and their extreme opponents. Representatives of the Metallist of
Commodity School--like Professor Laughlin, and Professor Scott in his
earlier writings--seem to deny that the money-employment has any direct
effect in increasing the value of money. The money-employment affects
the value of money only indirectly, by withdrawing the money metal from
the arts, so raising the value of the money metal, and consequently
raising the value of the coined metal. The quantity theory, on the other
hand, would utterly divorce the value of money from causal dependence on
the stuff of which the money is made. Both these views seem to me
extreme. Unless money has value from some source other than the money
employment, it cannot be used as money at all. Nobody will want it. On
the other hand, the money use is a valuable use. Exchange is a
productive process. Money, as a tool of exchange, enables men to create
values. And you can measure the value of the money service very easily
at a given time if you look at the short time "money-rates," _i. e._,
rates of discount on prime short term paper. These are properly to be
considered, not interest on abstract capital, but the rent of a
particular capital-good, namely, money. The money is hired for a
specific service, namely, to enable a man to get a specific profit in a
commercial transaction. Money is not the only good which can be thus
employed, and which is paid for for this purpose. Ordinarily a man will
pay for money for this purpose. Sometimes, however, one needs the
temporary use of something else more than one needs money, and the
holder of money pays a premium for the privilege of temporarily holding
the other thing. I refer especially here to the practice of "borrowing
and carrying" on the stock exchange. The "bear" sells stock which he
does not possess, and must deliver the stock before he is ready to close
his transaction by buying to "cover." He goes to a "bull" who has more
stock than he can easily "carry," and who is glad to "lend" the stock in
return for a "loan" of its equivalent in money. Ordinarily the bull is
glad to pay a price for the money, as it is of service to him.
Sometimes, however, the situation is reversed, and the service which the
temporary loan of the stock performs for the hard-pressed bears is
greater than the service which the money performs for the bulls, and the
payment is reversed. When the bull pays a premium to the bear, for the
use of the money, the amount paid is called "carrying charge," "interest
charge for carrying," "contango," (London) or (in Germany) "_Report_."
This is the usual case. But sometimes the bear pays the bull a premium
for the use of the stock, and the charge is then called "premium for
use," "backwardation," (London) or "_Deport_" (Germany).[125] Money is,
thus, not the only thing which has a "use" in addition to the ordinary
"uses" which are the primary source of its value.[126] In the case of
other things, however, this kind of "use" is unusual. In the case of
money it is the primary use. The essence of this use is to be found in
the employment of a quantum of _value_ in highly saleable form in
facilitating commercial transactions. Commercial transactions, in this
sense, are not limited to ordinary buying and selling. I think it best
to defer further analysis of the money service to a later chapter, on
the functions of money, which will best be preceded by a consideration
of the origin of money. For the present, it is enough to note that money
has certain characteristics which enable it to facilitate exchanges, and
to pay debts, better than anything else, and that this fact makes an
addition to its value. It is possible, I think, to measure this addition
to value rather precisely in certain cases. Thus, in the case of the
American Greenbacks, we find them at a discount, say from the beginning
of 1877 on, as compared with the gold dollar in which they were to be
redeemed in Jan. 1879. I think it safe to contend that the country was
practically free from doubt as to their redemption after the early part
of 1877. The discount steadily diminished as the time of redemption
approached. Laughlin's theory is thus far beautifully vindicated. The
central fact governing the value of the Greenbacks during this period
was the prospect of redemption. But, and here I think we see the
influence of the money-use, the discount was not as great as would have
been called for by the prevailing rate of interest, as measured by the
yield on other obligations of the Federal Government, at this time. And
the discount completely disappeared some little time before the actual
redemption. I see no cause for the absence of a discount in the later
months of 1878 except the additional value which came from the money
use. This additional value is, ordinarily, not very great. And money is
not alone in possessing it. In extraordinary circumstances it may become
quite large. Thus, in 1873, in the midst of the panic, the gold premium
fell sharply. At this time the significance of the Greenbacks as a legal
tender, a means of final payment of obligations (_Zahlungs_- or
_Solutions-mittel_), as distinguished from medium of exchange
(_Tauschmittel_), attained an unusual significance. In ordinary times,
the marginal value of this function of money sinks to zero, but in
emergencies it may become very great. In ordinary times, during the
Greenback period, uncoined gold bullion, or gold coin used, not as
money, but simply by weight in exchanges, played an important role,
competing with the Greenbacks in various employments, particularly as
bank reserves, and as secondary bank reserves, and so reducing the
marginal value of the money-employment of the Greenbacks themselves.
Gold bullion is not the only thing which can thus serve, however.
To-day, and generally, securities with a wide market, capable of being
turned quickly into cash, without loss, or capable of serving as the
basis of collateral loans, up to a high percentage of their value, have
a much higher value, for a given yield, than have other securities,
equally safe, but less well-known and less easily saleable. The
"one-house bond" (_i. e._, the bond for which only one banking house
offers a ready market) must yield a great deal more to sell at a given
price than the bond of equal security which is listed on the exchanges,
and has a wide market. Part of this is in illustration of another
function of money, the "bearer of options" function, which enables the
holder to preserve his wealth, and at the same time keep options for
increasing its amount when bargains appear in the market. Foreign
exchange performs many of these functions of money in European
countries, particularly Austria-Hungary.[127]
The notion that the whole value of gold coin rests on its bullion
content arises most easily in a situation where free coinage has long
been practiced, and where there are no legal obstacles to the melting
down of coin for other uses. Where free coinage is suspended, the
peculiar services which only money can perform--or rather, the services
which money has a differential advantage in performing--may easily lead
to an agio for coined over uncoined metal. The mere fact that coined
metal is of a definite fineness well known and attested is often of some
consequence, though the attestation of well-known jewelers may give this
advantage to metal bars as well, for large transactions. But for smaller
transactions, nothing can easily take the place of money. A high premium
on small coins, apart from redemption in standard money, may easily
arise from the money-use alone. And standard coin may well attain, in
greater or less degree, a premium. If it is scarce, as compared with the
amount of business to be done, this premium may well be greater than if
it is abundant. But that an indefinite premium is possible, or that this
premium varies exactly and inversely with the quantity, I see no reason
at all for supposing. If the premium be great enough, men, especially in
large transactions, will make use of the uncoined metal--just as they
did use gold in this country during the Greenback period. The advantages
of money are not absolute. Money is simply more convenient for many
purposes than other things. The possibility of a premium is limited by
the possibility of substitutes. It is further limited by the fact that a
high premium would awaken a distrust which would bring the premium to
destruction, by destroying trade, and so destroying the money-use on
which the premium is based.
A detailed discussion of the Indian Rupee since 1893 lies outside the
scope of this chapter. I think it may be well, however, to recognize at
this point that the limitation in the quantity of the rupee, through
abrogation of free coinage, was a factor in the subsequent rise in its
value. It was not the only factor, by any means. But it was a factor. It
may be also recognized as a factor in the value of Austrian paper money.
The doctrine just laid down, as to the influence of the money-use in
adding to the value of money, is in no sense the same as the quantity
theory. For one thing, it is easily demonstrated that the value-curve
for the uses of money is not described by the equation, _xy_ = _c_. This
curve expresses, in terms of value, the idea of proportionality which is
an essential part of the quantity theory. Put in terms of the money
market, we have a demand-curve for money, not for the long-time
possession of money, but for its temporary use--a rental, rather than a
capital value, is expressed in the price which this curve helps to
determine. This curve is highly elastic. When money-rates are low,
transactions will be undertaken which will not be undertaken when the
rate is a little higher. In the second place, the method of approach is
very different. It is not the whole volume of transactions which must
employ money, but only a flexible part. In the third place, the
money-use is here conceived of as a source, not of the whole value of
money, but only of a differential portion of that value. In the fourth
place, the argument runs in terms of the absolute value of money, and
not in terms of the level of prices.
It is not the legal peculiarity of money, as legal tender, which is
necessarily responsible for this agio when it appears. In the first
place, not all money is legal tender. In the second place, we find the
same phenomenon in connection with "bank-money" at times--I would refer
especially to the premium on the _marc banko_ of the Hamburg Girobank.
(_Cf._ Knapp, _Staatliche Theorie des Geldes_, p. 136.) The legal tender
peculiarity may, however, in special circumstances be a source of a very
considerable temporary agio.
It is possible, however, to frame a hypothetical case in which, barring
temporary emergencies, the money-use will add nothing to the value of
money, and in which the whole value of money will come from the value of
the commodity chosen as the standard of values. Assume that the standard
of value is defined as a dollar, which is further defined as 23.22
grains of pure gold. Assume, however, that no gold is coined. Let the
circulating money be made of paper. Let this paper be redeemable, not in
gold, but in silver, at the market ratio, on the day of redemption, of
silver to gold. This will mean that varying quantities of silver will be
given by the redeeming agencies for paper, but always just that amount
required to procure 23.22 grains of gold. Let us assume, further, that
the government issues paper money freely on receipt of the same amount
of silver. Assume, further, that the government bears the charges which
the friction of such a system would entail, by opening numerous centres
of issue and redemption, by providing insurance against fluctuations in
the ratio of silver to gold for a reasonable time before issue and after
redemption, meeting transportation charges, brokerage fees, etc. In such
a case, the standard of value would not be used as money at all. It
would have no greater value than it would if it were not the standard of
value--abstracting from the fact that in the one case it might be used
in its uncoined form as a substitute for money more freely than in the
other. In any case, it would form no part of the quantity of money. Its
whole value would come from its commodity significance. The value of the
paper money, however, would be tied absolutely to the value of gold. As
gold rose in value, the paper money would rise in value, and vice versa.
The quantity of money would be absolutely irrelevant as affecting its
value. The quantity of silver would be likewise irrelevant. The
causation as between quantity of money and value of money would be
exactly the reverse of that asserted by the quantity theory. A high
value of money would mean lower prices. With lower prices, less money
would be needed to carry on the business of the country. Paper would
then be superabundant. But in that case, paper would rapidly be sent in
for redemption, and the quantity of money would be reduced.[128] The
value of money would control the quantity of money. The standard of
value, which was not the medium of exchange, would control the value of
money, and so the level of prices, in so far as the level of prices is
controlled from the money side.
In this hypothetical illustration, we have the extreme case of what the
Commodity or Metallist School seems to assert. In this case, barring
temporary emergencies too acute to admit of increasing the money-supply
by the method described, their theory that the value of money comes
wholly from the commodity value of the standard, would offer a complete
explanation. I offer this illustration as the antithesis of the
dodo-bone illustration of Nicholson. That illustration sets forth the
extreme claims of the quantity theory, and purports to be a case in
which the quantity theory would work perfectly. The case illustrative of
the commodity theory clearly brings out the fact that that theory rests
on exclusive attention to the standard of value function of money. The
dodo-bone theory gives exclusive attention to, but very imperfect
analysis of, the medium of exchange function. But I submit that the
extreme case of the commodity theory, in the illustration I have given,
is a thinkable and consistent system. It would work--even though not
conveniently. Indeed, it resembles in essentials the plan actually
proposed by Aneurin Williams, and later by Professor Irving Fisher[129]
for stabilizing the value of money. Substitute a composite commodity for
gold, and gold for silver, in the illustration, and you have the
essentials of that plan. The dodo-bone hypothesis, however, as I have
been at elaborate pains to show in the foregoing, is unthinkable. It
would not work. It is, thus, possible to construct a system for which
the commodity theory would offer a complete explanation. It is not
possible to do this for the quantity theory.
But the limiting case for the commodity theory is not the actual case.
Standard money is also commonly a medium of exchange. Standard money is
particularly desirable in bank and government reserves. Its employment
in these and other ways is a valuable employment, and adds directly to
its value both as money and in the arts. There is a marginal equilibrium
between its values in the two employments. The notion that the only way
in which the money employment adds to the value of money is an indirect
one, by withdrawing gold from the arts, so lessening its supply and
raising its value there, may be proved erroneous by this consideration:
what, in that case, would determine the margin between the two
employments? What force would there be to withdraw gold from the arts at
all? Why should more rather than less be withdrawn? There must be
ascending curves on both sides of the margin. Gold money in small amount
has a high significance per unit in the money employment. A greater
amount has a smaller significance per unit. The marginal amount of gold
put to work as money has a comparatively low significance in that
employment--a significance just great enough to secure it from the
competing employments in the arts.
* * * * *
We conclude, then, that money must have value to start with, from some
source other than the money function, and that there must always be some
source of value apart from the money function, if money is to circulate,
or to serve as money in other ways. But this is not to assert the
doctrine of the commodity school, that its value must arise from the
metal of which it is made, or in which it is expected to be redeemed.
Nor is it to deny that the money function may add to the original value.
On the contrary, the services which money performs are valuable
services, and add directly, under conditions which we shall analyze more
fully in a later chapter on the functions of money, to the value derived
from non-pecuniary sources. Value is not physical, but psychical. And
value is not bound up inseparably with labor-pain or marginal utility.
CHAPTER VIII
THE "EQUATION OF EXCHANGE"
In Professor Irving Fisher's _Purchasing Power of Money_[130] we have
the most uncompromising and rigorous statement of the quantity theory to
be found in modern economic literature. We have, too, a book which
follows the logic of the quantity theory more consistently than any
other work with which I am acquainted. The book deals with the theory
more elaborately and with more detail than any other single volume, and
sums up most of what other writers have had to say in defence of the
quantity theory. Professor Fisher's book has, moreover, received such
enthusiastic recognition from reviewers and others as to justify one in
treating it as the "official" exposition of the quantity theory. Thus,
Sir David Barbour cites Professor Fisher as the authority on whom he
relies for such justification of the theory as may be needed,[131] while
Professor A. C. Whitaker declares that he adopts "without qualification
the whole body of general monetary theory" for which Professor Fisher
stands.[132] Professor J. H. Hollander has recently referred to
Professor Fisher's work on money and prices as a model of that
combination of theory and inductive verification which constitutes real
science.[133] The _American Economic Review_ presents as an annual
feature Professor Fisher's "Equation of Exchange."
Not all, by any means, of those who would call themselves quantity
theorists would concur in Professor Fisher's version of the
doctrine--Professor Taussig, notably, introduces so many qualifications,
and admits so many exceptions, that his doctrine seems to the present
writer like Professor Fisher's chiefly in name. But there is no other
one book which could be chosen which would serve nearly as well for the
"platform" of present-day quantity theorists as _The Purchasing Power of
Money_. Partly for that reason, and partly because the book lends itself
well to critical analysis, I shall follow the outline of the book in my
further statement and criticism of the quantity theory, indicating
Professor Fisher's views, and indicating the points at which other
expositions of the quantity theory diverge from his, setting his views
in contrast with those of other writers. We shall find that this method
of discussion will furnish a convenient outline on which to present our
final criticisms of the quantity theory, and parts of the constructive
doctrine of the present book.
First, Professor Fisher presents in the baldest possible form the
dodo-bone doctrine. The quality of money is irrelevant. The sole
question of importance is as to its quantity--the number of
money-units.[134] I shall not here discuss this point, as a previous
chapter has given it extended analysis, except to repeat that it is in
fact an essential part of the quantity theory. If the _quality_ of money
is a factor, a necessary factor, to consider, then obviously we have
something which will disturb the mechanical certainty of the quantity
theory. Professor Fisher is thoroughly consistent with the spirit of his
general doctrine on this point.
Second, Professor Fisher has no absolute value in his scheme. By the
value of money he means merely its purchasing power, and by its
purchasing power he means nothing more than the fact that it does
purchase: the purchasing power of money is defined as the reciprocal of
the level of prices, "so that the study of the purchasing power of money
is identical with the study of price levels." (_Loc. cit._, p. 14.) In
this, again, Professor Fisher is absolutely true to the spirit and logic
of the quantity theory doctrine. The equilibration of numbers of goods,
and numbers of dollars, in a mechanical scheme, gives prices--an average
of prices, and nothing else. Any psychological values of goods or of
dollars would upset the mechanism, and mess things up. They are properly
left out, if one is to be happy with the quantity theory. Fisher, in
discussion of Kemmerer's _Money and Credit Instruments_, has criticised
the exposition of the utility theory of value with which Kemmerer
prefaces his exposition of the quantity theory, as "fifth wheel." I
agree thoroughly with Fisher's view in this, and would add that the only
reason that it has made Kemmerer little trouble in the development of
his quantity theory is that he has made virtually no use of it there!
The two bodies of doctrine, in Kemmerer's exposition, are kept, on the
whole, in separate chapters, well insulated. Coupled with this purely
relative conception of the value of money, however, there is, in
Fisher's scheme, an effort to get an absolute out of it: the general
price-level is declared to be independent of, and causally prior
to,[135] the particular prices of which it is an average. I mention this
remarkable doctrine here, reserving its discussion for a later
chapter.[136]
A further feature of Professor Fisher's system, to which especial
attention must be given, is the large role played in it by the "equation
of exchange." This device has been used by other writers before him,
notably by Newcomb, Hadley, and Kemmerer, receiving at the hands of the
last named an elaborate analysis. But Fisher, basing his work on
Kemmerer's, has made even more extensive use of the "equation of
exchange," and has given it a form which calls for special
consideration.[137] The "equation of exchange," on the face of it, makes
an exceedingly simple and obvious statement. Properly interpreted, it is
a perfectly harmless--and, in the present writer's opinion,
useless--statement. It gives rise to complications, however, as to the
meaning of the algebraic terms employed, which we shall have to study
with care. The starting point is a single exchange: a person buys 10
pounds of sugar at seven cents a pound. "This is an exchange transaction
in which 10 pounds of sugar have been regarded as equal to 70 cents, and
this fact may be expressed thus: 70 cents = 10 pounds of sugar
multiplied by 7 cents a pound. Every other sale and purchase may be
expressed similarly, and by adding them all together we get the equation
of exchange _for a certain period in a given community_."[138] The money
employed in these transactions usually serves several times, and hence
the money side of the equation is greater than the total amount of money
in circulation. In the preliminary statement of the equation of
exchange, foreign trade, and the use of anything but money in exchanges
are ignored, but later formulations of the equations are made to allow
for them. "The equation of exchange is simply the sum of the equations
involved in all individual exchanges in a year.... And in the grand
total of all exchanges for a year, the total money paid is equal in
value to the total value of the goods bought. The equation thus has a
money side and a goods side. The money side is the total money paid,
and may be considered as the product of the quantity of money multiplied
by its rapidity of circulation. The goods side is made up of the
products of quantities of goods exchanged multiplied by their respective
prices."
Letting M represent quantity of money, and V its velocity or rapidity
of circulation, p, p', p'', etc., the average prices for the period of
different kinds of goods, and Q, Q', Q'', etc., the quantities of
different kinds of goods, we get the following equation:
MV = pQ + p'Q' + p''Q'' + etc.[139]
"The right-hand side of this equation is the sum of terms of the form
pQ--a price multiplied by the quantity bought."[140] The equation may
then be written,
MV = [Greek: S] pQ (Sigma being the symbol of summation).
The equation is further simplified[141] by rewriting the right-hand
side as PT, where P is the weighted _average_ of all the
p's, and T is the _sum_ of all the Q's. "P then represents in
one magnitude the level of prices, and T represents in one
magnitude the volume of trade."
It may seem like captious triviality to raise questions and objections
thus early in the exposition of Professor Fisher's doctrine. And yet,
serious questions are to be raised. First, in what sense is there an
equality between the ten pounds of sugar and the seventy cents? Equality
exists only between _homogeneous_ things. In what sense are money and
sugar homogeneous? From my own standpoint, the answer is easy: money and
sugar are alike in that both are _valuable_, both possess the attribute
of economic social value, an absolute quality and quantity. The degree
in which each possesses this quality determines the exchange relation
between them. And the degree in which each other good possesses this
quality, taken in conjunction with the value of money, determines every
other particular price. Finally, an average of these particular prices,
each determined in this way, gives us the general price-level. The value
of the money, on the one hand, and the values of the goods on the other
hand, are both to be explained as complex social psychological forces.
But when this method of approach is used, when prices are conceived of
as the results of organic social psychological forces, there is no room
for, or occasion for, a further explanation in terms of the mechanical
equilibration of goods and money. Professor Fisher, as just shown, very
carefully excludes this and all other psychological approaches to his
problem of general prices, and has no place in his system for an
absolute value. In what sense, then, are the sugar and the money equal?
Professor Fisher says (p. 17), that the equation is an equation of
values. But what does he mean by values in this connection? Perhaps a
further question may show what he _must_ mean, if his equation is to be
intelligible. That question is regarding the meaning of T.
T, in Professor Fisher's equation, is defined as the sum of all the Q's.
But how does one sum up _pounds_ of _sugar_, _loaves_ of _bread_, _tons_
of _coal_, _yards_ of _cloth_, etc.? I find at only one place in
Professor Fisher's book an effort to answer that question, and there it
is not clear that he means to give a general answer. He needs units of Q
which shall be homogeneous when he undertakes to put concrete figures
into his equation for the purpose of comparing index numbers and
equations for successive years. "If we now add together these tons,
pounds, bushels, etc., and call this grand total so many 'units' of
commodity, we shall have a very arbitrary summation. It will make a
difference, for instance, whether we measure coal by tons or
hundred-weights. The system becomes less arbitrary if we use, as the
unit for measuring any goods, not the unit in which it is commonly sold,
but the amount which constitutes a 'dollar's worth' at some particular
year called the base year" (p. 196). If this be merely a device for the
purpose of handling index numbers, a convention to aid mensuration, we
need not, perhaps, challenge it. The unit chosen is, in that case, after
all a fixed physical quantity of goods, the amount bought with a dollar
in a given year, and remains fixed as the prices vary in subsequent
years. That it is more "philosophical" or less "arbitrary" than the more
common units is not clear, but, if it be an answer, designed merely for
the particular purpose, and not a general answer, it is aside from my
purpose to criticise it here. If, however, this is Professor Fisher's
_general_ answer to the question of the method of summing up T, if it is
to be employed in his equation when the question of _causation_, as
distinguished from _mensuration_, is involved, then it represents a
vicious circle. If T involves the price-level in its definition, then T
cannot be used as a causal factor to explain the price-level. I shall
not undertake to give an answer, where Professor Fisher himself fails to
give one, as to his meaning. I simply point out that he himself
recognizes that the summation of the Q's is arbitrary without a common
unit, and that the only common unit suggested in his book, if applied
generally, involves a vicious circle.
What, then, is T? Perhaps another question will aid us in answering
this. What does it mean to _multiply_ ten pounds of sugar by seven
cents? What sort of product results? Is the answer seventy pounds of
sugar, or seventy cents, or some new two-dimensional hybrid? One
multiplies feet by feet to get _square_ feet, and square feet by feet to
get cubic feet. But in general, the multiplication of _concrete_
quantities by _concrete_ quantities is meaningless.[142] One of the
generalizations of elementary arithmetic is that concrete quantities may
usually be multiplied, not by other concrete quantities, but rather by
_abstract_ quantities, pure numbers. Then the product has meaning: it is
a concrete quantity of the same denomination as the multiplicand. If the
Q's, then, are to be multiplied by their respective p's, the Q's must be
interpreted, not as bushels or pounds or yards of concrete goods, but
merely as abstract numbers. And T must be, not a sum of concrete goods,
but a sum of abstract numbers, and so itself an abstract number. Thus
interpreted, T is equally increased by adding a hundred papers of
pins,[143] a hundred diamonds, a hundred tons of copper, or a hundred
newspapers. This is not Professor Fisher's rendering of T, but it is the
only rendering which makes an intelligible equation.
We return, then, to the question with which we set out: in what sense is
there an equality between the two sides of Professor Fisher's equation?
The answer is as follows: on one side of the equation we have M, a
quantity of money, multiplied by V, an abstract number; on the other
side of the equation, we have P, a quantity of money, multiplied by T,
an abstract number. The product, on each side, is a _sum of money_.
These sums are equal. They are equal because they are _identical_. The
equation asserts merely that what is _paid_ is equal to what is
_received_. This proposition may require algebraic formulation, but to
the present writer it does not seem to require any formulation at all.
The contrast between the "money side" and the "goods side" of the
equation is a false one. There is no goods side. Both sides of the
equation are money sides. I repeat that this is not Professor Fisher's
interpretation of his equation. But it seems the only interpretation
which is defensible.
A further point must be made: Sigma pQ, where the Q's are interpreted as
abstract numbers, is a summary of concrete money payments, each of which
has a causal explanation, and each of which has effected a concrete
exchange. Mathematically, PT is equal to [Greek: S] pQ, just as 3 times
4 is equal to 2 times 6. But from the standpoint of the theory of
causation, a vast difference is made. Three children four feet high
equal in aggregate height two men six feet high. But the assertion of
equality between the three children and the two men represents a high
degree of abstraction, and need not be significant for any given
purpose. Similarly, the restatement of [Greek: S] pQ as PT. One might
restate [Greek: S] pQ as PT, defining P as the _sum_ (instead of the
average) of the p's, and T as the weighted average (instead of the sum)
of the Q's. Such a substitution would be equally legitimate,
mathematically, and the equation, MV = PT equally true. [Greek: S] pQ
might be factorized in an indefinite number of ways. But it is important
to note that in PT, as defined by Professor Fisher,[144] we are at three
removes from the concrete exchanges in which actual concrete causation
is focused: we have first taken, for each commodity, an average, for a
period, say a year, of the concrete prices paid for a unit of that
commodity, and multiplied that average by the abstract number of units
of that commodity sold in that year; we have then summed up all these
products into a giant aggregate, in which we have mingled hopelessly a
mass of concrete causes which actually affected the particular prices;
then, finally, we have factorized this giant composite into two numbers
which have no concrete reality, namely, an average of the averages of
the prices, and a sum of the abstract numbers of the sums of the goods
of each kind sold in a given year--a sum which exists only as a pure
number, and which, consequently, is unlikely to be a causal factor! It
may turn out that there is reason for all this, but if a _causal_ theory
is the object for which the equation of exchange is designed, a strong
presumption against its usefulness is raised. Both P and T are so highly
abstract that it is improbable that any significant statements can be
made of either of them. As concepts gain in generality and abstractness,
they lose in content; as they gain in "extension" they lose (as a rule)
in "intension." On the other side of the equation, we also look in vain
for a truly concrete factor. V, the average velocity of money for the
year, is highly abstract. It is a mathematical summary of a host of
complex activities of men. Professor Fisher thinks that V obeys fairly
simple laws, as we shall later see, but at least that point must be
demonstrated. Even M is not concrete. At a given moment, the money in
circulation is a concrete quantity, but the average for the year is
abstract, and cannot claim to be a direct causal factor, with one
uniform tendency. Of course Professor Fisher himself recognizes that his
central problem is, not to state and justify, mathematically, his
equation[145]--that is a work of supererogation, and the statistical
chapters devoted to it seem to me to be largely wasted labor. Professor
Fisher recognizes that his central problem is to establish _causal_
relations among the factors in his equation of exchange. It is from the
standpoint of its adaptability as a tool in a theory of causation that I
have been considering it. It should be noted that "volume of trade," as
frequently used, means not numbers of goods sold, but the money-price of
all the goods exchanged, or PT. It is in this sense of "trade" that
bank-clearings are supposed to be an index of volume of trade. The
sundering of the p's and Q's really is a big assumption of many of the
points at issue. Indeed, it is absolutely impossible to sunder PT. It is
always the p aspect of the thing that is significant, Fisher himself
finally interprets T, statistically, as billions of _dollars_.[146] As a
matter of mathematical necessity, either P must be defined in terms of T
or T defined in terms of P. The V's and M and M' may be independently
defined, and arbitrary numbers may be assigned for them limited only by
the necessity that MV + M'V' be a fixed sum.[147] But P and T cannot,
with respect to each other, be thus independently defined. The highly
artificial character of T has been pointed out by Professor E. B.
Wilson, of the Massachusetts Institute of Technology, in his review of
Fisher's _Purchasing Power of Money_ in the _Bulletin of the American
Mathematical Society_, April, 1914, pp. 377-381. "Various consequences
are readily obtained from the equation of exchange, but the
determination of the equation itself is not so easy as it might look to
a careless thinker. The difficulties lie in the fact that P and T
individually are quite indeterminate. An average price-level P means
nothing till the rules for obtaining the average are specified, and
independent rules for evaluating P and T may not satisfy [the equation.]
For instance, suppose sugar is 5c. a pound, bacon 20c. a pound, coffee
35c. a pound. The average price is 20c. If a person buys 10 lbs. of
sugar, 3 lbs. of bacon, and 1 lb. of coffee, the total trading is in 14
lbs. of goods. The total expenditure is $1.45; the product of the
average price by the total trade is $2.80; the equation is very far from
satisfied." Wilson thinks it necessary, to make the matter straight, to
define T, arbitrarily as (MV + M'V')/P in which case, the equation is
true, but so obviously a truism that no one would see any point in
stating it. T no longer has any independent standing. Fisher has,
however, an escape from this status for T, but only by reducing P to the
same position. He defines P as the _weighted_ average of the p's (27),
and fails, I think, to see how completely this ties it up with T. The
only method of weighting the p's that will leave the equation straight
is to weight the different prices by the number of units of each kind of
good sold, namely, T. Thus, in Wilson's illustration, we would define P
as [(5c.x10) + (20c.x3) + (35c.x1)]/14 P is then 10-5/14 c., while T is
14. PT is, then, equal to $1.45, which is the total expenditure, or MV +
M'V'. Be it noted, here, that P is defined in terms of T, _i. e._, P is
defined as a fraction, the denominator of which is T. No other
definition of P will serve, if T is to be defined independently.
But notice the corollary. P must be differently defined each year, for
each new equation, as T changes in total magnitude, and as the elements
in T are changed. The equation cannot be kept straight otherwise.
Suppose that the prices remain unchanged in the next year, but that one
more pound of coffee, and two less pounds of sugar are sold. P, as
defined for the equation of the preceding year would no longer fit the
equation. P, as previously defined, would be unaltered, since none of
the prices in it had changed. P, defined as a weighted average with the
weights of the first year, would, then, still be 10-5/14 cents. The T in
the new equation is 13. The product of P and T is $1.34-9/14. But the
total expenditure, (MV + M'V') is $1.70. The equation is not fulfilled.
To fulfill the equation, it is necessary to get a new set of weights for
P, in terms of the new T of the new equation. From the standpoint of a
_causal_ theory, this is delightful. P is the _problem_. But you are
not allowed to _define_ the problem until you know what the
_explanation_ is! Then you define the problem as that which the
explanation will explain!
Fisher, however, appears unaware of this. At all events, he does not
mention it. And he ignores it in filling out his equation statistically,
for he assigns one set of weights to the particular prices in his P
throughout.[148]
The causal theory with which the equation of exchange is associated is
as follows: P is passive. A change in the equation cannot be initiated
by P. If P should change without a prior change in one of the other
factors, forces would be set in operation which would force it back to
its original magnitude. M and T are independent magnitudes. A change in
one does not occasion a change in the other. An increase or decrease in
M will not cause a change in V. Therefore, an increase in M must lead to
a proportionate increase in P, and a decrease in M to a proportionate
decrease in P, if the equation is to be kept straight. Changes in T have
opposite proportional effects on P.
Before examining the validity of the causal theory, and the arguments by
which it is supported, it will be best to state the more complex formula
which Professor Fisher advances as expressing the facts of to-day. The
original formula ignored credit, and ignored the possibility of resort
to barter. It also failed to reckon with certain complications which
Fisher deals with as "transitional" rather than "normal."
The formula which includes credit is as follows:
MV + M'V' = PT
Here, MV and PT have the same significance as before. M' is the average
amount of bank-deposits in the given region for the given period, and
V' is the velocity of circulation of those deposits. M, money, consists
of all the media of exchange in circulation which are _generally_
acceptable, as distinguished from those which are acceptable under
particular conditions, as by endorsement. M excludes money in bank
reserves and government vaults. Money, specifically, includes gold and
silver coin, minor coins, government paper money, and bank-notes; M'
consists of deposits transferable by check. This version would not
satisfy such a writer as Nicholson,[149] who would limit money to gold
coin, and would include in M' not only deposits, but also bank-notes,
and other credit instruments. I may suggest here, what I shall later
emphasize, that Fisher's "money," though he doubtless is using the most
common definition of money, is really a pretty heterogeneous group of
things, concerning which it is possible to make few general statements
safely. In economic essence, _e. g._, bank-notes are much more like
deposits than like gold, and if one wishes to separate money and credit,
bank-notes belong with M' rather than with M. But we must take the
theory as we find it! Again, credit is by no means exhausted when
bank-deposits are named. Why should not book-credits, and bills of
exchange be included? Why not postal money-orders, why not deposits
subject to transfer by the giro-system? M' is defined[150] as "the total
deposits subject to transfer by check," and would, thus, exclude the
giro-system of Germany. It is surely a very provincial equation of
exchange, with which Fisher and Kemmerer seek to set forth the universal
laws of money! Fisher's reason for excluding book-credits is that
book-credits merely postpone, and do not dispense with, the use of money
and checks.[151] Book-credits, unlike deposits, have no _direct_ effect
on prices (_Ibid._, 82, n.; 370), but only an indirect effect, by
increasing the velocity of money. (_Ibid._, 81-82; 370-371.)
Book-credit, indeed "time-credit" in general thus has no direct effect
on prices, and is properly excluded from the equation of exchange. These
distinctions seem to me highly artificial. In the first place, the use
of checks, in part, merely postpones the use of money: money is moved
back and forth from one part of the country to another, and from one
bank to another, to the extent that checks fail to offset one another,
and in the case of book-credit, while there is less of this offsetting,
there is a good deal of it, especially between stockbrokers in different
cities, and in small towns and at country stores, and particularly in
the South, where the country storekeeper and "factor" are also dealers
in cotton, etc., and where they advance provisions during the year to
the small farmers, receiving their pay, in considerable degree, not in
money, but in cotton, which they credit on the books in terms of money
to the customer--a point which Fisher mentions in an appendix. (_Ibid._,
p. 371.) The difference on this point is a difference in degree
merely.[152] Further, Fisher makes the same point with reference to
deposits subject to check that he makes with reference to book-credits,
namely, that their use increases the velocity of money. To say that one
has a _direct_ effect on prices, and the other only an indirect effect
is absolutely arbitrary. If buying and selling are what count, if prices
are forced up by the offer of money or credit for goods, and forced down
as the amount of money and credit offered for goods is reduced, then one
exchange must count for as much as any other of like magnitude in fixing
prices. The same is true of transactions in which bills of exchange or
other credit devices serve as media of exchange. Of course these
considerations do not render the equation of exchange, as presented by
Fisher, untrue. The equation simply states that the money and
bank-deposits used in paying for goods in a given period are equal to
the amount paid for those goods in a given period. It makes no assertion
concerning payments for other goods, and makes no assertion as to the
amount of other transactions which are paid for in other ways. General
Walker, presented with the problem of credit phenomena, simplifies the
thing even more.[153] He rules out all exchanges which are effected by
credit devices, counting only those performed by coin, bank-notes and
government paper money, and insists that the general price-level is
determined in those exchanges in which money alone (as thus defined) is
employed. His equation--if he had considered it worth while to use
one--would then have been simply
MV = PT
where T would be merely the number of goods exchanged by means of money.
One could make a similar equation, equally true, by defining money as
gold coin, and reducing T correspondingly. Is there any reason for
limiting the equation at all?[154] Is there any reason for supposing
that any one set of exchanges is more significant for the determination
of the price-level than any other set of exchanges? Does not the logic
of the quantity theory require us to include all exchanges which run in
terms of money?--If one wishes a complete picture of the exchanges, some
such equation as this would be necessary:
MV + M'V' + BV'' + EV''' + OV'''' = PT,
where B represents book-credit, V'' the number of times a given average
amount of book-credit is used in the period, E bills of exchange, and
V''' their velocity of circulation, and O all other substitutes for
money, with V'''' as their velocity of circulation. Even then we have
not a complete picture, if direct barter or the equivalents of barter
can be shown to be important.
For the present, I waive a discussion of the comparative importance of
these different methods of conducting exchanges. The situation varies
greatly with different countries. Fisher's and Kemmerer's equations are
at best plausible when presented as describing American conditions, are
much less plausible when applied to Canada and England, and are
caricatures when applied to Germany and France.
So much for the statement of the equation of exchange, except that it is
important to add that the period of time chosen for the equation is one
year. Just why a year, rather than a month or two years or a decade
should be chosen, may await full discussion till later. I shall venture
here the opinion that the yearly period is not the period that should
have been chosen from the standpoint of Fisher's causal theory, and
that it probably was chosen, if for any conscious reason at all, because
of the fact that statistical data which Fisher wished to put into it are
commonly presented as annual averages. The question now is, however, as
to the use to be made of the equation in the development of a causal
theory.
CHAPTER IX
THE VOLUME OF MONEY AND THE VOLUME OF CREDIT
John Stuart Mill, who first among the great figures in economics gives a
realistic analysis of modern credit phenomena, thought that credit acts
on prices in the same way that money itself does[155] and that this
reduces the significance of the quantity theory tendency greatly, and to
an indeterminate degree. The quantity theory is largely whittled away in
Mill's exposition of the influence of credit. In Fisher we have a much
more rigorous doctrine. The quantity of money still governs the
price-level, because M governs M'. The volume of bank-deposits depends
on the volume of money, and bears a pretty definitely fixed ratio to it.
Just how close the relation is, Professor Fisher does not say, but the
greater part of his argument, especially in ch. 8,[156] rests on the
assumption that the ratio is very constant and definite indeed. At all
events, the importance of the theory, as an explanation of concrete
price-levels, will vary with the closeness of this connection, and the
invariability of this ratio. It is not too much to say _that the book
falls with this proposition_, to wit, that M controls M', and that there
is a fixed ratio between them. We would expect, therefore, a very
careful and full demonstration of the proposition, a care and fullness
commensurate with its importance in the scheme. But the reader will
search in vain for any proof, and will find only two propositions which
purport to be proof. These are: (1) that bank reserves are kept in a
more or less definite ratio to bank deposits; (2) that individuals,
firms and corporations preserve more or less definite ratios between
their cash transactions and their check transactions, and between their
cash on hand and their deposit balances.[157]
If these be granted, what follows: the money in bank-_reserves_ is no
part of M! M is the money in circulation, being exchanged against goods,
not the money lying in bank-vaults![158] The money in bank-vaults does
not figure in the equation of exchange. As to the second part of the
argument, if it be granted, it proves nothing. The money in the hands of
individual and corporate depositors is by no means all of M. It is not
necessarily the greatest part. The money in circulation is largely used
in small retail trade, by those who have no bank-accounts. A good many
of the smallest merchants in a city like New York have no bank-accounts,
since banks require larger balances there than they can maintain.
Enormous quantities of money are carried in this country by laborers,
particularly foreign laborers. "The Chief of the Department of Mines of
a Western State points out that when an Italian, Hungarian, Slav or Pole
is injured, a large sum of money, ranging from fifty dollars to five
hundred or one thousand, is almost always to be found on his person. A
prominent Italian banker says that the average Italian workman saves two
hundred dollars a year, and that there are enough Italian workmen in
this country, without considering other nationalities, to account for
three hundred million dollars of hoarded money."[159] I do not wish to
attach too great importance to these figures, taken from a popular
article in a popular periodical. It is proper to point out, too, that
these figures relate to hoarded money, rather than to M, the money in
circulation. But in part these figures represent, not money absolutely
out of circulation, but rather, money with a sluggish circulation. And
they are figures of the money in the hands of poor and ignorant elements
of the population. Outside that portion of the population--larger in
this country than in any other by far[160]--which keeps checking
accounts, are a large body of people, the masses of the big cities, the
bulk of rural laborers, especially negroes, the majority of tenant
farmers, a large proportion of small farm owners, especially nominal
owners, and not a few small merchants in the largest cities, who have no
checking accounts at all. A very high percentage of their buying and
selling is by means of money. Kinley's results[161] show that 70% of the
wages in the United States are paid in cash, and, of course, the
laborers who receive cash pay cash for what they buy. (Not necessarily
at the _time_ they buy!) Money for payrolls is one of the serious
problems in times of financial panics.[162] To fix the proportion
between money in the hands of bank depositors and non-depositors is not
necessary for my purposes--_a priori_ I should anticipate that there is
no fixed proportion. But it is enough to point out that money in the
hands of depositors is not the whole of Fisher's M. Of what relevance is
it, then, to point out, even if it were true, that an unascertainable
portion of M tends to keep a definite ratio to M', when the thing to be
proved is that the _whole_ of M tends to keep a definite ratio to M'?
Fisher's argument is a clear _non-sequitur_. If it proves anything, it
proves that a sum of money,[163] not part of M, and another sum of
money, an unknown fraction of M, each independently, for reasons
peculiar to each sum, tends to keep a constant ratio to M'. This gives
us _l'embarras des richesses_ from the standpoint of a theory of
causation! Two independent factors, bank-reserves and money in the hands
of depositors, each tending to hold bank-deposits in a fixed ratio, and
yet each moved by independent causes! By what happy coincidence will
these two tendencies work together? Or what is the causal relation
between them? And if, for some yet to be discovered reason, Professor
Fisher should prove to be right, and there should be a fixed ratio
between M as a whole and bank-deposits, would it not indeed be a miracle
if all three "fixed ratios" kept together? Bank-deposits, indissolubly
wedded to three independent variables[164] (independent, at least, so
far as anything Professor Fisher has said would show, and independent
in large degree, certainly, so far as any reason the present writer can
discover), must find their treble life extremely perplexing. May it not
be that Professor Fisher has pointed the way to the real fact, namely,
that bank-deposits are subjected to a multitude of influences, no one of
which is dominant, which prevent any fixed ratio between bank-deposits
and any other one thing? At a later point, I shall maintain that this
is, indeed, the case.
Be it noted further, however, that even if we grant a fixed ratio, on
the basis of Fisher's argument, between M and M', Fisher has offered no
jot of proof that the causation runs from M to M'. He simply assumes
that point outright. "Any change in M, the quantity of money in
circulation, _requiring as it normally does a proportional change in
M'_, the volume of deposits subject to check." (_Ibid._, p. 52, Italics
mine.) For this, no argument at all is offered. A fixed ratio, so far as
causation is concerned, might mean any one of three things: (a) that M
controls M'; (b) that M' controls M; (c) that a common cause controls
both. Fisher does not at all consider these alternative possibilities. I
shall myself avoid a sweeping statement as to the causal relations among
the factors in the equation, because I do not think that any of the
factors is homogenous enough, as an aggregate, to be either cause or
effect of anything. But if a generalization concerning these magnitudes
were required, I should be disposed to assert that the third alternative
is the most defensible, and that to the extent that M and M' vary
together it is under the influence of a common cause, namely, PT! That
is to say, that the volume of bank-deposits and the volume of money tend
to increase or decrease in a given market--and Fisher's theory is a
theory of the market even of a single city[165]--_because of_ increases
or decreases in PT (considered as a unitary cause rather than as two
separate factors) in that market. But I shall not put my proposition in
quite that form, as I find the factors in the equation of exchange too
indefinite for satisfactory causal theory.
So much for the validity of Fisher's argument, assuming the facts to be
as he states them. Are the statements correct? Do banks tend to keep
fixed ratios between deposits and reserves? Do individuals, firms, and
corporations tend to keep fixed ratios between their cash on hand and
their balances in bank? Regarding this last tendency, Professor Fisher
says in a footnote on p. 50, "This fact is apparently overlooked by
Laughlin." I think it has been generally overlooked. I have found no one
who has discovered it except Professor Fisher. Certainly no depositor
whom I have consulted can find it in his own practice--and I have put
the question to "individuals, firms, and corporations." The further
statement which Professor Fisher adduces in its support does not prove
it, namely, that cash is used for small payments, and checks for large
payments.[166] It would be necessary to go further and prove that large
and small payments bear a constant ratio to one another, and further,
that velocities of money and of bank-deposits employed in these ways
bear a constant relation. If Fisher has any concrete data, of a
statistical nature, to support the doctrine of a constant ratio between
bank-balance and cash on hand in the case of individual depositors, he
has failed to put them into his book. Nor is there any statistical
evidence offered in the case of banks. It should be noted here that
finding a general average for a whole country or community would not
prove Fisher's point. General averages give no concrete causal
relations. Fisher's argument, moreover, starts with individual banks and
individual deposit-accounts (pp. 46 and 50) and generalizes the
individual practice into a community practice. He would have to offer
data as to individual cases.
While general averages could not _prove_ the contention of a constant
ratio between reserves and deposits for individual banks, general
averages can _disprove_ the contention. A constant general average would
be consistent with wide variation in individual practices, on the
principle of the "inertia of large numbers." But if the general average
is _inconstant_, it is impossible that the individual factors making it
up should be constant. This disproof is readily at hand, both for the
ratio of deposits to reserves in the United States, and for the ratio of
demand obligations to reserves among European banks (most of which do
not make large use of the check and deposit system).
For the United States, from 1890 to 1911, taking yearly averages, we
have a variation in the ratio of reserves to deposits of over 73% of the
minimum ratio. The ratio was 26% in 1894, and 15% in 1906. "The
juxtaposition of these extreme variations shows how inaccurate is the
assumption that the deposit currency may be treated as a substantially
constant multiple of the quantity of money in banks."[167] For New York
City, the annual average percentage of reserves of Clearing House banks
to net deposits varies from 24.89% in 1907 to 37.59% in 1894.[168] The
extreme variations[169] in weekly averages are (for the sixteen years,
1885-1900) 20.6% in August, 1893 and 45.2% in February, 1894. These
figures are extreme, since the number of occurrences is small for them,
but there are numerous occurrences of deviations from the mean as wide
apart as 24% and 42%.[170] The yearly fluctuation in all these ratios is
very great.
The ratio of money held by the banks and money held by the people also
shows wide variation, and considerable yearly fluctuation. There is a
further complication, for the United States, of varying proportions of
the total monetary stock held by the Federal Treasury. As between the
banks and the public, the banks held about a third in 1893 (average for
the year), and nearly half in 1911.[171] Whatever may be the relations
between money in the hands of the people, money in banks, and volume of
deposits, in "the static state," there is no statistical evidence
whatever to justify the notion of fixed relations among them in real
life.[172] We shall later show that there can be no static laws whatever
governing the relations of credit and reserves.[173]
For European banks, the case is equally clear. European bankers deny
any intention of keeping any definite reserve ratio. This appeared very
clearly in the "Interviews" obtained for the Monetary Commission with
leading European bankers.[174] The Banque de France increased its gold
reserves, between 1899 and 1910, by 75%, but increased its discounts and
advances during the same period by only 5%.[175] J. M. Keynes[176]
points out that the reserves of the great banks of the world, and of
Treasuries which act as central banks, have absorbed an enormous part of
the gold produced in the fifteen years before the War, increasing their
holdings from about five hundred million pounds sterling in 1900 to one
billion pounds sterling at the outbreak of the War. "The object of these
accumulations has been only dimly conceived by the owners of them. They
have been piled up partly as the result of blind fashion, partly as the
almost _automatic consequence_, in an era of abundant gold supply, of
the particular currency arrangements which it has been orthodox to
introduce.... The ratios of gold to liabilities vary very extremely from
one country to another, without always being explicable by reference to
the varying circumstances of those countries.... The contingencies,
against which a gold reserve is held, are necessarily so vague that the
problem of assessing the proper ratio must be, within wide limits,
indeterminate. It is natural, therefore, that bankers, who must act one
way or the other, should often fall back on mere usage or accept _that
amount of gold as sufficient_ which, _if they are chiefly passive, the
tides of gold bring them_. [Italics mine.] At any rate, the management
of gold reserves is not yet a science in most countries. There is no
ideal virtue in the present level of these reserves. Countries have got
on in the past with much less, and under force of circumstances could do
so again."
It will be noticed that Keynes, in the passage cited, is speaking of
_gold_ reserves, while Fisher's contention relates to all kinds of money
available for reserves, which in this country would include gold, silver
dollars, greenbacks, and, for many State banks, the notes of national
banks. He is also talking of the relation of reserves to demand
_liabilities_, which for most great European banks are primarily notes,
rather than of reserves to deposits. But as an exposition of the theory
of the ratio of reserves to deposits (the chief liability of American
banks), it is applicable to American conditions, and as a statement of
the facts, it of course gives a basis for testing Fisher's doctrine
generally. I do not think that Fisher's fixed ratio, as between reserves
and deposits, or even the ratio which more moderate quantity theorists
might seek to find between gold and demand liabilities, will find any
justification in the facts of banking history.[177]
A factor which has developed on a grand scale in recent years has tended
still further to weaken any tendency that may be supposed to exist
toward a fixed ratio between money-reserves and demand-liabilities. I
refer to the gold exchange-standard, in India, the Philippines, and
elsewhere, and to the practice of the great banks of the continental
countries of Europe, particularly the Bank of Austria-Hungary, of
holding foreign gold bills, rather than gold exclusively, as reserve to
cover note issue. In the case of the Austro-Hungarian Bank, which has
carried this practice to the extreme, all possibility of a fixed ratio
between gold reserves and demand-liabilities has vanished. The ratio is
highly flexible. When bills are cheap, _i. e._, when the exchange is "in
favor" of Austria-Hungary, the Bank buys bills with gold; when bills
are high, when the exchanges have turned "against" Austria-Hungary, the
Bank sells bills for gold. Commonly, the holder of a note of the
Austro-Hungarian Bank does not ask for it to be redeemed in gold, but in
foreign exchange. The reason for this practice on the part of the Bank
is primarily economy. A large holding of gold would represent idle
capital--a heavy burden for the Bank of a debt-ridden and poorly
developed country. Foreign bills, however, serve equally well for
maintaining the value of the bank-notes, and at the same time bear
interest.[178] A similar practice has been employed by the Reichsbank,
by the National Bank of Belgium,[179] by virtually all the debtor
countries of Europe, and the great trading countries of Asia.
Confidence in these conclusions is much increased by a study of the
views of Professor Taussig.[180] Professor Taussig is, in his initial
formulations of his doctrine, a quantity theorist. In a situation where
only money is used, credit being excluded, in effecting exchanges, he
would hold that the quantity theory correctly accounts for prices. He is
fond of the old formulation, as a first approximation, even in dealing
with the complex facts of modern banking. But he does not dodge the
complex facts, and his theory becomes, substantially, first, a general
formula, and second, an elaborate body of qualifications and exceptions,
the latter making up the major part of the theory. His doctrine
regarding the relation of money and credit is as follows: there is, in
the long run, a real _limitation_ on elastic credit instruments in the
quantity of _specie_. (This is very different from the assertion that
there is a _fixed_ ratio between _deposits_ and _money_ in circulation,
including paper, bank-notes, etc., in money. The present writer has no
quarrel with the doctrine that the gold supply of the _world_ imposes
_outside_ limitations on the _possible_ expansion of credit.) The
limitation, Taussig holds, comes in two ways: (1), in the connection
between prices in any one country, and prices in the world at large;
(2), in various links of connection between the volume of deposits (and
of notes elastic like deposits) and the quantity of specie. I shall
consider at a later point the relation between prices in different
countries.[181] I shall there maintain that the quantity theory, which
explains gold movements on the basis of price-_levels_ in different
countries, is inadequate; that not price-levels, but particular prices,
of goods most available for international trade, are of primary
importance, and that of these particular prices, one, namely the "price
of money," or the short time money-rate, is most significant of all. For
the present, I wish to analyze the linkages which Taussig finds between
elastic credit instruments and specie, and to see how far they would go,
not in proving Taussig's point (with which I have little quarrel) but in
proving Fisher's contentions. The points involved are: (a) _Direct
necessity_ constrains the bankers to keep _some_ cash on hand.[182] This
fixes a _minimum limit_ (Taussig's contention), but does not at all
suggest a "normal ratio" (Fisher's contention). (b) _Binding custom_, as
to the proper amount of reserve that banks should carry, particularly
important in connection with the Bank of England, but also in evidence
in the Banque de France and the Reichsbank. Here again, however,
minimal, rather than fixed, ratios are suggested. Limitations on the
_expansion_ of credit these customs may impose, but they by no means
determine a normal, or average amount of credit expansion--in England
least of all, since there is so large a flexible element in the deposits
of the Joint Stock Banks, whose reserves are largely secret. The
statement _supra_ quoted from Keynes, together with the testimony of
European bankers, may be considered in connection with this point, also,
as to the factors determining the reserve policies of the great European
banks. The extent to which custom really binds is doubtful. (c) _Direct
regulation by law_, peculiar to the United States. Here again, a
minimum, rather than a fixed ratio, is indicated. Some _limitation_ on
credit expansion by the banks is caused by this at times, but Fisher's
argument would require vastly more. (d) _The interaction in the use of
deposits, notes, and other constituents in the circulating medium._ The
point involved here is that different kinds of business call for
different kind of media. Small retail business is not done with hundred
dollar bills, nor are stocks and bonds bought with pennies. Limiting the
size of bank-notes to five pounds in England compels the use of a large
amount of gold for smaller transactions, and keeps a larger amount of
gold in use than would otherwise be the case. Expanding business draws
cash from the banks for circulation, trenching on reserves. That
Professor Taussig has a point here is not to be doubted, but how closely
it limits the expansion of credit will depend on the degree to which
different kinds of media of exchange really _are_ thus specialized. In a
country like the United States, where checks may be used for virtually
any transaction of over a dollar, and where small change for less than a
dollar will be increased by the Government to meet the demands of trade,
the point would not seem to involve a practically serious limitation.
Finally, Professor Taussig recognizes a coefficient with the quantity of
specie in the _temper of the business community_. Whether or not
deposits are to expand, depends not only on reserves, but also on the
attitude of borrowers.
Taussig concludes: "Thus there is only a rough and uncertain
correspondence of bank expansion with bank reserves; much play for ups
and downs which have no close relation to the amount of cash in bank
vaults, _and still less direct relation to the amount of money afloat in
the community at large_. Where bank media, whether in the form of
deposits or notes, are an important part of total purchasing power, the
connection between general prices and quantity of 'money' is irregular
and uncertain." (Italics mine.)
This conclusion would be of little service in supporting Fisher's
rigorous contentions! Our constructive theory concerning the relations
of reserves and deposits, or reserves and demand liabilities, must wait
for later discussion, in the chapter on "Bank Assets and Bank Reserves"
in Part III. It will there be maintained that there are no "normal" or
"static" laws governing the percentage of reserves to demand
liabilities, or to deposits, that the reserve function of money is a
_dynamic_ function, and that its whole explanation must be found in
dynamic considerations. For the present, I am content to have analyzed
two widely divergent views, one the extreme view of Professor Fisher,
representing the quantity theory in its utmost rigor, and the other, the
view of Professor Taussig, who virtually surrenders the quantity theory
in complex modern conditions.
In between these two writers, verging more toward Fisher than toward
Taussig, will be found, with great individual variation, the rest of the
quantity theorists. The quantity theory, as an instrument of prediction,
becomes important only to the extent that Fisher's view is maintained.
CHAPTER X
"NORMAL" VS. "TRANSITIONAL" TENDENCIES
The Quantity Theory, as a causal theory, is, then, little altered by the
passage from a hypothetical, creditless economy to the actual world,
where a vast deal of credit is used,--particularly in Professor Fisher's
hands. Of the different kinds of credit, only deposits subject to check
are recognized as directly influencing prices, and deposits subject to
check are controlled by the volume of money. The causal theory[183]
remains, then, as follows: if M be increased, it will increase M'
proportionately; it will not change the V's; it cannot increase T; to
keep the equation straight, therefore, P must rise in proportion to the
rise in M. A decrease of M, reducing M' proportionately, leaving V's and
T unchanged, must proportionately reduce P. P is passive. A change in P
cannot sustain itself, unless it be due to a prior change in T, the V's,
M or M'.
This theory is set forth with the qualification that these effects are
the "normal" effects of the changes in question. The proportion between
quantity of money and price-level is not strictly maintained during
"transition periods." I now approach the most difficult question which I
shall have to answer as to the meaning of Fisher's terms. The same
problem arises for all quantity theorists. Precisely what is the
distinction between "transition periods" and "normal periods"? What
limitations and qualifications does he admit to the rigorous statement
of his theory so far given? I may first express the opinion that the
line shifts greatly in his own mind, or at least shifts greatly in the
exposition. I do not find an explicit statement in which definitions are
given. The matter is chiefly discussed by Fisher in ch. 4,[184] which is
called "Disturbance of Equation and of Purchasing Power during
Transition Periods." There we find, as I have stated, no definitions,
but the initial statements would suggest the following: a transition
period is the period following a change in any one of the factors in the
equation during which a readjustment among all the others is taking
place; the normal period is the period preceding such a change, or
following the transition after such a change, and is characterized by
the fact that all the factors are at rest, in stable equilibrium.
Equilibria during transition periods are unstable. During the
transition, the relations among the factors vary: M and M' need not keep
their fixed ratio; P need not be wholly passive; M and P need not keep
the same proportion. But until M and M' get back into the normal ratio,
until P becomes proportional to M (in the proportion prior to the
initial disturbance), there is no rest; the equilibrium is unstable. How
long is a transition period? How realistic is the notion of a transition
period? Is the transition period a theoretical device, to aid in
isolating causes, or is it supposed to be a real period in time? Is the
normal period a real period in time, or is it merely a theoretical
hypothesis? It is not easy to answer these questions. Thus (p. 72) the
seasonal fluctuations are declared to be "normal and expected," and, at
the same time, one gets the impression that Fisher considers them
illustrations of his "transitions," in which the normal theory does not
strictly hold (pp. 72, 169). What is described chiefly in the chapter on
transition periods is the business cycle--a theory of the business
cycle, based primarily on the notion that the failure of interest to
rise as fast as prices rise causes the "boom," and that the draining of
bank reserves precipitates the crisis. I shall not discuss this theory,
as a theory of business cycles, further than to say that Wesley
Mitchell's study would indicate that the interest rate is a minor
factor, and that, while as a theoretical possibility, the drains on bank
reserves may check prosperity if something else doesn't do it first,
practically something else always does come in ahead, so far as his
studies have gone.[185] My interest here is primarily in seeing the
limitations Fisher imposes on his theory, and the qualifications he
admits. If the business cycle is the typical transition period, during
which his normal theory doesn't hold, when does the normal theory hold?
When are the "normal periods"? There is no concrete period during which
prices are neither rising nor falling, during which no important changes
are taking place among the factors.[186] At times, Fisher seems to
indicate that the normal period is imaginary (pp. 56, 159). Is, then,
the contrast between a realistic "transition period" and a hypothetical
"normal period" or are both hypothetical? Is the equation of exchange,
too, a mere hypothesis? It should be, if it is to set forth a merely
hypothetical theory. But no, Fisher insists on putting concrete data
into it, and, indeed, gives an elaborate statistical "proof" of the
equation. It, at least, is realistic. I confess that my certainty as to
Fisher's meaning grows less, as I study his book with greater care. If
the typical transition period be the business cycle, then the normal
period could come only once, say, in ten years--or whatever period,
regular, or irregular, one chooses to assign to the business cycle. The
concrete price-levels for the greater part of the time are then
surrendered to other causes. And the one-year cycle described in the
equation of exchange is quite irrelevant. The equation of exchange
should cover the whole business cycle, to fit in with the theory.
Indeed, a realistic equation of exchange would then have no meaning at
all, as the average price-level during the business cycle, played upon
by a host of causes other than the factors described in the quantity
theory, would not be the same as the average price-level which _would
have_ obtained had only the "normal" causes been in operation.[187]
The distinction between "normal" and "transition" _periods_ suggests a
dangerous fallacy: namely, that during one period one sort of causation
is working, with the other in abeyance. In fact, whatever causes there
are are working all the time. The only legitimate thing is to abstract
from one set of causes, and see what the other set, if left to
themselves, will bring about. But this sort of abstraction has many
dangers, one of which is that the causes abstracted from are frequently
thought of as non-existent. The chemist, in his laboratory, can in
actual physical fact abstract impurities from his chemicals, and see
what they will do. He can even perform experiments in what is
practically a vacuum. But the economist has no right to _think in
vacuo_! All that he has a right to do is to assume the factors which he
does not wish to study _constant_. And even that he must not do if (1)
changes in the factors which he wishes to study do in fact lead to
changes in the factors abstracted from, or (2) if the factors which he
wishes to study can only change _because_ of prior or concomitant
changes in the factors from which he is abstracting. Is it, for example,
legitimate to assume an increase in M' apart from its usual
accompaniment, an increase in PT?
The notion, too, that causation can be seen in a state of stable
equilibrium should be critically analyzed. Causation is only _revealed_
by a _course of events_, when mechanical causation is involved. The
relation of cause and effect may be a contemporaneous relation in fact,
and it is possible, where conscious, psychological phenomena are
involved, to discern causal relations among the elements in a mental
state by direct introspection. It is the not uncommon practice, also, in
the theory of mechanics, or in theoretical economics, where the method
of investigation is deductive rather than inductive, to abstract from
the temporal sequence, and to construe causal relations as timeless,
logical relations. But even here, the cause of a _change_ in the general
situation precedes the change in time, and it is only by abstraction
that the time element is left out. If there is no question as to the
causal relations, this abstraction is legitimate, but if all that one
knows about the situation be that in a stable equilibrium certain
constant ratios obtain, then the question as to which term in the ratio
is cause and which is effect remains unanswered. In Fisher's situation,
then, assuming that it be true--which I shall deny--that the only stable
equilibrium is that which the normal theory requires, it still remains
true that the causal relations among the factors can only be revealed by
a study of the transitions, by seeing the temporal sequence of changes
in the factors of the equation. Even if it be granted that M, M' and P
tend to keep a constant relation to one another, the quantity theory
falls if, for instance, it can be shown that a change may first occur in
P, spread to M', and finally reach M last of all, leading to a new
normal equilibrium which is stable. I shall later show cases of this
sort.[188]
The abstract formulation of Fisher's contrast will not, I believe, give
us an answer as to the extent to which he thinks his quantity theory
realistic. I find myself particularly in genuine uncertainty as to the
point mentioned above: would an actual equation of exchange for the
whole business cycle, made up of the averages of M, M', V, V', P and T
for the whole period, exhibit the "normal" relations among these
factors? Or would this "normal" relation only emerge concretely at some
moment of time in the course of the cycle when the abnormal causes
affecting the price-level happened to offset one another? Or is it true
that no actual figures which might be found, either for a moment of
time, or as averages for any given period, will exhibit the relations
required, and that only a hypothetical equation, based on the figures
for M, M', V, V', P and T that _would have been realized_ had there been
no "disturbing" causes, will show these "normal" relations? If, as
Fisher at times indicates--as in his reference to Boyle's Law (p.
296)--he is stating only an abstract tendency, which may be neutralized
by other tendencies in the situation, so far as concrete results are
concerned, then it is this last doctrine which we must take, and the
concrete equation of exchange has little if any relevance. If, moreover,
this last interpretation be given, then the whole of Fisher's elaborate
statistical "proof" is pointless. The only sort of statistical proof
which would be relevant would be of a much subtler sort, not a mere
filling out of the equation of exchange by means of annual figures, but
an effort to disentangle and measure the _importance_ of his tendency,
as compared with other tendencies. But we have the other tendencies
merely mentioned in qualitative terms, and we never find any definite
statement, of mathematical character, as to how important they are.
It seems pretty clear, however, that on the whole, despite occasional
suggestions that his theory is abstract, Fisher means his theory to be
the overwhelmingly important point in the explanation of actual
price-levels. He is particularly insistent on the high degree of the
generality of his contention that P is passive. Thus: "So far as I can
discover, _except to a_ LIMITED _extent during transition periods, or
during a passing season_, (_e. g._, _the fall_) (capitals mine, italics
Fisher's), there is no truth whatever in the idea that the price-level
is an independent cause of changes in any of the other magnitudes, M,
M', V, V', or the Q's."[189] On p. 182 he enumerates in a series of
propositions his general normal theory, and adds, as the first sentence
of proposition 9: "Some of the foregoing propositions _are subject to_
SLIGHT _modification during transition periods_." (Italics and capitals
mine.) And the general drift of the argument, particularly in chapter 8,
where the heart of Fisher's causal theory is presented, would indicate
that the concessions he is disposed to make are very slight, indeed.
The question as to how long a _time_ is required, in Fisher's view, for
a transition to occur, and for his normal tendencies to dominate, is
nowhere made clear. The quantity theory, in the hands of some writers,
is a very long run theory, for others, it is a short run theory. Thus,
Taussig would make the "run" exceedingly long.[190] Mill makes it a
short run theory. "It is not, however, with ultimate or average, but
with immediate and temporary prices, that we are now concerned. These,
as we have seen, may deviate widely from the standard of cost of
production. Among other causes of fluctuation, one we have found to be,
the quantity of money in circulation. Other things being the same, an
increase of the money in circulation raises prices, a diminution lowers
them. If more money is thrown into circulation than the quantity which
can circulate at a value conformable to its cost of production, the
value of money, so long as the excess lasts, will remain below the
standard of cost of production, and general prices will be sustained
above the natural rate."[191] I pause to note that it is really strange
that a single name should describe theories so different, resting on
such essentially different logic. Long run or short run theories, all
are "quantity theories," whether "money" be defined as gold, or as all
manner of media of exchange, or as only those media of exchange which
pass from hand to hand without endorsement. Fisher would doubtless call
his theory a long run theory. From the standpoint of the notion that
"prices ... lag behind their full adjustment and have to be pushed up,
so to speak, by increased purchases,"[192] however, we get a short run
quantity theory doctrine. The logic of these two is very different. The
short run doctrine seeks to explain the actual process of price-making
in the market. Money is offered against goods, and the actual quantities
on each side determine the momentary price-level, concretely. Or, when
credit is considered, money and credit offered against goods, at a given
time, or in a given short period, determine the actual price-level
reached. This is the logic of the equation of exchange--actual money
paid is necessarily equal to actual money received. The long run
doctrine is fundamentally based on a different notion. Surrendering the
actual or average of price-levels to other causes, in part, it still
asserts that, given time enough, and barring new disturbing tendencies,
a price-level will ultimately be reached which will bear it out. I find
no recognition, on Fisher's part, of the fact that these two doctrines
are different, and, in fact, I find them blended and confused in the
course of his argument. He would doubtless maintain that his is a long
run doctrine. But how long is the "run"? Sometimes it seems to be, as
already shown, a whole business cycle. Sometimes a passing season, as
the fall. When he undertakes to apply his theory to a practical proposal
for regulating the value of money, he relies on the quantity theory
tendency to bring about adjustments so quickly that it is worth while to
make _monthly_ adjustments in anticipation of it.[193] When discussing
the changes in gold premium on the Greenbacks during the exciting times
of the Civil War, he relies so thoroughly on his theory that he will not
allow even the rapid change of four per cent in a single day following
Chickamauga to occur except in conformity with the quantity theory. This
last statement is so remarkable that I must quote Fisher himself: "It
would be a grave mistake to reason, because the losses at Chickamauga
caused greenbacks to fall 4% in a single day, that their value had no
relation to their volume. This fall indicated a slight acceleration in
the velocity of circulation, and a slight retardation in the volume of
trade" (263). It would be indeed remarkable if the changes in the gold
market, which got war news before the newspapers got it, and where
changes in gold premium occurred before the rest of the country could
possibly react to the war news, should be controlled by V and T! I had
not supposed that the most rigorous of short run quantity theorists
would make any such demands on his theory as that. Indeed, I had not
supposed that the quantity theory would feel called on to explain the
gold premium, as such, except in so far as the gold premium is an index
of general prices.
Finding it impossible to limit Fisher to any single statement of the
quantitative importance of his normal theory as compared with the other
tendencies at work, but concluding that, on the whole, he considers it
of high importance, I shall now proceed to an analysis of the reasoning
by which he seeks to justify it as a _qualitative_ tendency. I shall
maintain that, however long or short the period required, however strong
or weak the tendency he defends, the reasoning by which he seeks to
justify it is unsound, and that even as a qualitative tendency, the
quantity theory is invalid. At a later part of the book, as in an
earlier part,[194] I shall undertake to find the modicum of truth which
the quantity theory contains, and shall show that no quantity theory is
needed to exhibit this modicum of truth.
CHAPTER XI
BARTER
In the statement of the quantity theory, the proviso is commonly made
that all exchanges must be made by means of money, or of money and
bank-credit. Barter is excluded by hypothesis. If resort to barter were
possible, then people might avert the fall in prices due to scarcity of
money, or increase in trade, by dispensing with money in part of their
transactions, and the proportional decrease in prices which the quantity
theory calls for would be lacking. Is this assumption true? Is barter
banished from the modern world, or does it remain reasonably possible,
and, to a considerable degree, actual?
Fisher maintains the thesis--the failure of which he admits would spoil
the quantity theory[195]--that barter is practically impossible, and
negligible in modern business life. "Practically, however, in the world
to-day, even such temporary resort to barter is trifling. The
convenience of exchange by money is so much greater than the convenience
of barter, that the price adjustment would be made almost at once. If
barter needs to be seriously considered as a relief from money
stringency, we shall be doing it full justice if we picture it as a
safety valve, working against a resistance so great as almost never to
come into operation, and then only for brief transition intervals. For
all practical purposes and all normal cases, we may assume that money
and checks are necessities for modern trade."[196]
This contention seems to me untenable. I think it can easily be shown
that barter remains an important factor in modern business life,
especially if one extends the term barter, a little, to cover various
flexible substitutes for the use of money and checks in effecting
exchanges. Clearly from the standpoint of the present issue, such an
extension of the meaning of barter is legitimate, as any such
substitutes would equally spoil the proportionality in the supposed
relation between prices and money, or prices and trade.
Where does one find barter? Well, not to be ignored would be the
advertisements which fill many columns of such a paper as the New York
_Telegram_ in the course of a week; "Wanted: to trade a well-trained
parrot for a violin"--a trade that might, or might not, be a wise one!
There is a good deal of such simple barter among the people. Then,
perhaps more important, is the regular practice of sewing machine,
piano, automobile, and other similar companies of taking part of the
payment for a new machine, piano,[197] or automobile in the similar
thing which the owner is discarding. The old machine, piano, etc., are
then repaired, repainted, and sold again. This is a very extensive
practice. Again, there are companies which combine the business of
wrecking old houses and building new ones, who regularly take the old
materials as part of their pay. This is a highly important feature of
the organized building trade in great cities, and is frequently done in
small towns. The building trade is no negligible matter. The
"horse-trade" still thrives in rural regions, and barter of various
kinds, of live stock, of grain and hay, of fresh and cured meat, and of
labor, is an important feature in rural life in many sections. Much of
agricultural rent in the South is still paid in kind, under the "share
system." Much labor, especially farm and domestic labor, is still paid
for partly in kind. Where payments for labor are made in orders on
company stores, we have again what is virtually barter, from the
standpoint of the point at issue. _Real estate_ transactions make large
use of barter. Farms are exchanged for one another, with some cash (or
more usually, a promissory note) "to boot." The writer has repeatedly
heard real estate men say to customers: "I can't sell it for you very
easily, but I can trade it off, and maybe you can sell what you trade it
for." This is perhaps more frequent in rural real estate transactions,
and in the smaller cities, than in large cities, but it is very
extensive in New York City.[198]
Again, when corporations are to be combined, various plans are possible.
There may be a merger; there may be a holding corporation; there may be
a lease. If the money market is easy, one of the former methods will be
used,--most frequently, for legal reasons, the holding corporation, if
there are any valuable franchises involved. But mergers and holding
corporations commonly involve buying out the interests which are to be
absorbed, and call for the use of checks. If the money market is tight,
therefore, the promoter of the combination may frequently find the lease
the more advantageous form of consolidation.[199] The great advantage of
the lease is that, when the money market is tight, it involves no
_financial plan_, no underwriting, no outlay of "cash." This is,
therefore, an equivalent of barter, so far as the point at issue is
concerned. Even where a holding corporation is formed, however, there
may be considerable barter: the stockholders of the corporation which is
absorbed may receive payment for their stocks, in whole or in part, in
the securities of the holding company, rather than in checks. An era of
financial consolidation, such as we have been passing through, and
through which we have not by any means gone, though the movement toward
_monopoly_ has been in great degree checked, presents a great deal of
this sort of barter, or equivalents of barter.[200] A striking thing to
notice here, moreover, is the flexible margin between use of bank-credit
and barter, a margin depending primarily upon the condition of the money
market, and particularly upon the money-rates.
Not yet has the most important element in modern barter been mentioned.
I refer to the "clearing-house" arrangements of the stock and produce
exchanges. Under these arrangements, brokers who have sold ten thousand
shares of Westinghouse El. and M. Common during the day, and bought
seven thousand shares, buying and selling being in smaller lots, with a
number of different houses, no longer are obliged to deliver ten
thousand shares, receiving therefor $700,000, and to receive seven
thousand shares, paying therefor $490,000. Instead, they deliver three
thousand shares only to the clearing house, and receive from the
clearing house only $210,000 when the transaction is, from the
standpoint of the particular broker involved, completed. This is a far
remove, in technical perfection, from primitive barter, but it is
barter, and it saves the using of a vast deal of bank-credit as between
brokers. How important it is, from the standpoint of the stock exchange,
may be judged from the following statement in Sprague's _Crises Under
the National Banking System_: "A much more fundamental change in the
organization in the New York money market came with the establishment of
the stock exchange clearing house in May, 1892. It led to a very
considerable reduction in the _clearing-house exchanges of the banks_
and also, and more important, in the volume of certified checks.
[Italics mine.] Overcertification of checks ceased to be a factor of the
first magnitude in the banking methods of the city. Had not this
arrangement for stock-exchange dealings been set up, it is probable that
it would have been necessary to close the stock exchange in 1893 and in
1907, and it is also probable that the volume of business transacted in
the years after 1897 could not have been handled." (P. 152.)
The same arrangements have been widely introduced in other stock
exchanges, and in the produce exchanges.[201]
In general, with reference to barter, this point is significant. The
money economy has made barter _easier_ rather than harder. It has made
possible a host of refinements in barter, which make it at many points
more convenient and cheaper than check or money exchanges. It is common
to find our present methods of conducting foreign trade described as a
"system of refined barter," which indeed, from the standpoint of the
present issue, it is: bills of exchange are neither money nor
bank-credit! Where bills of exchange are used in internal trade
extensively--as in Germany, where they pass from hand to hand in several
transactions before being discounted at banks[202]--we have a highly
important substitute for money and deposits, which functions as
barter,--flexibility of substitutes for money and deposits is strikingly
evident. The feature of the money economy which has thus refined and
improved barter is the _standard of value_ (_common measure of value_)
function of money.[203] This standard of value function, be it noted,
makes no call on money itself, necessarily. The _medium of exchange_ and
"_bearer of options_" functions of money are the chief sources of such
additions to the value of money as come from the money-use. But the fact
that goods have money-prices, which can be compared with one another
easily, in objective terms, makes barter, and barter-equivalents, a
highly convenient and very important feature of the most developed
commercial system. And so we reject another essential assumption of the
quantity theory.[204]
CHAPTER XII
VELOCITY OF CIRCULATION
For the quantity theory, it is important to treat velocity of
circulation of money and of deposits, as self-contained entities, really
independent factors. This is true of Fisher's theory. It is particularly
necessary that V and V' should vary from causes unconnected with M and
M'. The V's are to be a sort of inflexible channel, through which M and
M' run in their influence on the passive P, which is to rise or fall
proportionately with them. If an increase of M or M' should lead to a
reduction in the V's, if people, having more money available, should be
less assiduous in using every bit of it in effecting exchanges, then P
would not rise in proportion to the increase in M. Complete
demonstration of Fisher's thesis, therefore, requires the proof of the
negative proposition that V does not change as a consequence of changes
in M or M'. This proof Fisher finds in the contention that the V's are
fixed by the habits and conveniences of individuals, whence they are not
influenced by such a cause as a change in the amount of money.[205]
V is defined,[206] not as the number of times a given dollar is
exchanged in a given year (the "coin-transfer" notion), but as a social
average based on the average number of coins which pass through _each
man's_ hands, divided by the average amount held by him (the
"person-turnover" concept of velocity.) V' is similarly defined. Fisher
asserts that both concepts, if correctly employed, lead to the same
result. I would point out one important difference between them here:
if money is _short-circuited_, if, _i. e._, a part of the economic
community loses its incomes, or finds its incomes reduced, then the
"velocity of money," on the "coin-transfer" basis is reduced, provided
the "person-turnover" average remains the same, while on the
"person-turnover" basis the velocity will remain unchanged. It is
clearly the "coin-transfer" concept which is fundamental, from the
standpoint of the equation of exchange, and Fisher feels justified in
using the other method only because he considers it an equivalent of the
"coin-transfer" concept. I shall later show cases where the distinction
between the two concepts is all-important, particularly in the case
where T is reduced by the elimination of _middlemen_.[207]
The conception of velocity of circulation as a real, unitary entity, a
_cause_, in the process of price-determination, is, I suppose, almost as
old as the quantity theory itself. It is an essential part of the
quantity theory. To me "velocity of circulation" seems to be a mere
name, denoting, not any simple cause or small set of causes, which can
exert a specific influence, but rather a meaningless abstract number,
which is the non-essential by-product of a highly heterogeneous lot of
_activities of men_, some of which work one way, and others of which
work in another way, in affecting prices. It is at best a passive
_resultant_ of conflicting and divergent tendencies, and has, to my
mind, no more _causal_ significance than the average of the abstract
numbers of yards gained by both sides, heights and weights of players,
kick-offs, and minutes taken out for injuries, would have on the result
of the Yale-Harvard game. The real causes of changes in prices lie
deeper! I should expect V and V' to be the most highly flexible factors
in the equation of exchange, and should expect to be able to keep the
equation straight, in a great variety of situations, by allowing the V's
to vary.
Before undertaking detailed analysis of the causes governing V, I shall
discuss Fisher's specific argument, typical of the quantity theory, that
an increase of money cannot change the V's. "As a matter of fact, the
velocities of circulation of money and deposits depend, as we have seen,
on technical conditions, and bear no discoverable relation to the
quantity of money in circulation. Velocity of circulation is the average
rate of 'turnover,' and depends on countless individual rates of
turnover. These, as we have seen, depend on individual _habits_. Each
person regulates his turnover to suit his individual _convenience_....
In the long run, and for a large number of people, the average rate of
turnover, or what amounts to the same thing, the average time money
remains in the same hands, will be closely determined. It will depend on
density of population, commercial _customs_, rapidity of transport, and
other technical conditions, but not on the quantity of money and
deposits nor on the price-level." (Italics mine.[208]) He proceeds to
assume that money is doubled with a _halving_ of the V's, instead of a
_doubling_ of P. Everybody now has on hand twice as much money _and
deposits_ as his convenience has taught him to keep on hand. He will
then try to get rid of this surplus, and he can only do it by buying
goods. But this will increase somebody else's surplus, and he will
likewise try to get rid of it. This will raise prices. "_Obviously_ this
tendency will continue until there if found another adjustment of
quantities to expenditures, and the _V's are the same as
originally_."[209] The foregoing argument rests in part, it will be
seen, on the assumption that a fixed ratio between M and M' obtains,
else the increase of _money_ in everybody's hands would not mean a
corresponding increase in their _deposits_. I have already criticised
this doctrine. For the contention that the V's will finally be _just the
same_ as before, I find no specific argument at all--"_obviously_"
presumably making that unnecessary.
As the point immediately at issue is that V's will be _unchanged_ by the
increase in M (otherwise P would not increase _proportionately_--let us
see if considerations can be adduced which will make this a little less
"obvious." First, it will be noticed that Fisher, in the foregoing, in
one sentence speaks of the matter as resting on _habit_, and in the next
sentence, on _convenience_. He speaks, also, of business _custom_. Now
it is important to note that habit and custom, on the one hand, and
considerations of convenience on the other, do not necessarily coincide.
Many habits and customs are highly inconvenient. And it is not at all
likely that habit and custom should govern so highly complex a thing as
the ratio between cash on hand and the price-level. Rather, in so far as
custom and habit rule, one would expect them to relate to a simpler
matter, namely, the _amount of cash on hand_. If the amount of cash kept
on hand should remain controlled by habit, while the amount of money is
increased, then V, instead of remaining unchanged, would actually be
increased, unless the habits should be broken in on. I shall show in a
moment that considerations of convenience would probably lead to a
reduced V, in so far as individual turnover is concerned. But which
tendency will prevail? Well, that will depend on the degree to which
custom and habit rule as compared with considerations of
convenience--_i. e_., there would be no rule valid for all communities.
That convenience would lead to a larger amount of money on hand--and I
am following Fisher's temporary hypothesis that there has been no rise
in prices prior to the movement to restore the V's to their old
magnitudes--will appear from considerations like these. Few men have as
much on hand as they would like to have, including both their cash in
hand and their deposit balances. Most people have the tendency to hoard,
though it is usually held in check by necessity. If money on hand be
increased suddenly, without prices being increased, and without any
prospect of increased incomes in the future--and there is nothing in
Fisher's provisional hypothesis to call for increased incomes, as they
could, in fact, come only from an increase in prices--why might not
there be a considerable saving of money, with a corresponding reduction
in V? If it be objected that people, in saving their money, will in
considerable degree put it into the banks, and that the banks, with
larger reserves, will increase loans and deposits, I would urge, that it
is on the part of banks that this tendency to increase hoards in times
of abundant money is particularly marked, and for proof would point to
the figures quoted from Keynes[210] for the great banks and treasuries
of Europe in the last fifteen years. It is not necessary for my purpose
at this point to do more than show that there is reason to expect an
increase in money to _change_ the V's. Fisher's argument rests on the
contention that the V's will be neither increased or reduced--otherwise
an increase in money will not _proportionately_ raise prices. The appeal
to habit and custom in the matter is particularly unsatisfactory. Custom
and habit could not possibly regulate things so complex as velocities of
money and bank-deposits.
Whatever be the ultimate effect of an increase in money, the immediate
effect is commonly to reduce the money-rates. Banks have less inducement
to pay interest on deposits, and charge lower rates for loans. Now
merchants, especially small merchants, are often embarrassed in making
change for customers. The man who has tried to make payment with a ten
dollar bill in a country store has not infrequently put the storekeeper
to much inconvenience. To offer a ten dollar bill, or even a five dollar
bill, to a storekeeper on Amsterdam Avenue in New York City may well
mean that the one clerk in the establishment, or the proprietor's wife
will run out with the bill to three or four neighboring stores before
finding change with which to break it. If money is more abundant, if
money-rates are easier, for a time, it may easily happen that many small
merchants will experience the superior convenience of having a more
adequate amount of change in the till, and will, even after the
money-rates have risen--if they do rise again to the old figure--find a
new reason for keeping more cash on hand. There is a marginal
equilibrium between the interest on the capital invested in cash in the
till, and the wages of the clerk,[211] whose active legs assist the
velocity of money. Not only banks and small dealers, however, find it
advantageous to increase their supply of ready funds, held idle for
special occasions. The United States Steel Corporation has kept as much
as $50,000,000.00 to $75,000,000.00 in idle cash or idle deposits, as a
means of being independent of banks in times of emergency.[212] The
motive for accumulating reserves and hoards, either of cash or deposit
accounts, is at all times strong. In times of financial ease, it may
easily find the difficulties which ordinarily repress it give way, and,
by being gratified, grow stronger.
I conclude that there is positive reason for expecting an increase of
money to reduce the velocity of money.
Horace White, in his _Money and Banking_, in the earlier editions,
speaks of the velocity of money, "_alias_ the state of trade." Is not
this the truth? Is not money circulating rapidly, when business is
active, and slowly when business is dull? Is not the velocity of
circulation a highly flexible and variable average, a _cause_ of
nothing, and an index of business activity? Or, better, perhaps, are not
the V's and T both governed, in large degree, by more fundamental causes
which are largely the same for both? Fisher would admit something of
this for transition periods. Even for normal adjustments, he admits that
an increase in T, unaccompanied by an increase in M, leads to some
increase in the V's, though he doesn't say how much.[213] He denies,
however, that an increase in the V's will increase T.[214] In general,
it is clear that he regards the V's and T as governed by different
causes. The control of the V's by T is not the only or the chief control
of the V's. The V's can increase greatly without an increase of T, in
his scheme. That this is so, will appear from a comparison of the list
of causes which he gives as governing the V's and T respectively:
Causes governing V's:
1. Habits of the individual.
(a) As to thrift and hoarding.
(b) As to book credit.
(c) As to use of checks.
2. Systems of payments in the community.
(a) As to frequency of receipts and disbursements.
(b) As to regularity of receipts and disbursements.
(c) As to correspondence between times and amounts
of receipts and disbursements.
3. General causes.
(a) Density of population.
(b) Rapidity of transportation.
Compare this list with the causes governing T:[215]
1. Conditions affecting producers:
Geographical differences in Natural Resources; the
division of labor; knowledge of technique of production;
accumulation of capital.
2. Conditions affecting consumers: the extent and
variety of human wants.
3. Conditions connecting consumers and producers:
(a) Facilities for transportation.
(b) Relative freedom of trade.
(c) _Character_ of monetary and banking systems. (Not
their _extent_.)
(d) Business confidence.
These two lists are quite different, and indicate that in Fisher's mind
the magnitudes, T and the V's, in general obey different laws. The only
factor in both lists is facilities for transportation ("rapidity of
transportation," in the first list). Strangely enough, T, though later
recognized as having influence on the V's[216] is not included in these
lists in ch. 5. The "character of the monetary and banking systems" in
the second list is evidently not the same as "use of checks" in the
second list, though it will doubtless affect that factor, as also the
"habits as to thrift and hoarding," in some degree. "Business
confidence," which is, in the view I am maintaining, as in the view, I
should take it, of Horace White, the great variable affecting both T and
the V's, does not appear in the first list. Indeed, one wonders why
business confidence appears in either list, if only "normal," and not
merely "transitional" causes are to be considered, but it appears from
the fuller discussion on p. 78 that Fisher is not thinking of business
confidence as a _variable_ at all--his normal theory has nothing to do
with _variables_--but as a thing which either is or is not present, a
sort of Mendelian unit, not a thing of degrees.[217] It will be noted,
further, that most of the causes which Fisher lists as affecting T are
really causes affecting _production_--they would be just as important
under a socialistic as under an exchange economy.
Now I propose to show, on the basis of Fisher's own list of causes, that
most, if not all, of the factors affecting the V's, will also affect T,
_and in the same direction_. He admits this as to transportation
facilities. It is surely true of thrift and hoarding. The miser neither
circulates money nor buys goods. It is emphatically true--though
Fisher's theory, as will later appear, is obliged to deny it,--of both
book credit and banking facilities. Without the use of credit, much of
the business now done simply would not be done at all. For Fisher, and
the quantity theory in general, the contention would be simply that the
same business would be done _on a lower price-level_. I reserve a full
discussion of this fundamental point till later, noting here, in
passing, that the function of banks is to assist in effecting transfers,
that that is why, from the social standpoint, banks are encouraged, and
that the extension of banking would be folly if they did not, in fact,
do this. As to book credit, let us suppose that, for example, in the
great cotton section of the South the stores should cease to give
advances of supplies on credit to negroes and small white farmers,
pending the "making" of the crop. The outcome would be starvation for
many of them, and no cotton crop at all. Under a system of private
enterprise, the very division of labor itself, including the
specialization of the capitalist, involves credit, and it is difficult
to conceive a form of credit which does not either dispense with the use
of money, or increase its "velocity." Admittedly, the division of labor
increases trade.
The three factors listed under "Systems of payment in the community"
also affect trade. To the extent that receipts are frequent, regular,
and synchronous with outgo, we have a smoothly working economic system,
which facilitates commerce.
Finally, density of population enormously increases trade. The
concentration of men in cities is essential for modern factory
production, and the great cities have necessarily grown up about good
harbors, or at strategic points for connecting lines of railroads. It
seems almost trivial to insist on so obvious a point, but Fisher seems
totally to ignore it, for he says: "We conclude, then, that density of
population and rapidity of transportation have tended to increase prices
by raising velocities. _Historically this concentration of population in
cities has been an important factor in raising prices in the United
States._"[218] (P. 88. Italics mine.)
This is an astounding proposition. It is not merely that the
concentration of population in cities has _tended_ to raise prices
through raising velocities. It is a statement that this has been an
important historical cause of the actual increase in prices. For
Fisher's own theory, if the same cause had tended to increase T,[219]
that would have offset the rising V's on the other side of the equation,
and left prices little affected. But he sees in the V's an independent
cause here, divorces them from their connection with T, and follows his
logic fearlessly where it leads. I do not see how one could more
strikingly illustrate the essential vice of erecting the V's into causal
entities.
In concluding the discussion of the role of velocity of circulation, I
think it worth while to mention Fisher's own efforts to measure them. I
examine his statistics in a later chapter. I do not regard the points at
issue as points which can properly be handled by inductive methods,
primarily. I do not accept his conclusions with reference to the
magnitudes of V, the velocity of money, partly because I do not accept
his doctrine that "banks are the home of money" (p. 287).[220] He finds
for V a fairly constant magnitude during the thirteen years from 1896 to
1909, the range being from 19 to 22, the figures for all the years
except 1896 and 1909 being interpolations.[221] For V, however, which is
much the more important magnitude, from the standpoint of his equation
of exchange for the United States, since deposits do so much more
exchanging than does money, he finds a wide range of variation, from 36
to 54, and he states: "We note that the velocity of circulation has
increased 50% in thirteen years and that it has been subject to great
variation from year to year. In 1899 and 1906 it reached maxima,
immediately preceding crises" (285). I think Fisher's own statistical
results show that V', at least, is a child of the "state of
trade."[222] Critical analysis of these statistics show that they
greatly underestimate the variability of the V's.[223]
In summary: V and V' are not, as Fisher contends, independent of the
quantity of money. Instead of resting on "technical conditions," and
having large elements of constancy and rigidity, they are highly
flexible, and vary, on the whole, with the same highly complex and
divergent sets of causes which govern the volume of trade. The biggest
factor affecting the variations of the V's on the one hand, and volume
of trade on the other is business confidence--a factor which Fisher's
normal theory is not concerned with, so far as it is considered as a
variable, but which, more than anything else, does affect the concrete
figures which go into the equation of exchange, either for a single
year, or for an average of a good many years. The V's are not true
causal entities, but merely abstract summaries of a host of
heterogeneous facts. I have indicated before, and shall later
demonstrate more fully, that the same is true of T. Even the "normal"
causes governing the V's, however, are factors which likewise affect T,
and in the same direction.
Among the factors affecting both V and T, there is one which sometimes
makes them move in opposite directions, and that is the _value of money_
itself. This is so well stated in Wicksteed's interesting criticism of
the quantity theory that I content myself with a quotation:[224] "Again,
the history of paper money abounds in instances of sudden changes,
within the country itself, in the value of paper currency, caused by
reports unfavorable to the country's credit. The value of the currency
was lowered in these cases by a doubt as to whether the Government would
be permanently stable and would be in a position to honor its drafts,
that is to say, whether this day three months, the persons who have the
power to take my goods for public purposes will accept a draft of the
present Government in lieu of payment. It is not easy to see how, on the
theory of the quantity law, such a report could affect very rapidly the
magnitudes on which the value of the note is supposed to depend, viz.,
the quantity of business to be transacted, and the amount of the
currency. Nor is it easy to see why we should suppose that the frequency
with which the notes pass from hand to hand, is independently fixed. On
the other hand, the quantity of business done by the notes, as distinct
from the quantity of business done altogether, and the rapidity of the
circulation of the notes may obviously be affected by sinister rumors.
Two of the quantities, then, supposed to determine the value of the unit
of circulation, are themselves liable to be determined by it."
CHAPTER XIII
THE VOLUME OF MONEY AND THE VOLUME OF TRADE--TRADE AND SPECULATION
In proving that an increase of money must proportionately increase
prices, it is necessary to prove that the volume of trade is independent
of the quantity of money and credit instruments by means of which trade
is carried on. Money on the one hand, and quantity of goods to be
exchanged on the other, are the two great independent magnitudes, whose
equilibration mechanically fixes the average of prices. This notion, as
to the essence of the quantity theory, finds expression in Taussig,[225]
"The statement of a quantity theory in relation to prices assumes two
independent variables: total money or purchasing power on the one hand,
total supply of goods or volume of transactions on the other." Taussig,
though he would maintain that this independence holds, so far as money
and trade are concerned, admits that it breaks down so far as trade and
elastic bank credit, bank-notes and deposits, are concerned. Trade and
elastic bank-credit are largely _inter_dependent.[226] This concession
on Taussig's part means virtually giving up the quantity theory for
Western Europe and the United States and Canada, though Taussig still
sees something left of the quantity theory tendency in view of the
"irregular and uncertain" connection which he finds between money and
bank-credit.[227] Fisher, however, makes no such surrender. He is quite
as uncompromising as to the independence of _deposits_ and trade as he
is with reference to the independence of _money_ and trade. He does,
indeed, make the concession that increasing trade tends to increase
deposits _indirectly_, by increasing the ratio of M' to M, by modifying
the habits of the people as to the use of checks as compared with cash
(p. 165),[228] but he denies stoutly that there is any _direct_ relation
between them. (P. 168.) Trade acts only _via_ a modification of the
ratio between M and M', and M still remains controlled, not by trade,
but by quantity of money. As to any control over T by M', he repudiates
it explicitly, (P. 163.) Increasing M', either through an increase of M,
or through an increase in the normal ratio between M and M', will have
no effect on T,--or, for that matter, on the V's. The introduction of
credit, therefore, leaves the quantity theory intact: an increase of M,
increasing M' proportionately, leaving the V's unchanged, and having no
effect on T, must exhaust its influence on P, raising P proportionately,
if the equation of exchange is to remain valid.