_reductio ad absurdum_. "To show the untenability of such an idea let us
grant for the sake of argument that--in some other way than as effect of
changes in M, M', V, V', and the Q's--the prices in (say) the United
States are changed to (say) double the original level, and let us see
what effect this will produce on the other magnitudes in the
equation."[333] Then, if the equation of exchange is to be maintained,
either M or M' or their velocities must be increased, or trade must be
reduced. But he holds that none of these is possible. (1) Money will be
reduced. High prices drive money away to other countries. Nor can gold
come in via the mints. "No one will take bullion to the mints when he
thereby loses half its value."[334] On the contrary, men will melt down
coin. Nor will high prices stimulate mining. Rather, by raising the
expenses of mining, they will discourage mining. (2) Bank-deposits
cannot increase. Bank-deposits depend on the amount of money, and as
that is reduced, they must be reduced, to keep their normal ratio to the
volume of money. (3) The appeal to velocities is no more satisfactory.
These have been already adjusted to individual convenience.[335] (4) Nor
can trade be decreased. Since the average person will not only pay, but
also receive, high prices, there is no reason why he should reduce his
purchases. "_The price-level is normally the one absolutely passive
element in the equation of exchange._"[336]
"But though it is a fallacy to think that the price-level in one
community can, in the long run, affect the money in _that_ community, it
is true that the price-level in one community may affect the money in
_another_ community. This proposition has been repeatedly made use of in
our discussion, and should be clearly distinguished from the fallacy
above mentioned. The price-level in an outside community is an influence
outside the equation of exchange of that community, and operates by
affecting its money in circulation and not by directly affecting its
price-level. _The price-level outside New York City, for instance,
affects the price-level in New York City only_ via _changes in the money
in New York City_."[337]...
"Were it not for the fanatical refusal of some economists to admit that
the price-level is in ultimate analysis effect and not cause, we should
not be at so great pains to prove it beyond cavil." To explain this
"fanatical refusal," Fisher alludes to the "fallacious idea" that the
equation of exchange cannot determine the price-level, because the
price-level has already been determined by other causes, usually alluded
to as "supply and demand." He urges, however, that supply and demand,
cost of production, etc., relate, not to the price-level, but only to
particular prices: that the price-level is a factor prior to, and
independent of, the particular prices, and is presupposed by theories
like supply and demand, cost of production, etc.[338]
The _reductio ad absurdum_, at first blush, looks impressive. One
obvious criticism suggests itself, however, and it will be found to give
a clue to a much more fundamental criticism: is it reasonable to assume
a doubling of _all_ prices? Above all, must the assumption involve the
doubling of the price of gold bullion? Part of the argument to show that
gold bullion would not be minted rests on that assumption. But, more
fundamental, for such an all round doubling of prices, no _cause_ could
be assigned. Of course the hypothesis of an increase in prices without
any cause is absurd, and Fisher easily disposes of it. But suppose we
assign some _concrete causes_, outside the equation of exchange, which
might affect prices, and see how the thing works then!
Fisher states on p. 95 that "other elements in the equation of exchange
than money and commodities[339] cannot be transported from one place to
another." And in the passage quoted above he maintains that price-levels
in one country can influence price-levels in another country, or even
price-levels in one city can influence price-levels in another city,
only _via_ changes in money, in the second country or city. But other
elements in the equation are _directly_ transferable, in fact.
_Deposits_, _e. g._, in London, to the credit of New York bankers, may
be transferred to Paris, directly, by _cable_ or by _letter_, and
_prices_ are constantly being directly passed from one country or market
to another by the same media. Let us suppose a strong case, to put our
principle in relief. Assume an island, which produces a staple widely
used, whose chief centre of production is outside the island. Assume
that this staple, an agricultural product, rises greatly in price, owing
to a blight, which promises to be permanent, in the main producing
region. The blight does not affect the island, however. Let this product
be the main product of our island, which we shall assume to be small.
Let the island have communication with the outside world by boat only
once in three months. Let it be, however, in constant communication by
cable. Word comes by cable of the rise in the price in the staple. The
staple at once rises in the island. No new money has come in to cause
it. Will this be a rise in the price-level? Will there be compensating
reductions in the prices of other things to leave the price-level
unchanged? What prices can fall? Not the prices of goods that have been
imported to the island, surely. They will rather tend to rise, because
everybody on the island will feel richer than before, and will be
disposed to buy more freely. Meanwhile, merchants and bankers on the
island will be more ready to extend credit than before, so that they
will be able to buy more freely. What else can fall? Not the prices of
the land! Rather, the land will rise in price greatly, because the
increased price of the staple, expected to be permanent, will promise
bigger rents, and the price of the land, being a _capitalization_ of the
annual rental, will rise very much more than anything else--it will rise
to the extent of the capitalized price of the increase in the rents.
Wages, likewise, will rise, since the price of the product of labor has
risen. And the capital instruments in use in producing the staple will
also rise, though not so much as land and wages, inasmuch as they can be
brought in from outside at the end of three months. What is there that
can fall--except, perhaps, such goods as are exclusively designed for
the construction of poorhouses! A significant particular price
rises--that is the first step; then, from causes familiar to all
students of economics, other related prices rise; there is a general
_sympathetic_ rise in prices, the _price-level_ has risen independently,
from causes _outside the equation of exchange_. But now, can this rise
sustain itself? Well, what can bring it down? When the ship comes, at
the end of three months, it will bring in additional supplies of the
articles of import, and they will go down to their old level. Will they
go any lower than the old level? What is there to cause them to do so?
The outside price-level should be higher now, rather than lower, since
the _stock_ of the staple in question is reduced, and nothing else
increased to compensate. Nor can any reason be assigned why other prices
on the island: the staple in question, lands, wages, etc., should fall
at all from the level they reached when the news first came.
Incidentally, our ship may also bring in more gold. The bankers, finding
their deposits expanding, may feel it well to cable orders for more gold
to increase their reserves, especially as they have been subject to
somewhat unusual calls for cash for hand to hand circulation--though
this last need they might well have been meeting by expanding their note
issue.
Is there anything else to be said? Is not the new equilibrium stable?
And is not the causal sequence precisely the reverse of that assigned by
the quantity theory? _First_. a rise in prices; _second_, an expansion
of credit, book-credit, notes and deposits; _third_, money comes in. If
anyone is particularly anxious about the equation of exchange in this
process, he may add to my expansion of credit an increase in velocities
to keep it straight!
I may add that I see nothing in the "transition" I have described to
cause trade to be reduced. Rather, I should expect the rising prices to
make trade more active--or better, I should expect the rising _values_
of goods, etc., of which rising prices are the symptom, to make trade
more active, particularly as there would be an increase in speculation
to bring about readjustments, and to "discount" the prosperity. Nor can
I find any reason why trade should be reduced below the old level in the
new normal equilibrium. It would make no difference, however, if trade
were reduced either transitionally or normally, since the point at issue
is the possibility of a rise in prices originating from causes outside
the equation of exchange, and compelling a readjustment of a permanent
character in the other factors of the equation. The quantity theorist
is at liberty to make this readjustment in any way he pleases. My point
is made if he has to make the readjustment, and if the price-level stays
up!
I have put my illustration in an extreme form to throw the whole thing
in relief, and to make the demonstration free from a host of
complexities. But is not the causal process essentially the same if we
substitute, say, the Southern States for our island, and cotton for our
staple? So long as the telegraph bringing news of the ruin of cotton
production in India and Egypt, with the higher price of cotton, can come
in ahead of the money that the quantity theorist might imagine rushing
in a race with it on the train to be offered for the cotton, my point is
made. In point of fact, there would be a general rise in prices and
wages in the South, which, leading to an expansion of credit, would only
gradually and in no definite ratio lead to an increase in money drawn
from outside. Buyers outside would pay, not with money, but with checks
drawn on New York, and Southern bankers would use their discretion as to
how much actual cash they would bring in. With the elastic note issue of
our Federal Reserve system, I see no reason to anticipate that money
would be drawn to the South in an amount proportionate to the increase
in prices. Even if it were, the causation would not run from money to
prices, and that is the point at issue. If _rising_ prices can cause
increasing money, the whole quantity theory is upset, whatever the
proportions involved.
It will be noted that my illustration might be put partly in the form of
the supply and demand argument. Increasing demand for cotton in the
South leads to higher price of cotton; higher price of cotton makes
cotton-growers richer, and enables them to increase their demand for
imported goods, for land, and for labor. Supply and demand comes into
conflict with the quantity theory, and does not suffer in the conflict!
Supply and demand determine particular prices, and particular prices
determine the price-level!
Now I wish to generalize this point. I shall show that the quantity
theory conflicts with most of our doctrines of prices, as worked out in
our systems of economics. I shall show that, in important cases, the
quantity theory conflicts with the law of supply and demand, with the
doctrine of cost of production, with the capitalization theory, and with
the doctrine of imputation as worked out by the Austrians, whereby the
prices of labor, land, and other agents of production rise or fall with
the prices of the consumption goods which they produce. I shall show the
conflict in important cases, and shall show also, in those cases, that
it is not the quantity theory which can be sustained.
The general form of the conflict may be stated for all these theories.
They are theories of the _relations_ of particular prices, concerned
with showing that individual prices are so related that they tend to
_vary together_. A rise in one price, according to these theories, tends
to bring about _rises_ in others, and _vice versa_. The quantity theory,
on the other hand, asserts a relation among individual prices such that
a rise in one tends to bring about a _fall_ in others--it requires a
_compensatory_ fall at one point, if there has been a rise somewhere
else.
Let us take some cases. I shall take, first, the conflict between the
quantity theory and the capitalization theory, as I can use the
illustration just given in connection with it. I have, in a preceding
chapter, given a statement of the capitalization theory. It is a theory
concerned with the prices of long-time goods and income-bearers, as
lands, houses, capital goods of various sorts that give forth their
services through a series of years, stocks, bonds, etc. The prices of
things of this sort, according to the capitalization[340] theory, depend
on two factors: one, the money income expected from the income-bearer,
the other, the prevailing rate of interest. This money income, except in
the case of bonds, commonly depends on the prices of the products of the
income-bearer, or (in the case of stocks) of the products of the
concrete capital-goods to which the income-bearer gives title. If we may
follow the Austrian division of goods into higher and lower "orders," or
"ranks," we may say that the prices of the goods of higher ranks are the
capitalizations of the prices of the goods of lower ranks specifically
produced by them. Thus, concretely, if the price of wheat rises, we may
expect the prices of land to rise, if the rate of interest remains the
same. If the price of steel rises, we may expect the stocks of the U. S.
Steel corporation to rise, also. If the prices of smokeless powder, and
other war munitions soar, we may expect the prices of the stocks of the
corporations involved to do precisely what they have done in the recent
course of the stock market. All this, on the assumption that the rate of
interest does not change, and that the risk factor remains constant. If
these factors vary, the results will not present the mathematical
exactitude that the formula calls for, but the general tendency will
remain the same. On the other hand, if the incomes remain unchanged,
but the rate of interest rises, then we may expect the capitalized
prices to fall, and if the rate of interest falls, we may expect the
capitalized prices to rise. From the standpoint of the present
discussion, I suppose it might be fairest and best to state the
capitalization theory on this point as Fisher himself states it. In his
_Elementary Principles of Economics_ (ed. 1912) after giving a table
showing in figures the difference made in different capital prices by
different rates of interest (p. 125) he states (126): "If the value of
the benefits derivable from these various articles continues in each
case uniform, but the rate of interest is suddenly cut down from 5% to
2-1/2%, there will result a general increase in the capital values, but
a very different increase for the different articles. The more enduring
ones will be affected the most." And in his book, _The Rate of
Interest_: "The orchard whose yield of apples should increase from
$1,000 worth to $2,000 worth would itself correspondingly increase in
value from, say, $20,000 to something like $40,000 and the ratio of the
income to the capital value, would remain about as before, namely, 5%."
(P. 15.) On the next page, he generalizes his notion: "One cannot escape
this conclusion (as has sometimes been attempted) by supposing the
increasing productivity to be universal. It has been asserted, in
substance, that though an increase in the productivity of one orchard
would not affect the total productivity of capital, and hence would not
appreciably affect the rate of interest, yet, if the productivity of all
the capital in the world could be doubled, the rate of interest would be
doubled. It is true that doubling the productivity of the world's
capital would not be entirely without effect upon the rate of interest;
but this effect would not be in the simple direct ratio supposed.
Indeed, an increase of the productivity of capital would probably result
in a decrease, instead of an increase, of the rate of interest. _To
double the productivity of capital might more than double the value of
the capital._" (_Rate of Interest_, p. 16.)[341] Fisher reiterates this
doctrine in his reply to Seager, in the _American Economic Review_,
Sept. 1913, pp. 614-615.
Now my concern here is not with the points at issue as between Fisher
and Seager: the "impatience" vs. the "productivity" theories of
interest. For the present, I shall accept Fisher's doctrine on that
point as true.[342] I am here interested in Fisher's doctrine that a
doubling of the general productivity of capital would double, or more
than double, the prices of capital instruments, including land. How is
such a general rise in prices possible, if the quantity theory be true?
Is not this a rise in general prices from causes outside the equation of
exchange? That Fisher means the _money-prices_ of capital goods when he
speaks of capital-values is perfectly clear. In the second quotation, he
speaks of "capital-value of $40,000", and in general, his definition of
value runs in terms of _price_ (_e. g., Purchasing Power of Money,_ pp.
3-4, and _Elementary Principles_, p. 17). Fisher has no absolute value
concept in his system. We have in the passages cited two doctrines, both
of which contradict the quantity theory: (1) that a reduction in the
rate of interest will raise capital-prices (which are the largest factor
by far in the price-level), and (2) that an increase in the product of
capital goods means, not only more money paid for the products, but also
more money paid for the production-goods. Incidentally, the general
imputation theory would call for more money paid to laborers as well.
How can all this be, on the quantity theory? And what can the poor
equation of exchange do in such a case, if money does not increase, if
bank-credit is limited by money, if velocities of circulation are fixed
by individual habits and convenience, if trade _increases_ as a
consequence of the increased number of goods produced, and if prices
rise? It will not help much to assume that the productivity of gold
mines is doubled also. The quantity of money does not depend very much
on the annual production of gold. Besides, money need not, from the
standpoint of the quantity theory, be made of gold. It might be
irredeemable Greenbacks, fixed in quantity by law, or even dodo-bones!
Would not the capitalization theory apply in the Greenback Period? I
shall not try to solve the riddle. I am not responsible for it!
The conflict between the capitalization theory and the quantity theory
may be more simply stated. Assume that the prices of consumers' goods
and services rise, quantity of money and volume of exchanges remaining
unchanged. On the quantity theory, other prices, the prices of
producers' goods and services, lands, and securities, would have to come
down enough to compensate, in order that the price-level might remain
unchanged. For the capitalization theory, however, the prices of lands,
securities, and long time capital goods in general would have to rise,
since the incomes on which they are based have risen. Wages of labor
engaged in making consumers' goods would also have to rise, on the
general imputation theory.
The quantity theory conflicts with the capitalization theory. The
quantity theory as presented by Fisher conflicts with the capitalization
theory as presented by Fisher. Which theory is true? Would prices rise
thus, or would they be held down in some way by the limitations on the
quantity of money? I hold that I have already proved, in the reasoning
given in connection with my hypothetical island, and in the case of the
South with its cotton, that the capitalization theory tendency would
prevail. The prices of products rise, and then the prices of the labor,
land, and other capital goods which have produced them, rise, the rise
in the prices of the capital goods behaving in accordance with the laws
of the capitalization theory, and all of the rises after the initial
rise in products being in accordance with the imputation theory of the
Austrians.
This conflict suggests an interesting point. Various elements in our
economic theory, added from time to time by different writers, have
necessarily come from different philosophical and sociological
view-points, and have behind them different philosophical,
psychological, and sociological assumptions. The quantity theory,
developing, as shown in the chapter on "Supply and Demand and the Value
of Money," largely in isolation from the general body of economic
theory, has a background of psychological and sociological assumptions
quite different from that of many other doctrines. In the chapter on
"Dodo-Bones," I stated these assumptions. The quantity theory rests in a
psychology of blind habit. It assumes a rigidity in the social system
such that it might be likened to a machine, with a hopper into which
money is poured, which grinds out prices at the other end. I set this in
contrast with the psychological assumptions underlying the commodity
theory of money. That theory rests on the "banker's psychology." It
assumes a highly reflective and calculating attitude on the part of
economic men, with the disposition to look behind appearances for the
security, to test things out, to get to bedrock in business affairs. Now
the capitalization theory likewise assumes this banker's psychology. In
its refinements, as represented by the mathematical formulae in the
appendices of Fisher's _Rate of Interest_, it assumes a degree of
precision in business calculation which few experts in bond departments
apply, and which the highly fluid and alert dealers in Wall Street
certainly have not time for, even if they had that degree of
mathematical knowledge! In practice, it need not be said, particularly
in the case of the prices of lands, the capitalization theory finds its
predictions very imperfectly realized! But the two theories, resting in
such divergent psychological assumptions, may be expected, _a priori_,
to conflict. That they do conflict is not remarkable.
I shall show a similar conflict between the quantity theory and the law
of costs. In general, the quantity theorist thinks that he has
reconciled his theory with cost theory by pointing out that reduced
costs manifest themselves in increasing production, which means
increasing trade, which should, on the quantity theory, mean lower
prices.[343] I need not, for my purposes, analyze this doctrine in
detail, though I am disposed to consider it an accident that the two
theories converge at this point. For the present, I shall analyze a case
where reducing costs actually come as a consequence of the _reduction_
in the volume of trade, and inquire whether such a case will lead, as
the cost theory would assert, to lowered general prices, or, as the
quantity theory would assert, to _higher_ general prices. The case is
that where by improved methods of handling goods, it is possible to
dispense with middlemen. Concretely, assume that retailers of milk get
in direct touch with dairymen, so that middlemen are eliminated, and
that as a consequence the price of milk is reduced two cents a quart.
What of the general price-level? T (trade) is reduced. There are less
exchanges. Volume of trade does not mean volume of goods _produced_, but
volume of _exchanges_. With a reduced trade, the quantity theory must
assert that prices of commodities other than milk must, on the average,
rise, not merely enough to compensate for the fall in milk, but more
than that, enough to compensate for the reduced trade as well. But how
can the other prices rise? Well, a point comes up obviously: the buyers
of milk save two cents a quart. They can spend it for something else.
This will raise the prices of other things. But, on the other hand, the
middlemen now have less to spend. They have _exactly as much less_ as
the others have _more_, the extra money that milk buyers have being, in
fact, the money that the middlemen would otherwise have had. The one
offsets the other. There is, then, no reason for the average of other
prices to rise. Suppose we carry the process one step further. After a
while, the middleman will find other work to do. Then they will have
incomes again to spend. But in going to work again, they will be engaged
in production, and so will, in general, be increasing the volume of
trade. The quantity theorist could not expect a rise in prices from
this!
And here we are given a clue to a fundamental confusion in the quantity
theory, a confusion which, accepted by the reader, gives the quantity
theory much of its plausibility. I refer to the confusion between
_volume of money_, and volume of _money-income_.[344] The two need not
be the same. The two generally are not the same. In the case I have
described, the one has changed without a change in the other. Now if one
wishes to view the process of price-causation from the standpoint of
money offered for goods,--an essentially superficial,[345] but
frequently useful, view-point--it is clearly money-_income_, rather
than mere quantity of money in the country that is important. Into the
determination of volume of money-income, however, come factors of a high
degree of complexity, among them, prices for which there is no possible
place within the confines of so simple and mechanical a doctrine as the
quantity theory.
In passing, I notice a point to which I called attention in discussing
Fisher's factors in the equation of exchange. I refer to his definition
of velocity of circulation as the average of "person-turnovers" of
money.[346] In the illustration given, there is no reason to suppose
that this average is changed. The middlemen simply drop out of the
average. They have no money to turn over! But velocity of circulation,
defined as "coin-transfer," (_cf._ _supra_, p. 204) has clearly changed.
The course of money has been short-circuited. It goes through fewer
hands in the course of a given period. This last concept of velocity of
circulation is clearly the one that must be used, if the equation of
exchange is to be kept straight. But this fact should make it clear that
velocity of circulation, instead of being the inflexible thing that
Fisher has described, resting in individual habits and practices, a true
causal factor in the price making process, is really a highly flexible
thing, in large degree a passive function of trade and prices.
With this distinction between volume of money and volume of
money-income[347] clearly held, we are prepared to go further in our
attack on the quantity theory, granting the quantity theorist all his
most rigorous assumptions, and still demonstrating that prices can vary
independently, without prior change in quantity of money, volume of
trade, or velocity of money. Let us assume the extreme case of the
quantity theory: a closed market; no credit; no barter; a fixed supply
of money; a fixed volume of trade; a fixed set of habits affecting
velocity, namely, that everyone spends, in the course of the month, all
that he has accumulated by the first of the month. The quantity theorist
could not ask a more iron-clad set of assumptions than this! If the
quantity theory is not valid here, if the price-level is not absolutely
fixed, helpless to change, with these assumptions, then the quantity
theory, even as a minor tendency, must be surrendered, and the quantity
theorist must admit that the whole line of thought has been fallacious.
But is the price-level passive? Suppose we assume a combination of
employers of maid-servants, which forces down the wages of maid-servants
from $20 to $10 per month. Assume further that there is no alternative
employment for the maid-servants, so that they all remain at work.[348]
So far, we have made a change in _one_ price, the price of domestic
service. What of the general average of prices, the price-_level_? Well,
so far, the price-level is down. If nothing else takes place, we have
reduced the price-level by reducing one price. What else can take place?
Two things: (1) the masters now have $10 per month each more to spend
for other things than before. That tends to raise prices in their other
channels of expenditure. (2) The maid-servants now have $10 each less to
spend,--the same ten dollars! That lessens prices in the lines of their
expenditure. These last two changes exactly neutralize one another. The
first change, in the price of domestic service, remains unneutralized.
The general price-level is, then, lowered--by a cause acting from
outside the equation of exchange, directly on prices. The first change
comes in one price. In the final adjustment, that change remains
unneutralized. How is this possible? Is the equation of exchange still
valid? As a mathematical formula, yes. As expressing a causal theory, in
which prices are effect, and money, trade, and velocity causes, no. The
equation is kept straight by a reduction in velocity. _Because_ the
wages of maid-servants are reduced, _less_ money goes through their
_hands_; $10 per month per maid are short-circuited. But the _cause_ is
with the _prices_. The price-level, even under these absolutely rigorous
assumptions, is not passive.
In general, I conclude that the price-level, under the laws governing
particular prices, supply and demand, cost of production, the
capitalization theory, the imputation theory, etc., can vary of its own
initiative, independently of prior changes in the quantity of money, or
of volume of trade, or other factors that the quantity theory stresses;
and that these changes in the price-level (or in the particular prices
which govern the price-level) can maintain themselves, and compel a
readjustment in trade, credit, money and velocities, to correspond. This
conclusion strikes at the very heart of the quantity theory, and, if
valid, leaves the quantity theory disproved. More fundamentally, I
should put it, prices can change because of changes in the psychological
values of goods. These values are _social_ values, and are to be
explained only by a social psychology. But for the present it has seemed
best to me, as a means of attracting sympathetic attention from a wider
circle of economists, to make use of the less debated doctrines of the
science in attacking the quantity theory. It is not necessary to rest
the case on my own special theory of value. Supply and demand, cost of
production, the capitalization theory, the imputation theory--the
general laws of the concatenations and interrelations of prices--are
quite adequate for the confutation of the quantity theory. They are laws
concerned with particular prices, and the price-level is nothing but the
average of particular prices. Whatever explains, really explains, the
particular prices, also explains the price-level.
Fisher, as we have seen, is not of this opinion. Although he has defined
the price-level as an average of particular prices[349] he none the less
exalts this average into a causal entity, prior to and master of the
particular prices out of which it is derived, of which it is a mere
average.[350] This average, he maintains, is presupposed in the
determination of all particular prices.[351] This seems to me a wholly
untenable position. _Ex nihilo nihil fit._ There cannot be _more_ in the
average than there is in the particulars from which it is derived. In
point of fact, there is necessarily vastly less. All the concrete
causation is lost. The average, in itself, is nothing but a _statement_,
a summary of _results_. I know nothing more metaphysical in the history
of economic theory than this hypostasis of an average.[352]
I reject Fisher's notion that the average of prices is an independent
entity. But I do not consider that the idea lying behind this untenable
doctrine is absurd. Cost of production, supply and demand, and the other
price theories _do_ presuppose something more fundamental. They do
presuppose _money_, and the _value_ of money, as has been shown at
length in Part I. The trouble with Fisher's notion comes in his
definition of the value of money in purely relative terms as the
_reciprocal of the price-level_, and his contention that the study of
the value of money is identical with the study of price-levels.[353]
Value is not a mere exchange relation.[354] Rather, every exchange
relation involves _two_ values, the values of the two objects exchanged.
These two values _causally_ determine that exchange relation. In the
case of particular prices, then, we must consider not only the value of
goods, but also the value of money. And the causes determining the
general price-level will therefore include not alone the values of
goods, but also the value of money. In the foregoing arguments by which
I have shown that the price-level can vary independently of the other
factors in the quantity theory scheme, I have been concerned only with
changes in the values of goods, measured by a constant unit of value. If
the value of money should also be varying, the concrete results on the
price-level would have been different. On the face of things, there was
nothing in the cases I discussed to require us to suppose that the value
of money would also vary. The argument ran on the assumption of a fixed
value of money. I have shown, in earlier chapters, that the assumption
of a fixed value of money is fundamental to the laws of supply and
demand, cost of production, and the capitalization theory. In point of
fact, this assumption is rarely true--never strictly true. For causes
which are in considerable degree independent of the causes governing the
values of goods (as the causes governing their values are in
considerable degree independent of one another), the value of money
varies, now in the same direction as the values of goods in general, now
in an opposite direction. Further, money itself does not escape the
general laws of concatenation of values. The value of money has causes
which are bound up with the values of other goods. Thus, when prices are
rising and trade expanding, there is a tendency--commonly a minor
tendency--for money also to rise in value, and so prices do not go
quite as high as they would have gone had money remained constant. This
tendency arises from the fact that there is more work for money to do in
a period of active trade and rising prices. Gold also tends to rise in
value in the arts, with prosperity. The reverse tendency manifests
itself when prices are falling: money tends, in some measure, to fall in
value with the goods,[355] and so prices do not fall as far as they
would fall if money remained constant. But in general, the causes
governing the values of goods, and the causes governing the value of
money, are sufficiently independent to justify us in studying each
separately, in abstraction, on the assumption that the other is
unchanged. Hence, supply and demand, cost of production, and the other
price theories, which assume a fixed value of money, are proper tools of
thought for the study of the prices of goods.
CHAPTER XVI
THE QUANTITY THEORY AND INTERNATIONAL GOLD MOVEMENTS
The quantity theory explanation of international gold movements is as
follows: if money comes into a country, it raises prices. If the
price-level of the country is raised more rapidly than the price-levels
of other countries are rising, then the country becomes a bad place in
which to buy and a good place in which to sell; its exports fall off,
its imports increase, and finally the inflow of money is checked, and,
perhaps, money flows out again. The equilibrium of the gold supplies of
different countries is thus dependent on the price-levels of the
countries involved. The quantity of gold in a country determines its
price-level, and no more gold can stay in a country, on this theory,
than that amount which keeps its price-level in proper relation to the
price-levels of other countries. It is not necessarily asserted that the
price-levels of all countries must be equal--the facts too obviously
contradict that. But when this precise statement is not made, the
substitute statement of some "normal" relation between the price-level
of one country and that of another becomes a very vague one, and the
theory becomes pretty indefinite.
I am here concerned chiefly with one contention: the price-_level_, the
average of prices, is not a _cause_ of anything--not of gold movements
or anything else. It is a mere summary of many concrete prices. Some of
these concrete prices have highly important influence on international
gold movements, tending, if they are low, to bring gold in, and if they
are high, to repel gold. Others work in the opposite direction, tending
if they are low to attract less gold than if they are high. Finally,
among all the prices affecting international gold movements, the one
which is most significant is commonly not included in the price-level at
all: I refer to the "price of money," the short-time interest rate.
Let me elaborate each point. First, it is true that high prices of
articles which enter easily into international trade tend to repel gold
from the country--meaning by "high prices" prices that are higher than
the prices of the same goods abroad. This relates, however, not to the
general price-level, but only to a comparatively small set of prices.
Most prices in a country are not prices of articles of international
trade. High wages may, indeed, draw in immigrants. But high land rents,
and high prices of land cannot bring in land. Nor do high land prices
send away much gold to other countries for the purchase of land there.
Indeed, within a single country, the differences in the relation between
land yield and capital value of land are enormous. The following figures
are taken from an article by J. E. Pope:[356] In Yazoo Co., Mississippi,
farm lands are sold at $10 to $25 per acre. The average gross income per
acre is $28. In Cass Co., Iowa, the land prices are from $100 to $125
per acre while the gross income amounts to only $11 per acre, if only
crops and dairy products are taken into account, and to $20 if the sales
of live stock are included. In Oglethorpe Co., Georgia, the average
price is from $10 to $25 per acre, and the average income $10. In
Paulding Co., Ohio, land is sold at from $75 to $100 per acre, and the
average income per acre, including returns from live stock sold, is $15.
Why should not landowners in Cass County, Iowa, sell their comparatively
unproductive land, at a high price, and go, with their money, to Yazoo
County, Mississippi? The answer is simply, that they would have to go
_with_ their money, and they prefer to stay at home! Absentee
landlordism is not generally popular with men who are seeking paying
investments. Land stands at one extreme. But then land is the very
biggest item in an inventory of wealth, and, while not _as land_,
actively bought and sold,[357] it is a big element in the values of many
active securities. The principle holds in less degree of many other
things, however. The securities of a local corporation, say a gas plant,
find their best market at home, as a rule, unless the city be large. If
they are held by foreign capitalists, they still find a very restricted
market in the foreign country. Only those who have investigated at first
hand will feel free in buying them--unless, indeed, they are guaranteed
in some way by a big and well-known house. Prices of personal and
professional services vary enormously in different sections of the same
country, to say nothing of variations between different countries, and
there is a very slow movement indeed toward bringing about higher
salaries for rural preachers in Kansas because the salaries of London
preachers have risen, or because of increased demand for preachers in
Germany. Great numbers of commodities are too bulky to move far. Their
prices vary with little relation to similar prices elsewhere. But the
principle needs no more elaboration. If the reasoning be simply that men
tend to buy where things are cheap, and to sell where things are dear,
it is clear that that establishes a very loose relation indeed between
the price-levels of different countries.
The second point is that some prices, by rising, actually bring in gold
from abroad, while by falling they tend to release gold. I am not here
referring to the case discussed in the chapter on "Supply and Demand,"
where a commodity, cotton, with an inelastic demand, is doubled, the
doubled quantity selling for a less aggregate price, and so bringing in
less money from abroad. That case would bear considerable
generalization. I am referring here to the case where _credit_ is built
on the value of long time goods, as lands, or railroads. Concretely, let
us suppose an increase in railroad rates allowed by the Public Service
Commission of Missouri. This is, in itself a rise in prices. It will,
further, on the capitalization theory, make the prices of stocks of the
roads operating in the State rise also, and give a margin of additional
security for bond-issues. This will make it possible for these roads to
float foreign loans (or would have done so before the War), and so will
tend to turn the exchanges in our favor. Gold will tend to come in, not
to go out. Similarly if the prices of dairy products, or truck gardens,
or orchards, or orange groves rise, leading to a rise in the prices of
the lands involved, foreign capital will tend to come in as loans--_i.
e._, the exchanges will turn more favorable to us, and the gold movement
tend to turn our way. I suppose, by the way, that something of a point
could be made against the Single Tax at this point: destroying land
values would lessen the security which a community could offer outside
lenders. The Single Tax would, thus, hamper the development of countries
which need capital from outside. Men who wish to use their own capital,
under their own management, might, as the Single Taxers claim, be
tempted to come in, if they could be free from taxation on the capital
they bring with them; but _lenders_, who wish a good margin of security,
would find less inducement to lend.[358] This is a digression, but one
feature of it is pertinent: though the foreigner does not care to
migrate from his high-priced land to _low_-priced land elsewhere, he is
often willing to trust a _loan_ to the owner of _high_-priced land
elsewhere. I will not venture the generalization that high-priced land
necessarily attracts loans, and tends to turn the gold movements in
favor of the country where prices are high. The point has been made that
if lands are being exchanged frequently, the new buyer tends to exhaust
his credit resources in paying for the land: _i. e._, puts so large a
mortgage on it that he has little margin of security to offer for
working capital.[359] I shall not here undertake to determine how far as
a matter of fact, in different places, the one tendency outweighs the
other. It is enough to point out that in many cases, where this factor
is absent (as in the case of the railroads cited), rising prices
attract, and do not repel, foreign gold, and that for none of these
cases is the consequence of rising prices for the gold movements to be
explained in the simple way that the quantity theory doctrine would
require.
Finally, the international movements of gold[360] are enormously moved
by the short-time rate of interest. The raising of the Bank Rate in
England, supplemented, when necessary, by "borrowing from the market" by
the Bank of England, as a means of making the Bank Rate effective,
quickly turns the course of the exchanges. This is, as has been pointed
out, a more effective device when used by the English money-market than
when used by borrowing countries, since the borrower, by offering higher
rates, is not always able to borrow more, whereas the lender, by
demanding higher rates, is usually able to reduce his loans. But the
difference is one of degree, and in point of fact a rise in the short
time rates in New York City is commonly an effective means of bringing
in gold from abroad. It is true that this is not the only factor. I have
been at pains to point out how other factors work. I am as far as
possible from denying the powerful influence of the "balance of trade"
as treated by the older economists on international gold movements, when
both visible and invisible items are included. But my point is, first,
that these invisible items are numerous and flexible, and that a big
factor in their determination is the short time rate of interest; and
second, that the balance of physical items, even, depends, not on the
price-level as a whole, but merely on the prices of those particular
goods which enter into foreign trade. It is perfectly possible, and,
indeed, is very common, for rising prices in a country to lead to
expanding trade and expanding bank-credit, which causes bankers to wish
to expand their reserves, which leads them to raise their rates on short
time loans, which leads gold to come in from abroad. More simply still,
the bankers may merely offer an attractive rate to the foreign bankers,
and establish credits abroad, against which they draw "finance bills,"
which influence the gold movements in the desired manner.
CHAPTER XVII
THE QUANTITY THEORY _vs._ GRESHAM'S LAW
There is a pretty obvious conflict between the quantity theory and
Gresham's Law. The latter is, essentially, a "_quality_" theory of
money. For the quantity theory, dodo-bones, or anything else will do.
"It is the number, and not the weight, that is essential"![361] For
Gresham's Law, the weight makes all the difference in the world, if it
is a question as between full weight and light weight coins, and, in
general, the _value_ of the thing of which money is made, considered in
its commodity aspect, is the starting point of that doctrine.
The quantity theorist seeks, indeed, to harmonize the two. His theory is
that Gresham's Law manifests itself only when there is a _redundancy_ of
the currency due to the issue of paper money, or overvalued metal. In
such a case, prices rise, he holds, and then the undervalued metal, or
the metallic currency, which count no more than the paper or the
overvalued metal in circulation, tend to leave the country, to another
country where prices are lower, or tend to leave the money use for the
arts. But the quantity theorist must maintain that it is only _via_
increased issue, with consequent rising prices, that Gresham's Law comes
into operation. If there are a million dollars of gold in circulation,
and a half million of irredeemable paper is added, then only half a
million of the gold (or rather a little less than half) will leave. If
more than that left, prices would fall, because of the scarcity of
money, and then the gold would come back, because it would be worth
more in concurrent circulation with the paper than it would be worth as
money abroad, or in the arts. On the quantity theory, there can be no
difference in the value of gold and paper, in such a case, after enough
gold has left to balance the paper that has been issued. Falling prices
would prevent it.
But Gresham's Law is not held by any such fetters! And the facts of
monetary history, in important cases, show Gresham's Law controlling,
despite the quantity theory. I will refer briefly to two such cases.
The first centres about the suspension of specie payments by the
Northern banks and the Federal Treasury on January 1, 1862. This
suspension was not accompanied by any increase of money. Rather, there
was a _decrease_,[362] shortly following, in the amount of paper money.
The banks in New York, and certain other States, were bound so strictly
by their charters, and by the State laws, that they dared not leave
their notes unredeemed. Speculators, buying notes at a discount--for
virtually all bank-notes fell to a discount--were able to present them
to the banks in these States and demand gold, which led to a very
profitable business. The banks protected their gold by ceasing to issue
notes, or by reducing the volume of note issue. Certified checks were
used to a considerable extent instead. There was certainly no increase,
and probably a reduction, a considerable reduction, in the volume of
bank-notes in circulation. The only other paper money in circulation was
the Demand Notes of the Federal Government, which were not increased
after the date of the suspension, and which were in any case small in
volume as compared with the total amount of money. On the quantity
theory version of Gresham's Law, there was nothing to drive gold out.
Gold was _not pushed out_ by redundant currency. Rather, it _left_,
leaving a monetary vacuum behind. Coincidently, strangely enough, prices
_rose_. The vacuum in the money supply was so serious, that the
subsequent first issue of the Greenbacks brought a welcome relief.
Throughout the whole of the first year of the suspension, the volume of
money was less than it had been in the preceding year. None the less,
the gold stayed out of general circulation. It did not come back from
abroad. And prices _rose_.[363]
A similar episode, the obverse of this, occurred when the Bank of
England _resumed_ specie payments in the early '20's. Then gold came
back, the currency was increased, and, coincidently, _prices fell_.[364]
I conclude that the conflict between Gresham's Law and the quantity
theory is real and fundamental, and that in cases where different
_qualities_ of money are in concurrent circulation, the undervalued
money will leave, regardless of the question of quantity.
CHAPTER XVII
THE QUANTITY THEORY AND "WORLD PRICES"
Some writers, who would call themselves quantity theorists, would
repudiate many of the doctrines for which Fisher stands, and which the
historical quantity theory involves. The recognition which Fisher's book
has received from quantity theorists generally, justifies me in treating
his book as the "official" exposition of the modern quantity theory,
and, indeed, it is easy to show that Fisher is fundamentally true to the
quantity theory tradition. With many writers, the disagreement with
Fisher would be a mere matter of degree; they would hold that Fisher has
set forth the central principle, that his qualitative reasoning is
correct, but that the relations among the factors in his equation are
less rigid than he maintains. As I reject even the qualitative reasoning
by which Fisher defends his doctrine, and reject even the qualitative
tendency which he maintains, my criticisms will apply as well to the
position of this group of writers, though I should have less practical
differences with them, to the extent that they admit qualifications and
exceptions to Fisher's doctrine.
There is, however, a group of writers who seem to feel that the quantity
theory remains sufficiently vindicated if it can be shown that an
increase in _gold production_ tends to raise prices throughout the
world, while a check on gold production tends to lower prices, and who
rest their case on the necessity which bankers find of keeping reserves
in some sort of relation to the expansions of bank-credit.
A view of this sort is presented by J. S. Nicholson, whose statement of
the application of the quantity theory to the modern world differs
almost _toto coelo_ from his original statement in the dodo-bone
illustration already discussed. Nicholson[365] declares that in our
modern society "the quantity of _standard_ money, other things remaining
the same, determines the general level of prices, whilst, on the other
hand, the quantity of _token_ money is determined by the general level
of prices." Nicholson's reasoning is, substantially, as follows:
Although the bulk of exchanging is carried on by means of credit
devices, there is still a certain part of exchanging, especially in the
matter of paying balances, for which standard money only can be used. He
regards the whole credit system as based on standard money, and says
that for any given level of prices there is a minimum amount of standard
money, absolutely demanded. If the volume of standard money falls below
this minimum, the price-level will fall to such a point that the volume
of standard money is again adequate. He takes, moreover, a world-wide
view, declaring that it is the relation between the volume of gold money
throughout the world and the demand for standard money throughout the
world which determines the relative values of money and commodities.
"The measure of values or the general level of prices throughout the
world will be so adjusted that the metals used as currency, or as the
basis of substitutes for currency, will be just sufficient for the
purpose. We see then, that the value of gold is determined in precisely
the same manner as that of any other commodity, according to the
equation between supply and demand."
In the consideration of this doctrine, let us note several points in
which it differs fundamentally from the quantity theory proper, and from
the situation assumed in the dodo-bone illustration. First, it is not a
quantity theory of _money_. Money is not regarded as a homogeneous
thing, each element having the same influence on prices. Rather, _token_
money is the child of prices. This doctrine would in no way fit in with
the logic of the equation of exchange, as presented by Fisher. Further,
the dodo-bone idea is entirely gone. _Gold_, a commodity with value in
non-monetary employments, is under discussion, and it is the quantity of
gold that is counted significant. This recognizes, if not the need, at
least the _existence_, of a commodity standard. Nicholson definitely
avows the necessity for the _redemption_ of representative money, even
going so far as to say that "all credit rests on a gold basis,"[366]
that all instruments of exchange derive their value from the volume of
standard money which supports them, and that if this basis were cut away
the whole structure would fall. Nicholson recognizes, further, that gold
has value independent of its use as money.[367]
In evaluating Nicholson's doctrine, I wish to point out, first, the
inaccuracy of the statement that all credit rests on a gold basis. It is
true that credit instruments are commonly drawn in terms of standard
money, which is commonly gold. International credit instruments may even
specify gold, and the same thing happens at times within a country. But
commonly, in this connection, gold functions, not as the value basis
lying behind the credit instrument, the existence of which justifies the
extension of the credit, but rather as the _standard of deferred
payments_, by means of which the credit instrument may be made definite.
The real basis of the value of a mortgage is not a particular sum of
gold, but rather the value of the farm, expressed in terms of gold. The
basis of a bill of exchange is not a particular sum of gold, but rather
is the value of the goods which changed hands when the bill of exchange
was drawn,[368] supplemented by the other possessions of drawer, drawee,
and the endorsers through whose hands it has gone. Even a note unsecured
by a mortgage, or not given in payment for a particular purchase, is
based, in general, on the value of the general property of the man who
gives it, and on the value of his anticipated income.[369] So
throughout. Credit transactions, for the most part, originate in
exchanges, and carry their own basis of security in the goods and
securities which change hands, not in that small fraction of the world's
wealth, the stock of gold, which could, Coin Harvey asserted in the
middle '90's, be put in the Chicago grain-pit! And now let me extend
this idea. Although coin made from the standard of value is a great
convenience, there is yet no vital need, in theory, for a single dollar,
pound or franc made from the standard of value. If gold should cease
entirely to be used as a medium of exchange, or in bank or government
reserves, if the gold dollar should become a mere formula, so many
grains of gold, without there being any coins made of it, still, so long
as that number of grains had a definite, ascertainable value,
commensurate with the value of some other commodity which could be used
as a means of paying balances and redeeming representative money, the
gold dollar could still serve as a measure and standard of values. In
the situation I have assumed, silver bullion, at the market ratio, could
perform all the exchange and reserve functions now performed by gold,
even though not so conveniently.[370] Nicholson's description of the use
of gold as a reserve, while calling attention to an important fact, has
led him into the error of supposing that what may be true of gold, the
_medium of exchange_, and _reserve for credit operations_ is necessarily
true of the _standard of value as such_.
Nicholson is correct, however, in looking to the standard of value for
part of the explanation of changes in prices. And, _since it so happens_
that a considerable part of the value of the standard of value comes
from its employment as medium of exchange and reserve, he is correct in
looking to its use as money as part of the explanation of its value. His
error comes, however, in failing to see that independent changes in the
values of goods may also change the price-level, and that variations in
the demand for gold as a commodity may also change the value of gold,
and so change the price-level.
Further, in so far as Nicholson clings to the notion of prices as
depending on a mechanical equilibration of physical quantities, he is
subject to the criticisms given before of the general quantity theory,
and in so far as he clings to the identity of the value of gold with the
reciprocal of the price-level,--the relative conception of value--he is
subject to the criticisms already urged.
Again, even for a single country, the connection between volume of
reserves and volume of credit is very loose and shifting. A thousand
factors besides volume of standard money in a country determine the
expansions and contractions of credit, and the long run average of
credit. For the whole world, this connection is even looser. To assume a
fixed ratio between them for the whole world, one would have to assume
that all the world was simultaneously, and normally, straining its
possibility of credit expansion to the utmost, so that the minimum
ratio--a notion which is far from precise[371]--should also be the
normal maximum, and so that no country, in expanding its credit, could
draw in new reserves from other countries which had more quiescent
business conditions.
Nicholson's notion of the world price-level, moreover, is subject to the
criticisms I have made in the chapter on "The Quantity Theory and
International Gold Movements." How can the world level have a close
connection with the volume of gold, if different elements in the world
price-level, the price-levels of different countries, can vary so widely
and divergently as compared with one another? Even granting--which I do
not grant, and which I maintain I have disproved--that the price-level
in one country has a close connection with its stock of gold, would it
not be true that the average price-level for the world would vary
greatly, with the same world stock of gold, depending on which countries
had the gold?
There is nothing in Nicholson's doctrine which seems to me to justify in
any degree the doctrine that prices, in a single country, or in the
world at large, show any tendency to _proportional_ variation with the
quantity of money, or with the world's stock of gold.
Is it not true, then, that there is _some_ sort of relation between gold
production and world prices? It is. Gold is like other commodities. Its
value tends to sink as its quantity is increased. As its value sinks,
prices tend to rise. As to the elasticity in the value-curve for gold, I
think it will be best to reserve discussion till a later chapter,[372]
in Part III. We shall there find reason for thinking that gold has much
greater elasticity in this respect than most other commodities. That its
value should fall _proportionately_ with an increase in its quantity, I
should not at all conclude. Even if its value did sink proportionately
with an increase, prices would rise proportionately only if the values
of goods remained unchanged.
But why do we need a _quantity theory_ of _money_, with all its
artificial assumptions, and its law of strict proportionality, to enable
us to assert the simple fact that gold, like other commodities, has a
value not independent of its quantity? What theory of money would deny
it? Surely not the commodity or bullionist theory. For that theory,
which seeks the explanation of the value of money in the value of gold
in the arts, it would go without saying that an increase in the supply
of gold for the arts would lower its value there and consequently, its
value as money. Surely the theory which I shall maintain in Part III of
this book will not deny that increased gold production tends to lower
the value of money, and consequently to raise prices. With the "quantity
theorist" who is content with this conclusion, I have no quarrel--unless
he claims this obvious truth as the unique possession of the quantity
theory!
CHAPTER XIX
STATISTICAL DEMONSTRATIONS OF THE QUANTITY THEORY--THE REDISCOVERY OF A
BURIED CITY
In the following chapter, as in most of the preceding chapters,
constructive doctrine is aimed at, even though the discussion takes, in
considerable part, the form of critical analysis of opposing views. We
shall seek to set forth the facts, as far as may be, regarding the
relations of banking transactions to trade, the relations of clearings
to amounts deposited in banks, the relation of New York City clearings
to country clearings, and of New York bank transactions to bank
transactions in the rest of the country. We shall seek to ascertain the
extent of variability in that highly elusive magnitude, "velocity of
circulation," particularly "V'." We shall indicate something of the
bearing of index numbers of prices on the theory of the value of money
as here presented. In reaching conclusions on these and related matters,
we shall build on the investigations of Dean Kinley, on the very
interesting statistical studies of Kemmerer and Fisher based on Kinley's
figures, on investigations more recently made by the American Bankers'
Association regarding the relation of bank transactions and bank
clearings, on figures from reports by the Comptroller of the Currency,
as well as on other sources. One purpose of the chapter is to criticise
the statistics which purport to prove the quantity theory. The bulk of
the chapter is given to this. But the work of Fisher and Kemmerer thus
criticised yields rich rewards for the study. The conclusions they have
drawn from their figures are, in the judgment of the writer, untenable,
but the figures themselves are of immense interest and importance.
The controversy over the quantity theory has been waged with many
weapons. Theory, history, and statistics--to say nothing of
invective!--have been freely employed. In large measure, the statistical
studies have been concerned with the direct comparison of quantity of
money and prices, in their variations from year to year. One of the best
of these studies, that of Professor Wesley C. Mitchell, in his _History
of the Greenbacks_ (followed by his _Gold, Prices and Wages under the
Greenback Standard_), has, to the minds of many students, including the
present writer, put it beyond the pale of controversy that the
fluctuations in the gold premium, and in the level of prices, in the
United States during the Greenback period, both for long periods and for
daily changes, were not occasioned by changes in the quantity of
money,[373] but rather, primarily, by military and political events, and
other things affecting the credit of the Federal Government, together
with changes affecting the values of gold and of goods. Professor
Mitchell's discussion is so detailed and thorough, that what controversy
remains relates, not to his facts, but rather to the possibility of
interpreting those facts in harmony with the quantity theory, by
repudiating the notion that the direct comparison of gold premiums or of
prices with quantity of money gives a valid test.[374]
Recent defenders of the quantity theory have undertaken the examination
of more complex statistics than those concerned with the simple
concomitance of quantity of money and prices. Two of these studies, the
first by Professor Kemmerer[375] and the second by Professor Fisher,
are so elaborate, have commanded such general attention, and have been
accepted by so many students as conclusive demonstrations, that I feel
it proper to give them detailed examination. I do this especially
because highly important facts for our construction argument emerge from
this critical examination. Kemmerer's and Fisher's studies reach
high-water mark in the effort to give statistical demonstrations of the
quantity theory. If they are invalid, then I know no other attempts
which many students would suppose to be possible substitutes. The theory
involved in both these studies is clearly stated by Professor Kemmerer:
"A study of this kind, to be of any value, must cover the monetary
demand as well as the monetary supply. Any test of the validity of the
quantity theory consisting merely of a comparison of the amount of money
in circulation with the general price-level is as worthless as would be
a test of the power of a locomotive by a simple reference to its speed
without taking into account the load it was carrying or the grade it was
moving over." This criticism of many previous studies is, in general, I
think, valid, though I should except from this list such detailed
studies as that of W. C. Mitchell, who takes account, as far as may be,
of all the variables involved, and who considers day by day and week by
week changes. I think the older studies of Tooke,[376] may also be
excepted. In point of fact, if one wishes to know how much reliance may
be placed in the quantity theory as a basis for prediction, when one
knows that money is increasing, the simple comparison of money and
prices is a fair test. If the "other things" which must be "equal" are
so numerous and complex that the quantity theory cannot manifest itself
in a direct comparison, much of its significance _as a basis of
prediction_ is gone.
It is perfectly true, however, that studies running through long
periods, which give simply figures for general prices and figures for
quantity of money, omitting volume of trade, are not very relevant
either for proof or disproof.[377] And the conception underlying the
studies of Kemmerer and Fisher, that not merely money and prices, but
also volume of bank-credit, volume of trade, velocity of monetary
circulation, and velocity of bank-credit, must be measured, undoubtedly
represents a big advance in the conception of the statistical problem
involved. The mere stating of the problem is an intellectual achievement
of no mean order, and the ingenuity and scholarship involved in seeking
data for concrete measurement of these highly elusive elements must
command the admiration of every student of monetary problems. Volume of
trade, velocity of money and velocity of bank-credit had been generally
supposed, until these studies were undertaken, to be beyond the reach of
the statistician. There can be no doubt at all that the efforts to
measure them, or to measure variations in them, by Kemmerer and Fisher,
have greatly advanced our general knowledge of the phenomena of money
and credit.
With great admiration for the magnificence of the problem undertaken,
and for the industry, ingenuity and scholarship which have been devoted
to its solution, I have nevertheless reached the conclusion that the
figures assigned by these writers to the magnitudes of their "equations
of exchange" are, with the exceptions of the figures for money and
deposits, widely at variance from the real facts in the case, and
second, that if they were correct, they could in no sense be said to
constitute proof of the quantity theory.
In the critical analysis which follows, chief attention will be devoted
to Fisher's statistics. His is the later study, and it follows, in main
outlines, the methods laid down by Kemmerer. He has employed Kemmerer's
statistics in considerable part, amplifying them for later years, using
some data not available when Kemmerer wrote, and undertaking a fuller
solution of certain problems than Kemmerer did. I shall, however, from
time to time make reference to Kemmerer's figures, and show points of
difference between the two studies.
Let me first briefly state the second point of my criticism of these
studies: namely, that even if the statistics are correct, they do not
constitute proof of the quantity theory. The statistics purport to be
concrete data filling out for different years the equation of
exchange.[378] But the equation of exchange, as we have seen, does not
prove the quantity theory. The quantity theory is a _causal_ theory, and
causation involves an order _in time_. The concrete figures for the
equation do not prove that. Even Kemmerer's concluding chart on p. 148,
showing a rough concomitance between "relative circulation" and general
prices does not show that changes in relative circulation are _causes_
of changes in general prices. The causation might be the reverse for
anything his figures tell us. Fisher himself recognizes this, in
considerable degree: "As previously remarked, to establish the equation
of exchange is not completely to establish the quantity theory of money,
for the equation does not reveal which factors are causes and which are
effects."[379] Again: "But, to a candid mind, the quantity theory, in
the sense in which we have taken it, ought to appear sufficiently
secure without such checking. Its best proof must be _a priori_."[380]
The main criticism here, however, relates to the figures themselves,
rather than to their meaning. The figures given by Professor Fisher are
concrete magnitudes to fill out his equation of exchange, MV + M'V' =
PT[381] for the years since 1896. Thus, for 1909, the figures are: M =
1.61 billions; M' = 6.68 billions; V = 21.1; V' = 52.8; P = $1; T = 387
billions.[382]
Now in what follows, I shall challenge all these estimates except P for
1909, V for 1896 and 1909, and M and M' for all years. The figures for M
and M', being the results of fairly simple computations based on
Governmental statistics, need not be questioned. P for 1909 is
arbitrarily placed at $1.00. V for 1896 and 1909, for reasons which will
later appear, is better based than for other years, though Kemmerer and
Fisher have differed greatly in their estimates for V, the former
placing it at 47 and the latter at 18 or 20.[383] My criticisms with
reference to V, however, will relate to the years other than 1909 and
1896.
The sources from which these absolute magnitudes are drawn are,
primarily, two investigations by Dean David Kinley, one in 1896 and the
other in 1909, in cooeperation with the Comptroller of the Currency.[384]
The purpose of these investigations was to ascertain the proportions of
checks and money in payments in the United States. Banks of all kinds,
national and State banks, trust companies, private banks, etc., were
requested by the Comptroller to supply data for a given day (March 16 in
1909) showing what their customers deposited on that day. They were
asked to classify these deposits as cash, on the one hand, and as
checks, drafts, etc. on the other. They were also asked to give a cross
classification of the same deposits, as "retail deposits," "wholesale
deposits," and "all other deposits." In 1909, over 12,000 banks of all
kinds, out of about 25,000 banks, replied, and of these replies 11,492
were in available form. These replies showed a total of deposits of over
688 millions of dollars. Of this total, 647 millions were in checks, so
that checks made up 94.1% of the whole. About 60 millions of this total
were retail deposits, about 125 millions were wholesale deposits, and
the rest, about 503 millions, were classed in the "all other" category.
Kinley's use of these figures, _for his purpose_, seems to me in every
way conclusive and safe. He was interested merely in the question of the
_proportions_ of checks and money in _payments_, retail, wholesale, and
"_all other_." The absolute magnitudes of the elements in the equation
of exchange he was not trying to measure. Professor Fisher's use of the
figures presents a different problem.[385]
Let us consider, first, Professor Fisher's estimate of M'V', taken
together. M'V' is considered to be equal to the total amount (in
dollars) of checks deposited during the year.[386] To get this, for
1909, Kinley's figure, above, for checks deposited in 11,492 banks on
March 16, 1909, is used. This figure is 647 millions. As half the banks
had not reported, an estimate for the non-reporting banks was obtained
from Professor Weston, who had aided Dean Kinley in the investigation,
and who had access to the original data. Professor Weston estimated the
total checks deposited during the day at 1.02 billions.[387] The
question then arose as to whether this day was typical for the year.
Professor Fisher found New York City bank clearings of March 17 (the day
after, on which these checks would get into the clearings) to be 28%
below the average for the year. He assumed the rest of the country to be
half as abnormal as New York City, and increased the 1.02 billions to
1.20 billions, getting what he conceived to be the daily average of
checks deposited in the United States in 1909. Multiplying this figure
by 303, the number of banking days in New York City (and so, presumably,
a fair average for the number of banking days in the country), he
obtained 364 billions for the checks deposited in 1909. This figure he
considered to be M'V', the volume of bank deposits,[388] multiplied by
its velocity of circulation. To obtain V', therefore, his problem was
simple: he divided the figure for M'V' by the figure for M' previously
obtained from government statistics, and obtained V'.
Now I wish to call attention to three important errors involved in this
calculation of M'V' for 1909. (1) The assumption that the total check
circulation is the same as the volume of checks actually used in _trade_
is a violent one. _Payments_ may be tax payments, loans and repayments,
gifts, what not. Many checks may be used in a single transaction. Surely
not all of this is properly to be counted in the M'V' of the equation of
exchange. But this topic is better discussed in connection with the
estimate for T, and I reserve its fuller discussion till then. (2) The
assumption that the rest of the country was abnormal in its clearings on
March 17, 1909, is a pure assumption, which investigation does not
verify. The rest of the country was, in fact, nearly normal! The error
that comes for the year from increasing the total on this assumption
amounts to at least 31 billions! The total for the year, on Professor
Fisher's method of computation, with the correction to make the
assumption regarding outside clearings correspond with the facts, is 333
billions, instead of 364 billions! As the figure for 1909 is a basic
figure, on which figures for other years are calculated, this error is
extremely significant.[389]
(3) A yet more serious error in this computation is the assumption that
New York City was complete in Kinley's figures, while the rest of the
country was incomplete. This error, as we shall see, largely neutralizes
the error above, so far as the "finally adjusted" figure for 1909 is
concerned, but it makes a vital difference in the figures for other
years, as will appear, since it affects the "weighting" of New York
clearings and outside clearings in the index of variation by means of
which M'V' for years other than 1909 is determined. The assumption that
New York is complete, in Kinley's figures, and that all of the extra
hundreds of millions added by Professor Weston in his estimate for the
non-reporting banks belongs to the country outside New York, is made by
Professor Fisher both on pp. 444-445, in estimating M'V' for 1909, and
on p. 446, in finding an index of variation for M'V'. The only reason
given, so far as I can find, is the following: "This figure, _being for
New York_, [Italics mine], is probably nearly complete." (_Loc. cit._,
p. 446.) With this as a basis, Professor Fisher proceeds in his
calculations to treat the figure for New York, 239 millions, as
absolutely complete, and gives the rest of Professor Weston's 1.02
billions for the day, or 786 millions, to the country outside. The error
above mentioned, of assuming the rest of the country to be abnormally
low on March 17 in its clearings, still further increases the amount
assigned to the rest of the country in the total figures for the
year.[390] The conclusion finally is that New York had deposits of 93
billions in checks for the year, while the rest of the country had
deposits of 271 billions in checks. As New York clearings for the year
were 104 billions, while clearings for the rest of the country were only
62 billions, Professor Fisher concludes that New York clearings
overcount New York check deposits, and outside clearings greatly
undercount outside check deposits, so that, in the index of variation of
check deposits, for years other than 1909 and 1896, New York clearings
should be given a weight of only 1, while outside clearings should be
weighted by 5. "That is, on the basis of 1909 figures, five times the
outside clearings plus once the New York clearings should be a good
barometer of check transactions." (P. 447.) All this rests on the
assumption that New York figures for March 16, 1909, were complete, and
the only reason assigned is, "being from New York!"
Now the figures from New York were not complete. And New York clearings
do not overcount New York check deposits. Outside clearings do not
undercount outside check deposits nearly to the extent that Professor
Fisher assumes. For each of these three statements I shall offer what
would seem to be conclusive evidence, and I shall attempt to get an
estimate of the real relation between New York check transactions and
check transactions for the rest of the country.
First, the figures for New York were far from complete. It may be noted
that Dean Kinley, in his volume for 1909,[391] is very careful to
repudiate the assumption that the cities were complete more than the
country: "Moreover, it is a mere assumption that the non-reporting banks
are mainly the small banks in the country districts. _A great many city
banks also did not report._" (Italics mine.) That this is true for New
York is abundantly evident from figures there given for the private
banks and the trust companies, not to consider at all the State and
national banks. New York shows only $1,751 in checks deposited in the
"all other deposits" in private banks! This is a city which includes
among its private bankers J. P. Morgan & Co., Kuhn, Loeb and Co., J. &
W. Seligman & Co., and others! Figures from these banks appear nowhere
in Kinley's totals, since deposits made _by_ these banks in other banks
are also excluded from Kinley's figures.[392] Of course, exact figures
cannot be given to show how much New York would be increased had the
private banks made full reports. We have no reports of any kind from
these institutions. Every feature of their business is kept from the
lime light, as far as possible--a practice which is much to be
regretted, since it arouses hostility and suspicion, where a statement
of the facts in the case would frequently entirely dispel them. We have,
however, some information regarding the magnitude of their deposits,
meaning by deposits, not what Kinley means in this investigation,
namely, checks, etc., _deposited_ on a given day, but rather, deposits
in the balance sheet sense of demand obligations to depositors. In Nov.
1912, J. P. Morgan and Co. held deposits of $114,000,000, exclusive of
49 millions on deposit with their Philadelphia branch of Drexel & Co.
About half of these were deposits of interstate corporations. Kuhn-Loeb
held, on the average, for the six years preceding 1913 over 17 millions
of deposits of interstate corporations. What their aggregate deposits
were, we do not know. These figures are obtained from the report of the
Pujo Committee.[393] Morgan's deposits were equalled by only three banks
and two trust companies in New York (as of April 3, 1915), and
Kuhn-Loeb's deposits for interstate corporations alone exceeded the
total deposits of any one of the great majority of the New York Clearing
House banks and trust companies. Of course, large deposits in the
balance sheet sense need not mean large deposits made on a given day.
Private bankers' deposits may be inactive. But we know, first, that half
of these figures for Morgan, and the whole of the figures given for
Kuhn-Loeb, represent the deposits of active business corporations,
engaged in interstate business. They are not mere trust funds lying
idle, or awaiting investment in securities. What the rest are we can
only conjecture. That they are deposits of men and firms connected with
the Stock Exchange in some way is highly probable. The whole drift of
the statistics presented in this book, and of the argument developed in
this book, would serve to show that such deposits are likely to be more
than ordinarily active.[394] I refrain from assigning any figures as to
the amount of checks deposited in private banks in New York on March
16, 1909. It must have run high into the millions.[395] It certainly
exceeded the two thousands, or less, reported to Kinley! The figures for
New York were, thus, incomplete.
But the trust companies were also incomplete. The national banks in New
York reported checks totaling 186.5 millions, for all three classes of
deposits; the State banks reported only 38.1 millions; the trust
companies only 14.2 millions. With aggregate deposits, as shown by their
balance sheets, exceeding the deposits of national banks[396] the New
York City trust companies reported, as deposited on March 16, 1909, less
than half as much as the State banks, less than a tenth as much as the
national banks, and only 6.8% of the two combined--5.9% of the total
from all three classes of institutions!
These figures are hard to reconcile with the assumption that the trust
companies in New York were complete on that date.
It is, of course, possible that the trust companies, though having large
deposits, have inactive deposits. This is sometimes held to be the case.
But that the difference is so great in activity of deposit accounts
between banks and trust companies is hardly credible. I have looked into
this matter with considerable care, and have secured information and
opinions from men intimately acquainted with the trust companies of New
York from the inside. The only available quantitative measure of the
activity of deposits would seem to be the volume of a bank's clearings.
This is not perfectly accurate, by any means, but it is the best
available test. Through the courtesy of a Vice President of one of the
largest New York trust companies, I have obtained figures from an
official of the Clearing House, which show that in New York trust
company clearings run from 20 to 25% of the whole. On this basis, the
trust company figures for 1909 were incomplete to the extent of from 33
millions to 46 millions, on the day in question. These clearings
figures, however, are for the year, 1915, and not for the period before
May, 1911, when the trust companies were admitted to the Clearing House.
Prior to that time they did not deal directly with the Clearing House,
but _through_ the member banks. Do these figures, therefore, represent
the situation as it existed in 1909? The possibility was entertained
that entering the Clearing House had made a difference in the reserve
policy of the trust companies, and so had made them change the character
of their business, in such a way as to bring about greater activity of
accounts. This question was put to the official of the trust company
before mentioned, and his reply is that the State law regarding reserves
(passed after the Panic of 1907) had already brought about this change
in reserve policy, and so no difference was made upon entering the
Clearing House.
The same gentleman, by the way, replying to a question regarding the
deposits in private banks in New York, and the influence of such
deposits on clearings, writes: "The actual figures could not be obtained
from the Clearing House..., consequently can only say that deposits made
with these houses add to the Clearing House totals very large sums."
There is one piece of evidence which would seem to negative these
conclusions regarding the trust companies. In the Report of the New York
State Superintendent of Banks, for Dec. 31, 1907, p. xxxv, is a
statement that during the two years, 1903-05, the trust companies of New
York cleared only 7% as much as the banks. The statement relates,
however, to a period during which the trust companies not only had no
Clearing House membership, which of course was true up to 1911, but also
had largely withdrawn from the privilege of clearing _through_ member
banks.[397] Under these circumstances, even 7% would seem quite high.
Inquiry was made of the Honorable Clark Williams, who was State
Superintendent of Banks at the time the report was made, as to the
source of the figures.[398] Mr. Williams, in reply, defends the figures
as correct for that period, but authorizes the writer to quote him as in
no way surprised at the percentages given above, 20 to 25% of the total
clearings, in view of developments and changes in trust company
business.
I conclude that the trust company figures for March 16, 1909, were
exceedingly incomplete. The national bank figures were probably more
nearly complete than any others, first because they are large, and
second, because national banks would feel more obligation than other
banks to reply to questions from the Comptroller. The State bank
figures, 38.1 millions, as against national bank figures of 186.5
millions, were probably incomplete also, to a considerable extent,
though State banks are not dominating factors in New York City. That
they should exceed the figures for trust companies is surely evidence of
the incompleteness of the trust company figures. The private banks are
incomplete, with absolute certainty, since they are virtually not
represented at all.
Further evidence that the New York figures were incomplete, however,
will appear in the data regarding our second thesis, namely, that New
York clearings do not overcount New York check deposits. The aggregate
check deposits reported from New York, on the date in question, is 239
millions. Clearings for that day were 268 millions,[399] substantially
exceeding the reported check deposits. Now do clearings exceed check
deposits in New York City?
Evidence with reference to outside clearings, in connection with bank
transactions, we now have in very definite and abundant form, and it
will be convenient to approach the question of New York clearings,
first, indirectly, _via_ country clearings. We shall, therefore, take up
first the thesis that clearings outside New York do not undercount bank
deposits outside New York nearly as much as Professor Fisher thinks.
According to his estimate, checks deposited during the year in banks
outside New York (exclusive of checks deposited by one bank in another)
were 271 billions. (_Loc. cit._, 446.) Outside clearings were only 62
billions, and his conclusion is that the ratio of deposits to clearings
is 4.4 to 1, or, in other words, that outside clearings amount to less
than 22.8% of outside check deposits.
Now an extensive investigation, covering the period from June, 1913, to
Oct. 1914, inclusive, has been made by the American Bankers'
Association, through Mr. O. Howard Wolfe, Secretary of the Clearing
House Section. This investigation covered cities of various sizes, in
various parts of the country. Its results are immensely more trustworthy
than any results based on a single day, as Professor Fisher's results
are, could be, even had Professor Fisher's method been otherwise
correct. An account of this investigation is to be found in the
_Annalist_ of Dec. 7, 1914.[400] This investigation involves, for the
period in question, a comparison of "total bank transactions" in each
city with the clearings of that city, together with a summary covering
all the cities. "Total bank transactions" consist of all debits against
deposit liabilities of each member of the Clearing House, whether they
come through the Clearing House or over the counter. They include
payrolls, for example, which, of course, never get into clearings. They
include drafts on deposits of one bank in another. In a letter to the
Editor of the _Annalist_, Mr. Wolfe states that "total bank transactions
include all debits against deposit liabilities, whether by check, draft
or charge ticket. The only exceptions are certified checks and certain
cashier's checks, both of which to an extent represent a duplication."
For the period in question, clearings amounted, on the average, for all
cities, to 40% of "total transactions." The cities did not include New
York City, as stated.
Now we cannot apply this 40% at once to the question in hand. Professor
Fisher's 22.8% relates to the relation between clearings and checks and
drafts _deposited_, _excluding_ items deposited by banks, and excluding,
of course, cash deposited. What is the relation between Kinley's
"deposits" and Wolfe's "total transactions"?
It is clear that "total transactions" must, in a period of time,
_exceed_ Kinley's "deposits" very considerably. In a general way, what
goes out of a bank, and what comes into a bank, must approximately equal
one another in a period of time. In a general way, a depositor finds his
income and his outgo balancing. Of course, some accumulate, paying in
more than they withdrew, but in general such accounts are made with
savings banks. The business man borrows from his bank, getting a
"deposit credit" (without "depositing" in Kinley's sense), then checks
against his "deposit," then receives checks in payments to himself,
"deposits" them, building up his deposit balance again, and then checks
against his deposit balance, in favor of the bank, to pay off his loan.
What comes in and what goes out--abstracting from the growth of a
rapidly expanding bank--balance. But notice, in the case cited above,
that "total transactions" include more items than Kinley's "deposits"
show. When the bank makes a loan, and gives a deposit credit, this does
not, usually, show in Kinley's deposits. When, however, the loan is paid
off by a check to the bank, it does show in "total transactions."
Moreover, when a man deposits cash in the bank, it does not show in
Kinley's figures for checks deposited. When, however, he withdraws cash
from the bank, or his check to another is "cashed," it does appear in
"total transactions." Further, checks deposited to the credit of one
bank in another do not appear in Kinley's figures. Checks drawn,
however, by one bank on another do appear in total transactions. How
great the difference is between "total transactions" and "deposits" in
the banks outside New York we cannot say precisely. The cash items
alone, on the basis of Kinley's figures, would make a difference of
about 9%.[401] To allow 11% excess to "total transactions" over
"deposits" for the other reasons listed, is surely not to make an
exaggerated allowance. We thus count "deposits" in Kinley's sense, for
the banks outside New York City, as 80% of "total transactions." Since,
then, clearings are 40% of "total transactions," they will be 50% of
"deposits." This figure is more than twice as great as Professor
Fisher's figure of 22.8%. Even if we counted deposits as equalling total
transactions, Professor Fisher's estimate would be clearly very much too
low.
How, then, do we stand? On Professor Fisher's showing, the overwhelming
bulk of checks deposited were in the country outside New York--271
billions for the year, outside, as against 93 billions in New York City.
If the ratio (50%) for outside clearings to deposits was the same for
1909 that it was in 1913-14 for the outside banks, we shall have to
revise this radically. We have 62 billions of country clearings in 1909;
we would have, then, 124 billions[402] of country check deposits! If
Fisher's total figure for the country is correct, 353 billions as
"finally adjusted," the balance, or 229 billions, would belong to New
York! New York clearings, 104 billions, would thus be less than half of
New York deposits! If we count outside clearings for 1909 as only 40% of
outside check deposits, outside deposits would be, for 1909, only 155
billions, as against Professor Fisher's 271 billions, _a difference of
116 billions_! I am sure that his error in estimating outside check
deposits is at least as great as that, and that we cannot assign to New
York City less than a major part of the total check deposits of the
whole country.
This result fits in with the figures actually reported to Dean Kinley,
corrected to fit the known facts about March 17 clearings, better than
Professor Fisher's estimate, by a good margin. According to Professor
Fisher's estimate, New York City checks deposited are only 25.5% of the
total. Kinley's actual figures give 239 millions to New York City, and
408 millions to the country outside. But New York clearings were 28%
below normal on March 17, while country clearings were only 2.45% below
normal. Adding 28% to the figure for New York checks, we get 306
millions. Adding 2.45% to the outside checks, we get 418 millions. Of
the total, 724 millions, New York checks would be, then, 42.3%. We have
shown reasons for considering New York deposits to be very incomplete
for March 16, particularly as regards the private banks and trust
companies. Comparison of the New York figures with the results indicated
by the ratio of country clearings to country deposits would thus
indicate that New York was much less complete than the country as a
whole. Even so, I need to add but 7.3% of the total to Kinley's actual
figures for New York, corrected in the light of next day clearings, to
give New York half of the check deposits. Professor Fisher must subtract
16.8% of the total from the actual figures for New York, as corrected in
the light of next day's clearings, in order to get his figure of 25.5%.
To vary as widely from the actually reported figures as Professor Fisher
does, I should have to assign 59.1% of total check deposits to New York
City. I refrain from making an exact estimate. I am content with the
conclusion that something more than half of the checks deposited in 1909
were in New York. This seems to be too clear for serious controversy.
The indirect approach to the relation between New York clearings and New
York deposits, _via_ the study of outside clearings in 1913 and 1914,
taken in conjunction with the figures for check deposits in 1909, would
seem to make it quite clear that New York clearings do not exceed New
York deposits, or, indeed, constitute a substantially higher percentage
of them than is the case with country clearings and deposits.[403]
Logically, assuming the correctness of the estimate for checks
deposited, the case is complete: we have a simple problem in arithmetic:
given country clearings for 1909, 62 billions; given the ratio of
country clearings to country deposits (and a minimum for this ratio is
clearly given, in the 40% which country clearings are of "total
transactions"), we can fix a maximum for country deposits, which is 155
billions. Then, given our estimate of 353 billions for total check
deposits, we subtract the maximum possible for country deposits from it,
and get a minimum possible for New York City of 198 billions of check
deposits. Comparing this with the known clearings of 104 billions in New
York, we find that New York clearings constitute, as a maximum possible,
52.5% of New York check deposits. If the reasons given for holding check
deposits in the country to be less than total transactions are accepted,
the ratio of clearings to deposits in New York City is lower.
Indirect calculations, however, even when logically complete, ought to
be checked up by other methods, when possible. We have some further
data, drawn from an earlier period, 1890-91-92, which suggest the same
conclusion.
The reason commonly offered for holding that New York clearings
exaggerate local New York transactions, as compared with country
clearings and country transactions, is that New York is the clearing
house for the country. Country banks send their idle cash there; country
banks pay other banks by drafts on their New York balances; country
banks send out of town checks to New York for collection; business men
in St. Louis pay business men in Chicago with New York exchange, etc.
These items are supposed greatly to swell New York clearings.
Now several of these reasons are not at all valid. Cash shipped back and
forth between New York and the interior does not get into clearings.
Secondly, New York, because of the charges made for collecting out of
town checks, has tended to lose much of the collection business. Chicago
probably does a great deal more of it than New York does.[404] However,
even if checks on out of town banks were sent largely to New York for
collection, they would not get into the clearings. New York banks send
checks on country banks directly to country correspondents. Checks on
out of town banks sent in for collection do swell clearings in Boston
and Kansas City, where arrangements have been made, to the advantage of
all concerned, to have the clearing houses handle this business. But New
York has not made provision for it.[405] The only checks that get into
New York clearings will be checks drawn on New York banks.[406]
These checks will be of two kinds: (1) checks drawn by individuals and
firms on New York banks. These checks will commonly be drawn by people
in New York, and, in so far as they come from out of town, will
represent business between New York and other places, hence, New York
business. (2) Drafts by banks on their New York balances. These will be
of three kinds: (a) drafts sold, especially by country banks, to their
customers who need to make payments in other cities. Many of these will
represent payments to New Yorkers for transactions between New York and
the country, hence New York business, and will appear in the check
deposits of individuals, firms, and corporations in New York, (b) There
will also be drafts from one country bank, on New York, to another
country bank, in which New York is truly being used as a clearing
house, New York exchange taking the place of an intercity shipment of
cash.[407] (c) Drafts by New York banks on New York banks, to avoid
deficits at the Clearing House, or--especially in the case of private
bankers, between whom and brokers the line is hard to draw,--for general
purposes.
Now, fortunately, we have some data, trustworthy, even though old, for
the volume of bank-drafts on New York, and, more important, for the
proportion of drafts on New York to drafts on banks in other cities.
These figures are, as stated, from the three years, 1890, 1891, and
1892. For the purpose in hand, however, they are relevant, since then,
as now, New York clearings were nearly twice as great, on the whole, as
country clearings, and if this excess of New York clearings is due to
that cause, it should have manifested itself in these figures. If the
proportion of these drafts on New York to the total of bank-drafts was
greater than the proportion of New York clearings of total clearings, we
might find reason for supposing that New York clearings were unduly
swelled by this fact. But in fact, drafts on New York are not out of
proportion. The figures are virtually complete for drafts drawn by all
the national banks on national and other banks for the years in
question. They will be found in the Comptroller's _Reports_ for the
three years, under the caption, "Domestic Exchanges." For 1890 the
figures are:
Drafts on (000,000 omitted)
New York $ 7,284 (63.07%)
Chicago 1,084 ( 9.30%)
St. Louis 188 ( 1.64%)
Other reserve cities 2,537 (21.88%)
Other cities 464 ( 4.02%)
Total 11,550 ( 100%)
The Comptroller (_Report_ of 1890, p. 19) gives an estimate for drafts
drawn by State and private banks of an additional 6,089 millions. He
does not try to apportion these among New York and the other cities.
There is no reason to suppose that the percentage for these banks of
drafts drawn on New York would be higher than for national banks, and
there is some reason for supposing that they would be lower: namely,
that these institutions would lack the incentive supplied by the
National Bank Act for depositing reserves in a Central Reserve City. The
Comptroller's figures probably do not include the great private banks in
New York, which deposit in New York commercial banks, and draw huge
checks against their deposits. These checks, probably, however, chiefly
represent stock exchange collateral loans to brokers, and so appear in
brokers' deposits as well as in New York clearings--represent New York
deposits. I do not use this estimate in my computations. If I did, the
results, so far as proportions are concerned, would be the same, since I
could do nothing but assign the same proportions to them. It will be
seen that my argument rests on the proportions, chiefly.
Now what difference would be made if we wiped out all these draft
transactions, and reduced clearings to correspond? New York clearings in
1890 were 37,660 millions; country clearings were 21,184 millions. Let
us subtract the drafts on New York from New York clearings, and the
drafts on other places from the country clearings. The result is: New
York clearings, 30,376 millions; country clearings, 16,918 millions. New
York clearings still retain their former status! New York clearings are
still nearly twice as great as country clearings! It is not the bank
drafts used in making New York the "clearing house" for the country that
swell New York clearings as compared with the rest of the country! It is
something else! The main explanation, as we have in part seen, and shall
further see, is a mass of speculative transactions, chiefly Stock
Exchange transactions, and loan transactions connected therewith! New
York clearings grow out of New York business, primarily.
The figures for the other two years vary little from those of 1890. What
variation there is shows a growth of drafts on interior cities, and a
decline of drafts on New York. New York showed 63.07% of these drafts in
1890, 61% in 1891, and 60.77% in 1892.[408]
As we have seen, the only checks or drafts that get into New York
clearings are those drawn on New York banks. The checks on New York
banks probably almost all represent business in which one party is a New
York individual, firm, or corporation. The drafts by out-of-town banks
will contain all the items, virtually, that represent "clearings"
through New York. Not all of these, by any means, will represent such
clearings. A very substantial part of them will represent exchange sold
to customers to make payments in New York. We exaggerate the "clearing
through New York" when we subtract all these drafts from New York
clearings. Since, however, we treat country clearings in the same way,
no error results, so far as the proportions between them are concerned.
The two sets of data converge. Both from the figures of 1913-14, in
conjunction with estimated check circulation in 1909, and from the
figures of 1890-92, can we conclude that New York clearings do not
overcount New York transactions. The conclusion would seem to be
inevitable that New York is really as important in our volume of banking
transactions as its clearings would indicate. This may be qualified by a
recognition of the possibility that New York clearings are more
efficient in handling check deposits than are clearings in other cities.
Some scattering data from national banks for single days at a time
indicate that a higher percentage of checks is cleared in New York than
elsewhere in the country,[409] and one observation for five national
banks for a ten-day period shows 67% of checks deposited cleared.[410]
These checks include deposits made by other banks, as do the figures of
Kemmerer's observations. But there are no direct observations covering
New York for a long enough period, or for enough institutions, to
warrant any definite conclusions.[411]
The error of assuming clearings of March 17 in the country outside New
York to be abnormally low, swelled Professor Fisher's total figure for
check circulation by 31 billions, as we have seen. On the other hand,
the error of assuming New York City to be complete in Kinley's figures
tended to make the total smaller than it would have been, since New York
City was 28% below normal, and an increase of 28% applied to half of
Professor Weston's figure of 1.02 billions, gives about 70 millions more
for the day, or 21 billions more for the year, than when the 28%
increase is applied to only a quarter of Professor Weston's figure.
These two errors roughly neutralize one another, and we may accept
Professor Fisher's "finally adjusted" estimate of 353 billions[412] for
the year as roughly approximating the amount of checks deposited.[413]
How "rough" an estimate one gets by taking a single day as the basis for
a year need not be here discussed. I should be disposed to think that an
indirect calculation, _via_ clearings, in view of our more extensive
knowledge of the relation of clearings to "total transactions," might
well be worth more, so far as deposits outside New York are concerned.
Since, however, we lack any extended figures for the relation of
transactions and clearings in New York, and since even for the country
we are obliged to make guesses as to the relation of "checks deposited"
to "total transactions," I refrain from trying to improve further on
Professor Fisher's estimate for checks deposited in 1909--even though
questioning that "check deposits" and M'V' are identical.
What, however, shall we say of M'V' for other years? In the calculation
of this, Professor Fisher relies on the absolute figures for 1909 (and
1896, similarly calculated), together with an "index" based on New York
and country clearings. In this index he weights country clearings by
5,[414] and New York clearings by 1. The result is, of course, that
country clearings dominate the index. But New York clearings are much
more variable than country clearings. The range of variation in New York
clearings for the years 1897 to 1908, inclusive, is from 33.4 billions
in 1897, to 104.7 billions, in 1906; the latter figure being more than
three times as great as the former. The range in country clearings is
from 23.8 billions, in 1897, to 57.8 billions, in 1907, the latter
figure being 2-10/23 as great as the former. But more significant is the
degree of _year by year_ variability. The country clearings, with the
exception of 1908, always rise,--a steady, if not quite symmetrical,
increase. New York clearings, however, go up and down, 42 billions in
1898, 60.8 billions in 1899, 52.6 billions in 1900, 79.4 billions in
1901, 66.0 billions in 1903, 104.7 billions in 1906, 87.2 billions in
1907, 79.3 billions in 1908. New York clearings are highly variable in
both directions, while country clearings vary almost wholly in one
direction, with a maximum difference of 6.4 billions between any two
consecutive years, and with an average yearly variation of only 3.5
billions.[415] When country clearings are weighted by 5, almost all of
the high degree of variability of New York clearings is covered up, and
volume of checks deposited for years other than 1909 and 1896 is thrown
hopelessly away from the facts. It is too large by far in most years. In
1905, 1906 and probably 1901 it is too small. It does not vary nearly
enough. As V' for years other than 1909 and 1896 is determined, for
Professor Fisher's equation, by dividing the M'V' thus estimated by the
M' for the year, it is clear that V' as estimated by Professor Fisher is
very much less variable than it is in fact. It is pretty variable even
in his figures, but his figures do not nearly show how variable it
is.[416]
Again, this undue weighting of country clearings, swallowing up New
York, vitiates Professor Fisher's estimates for V, the velocity of
money, for years other than 1909 and 1896. One of the elements in the
calculation of V is the estimated V'.[417] Since V' is wrong, V will
also be wrong. V is probably much more variable than Professor Fisher's
figures would indicate. With great admiration for the ingenuity of
Professor Fisher's speculations regarding V, I find too many elements of
conjecture, and too many arbitrary assumptions, to give me confidence in
the figure for any year. I refrain from going into any general criticism
of his method of calculating V, however, contenting myself with the one
clear point that, to the extent that the values of V for years other
than 1909 and 1896 depend on the estimated M'V' for those years, they
are less variable than they ought to be.[418]
The same conclusion regarding Professor Fisher's estimates for V' have
been reached, by a different method, by Professor Wesley C. Mitchell.
He, too, concludes that V' is, in fact, more variable than Professor
Fisher would indicate.[419]
I conclude, therefore, that neither V' nor V has been correctly
calculated, for years other than 1909 and 1896. I pass now to a
consideration of T, the volume of trade, after which I shall consider P,
the price-level, in the equation of exchange.
Let us first recall the point made in the chapter on "The Equation of
Exchange," that P and T, the price-level and the volume of trade, are
not independent even in idea. If one is given an independent definition,
the other cannot be given an independent definition. If the equation is
to be true, then P must be weighted by the numbers of each item (as
hats) exchanged. P is not a mere average, but is a _weighted_ average,
and T is always the denominator in the formula for P. In developing
statistics for P and T, therefore, this fact must be kept in mind, and
the elements entering into each must coincide, and vary together year by
year.
In our chapter on "The Volume of Money and the Volume of Trade," we
showed that the great bulk of trade is speculation. We showed that the
_indicia_ of variation which Fisher[420] and Kemmerer have constructed
for trade, dominated by inflexible physical items of consumption and
production, give wholly misleading results for every year except the
base year. They give a steadily growing, inflexible figure, with little
variation from its steady path. Trade, if chiefly speculation, is highly
flexible, varies enormously from year to year, waxes and wanes. This
point need not be further developed. At best Fisher's figure for trade
can be accepted only for one year, 1909.
Is, however, the figure for 1909, 387 billions, an acceptable figure? Is
it not decidedly too large? It is made up, it will be recalled, by
taking the figures for MV and M'V', adding them together to get one side
of the equation, and declaring them equal to PT. P is then declared to
be $1, by the arbitrary device of taking as the unit of T one dollar's
worth of every sort of good at the prices of 1909. T is, then, 387
billions, since MV plus M'V' equals 387 billions. The theory underlying
this is that deposits made in banks correctly represent trade.[421] Our
criticisms as to the absolute magnitude assigned to T (and hence to MV
plus M'V') will rest in large measure in challenging this assumption. It
is our contention[422] that deposits made in banks very greatly
overcount trade.
Deposits made in banks include taxes and other public revenues; they
include loans and repayments, and interest-payments; they include gifts
and benevolences, money sent by parents to children away from home,
pensions, payments of insurance losses, annuities, dividends on stocks,
payments to and from savings and loan associations, fines, contributions
to churches, and other non-commercial organizations, etc., etc. None of
this represents trade.
But further, whether payments are in trade or not, many times indeed
does it happen that several checks are drawn in connection with the same
transaction. Professor Kemmerer, entertaining this possibility, thought
it might be neutralized by cases where the same check passes through
several hands, making payments in several different transactions. He
calls this, however, a "gratuitous assumption of unverifiable
accuracy,"[423] and makes no claim to have given the matter careful
study.
In general, I think it safe to hold that the case where a single check
passes through several hands is not important.[424] It will happen
chiefly with small checks in small places, or with small checks paid to
laborers. It is the pecuniary magnitude of checks, rather than their
number, that counts here. I am informed by several bankers that large
checks are almost universally deposited at once. This is for several
reasons: (1) The recipient of the check wishes to make sure that it is
good. (2) It is unlikely that the check is of the right size for another
transaction, unless the recipient is a mere agent for a third party, in
which case he should (but commonly does not) pass it on to his
principal, if double counting is to be avoided. (3) Every person who
handles sums of any size wishes a record of the transaction, and his own
canceled check is a receipt which he would not have if he passed on the
check of another.
This last point will go far toward explaining why bank transactions may
multiply without a corresponding multiplication of trade. The banks do
the bookkeeping for modern business in increasing degree. Checks are
records, of high legal value. A colleague recently told me that he, in
his own capacity, had just drawn a check to himself, as trustee,
transferring a sum from one account to another. Another colleague, with
eight different bank accounts, estimates that over 50% of the deposits
in three of them represent transfers from other accounts. This kind of
duplication, where trust relations are involved, is enormous.
Intercorporate relations and separate bank accounts within a corporation
complicate it still further.
A check is drawn by a subsidiary corporation to its dividend account,
and deposited; a check on this dividend account[425] is then deposited
in the general account of the parent corporation; a third deposit, of
the same funds, is then made in the dividend account of the parent
corporation; a fourth deposit of the same funds is made in a trust fund
which holds stock in the parent corporation; a fifth deposit in the
personal account of the beneficiary of the trust fund; a sixth deposit
may be made of a check on this fund in the personal account of the
beneficiary's wife. The first three of these deposits, at least, will be
made of the total dividend of the subsidiary corporation. _Not one_ of
these six deposits represents _trade_. Payments of wages and rents
should count as trade, but payments of interest and dividends stand on a
separate footing. When a man has bought a stock or a bond, he has
already bought all the income which is to come from them, and to count
the interest and dividends as separate items is double counting. They
are _payments_, but not _trade_. Even if the dividend payment be counted
as trade, however, it is counted _six_ times.
There is enormous overcounting as a consequence of the combinations of
corporations, each of which retains its own numerous bank accounts. The
Interstate Commerce Commission calls attention to great duplications
from this cause in connection with railway income accounts.[426] Even
within single corporations the duplications[427] are very great. Thus,
the local agent of a railroad deposits his receipts in a local bank. His
check, or, more usually, the draft of the bank, is subsequently
deposited in a bank at headquarters. Subsequent disbursements, in places
away from headquarters, particularly of wages, will frequently be
preceded by deposits in other local banks. This duplication will be true
of telegraph, telephone, insurance and other companies which have
scattered agencies, including the wholesale trade. Advertising agencies
will illustrate it. _All_ checks between agent and principal, customer
and broker, etc., will illustrate it. There is a great deal of double
counting in stock transactions from this source. Thus, a Boston broker
takes orders, with a check for margin, for execution in New York. The
order is executed by a New York broker, who deals with another New York
broker, who represents a Louisville broker, who represents a Louisville
client. Now to the extent that any checks at all pass between the Boston
broker and his client, the Boston broker and the New York broker, the
other New York broker and the Louisville broker, or the Louisville
broker and his client, we have overcounting. Only the check between the
two New York brokers is properly counted. It is, of course, well known
that a small percentage of the dealings of a customer of a brokerage
house is represented by checks between broker and customer. Professor
Fisher states this to be about 5%.[428] It is, however, 5% of
overcounting! Moreover, through keeping "open accounts," with irregular
settlements of "margins" only, the Boston broker and the New York broker
reduce markedly the checks passing between them. There is a back and
forth flow of items which in large degree cancel one another, since the
Boston broker sells in New York as well as buys there, and the New York
broker, to a less degree, both buys and sells Boston securities, through
his Boston correspondent. But not all by any means is canceled, and
_all_ the checks that pass in this way represent double counting. The
total is large.
_Public funds_ are included in the deposits reported to Kinley. Taxes
are not _trade_. Double, triple and multiple counting comes as revenues
are received by local authorities, transferred to State accounts,
subsequently redistributed to local accounts, or to the treasurers of
State institutions, transferred from one bank to another, etc. The State
of Massachusetts scatters its deposits in banks all over the State, and
makes transfers from one account to another. The City of Boston has many
bank accounts. The Federal Treasury deals largely with banks over the
country.
Whenever a retail store has branches, duplications are likely to occur.
"Chain stores" make great overcounting. "Kiting" swells bank deposits.
Replying to these contentions, Professor Fisher has urged that there is
large _undercounting_, also, and that the undercounting balances the
overcounting. I have myself called attention to a good deal of
undercounting in the chapter on "Barter." A substantial amount of
ordinary trade is carried on by means of partially offsetting
book-credit, time bills of exchange, simple barter, etc. The amount
might even run high, as compared with ordinary trade, when the clearing
arrangements in the stock and produce exchanges are taken into account.
But it is impossible to figure out anything at all in this line which is
to be compared with the great gap between the 141 billions of trade we
were able to find,[429] and the 387 billions Professor Fisher assigns to
trade. The gap of over 245 billions is much too great. Besides, in our
141 billions, we have counted barter items, book-credit items, time-bill
of exchange items, etc., already.
The main item of undercounting must be in connection with the clearing
arrangements in the speculative exchanges. This would seem to be
Professor Fisher's view, as well.[430] Data are at hand for the two
great exchanges of the country which enable us to measure, with some
precision, the amount of the undercounting--_i. e._, to tell the extent
to which checks are dispensed with in the trading of these two great
exchanges. The two exchanges are the Chicago Board of Trade and the New
York Stock Exchange.