncracy (II, p. 502). The objective
exchange value of goods (here Wieser uses "objektiver Tauschwert" as the
equivalent of his "volkswirtschaftlicher Wert" above mentioned) is the
common subjective part of the individual valuations leaving out the
remainder of individual peculiarities ("der allgemein subjective Teil
der persoenlichen Wertschaetzungen mit Verschweigung des individual
eigenartig empfundenen Restes").[72] Wieser does not seem to me to think
out clearly the distinction between absolute and relative value in this
connection. He wishes to get something more fundamental than a mere
relation between goods and money; he wishes a psychological phenomenon.
He wishes to have a value of goods which can be set over against the
value of money, the two, in combination, determining prices. And yet, he
wishes somehow to get these out of the prices themselves. "We must seek
a concept of the public economic value of money which, to be sure,
proceeds from the general price-level (_Preisstand_), but which excludes
from its content everything that comes purely from the value of goods"
(II, 511). To the public economic value of money, however, Wieser gives
no independent definition. The definition runs in terms of the values of
the goods. "The value of money rises when the same inner values (_innere
Werte_) of commodities are expressed in lower prices; it falls, when
they are expressed in higher prices" (II, 511-12). "Inner value" of
goods is not defined, but I take it that Wieser uses it as meaning
essentially the same thing as the public economic value already
described--an absolute value. (_Cf._ the usage of Menger and von Mises,
_infra_, in this chapter, with respect to the terms, "inner" and "outer"
value.) The definition is not strictly circular, perhaps, but at least
it is pretty empty. Nothing appears to give the value of money, as
distinct from its purchasing power, an independent standing. The reason
for this will later appear. It should be noted, however, that the
definition is not in terms of prices or purchasing power. Prices might
remain unchanged, in Wieser's scheme, and yet the value of money sink,
if the inner values of goods should sink.
The value of money, thus defined, is to be explained by marginal
utility. But money has no marginal utility of its own, it has no
subjective use-value, but only a subjective exchange value,--derived
from the use-value (marginal utility) of the commodity purchased with
the marginal dollar (II, 507-8). This subjective-exchange value of money
is the personal value of money, as distinguished from its public
economic value, and is the cause of the public economic value. The
personal value of money changes (1) with the volume of one's personal
income, (2) with the intensity of one's need for money, and (3) with
market prices. The personal value of money is directly influenced and
measured only in exchanges for consumption goods. Expenditures of other
kinds affect it only indirectly by leaving less for consumption
expenditures. The laborer always reckons with the personal value of
money, but not the business man, in his business calculations. As in the
case of goods, we pass from personal to public economic value (II, 509).
The personal value of money depends on the relation between an
individual's money income, and his real income, in terms of goods. The
public economic value of money depends on the money income of the
community as a whole, and its real income. (II, 516-18). Money income
grows faster than real income, through the extension of the money
economy. Money income is not, like real income, dependent on quantity.
The mere extension of the money economy increases the volume of money
income, lowers the personal value of money, lowers its public economic
value, and raises prices. Witness the effect on a rural community of
bringing it into the great market, where all costs are reckoned in money
and rising costs compel rising prices. Hence, there is a tendency for
the public economic value of money to sink, and this has been the
historical fact (I, II, 519-520.)
Criticism of this theory is almost superfluous. There are elements in
Wieser's discussion, not here presented, which have very considerable
importance, and which will be presented in a later chapter when the
criticism of the quantity theory is taken up. Wieser deals some heavy
blows to the quantity theory. But his constructive doctrine presents the
clearest possible case of the Austrian circle. The value of money
depends, not on its subjective use-value, its own marginal utility--it
has none. The value of money depends on its subjective value in
exchange, the marginal utility of the goods which are exchanged for it.
But these depend on prices. And prices depend, in part, on the value of
money itself! This circle, present in every form of the Austrian theory
which seeks a causal explanation of value and prices by means of
marginal utility,[73] though often less obviously present, is here quite
glaring. The distinction between volume of money income and quantity of
money is, on the other hand, an important one, and will be emphasized
when the quantity theory is taken up.[74] One further point in Wieser's
doctrine calls for comment. It is strange indeed to find an Austrian
seeing in a rise in money costs a _cause_ of a general rise in prices.
The Austrian doctrine is rather that rising money costs are
_reflections_ of rising general prices. Wieser's doctrine that the
extension of the money economy to rural regions, compelling the farmer
to reckon all his costs in money and so to raise his prices, has been
adequately criticised by von Mises, who points out that Wieser sees only
half the phenomenon; that eggs and butter are, indeed, higher in price
in the rural region when it comes into contact with the city, but that
they are correspondingly lower in the city from the same cause. On the
other hand, the doctrine of costs is not the whole point in Wieser's
notion of the extension of the money economy as a cause of higher
prices, and we shall deal with the doctrine again, in a different
connection.
By devitalizing the marginal utility theory, by stating it in such a way
that it makes no causal assertions, and in such a way that it leaves the
real value problem untouched, it is possible to free it from the circle
just pointed out. Schumpeter does so state it.
Schumpeter's theory of value,[75] though he attributes it to
Boehm-Bawerk, seems to the present writer to be essentially different.
Boehm-Bawerk undertakes to explain the value (objective value in
exchange) of each good by its _own_ marginal utility to different
individuals, buyers and sellers of the good--indeed, by its marginal
utility to _four_ individuals, the two "marginal pairs."[76] He sees at
points that the prices of other goods are sometimes factors, making
marginal utility give way to "subjective value in exchange," as the
determinant of an individual's behavior toward a given good in the
market--as in his much discussed overcoat illustration.[77] But
Boehm-Bawerk never gets out of the circle which this reaction of the
market-prices on the individual subjective values involves. Schumpeter
seems to rise to a higher conspectus picture, which, in form, avoids the
circle. His picture is that of a vast equilibrium, in which, instead of
attributing the market value of each good to its own marginal utility,
you explain the exchange ratios[78] of every good to every other good,
all at once, by reference to a total situation: _given_ the number of
goods of each class, given the number of individuals in the market,
given the _distribution_ of each class of goods among the individuals,
given the utility-_curves_ (not marginal utilities) of each good to each
individual, an equilibrium will be reached, through trading, in which
ratios between marginal utilities of each kind of good to each
individual are inversely proportional to the abstract ratios (ratios of
exchange) between the same goods, each measured in its own unit. The
ratios are abstract ratios, between pure numbers, so far as the market
ratios are concerned; the ratios in the mind of each individual are
concrete ratios, between marginal utilities. The scheme, thus stated,
says nothing as to the _causal_ relation between marginal utility and
market ratios; it merely states certain _mathematical_ relations between
each individual system of marginal utilities on the one hand, and the
abstract market ratios on the other. By avoiding _assertions_ as to
causation, it avoids a causal circle. In such a situation, marginal
utilities and market ratios are, in reality, alike resultants,
_effects_, of the given quantities of goods, distribution of goods,
numbers of buyers and sellers, and individual utility-_curves_--not
_marginal_ utilities. To this picture, one may add--what Schumpeter does
not add--the curves showing time-preferences of each individual for each
sort of good, and (an element which Schumpeter does include) the curves
of _dis_-utility for the individuals who produce each kind of good. The
system, it may be noted, is as good a proof of _real cost_ doctrine as
it is of utility doctrine.
Such a picture, I submit, avoids the circle which is presented in all
other formulations of the Austrian theory of value. I wish, however, to
indicate its limitations as a theory of value, and the impossibility of
any application of it to the problem of the value of money. (1) Its data
are inaccessible: nobody could possibly know all the utility-curves and
all the time-preference curves (and disutility of labor-curves, etc.) of
all goods to all individuals in, say, the United States. To explain
market ratios by utility-curves is a case of _ignotum per ignotius_, so
far as practical application is concerned. Moreover, the scheme is so
difficult to visualize that it is useless as a tool of thought--as one
will find who tries to think it through, without the aid of higher
mathematics, for ten goods, and ten persons, with unequal distribution
of wealth, and different utility curves, time-preference curves, and
disutility-curves for each kind of good to each individual. (2) The
scheme must assume smooth curves and infinitesimal increments in
consumption, which is a fiction so far as the individual psychology is
concerned. Without this assumption, the point-for-point correspondence
between individual and market ratios does not exist. It is only in
social-value curves, or in demand-curves in the big market (which are
social-value curves, expressed in money),[79] that you have, as a matter
of fact, the right to smooth out your curves. (3) The theory must assume
the frictionless static state, in which marginal adjustments are
perfectly accomplished, and equilibrium really reached. Without this
assumption, again the point-for-point inverse correspondence of market
ratios and individual ratios fails. But this makes it quite impossible
to apply the doctrine to any functional theory of the value of money, or
to bring money in any realistic way into the scheme. As will be shown
more fully in later chapters, money functions in bringing about just
the absence of friction which static theory assumes. That is what money
is _for_. The functional theory of money, therefore, cannot abstract
from friction and dynamic change.[80] It is, of course, possible, on
this scheme to pick out any one of the goods in the system, say the
1-1000th part of a horse, call it the "money-unit," and determine a set
of money-prices. These "money-prices" are already given in the scheme in
the ratios between the abstract numbers of this unit and the abstract
numbers of the units of all other goods. But this is meaningless, so far
as a theory of money is concerned. It abstracts entirely from the
_differences_ in _salability_[81] of goods, on which the theory of money
must rest. It gives us no clue to that part of the value of the
money-article which comes from its money-functions.
(4) The theory has no bearing on the problems of supply and demand.
Demand-curves are curves, not of utility, but of money-prices. They are
concerned, not with a _system_ of ratios among goods in general, but
with the absolute money-prices of particular goods, one at a time. The
modern demand-curves and supply-curves, representing the demand and
supply doctrine first made precise by J. S. Mill,[82] are concerned with
the money-prices of particular goods, and the "equation of supply and
demand"--amount supplied and amount demanded--gives an equilibrium in
which only one price is determined. Austrian theory, in Boehm-Bawerk's
hands, and in the hands of practically all adherents of the Austrian
School, including Davenport,[83] has been offered as really bearing on
the explanation of demand, and as giving a psychological account and
explanation of the demand-curve. The scheme of Schumpeter has simply no
bearing at all on this vital point. The equilibrium picture in which
_all_ goods are involved supplies no data from which to construct any of
the magnitudes above or below the margin of the demand and supply-curves
of any given good. One reason why this is so will appear from the point
made with reference to "money-prices" in the preceding paragraph. For
Schumpeter's scheme, the significance of the article chosen as "money"
would be as much a problem as anything else, when the conditions are
laid down. It would vary in the process of reaching the equilibrium. Its
ratios with all other things would, thus, fluctuate until the
equilibrium was reached. But, as we have seen, in the chapter on "Supply
and Demand," curves of supply and demand must assume a fixed
significance of the money-unit. It may be further noticed, as marking
off Schumpeter's scheme from supply and demand analysis, that in
Schumpeter's scheme, the individual is the centre of interest, and his
reactions _toward all kinds of goods_ is emphasized; whereas in supply
and demand analysis, the _good_--one good--is the centre of interest,
and the price-offers streaming toward it from all kinds of individuals
is emphasized. The two bodies of doctrine are quite distinct.
(5) The theory has no bearing on the explanation of entrepreneur
cost--money-outlay, "opportunity cost," alternative positive values, or
what not. It finds no place for the modern cost doctrine. It does not in
any way open the path to the Austrian theory of costs. Costs, for
Austrian theory, as, in general, for modern theory, are reflections of
_demand_ for the employment of the agents of production in alternative
uses. Thus, it costs a great deal to raise wheat in Illinois, because of
the rival demand for the land to produce corn. Labor costs are high in
ordinary manufacturing, because of the rival demand for labor in the
munitions factories, etc. As Schumpeter's theory can give no account of
the _demand_ for labor in the munitions factories, it follows that it
can give no account of the _cost_ of labor in the other factories.
Instead, indeed, of giving us the modern cost doctrine, we see
Schumpeter's scheme reviving the old _real cost_ doctrine, running in
terms of sacrifices in production.[84]
(6) The foregoing paragraph gives emphasis to the point with which we
started, namely, that Schumpeter's theory is not a _causal_ theory, but
merely a theory which gives mathematical relations in a static picture.
For the general theory of the Austrians, this real cost doctrine is
anathema. Values are positive. The emphasis is put on positive wants, as
_causes_ which guide and motivate industry. The _clue_ to all values is
in the values of _consumption_ goods, which are in direct contact with
the utilities which are the source of value. From the values of
consumption goods, we _derive_ the values of production goods, labor,
etc., which are goods of "second, third and fourth _ranks_" and whose
values are merely reflected from the causal marginal utilities of the
consumption goods they are destined to create. None of this causation is
brought into Schumpeter's conspectus picture. On the contrary, with the
bringing in of disutility of production, we have the doctrine of the
earlier English School revived. The equilibrium picture is as good a
proof of the one theory as of the other. If we assume the utility-curves
constant, and allow the cost-curves to vary, then causation would be
initiated by the cost-curves.[85]
(7) Such an equilibrium picture leaves untouched the vital question
which any theory must answer which means to be of practical use in
concrete situations: what are the real _variables_ in the situation, and
what factors are constant? What causes are _likely_ to produce changes
in market prices? The individual-utility curves, which in Austrian
theory are commonly treated as the only variables, except quantities of
goods,--in the strict static picture there are no variables at all!--are
really, when conceived of as individual, as growing out of the mental
processes of each individual separately, the most _constant_ factor in
the situation. For, on the principle of the inertia of large numbers,
each unit of which is moved by its own peculiar causes, changes in the
utility-curves of one man will be offset by opposite changes in the
utility-curves of another, and so the general system will remain much
where it was. Of course, if a rich man changes his curve, a poor man's
change will not offset it in the market, but this is to emphasize the
_distribution of wealth_ rather than the utility-curves. It is only when
you get changes of a sort that the individualistic psychology, and the
"pure economic" explanation factors, of the Austrians find no place for,
that you can predict a change in the general price-system. It is only
changes in fashion or mode, in general business confidence,[86] in moral
attitude toward this or the other sort of consumption or production, in
the distribution of wealth, changes in taxes and other laws--causes of a
general social character--that you can count on to produce important
changes in values. Of course, changes in the adequacies of supplies
would be taken account of on either interpretation.
(8) The scheme under consideration gives no value concept which the
economist can make any particular use of. It gives only ratios between
marginal utilities in the mind of the same individual, and abstract
market ratios. It gives no _quantitative_ value, which can be attributed
to goods as a quality,[87] a homogeneous quality of wealth by means of
which diverse sorts of wealth may be compared, funded, etc. Such a
concept is, however, necessary for the economic analysis, and Schumpeter
is driven to creating substitutes for it of various sorts, notably
_Kaufkraft_ and _Kapital_. _Kaufkraft_, as Schumpeter uses the term, is
not derived from marginal utility, but is an abstraction from the idea
of money. It is not a quantity of money alone, nor even of money and
credit, but is a fund of "abstract power," which depends not alone on
the quantity of money and credit in which it is embodied, but also on
the prices of goods.[88] This _Kaufkraft_ is needed to give the causal
"steam," the "motivating power," which the social value concept
connotes, but which ratios in the market lack. Similarly, _Kapital_ is
conceived of as an agent, a dynamic force, distinguished from
accumulations of concrete productive instruments, by means of which the
entrepreneur gets control of land, labor and instrumental goods.[89]
Other functions of the quantitative value are shouldered on a
hard-worked and unusually defined concept, _Kredit_, which leads
Schumpeter into certain "heresies"[90] regarding credit, which are
mostly harmless in themselves, but which will arouse misunderstanding
and opposition. "_Praeter necessitatem entia non multiplicanda sunt_,"
and the social value concept, which covers by inclusion the notion of
market ratio--market ratios being ratios between social values--and
which does all the work that Schumpeter attributes to _Kapital_ and
_Kaufkraft_, and most of the new work which he attributes to _Kredit_,
is to be preferred,[91] if only on grounds of intellectual economy.
"Capital" is then saved for more usual meanings, and economy in
terminology is also effected. Schumpeter also departs, as shown, from
the abstract market ratio notion in erecting a causal theory of value,
in which "marginal utility" is used as the equivalent of a quantitative
value, and is traced by the Austrian imputation process back to the
original factors of production. He even speaks of labor as having
"utility," whereas labor,[92] unless used in domestic service, has, not
utility, but only value.
In the marginal utility scheme above outlined there is no place
for money, on the assumptions laid down. It is a scheme of barter
relations. The utilities which come into equilibrium are not
subjective-exchange-values, which, as Schumpeter, with Wieser, contends,
are the only subjective values money has, but are real subjective use
values--marginal utilities. The scheme, assuming as it does, perfect
exchangeability of all goods, with infinitesimal increments in
consumption, has no place for money. There really is no money service to
be performed. Schumpeter, indeed, speaks of money as a mere "Schleier,"
which does not touch the essence of the phenomena, and such it is on his
assumptions. In a similar situation, Professor Irving Fisher gives up
the effort to find a psychological explanation of the value of
money,[93] and offers the quantity theory as a mechanical principle,
additional to the psychological barter scheme. Schumpeter, however, does
lip service still to the need for a psychological explanation. His
answer runs in Wieser's terms--indeed, he attributes it to Wieser. The
_Preis_ of money[94]--Schumpeter does not use Wieser's absolute value
concept, but lets his value of money run in purely relative terms--the
price of money in goods depends on the subjective value of money. This
subjective value of money rests on the experience of each individual in
making purchases--rests on the prices of consumption goods, determined
by the relation between real income and money income. The circle is as
clear as day.
Ludwig von Mises sees this circle, and tries to avoid it. In von Mises
there seem to me to be very noteworthy clarity and power. His _Theorie
des Geldes und der Umlaufsmittel_ is an exceptionally excellent book.
Von Mises has a very wide knowledge of the literature of the theory of
money. He has a keen insight into the difficulties involved. He
recognizes fully that, so far, the utility school has failed to solve
the problem (119-120). His theory is as follows: Individual valuations
(93) constitute the basis of the objective exchange value of money. But
while for other goods, subjective use-value and subjective
exchange-value are different concepts, for money the two coincide, and
both rest on the objective value of money (94). This seems to be our old
circle in unmistakable form, but Mises thinks he has an escape, as will
later appear. No function of money is thinkable which does not rest on
its objective exchange value. The subjective value of money rests on the
subjective use-values of the goods for which it can be exchanged (95).
Money, at the beginning of its money-functioning, must have objective
exchange value from other causes than its money-function, but it can
remain valuable, even though these causes fall away, exclusively through
its function as general instrument of exchange (111). He gives no
argument in support of this contention, but refers with approval to
Wieser (_loc. cit._), and to Simmel (_Philosophie des Geldes_, 115ff.).
Hence, the important consequence that in the value of money of to-day a
historical component is contained. Herein is to be found a fundamental
contrast between the value of money and the values of other goods
(119-120.). The individual valuation of money rests on the objective
exchange value of money of _yesterday_. This individual value of money
is the explanation, on the money side, of the objective value of money
of to-day. Going back, step by step, you come ultimately to the
subjective use-value of the money-stuff in its non-monetary
employment--a temporal _regressus_. This opens the way to a theory of
the value of money based on marginal utility. This avoids the circle of
explaining the objective value of money of to-day by the subjective
exchange value of money of to-day, which in turn rests on the
contemporary objective value of money.
I find this particularly interesting, since it employs a device which
had once suggested itself to me as a means of escape from the Austrian
circle, but which reflection led me to abandon. I have discussed the
whole matter in my _Social Value_, and therefore venture a quotation
from that book.[95]
"How are we to get out of our circle:[96] The value of a good, A,
depends, in part, upon the value embodied in the goods, B, C, and D,
possessed by the persons for whom good A has 'utility,' and whose
'effective demand' is a _sine qua non_ of A's value? The most convenient
point of departure seems to be the simple situation which Wieser has
assumed in his _Natural Value._[97] Here the 'artificial' complications
due to private property and to the difference between rich and poor are
gone, and only 'marginal utility' is left as a regulator of values. But
what about value in a situation where there are differences in
'purchasing power'? How assimilate the one situation to the other?
"A _temporal regressus_, back to the first piece of wealth, which, we
might assume, depended for its value solely upon the facts of utility
and scarcity, and the existence of which furnished the first 'purchasing
power' that upset the order of 'natural value,' might be interesting,
but certainly would not be convincing. In the first place, there is no
unbroken sequence of uninterrupted economic causation from that far away
hypothetical day to the present, in the course of which that original
quantity of value has exerted its influence. The present situation does
not differ from Wieser's situation simply in the fact that some, more
provident than others, have saved where others have consumed, have been
industrious where others have been idle, and so have accumulated a
surplus of value, which, used to back their desires, makes the wants of
the industrious and provident count for more than the wants of others.
And even if these were the only differences, it is to be noted that
private property has somehow crept in in the interval, for Wieser's was
a communistic society. And further, an emotion felt ten thousand years
ago could scarcely have any very direct or certain quantitative
connection with value in the market to-day. Even if there had been no
'disturbing factors' of a non-economic sort, the process of 'economic
causation' could not have carried a value so far. It is the living
emotion that counts! Values depend every moment upon the force of live
minds, and need to be constantly renewed. And there would have been, of
course, many 'non-economic' disturbances, wars and robberies, frauds and
benevolences, political and religious changes--a host of historical
occurrences affecting the weight of different elements in society in a
way that, by historical methods, it is impossible to treat
quantitatively.[98]
"What is called for is, not a temporal _regressus_, which, starting with
an hypothesis, picks up abstractions by the way, and tries to synthesize
them into a concrete reality of to-day, but rather, a _logical analysis_
of existing psychic forces, which shall abstract from the concrete
social situation the phases that are most significant. This method will
not give us the whole story either. Value will not be completely
explained by the phases we pick out. But then, we shall be aware of the
fact, and we shall know that the other phases are there, ready to be
picked out as they are needed for further refinement of the theory, as
new problems call for further refinement. And, indeed, we shall include
them in our theory, under a lump name, namely, the rest of the
'presuppositions' of value.
"Our reason for choosing a logical analysis of existing psychic forces
instead of a temporal _regressus_--instead, even, of an accurate
historical study of the past--is a two-fold one: first, we wish to
cooerdinate the new factors we are to emphasize with factors already
recognized, and to emerge with a value concept which shall serve the
economists in the accustomed way--it is illogical to mix a logical
analysis with a temporal _regressus_. But, more fundamental than this
logical point, is this: the forces which have historically _begot_ a
social situation are not, necessarily, the forces which _sustain_ it.
The rule doubtless is that new institutions have to win their way
against an opposition which grows simply out of the fact that we are,
through mental inertia, wedded to what is old and familiar. We resist
the new _as_ the new. Even those who are most disposed to innovate are
still conservative, with reference to propaganda that they themselves
are not concerned with. The great mass of activities of all men, even
the most progressive, are rooted in habit, and resist change. When,
however, a new value has won its way, has become familiar and
established, the very forces which once opposed it now become its surest
support. Or, waiving this unreflecting inertia of society, as things
become actualized they are seen in new relations. What, prior to
experiment, we thought might harm us, we find beneficial after it has
been tried, and so support it--or the reverse may be true. The psychic
forces maintaining and controlling a social situation, therefore, are
not necessarily the ones which historically brought it into being."[99]
Since the foregoing was written, I have found that another theorist,
Professor Alvin S. Johnson, had also given consideration to the same
idea, as a means of escape from the Austrian circle. Professor Johnson
refers to the notion briefly in his review of _Social Value_ (_Am. Econ.
Rev._, June, 1912, p. 322), holding that the doctrine is logically
tenable, though rejecting it on psychological grounds. "The value of a
thing newly created can be explained only with reference to values
antecedently existing." That there is a continuity in the value system,
as in the whole social-mental life of men, I should be the last to deny.
But it is not the antecedently existing values, _as_ antecedently
existing, that give value to the new piece of wealth. The antecedent
values function only as _persisting_, as _contemporary_ social forces.
We do not find the motivating power of existing values in the ashes of
burnt out desire! It seems to me very essential to distinguish the two
methods of approach to the problem. It is possible to state a historical
sequence--if you know it,--showing how values have historically come and
gone. But for an equilibrium picture, of the sort that our price theory
demands, where there is a mechanical balancing of contemporary factors
(as in Marshall's balls in the bowl illustration), such an account is of
no use. Existing social forces have their history. But, at a given
moment, they are what they are, and what they _were_ at a different time
adds no ounce of weight to the power they now exert. If a quantitative
account of value is called for--and price-theory is essentially
concerned with the measurement of values--we must bring measure and
measured into contemporary balance. The historical account is one
thing; the cross-section analysis is another. "Static theory" is a
mechanical abstraction from the organic cross-section picture, which, by
making it superficial, is able to make it exact.
It seems to me that this distinction must be kept clear if progress in
the science is to be made. At every point, divergent conclusions are
reached if the two view-points are merged. The distinction between
statics and dynamics is, in a general way, the same as the distinction
here made between the historical and the cross-section view. It is no
answer to the Ricardian theory of land-rent for Carey to point out that
historically, in new countries, the uplands are cultivated first, and
the more fertile river-valleys later. Ricardo is talking about statics,
and Carey about dynamics. Carey does not answer Ricardo, because he is
talking about a different problem. The utility theorist especially has
no right to leave the static view-point. All the elementary laws on
which the utility theory is based are static laws. The law of satiety,
of diminishing utility, is a static law, and the utility theorists are
careful to point out that it holds only for an individual at a given
time. It rests on nerve fatigue. Give the nerve time to rest, and
utility does not sink. On the contrary, the dynamic law of wants is that
wants expand. As old wants are satisfied, new wants arise, so that, in
the course of time, _marginal_ utilities do not sink--the competition of
new wants forces up the margins of the old wants. Moreover, with time,
tastes change, habits are formed, and the same wants may grow more
intense--as in the case of olives or whiskey. All this has been seen by
the creators of the utility theory. Thus, Wieser: "The want as a whole
of course retains its strength so long as a man retains his health;
satisfaction does not weaken but rather stimulates it, by constantly
contributing to its development, and, particularly, by giving rise to a
desire for variety. It is otherwise with the separate sensations of the
want. These are narrowly limited both in point of time and in point of
matter. Anyone who has just taken a certain quantity of food of a
certain kind will not immediately have the same strength of desire for a
similar quantity. Within any single period of want every additional act
of satisfaction will be estimated less highly than a preceding one
obtained from a quantity of goods equal in kind and amount." (_Natural
Value_, p. 9.) A similar statement is in Taussig's _Principles_ (I,
124), "In such cases, however, the tastes of the purchasers may be said
to have changed in the interval. At any given stage of taste and
popularity, the principle of diminishing utility will apply."
Illustrations could be multiplied.
It is true that _future_ marginal utilities come into the utility theory
scheme, but they come in, not as future utilities, but as "_present
worths_" of future utilities, or as "present anticipated feelings" in
Jevons' phrase[100] suffering a discount, usually, in the process. But I
am not aware of any writer among the founders of the utility school, who
has sought to bring past utilities into the scheme. The past is dead.
Its effects persist in the present only in present processes. A _memory_
is a _present_ psychological fact.
Consider further. Is it the prices of yesterday that determine the
subjective value of money to an individual, if the prices of yesterday
are different from the prices of to-day, _and the individual knows it_?
In so far as we have the clear, intelligent economic mind, seeking its
interests--and the marginal utility theory assumes this type of
mind--the tendency is to bring all the factors in the problem into the
present. If prices change slowly, so that the individual can count on
essentially the same situation to-day that he had yesterday, doubtless
he will not take the trouble to recast his value system. There is a
tremendous lot of trouble in bringing about, in the individual's mind,
the rational equilibration of values--trouble which the Austrian theory
commonly abstracts from, but which should be recognized in the analysis,
and accorded its own marginal significance in the scale. To throw the
emphasis on inertia, however, and to assume that men do not readjust
their margins to meet changed conditions, is to depart from the
fundamentals of the Austrian theory. If the price-situation is a rapidly
changing one, men do rapidly readjust their estimates of money. If money
is fluctuating rapidly in value--as, say, during a time when there is
depreciated paper money, whose future depends on military events, the
adjustments may be very rapid indeed. I quote the following from the
news columns of the _New York Times_, of April 4, 1914, p. 2: "Jaurez,
Mexico, Apr. 3.--After the hysterical outbursts last night that greeted
the news of the fall of Torreon, this city was preternaturally calm
to-day.... The silent gentleman with the dyed mustache who spins the
marble at the roulette wheel in the Jaurez Monte Carlo, conducted by
Villa's officers for the benefit of the rebel treasury, seemed the only
person who was not excited. When the crowd of players suddenly deserted
him on the sound of the bugle call of victory, he gave the marble
another whirl from sheer force of habit, but none returned.... In an
hour, however, play was faster and more furious than ever, for holders
of Constitutionalist money early realized that their currency had
suddenly increased in value, and that they were somewhat richer than
before." I do not question the fact, however, that men are slow in
making calculations, and that society is often unconscious of changed
conditions, and often readjusts less rapidly than occasion requires.
There is a vast deal of inertia, of blind habit, of custom, etc. But
emphasis on these factors is not marginal utility theory! Factors like
these are emphasized by a functional psychology, and by a social
psychology--not by an individualistic psychology which rests on the
assumption of rational calculation. It is not _past_ utilities that
explain present subjective values of money when these subjective values
are out of harmony with the present market facts, but rather _present_
habits, present customs, present disinclination to readjust, etc. There
is a big difference, psychologically, between the mental processes
through which one arrived at one's present state of mind, and the
present state of mind itself. The original "commodity utility" of the
money metal, in the far away time before the money use affected its
value, is surely no longer a factor. Certainly not on the basis of an
individualistic psychology of the Austrian type. All the individuals who
experienced that original utility are long since dead! Not even memories
of the original utilities persist.
When writing the passage in _Social Value_, quoted above, I did not
suppose that I was dealing with a notion that anyone else would ever
take seriously. My purpose in discussing it was chiefly to throw into
sharp relief the contrast between the historical and the cross-section
viewpoints, and to make clear that my own theory was based on analysis
of existing psychological forces. Since finding, however, that two
writers for whose views I have so much respect have independently
developed the same idea, and have taken it seriously, I have felt it
worth while to give it this extended consideration.
Von Mises, like Wieser, needs an absolute value of money in his
thinking. He does not call the concept by that name, but, following
Menger[101] speaks of the "inner objective value of money" and the
"outer objective value of money." (Mises, p. 132.) The latter is the
purchasing power of money, a relative concept, exactly expressed in the
price-level. The inner objective value of money is designed to cover the
causes of changes in prices which originate on the money-side of the
price relation alone.[102] This inner objective value of money performs
the same logical function in the theory of money that the absolute
social value concept of the present writer does, even though the
psychological explanation lying behind it is very different.
Von Mises considers the quantity theory at length, noting a number of
defects in it, chief of which is the fact that it has no psychological
theory of value behind it, that it does not account for the _existence_
of the value of money, and at most gives a law for _changes_ in a value
whose existence is taken for granted. The details of this criticism,
however, need not be here presented. The quantity theory is to be
treated in detail at a later point of our study.
The writer who has most definitely stated the relation of utility to the
functions of money, is David Kinley (_Money_, ch. viii). He would
explain the value of money, by (a) its utility as a commodity, and (b)
its utility in the money-employment, the employments reaching a marginal
equilibrium. The utility of the money metal in its commodity use calls
for no analysis. But what is meant by the utility of money as money?
Where the writers so far discussed have denied that money as money has
any utility, Dean Kinley finds a utility in the money-function itself:
money facilitates exchange, and exchange, by transferring goods from
those who do not need them to those who do need them, increases the
utility of those goods. Money, as money, thus produces utility.[103] The
utility of money is the extra utility which comes into being by virtue
of its use, as compared with what would exist in a state of barter. The
marginal utility of money is the utility of money in the marginal
exchange--the exchange which would be effected by means of barter if
money were any more difficult to procure. The marginal utility of money,
then, is not the whole of the marginal utility of the good for which it
is exchanged, but rather is the differential part of that utility which
is created by means of the use of money in exchange. The marginal
utility of money, thus, appears in separate services of money. Money is
a durable good, which gives forth its services bit by bit. The value of
money is based on these separate services, it is "the capitalized value
of the service rendered in the marginal exchange."
This conception is, it seems to me, much truer to the spirit of the
general marginal utility theory than the theories of Wieser, Schumpeter,
or von Mises. If the utility theory at large were valid, the application
here would be valid. To Dean Kinley's conception of a marginal utility
of the money service, I offer simply the objections which I offer to the
utility theory at large--objections indicated in what has gone before,
and in my _Social Value_. The application of the capitalization theory
to the value of money I have already discussed in a previous chapter,
and shall again consider in the chapter on "The Functions of Money."
I conclude that the marginal utility theory has not solved the problem
of the value of money. The reason, however, is simply that it has not
solved the general problem of value. The marginal utility theory, in so
far as it seeks to make marginal utility the _cause_ of value, is
circular. The effect of a given man's wants upon the value of the goods
he wants depends, not on the marginal intensity of those wants alone--a
penniless prisoner may desire a marble palace ever so intensely without
affecting its value--but also upon the value of the wealth possessed by
the individual who experiences the wants. But this is to explain value,
not by marginal utility alone, but by value as well--a circle. Or, if we
leave the standpoint of absolute values, and look at the matter in terms
of prices, the same situation presents itself. The price which an
individual is willing to pay for a good depends on his income,--which
commonly rests on prices--and on the prices he has to pay for other
goods which enter into his budget. His price-offer, expressive of the
marginal utility of a horse to him, is made with consideration of the
price of a buggy, of harness, of feed, of the wages of the servant who
cares for the horse, the price of a barn, and of the other things that
the possession of the horse involves. And not these alone: less
immediately, but still vitally, his whole budget enters. Higher prices
for theatre tickets or for food or for clothing will reduce his
price-offer for a horse. Further, his price-offer for the horse will be
tremendously influenced by his opinion as to the permanent market price
of horses. He will not be willing to pay a price for the horse which he
cannot expect to get back if he should decide later to sell the horse.
The direct influence of market price on individual demand-price is very
great indeed. Marginal utility (subjective use-value) very frequently
gives place to subjective value-in-exchange in the determination of an
individual's marginal demand-price--which means that the market controls
the individual instead of the individual controlling the market. With
sellers, it is _generally_ subjective-exchange-value, rather than
marginal utility, that determines supply-price-offer. The sellers, in so
far as they are producers, have little need for the great mass of their
stocks. They will sell them, rather than keep them, at almost any price.
The reason they ask high prices is simply that they think the market
will give them the high prices. The individual price-offers, in the
aggregate therefore, presuppose the whole market situation--presuppose a
general value and price system already fixed and determined. Each
individual price offer presupposes many other prices, though not, of
course, the whole market. Since, then, much of the market situation is
assumed in the determination of each particular price, by the Austrian
method, it is obviously circular reasoning to think that the
determination of each price separately by this method will supply data
for a summary of the market situation as a whole. In the one form in
which the utility theory avoids a circle,--that presented by Schumpeter,
and discussed in an earlier part of this chapter--it is not a causal
theory. Marginal utility is not a cause of market prices, but rather,
marginal utilities and market prices are alike resultants, effects, of
more fundamental factors. No writer[104] who has presented the utility
theory in this form has tried to apply it to the value of money, and
even if it could be so applied, it would not give a causal explanation
of the value of money in terms of marginal utility. In most of the
efforts to apply the utility theory to money, the circle becomes so
obvious that one marvels that able theorists should for a moment fail to
see it.
PART II. THE QUANTITY THEORY
CHAPTER VI
THE QUANTITY THEORY OF PRICES. INTRODUCTION
The quantity theory, in its usual formulations, is a theory, not of the
value of money, in the absolute sense of value, but of the general
price-level, the average price of goods exchanged for money. It is not a
psychological theory. It does not deal with psychological quantities, or
psychological forces. It is a mechanical theory, concerned simply with
quantities, and the relations between them. The essence of the quantity
theory comes out in the following brief statement: given a number of
units of money; given a number of units of goods to be exchanged; assume
these two numbers to be independent[105] of each other; assume all the
goods to be exchanged for all the money; then the average price will be
a simple function of the quantities of goods and of money respectively,
such that an increase in the amount of money will increase the average
price per unit of goods proportionately, if goods remain unchanged in
amount, or an increase in goods will lower the price per unit
proportionately, money being assumed to remain unchanged in amount. The
qualification is commonly added that if goods have to be exchanged more
than once, the effect is the same on prices as if there were an added
number of goods equal to the added number of exchanges, and that if
money is used more than once in exchanging a given number of goods, the
effect is the same as if there were proportionately more money. Both
quantity of goods and quantity of money are commonly defined as actual
quantity multiplied by "rapidity of circulation." Rapidity of
circulation, however, for both money and goods, is commonly thought of
as a constant, so that the original formula remains unaffected by the
qualification, so far as a prediction as to the effect of increase or
decrease of money or goods on prices is concerned. Involved in the
quantity theory, and explicitly stated by many writers, is the doctrine
that the substance of which money is made is irrelevant, that it is the
number, and not the quality or size of the money-units that counts. "In
short, the quantity theory asserts that (provided velocity of
circulation and volume of trade are unchanged) if we increase the
_number_ of dollars, whether by renaming coins, or by debasing coins, or
by increasing coinage, or by any other means, prices will be increased
in the same proportion. It is the number, and not the weight, that is
essential. This fact needs great emphasis. It is a fact which
differentiates money from all other goods and explains the peculiar
manner in which its purchasing power is related to other goods. Sugar,
for instance, has a specific desirability dependent on its quantity in
pounds. Money has no such quality. The value of sugar depends on its
_actual quantity_. If the quantity of sugar is changed from 1,000,000
pounds to 1,000,000 hundredweight, it does not follow that a
hundredweight will have the value previously possessed by a pound. But
if money in circulation is changed from 1,000,000 units of one weight to
1,000,000 units of another weight, the value of each unit will remain
unchanged." (Irving Fisher, _Purchasing Power of Money_, pp. 31-32.) To
the same effect is Nicholson's exposition, in which the money is assumed
to consist of dodo-bones, the most useless substance that Nicholson
could think of. For the quantity theory, prices are determined by the
_numbers_ of goods and dollars that are to be exchanged for one another,
and not by the _values_ of the goods and dollars;--indeed, for the
quantity theory, "value" commonly has no meaning apart from the prices
which are supposed to be adequately explained by the mechanical
relations of numbers.
In the critical study which follows, virtually every doctrine and every
assumption of this preliminary statement will be challenged. I shall
deny, first, that the quantity of goods to be exchanged and the quantity
of money to be exchanged for the goods, are independent quantities,
maintaining, rather, that an increase in either of them tends normally
to be accompanied by an increase in the other. Quantity of goods and
quantity of money _exchanged_ are not simple physical stocks, given
data. Rather, they are consequences of human choices and human
relationships, and vary from a large number of highly complex
psychological causes, many of which are common to both. I shall deny,
second, that "rapidity of circulation," either of goods or of money, is
a simple constant, independent of quantity of goods or of quantity of
money. I shall maintain, rather, that rapidity of circulation of money
is a phenomenon which calls for psychological explanation: that the
rapidity of money really means the _activities of men_; that these
activities are complex, and obey no simple law; that instead of being an
independent factor, constant, in the situation, the rapidity of
circulation of money is bound up with the quantity of money, the
quantity of goods to be exchanged, the rapidity of circulation of goods,
and the prices of the goods, and that the rapidity of circulation of
goods is likewise causally dependent on the factors named--or better, on
the causes which control them; that rapidity of circulation, whether of
money or of goods, is not a causal factor independent of prices, but
rather in part depends on prices. In the third place, I deny the
doctrine that the question as to _what_ the money-unit is made of is
irrelevant. On the contrary, I shall maintain that the _quality_ of
money, rather than its quantity, is the determining factor. I shall not
maintain that only money made of or redeemable in valuable bullion can
circulate, nor shall I maintain that the value of money depends wholly
on the value of its bullion content when money is made of valuable
metal. I recognize that value can come from other sources. But I shall
maintain that value from some source other than the monetary employment
is an essential precondition of the monetary employment, even though
recognizing that that monetary employment may, in a way later to be
analyzed, add to the original value of the money. The doctrine that only
physical quantities, or abstract numbers, of goods are relevant I shall
challenge especially, maintaining, on the contrary, that the
psychological significances, the values, of goods are the really
important thing, so that an increase in the number of one sort of goods
may have a very different effect on the average of prices from an
increase of the same number of units of some other good, and so that an
increase in the number of goods exchanged under one set of conditions
may have a very different effect on prices--or may be accompanied by a
very different movement in prices, for the question of causal relations
is a complicated one--from the change in prices that might accompany the
same increase in the amount exchanged of same goods under other
circumstances. Finally, the doctrine of the quantity theory that the
price-level is a passive result of the other factors named: quantities
of goods and money, and their respective velocities; that prices cannot
initiate a change in the situation, will also be challenged. I shall
undertake to show that the first change in the situation may appear in
prices themselves, and that the quantities of goods exchanged, and of
money, and their velocities, may then be altered to correspond with the
change in prices.
I shall further maintain, as against the whole spirit of the quantity
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. Quantity 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 "quantity 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 quantity 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 title 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
multitude of concrete facts. It is useful as a device for measuring
changes in the value of money, on the assumption that changes in the
values of goods neutralize one another. This assumption 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 quantity of money involved in a given set of exchanges. Neither
quantity of money, nor quantity of goods exchanged, nor rapidity of
circulation, nor general price-level is a simple, homogeneous quantity,
obeying definite laws.
I shall also undertake to show that in many important cases the quantity
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 assumption 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 quantity 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
quantity 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 assumption of
a fixed value of money. By the value of money I mean its absolute[108]
value, and not--what the quantity 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 quantity theory reasoning is the peculiar property of the quantity
theory school; that every valid conclusion which may be based on the
quantity 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 quantity theory, and shall undertake to show that the quantity
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 quantity 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 quantity 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 quantity theory in all the nakedness of its poverty, and I shall
present it at some length. "For simplicity," to isolate his phenomenon,
he assumes a hypothetical market, in which the following conditions
obtain: (1) No exchanges are to be made unless money (which he assumes
to consist of counters of a certain size made of dodo-bones) actually
passes 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 hoarding, _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 assumed 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 assumptions, 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 cooerdinate, in fixing the
price-level, with the volume of money. To illustrate this, he assumes
again his hypothetical market, and "dodo-bones," assuming 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 circumstances, with the same quantity 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 quantity of labour, or,
which is the same thing, the value of the produce of a greater quantity
of labour, to procure it.
"While the state alone coins, there can be no limit to this charge of
seigniorage; for, by limiting the quantity 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
quantity, 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 illustration to
throw into the sharpest relief the absence of any value from a
non-monetary employment. Nobody 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, _assigning_ 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
illustration, 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 quantitative relation can exist only between
_homogeneous_ 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 quantity 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 titles 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 title to, or claim on, or
representative of, goods in general. The notion, first, would not pass 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 quantity 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
title to things in general a somewhat more fundamental analysis, 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 assumption (_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 illustration 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 analysis 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 analysis 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 quantity 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 relationships 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. Analogous 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 justitia, 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 classical 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 quantity 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 quantity.[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 assumes. But that means that what might be true
in India, or to a less degree in Austria--countries to which the
quantity 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
circumstances,--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 assume. "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 quantity theorists! "The government is behind
it." There are plenty of men for whom that assurance 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 Constitution 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 analysis 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 quantity theorists to beg the
question at the outset, to assume money as circulating, without
realizing how much this assumption involves. The assumption involves the
further assumption 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 quantity 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 quantity, 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 quantity theory. One would have to assume
that money circulates purely from habit, without any present _reason_ at
all. The assumption must be that the economic life runs in steady
grooves, so that quantity 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 assumption is necessary. A thoroughly mechanical situation
must be assumed, 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 assumptions of the quantity 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 quantity of money? Which habits would give way,
those relating to prices, or those to velocities, or those relating to
quantities 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 quantity theory. My present purpose is accomplished in
pointing out the psychological assumptions which the quantity theory
makes: a psychology of blind habit, in a situation where the price-level
is free from control by customary prices.