I need not give the details of Kinley's figures again, as they have been

elaborately analyzed in connection with the estimate of the "volume of

trade."[535] The figures show that retail and wholesale deposits between

them make up about 25% of the total deposits. This would serve to show

that "commercial paper," which we have allowed to be about 24.8 of total

loans, is slightly more active (and hence "liquid") than the average of

loans.[536] It will also suggest, however, that our figure for

"commercial paper," truly liquid, is too high, since we should expect

this kind of paper to be more active than the average--unless, indeed,

stock exchange collateral loans are so exceedingly active as to make a

tremendously high average. I refrain from trying to get a definite

answer on this point, since there are many indeterminate elements: among

others, uncertainty as to the extent to which wholesale deposits and

retail deposits _include_ all commercial deposits, and uncertainty as

to the extent to which they _exclude_ manufacturer's deposits. The great

bulk of Kinley's deposits, however, fall into the "all other" class, and

the great bulk of the "all other deposits" are located in the great

financial and speculative centres, particularly New York. We have

concluded that they represent chiefly (a) transactions in securities;

(b) other speculation; (c) loan and other financial transactions,

particularly the shifting of call loans on stock exchange collateral. It

is, then, the deposits of those connected with the great financial and

speculative markets, particularly the stock market, whose deposits are

most active, and whose loans are most liquid. Stock market collateral

loans thus constitute the most perfectly satisfactory sort of bank loan,

from the standpoint of liquidity. Though such loans do not make up the

bulk of bank loans (we have concluded that they constitute 30.6% of the

loans of State and national banks and trust companies in 1909), they do

account for the bulk of banking activity, and supply the greatest part

of the liquidity of total bank loans.

When we consider further the item of securities (chiefly bonds) in

banking assets, we find another highly important source of liquidity.

The sales of bonds in the great banking centres are enormous. The

figures of bond sales on the exchanges do not begin to tell the story.

One big bank in New York in 1911 sold more than half as many bonds as

were sold in that year on the floor of the Stock Exchange.[537] It has

been frequently stated that ten bonds, of those listed on the Exchange

are sold over the counter for one on the floor. This is truer of Boston

than New York. The "outside market" for unlisted bonds is a very

important matter. Dealings among banks in these items and in foreign

exchange are exceedingly important. This is especially true of the

business of the great private bankers, as Morgan, Kuhn-Loeb and others.

Much of this does not appear in Kinley's figures, since neither the

deposits of the great private banks in other banks, nor the deposits

made in the private banks themselves (so far as New York City is

concerned) figure in his totals.[538] Had they been included, the

percentage of the "all other deposits" would have grown, and we should

have had still more impressive evidence of the fact that modern banking

in the United States is largely bound up with the security market, and

that modern bank-credit gets its liquidity chiefly from that source.

The story is even more impressively told by the figures for bank

clearings, which include the transactions between banks, and the

transactions of the private bankers. In New York, in 1909, total

clearings for the year were 104 billions, as against 62 billions for the

whole country outside New York.[539] That bank clearings are closely

correlated with stock exchange transactions, has been demonstrated fully

by N. J. Silberling, who has shown the following correlations: New York

Stock Exchange share sales with New York clearings, r = .718; total

clearings for the country with New York share sales, r = .607; total

clearings for the country with railway gross receipts (as representative

of ordinary trade), r = .356.[540] The active deposits and the liquid

loans are chiefly connected with activities in finance and speculation.

Now two important practical conclusions are suggested by this analysis.

The first is that the complaint of many farmers, merchants, politicians,

and even scientific writers that too much money and bank-credit are at

the disposal of Wall Street and other speculators rests on a

misunderstanding of causal relations. Wall Street does not, by using a

large amount of bank-credit, take just that much away from ordinary

business. Rather, it increases the amount available for ordinary

business! Wall Street, and the other financial and speculative centres,

supply the _liquidity_ for bank assets, and so make possible loans on

non-liquid paper. Banks do not need to have all their assets liquid. If

they did, American banks would have long since gone under! The foregoing

discussion of loans to farmers, and manufacturers and even merchants

should have made that clear. But banks do need a substantial margin of

liquidity, to protect the rest. They get it from stock exchange

collateral loans, and from ownership of listed and easily marketable

bonds, primarily. They get part of it from true commercial paper. Thus,

the director of a country bank in Iowa told the writer that banks in his

section--where banks owned in large measure by farmers, and dealing

largely with farmers, are very numerous and important--make a regular

practice of buying, through brokers, a considerable amount of notes of

outside merchants. They do this to protect themselves. Their other

loans, to farmers, while good, are slow. If pressed themselves, they

cannot press their depositors. These notes bought through note-brokers,

however, are impersonal. They can refuse to renew them. They can sell

them again. They thus buttress the rest of their assets. They can thus

lend more, rather than less, to local customers. They can safely get

along with much smaller cash reserves. Similarly with the practice of

country banks of sending a large part of their cash to Wall Street banks

to be lent on call, for which the country banks get, say, 2% from the

Wall Street banks. Their country customers would pay 6% or more for

that money in some cases, but the banks dare not tie up more of their

assets in non-liquid local paper. They lend more, rather than less, at

home, because they send part away. Wall Street is not "draining our

commerce of its life blood"![541] Wall Street is rather preventing that

life blood from coagulating!

A second important practical conclusion relates to the provision in the

Federal Reserve Act which forbids Federal Reserve Banks to rediscount

stock exchange paper. This provision was intended to keep funds from

being diverted from commerce to stock speculation, and doubtless met the

approval of many very good students of the subject. If the foregoing be

true, however, that provision is a mistake. It is a mistake, first,

because it will lessen, rather than increase, the power of the Reserve

Banks to provide relief to commerce through aiding in making bank assets

liquid _via_ the stock market. It will limit the liquid assets of the

Federal Reserve Banks in too great a degree to gold. It is a mistake, in

the second place, because it prevents the Reserve Banks, particularly in

New York and Boston, from making satisfactory profits--which is one

important purpose of a bank! Even more important, however, is the third

objection: it prevents, in large degree, the Federal Reserve Banks from

being effective weapons against the "Money Trust." How far we have a

"Money Trust" need not be here argued. The Pujo Committee, relying in

considerable degree on admissions of prominent financiers that

"concentration had gone far enough," and on the inability of Mr. Baker

to find more than one issue of securities of over $10,000,000 within ten

years, without the cooeperation or participation of one of the members of

a small group, concluded that we have a "Money Trust" in the sense that

there is "an established and well-defined identity and community of

interests between a few leaders of finance ... which has resulted in a

vast and growing concentration of control of money and credit in the

hands of a comparatively few men."[542] How far this conclusion is

justified is, of course, a matter that would require elaborate

discussion. There seems to be evidence that there is, since the death of

the elder Morgan, a decided loosening of ties. One feels the need,

moreover, of discounting very considerably many of the conclusions of

the Pujo Committee. The present writer feels that the case has been

made, however, that there has been, and probably continues, a much

greater concentration of such control than is desirable. Whether or not

there is at present such a "Money Trust," it seems pretty clear that

temporary, if not permanent, alignments, may give effective monopoly

control when the issue of very big blocks of securities is involved. For

present purposes, however, it is enough to note that _if_ there is, or

should come to be, a "Money Trust," it is a trust concerned with

_financing industry, through handling security issues_, and not a trust

_in the granting of ordinary commercial credit._[543] If, therefore, the

Federal Reserve Banks are to compete with it, and break its monopoly,

they must do it by entering the market with funds for the financing of

corporate industry. Power to rediscount commercial paper seems a feeble

and hardly relevant weapon against a combination concerned with

purchasing securities, and making collateral loans! No doubt, this power

is worth something. If an independent investment banker wishes to

compete with a "Money Trust" in financing a new enterprise, he can go to

his commercial banker, and offer collateral security for a loan; if the

commercial banker wishes to aid him, but is short of lending power, he

may, if he has plenty of commercial paper available for rediscount,

rediscount it with the Federal Reserve Bank, and so get the additional

funds. But a New York bank, or trust company, with the bulk of its

assets in stock exchange investments, may well not have enough

commercial paper eligible for rediscount, and the Federal Reserve Bank

could help very much more effectively if it could take collateral loans

directly. A fourth, and even more important objection to the restriction

on stock exchange collateral loans for Federal Reserve Banks relates to

the power of these banks to aid in a crisis. Crises first hit the stock

market. Financial panics are most acute there. The need for immediate

and drastic relief is greatest there. If stock exchange loans lose their

liquidity, what of the rest of bank loans? Power to lend on stock

exchange collateral, in the hands of the Federal Reserve Banks, may well

prove, in crises, an essential, if we wish to make our system definitely

"panic proof."[544]

And now for a vital theoretical conclusion from this lengthy analysis of

bank loans. For the quantity theory, and the "equation of exchange," all

exchanges stand on a par. If one exchange takes place, that lessens the

money and credit available for another exchange. The more exchanges

there are, the less money and credit there are per exchange, and the

lower prices must be, as a consequence. Nothing could be more false.

Exchanges are not on a par.[545] Some classes of exchanges increase,

rather than decrease the funds available for handling others. The

activity of the speculative markets, making loans fluid, enormously

increases the lending power of the banks for all purposes. Exchanges of

securities, especially, instead of lowering prices, make it easier for

prices to rise.[546] The years of extraordinary stock sales have always

been "bull" years. There have been big "bear" days,[547] but never big

bear years, in the record of New York Stock Exchange share sales. The

selling and reselling of speculative goods of securities, and of notes

and bills are especially important as making it easier for banks to

expand loans. To list all manner of items, as Professor Fisher

does,[548] "real estate, commodities, stocks, bonds, mortgages, private

notes, time bills of exchange, rented real estate, rented commodities,

hired workers," and count them all as "actual sales," all part of the

"goods"[549] which make up the "volume of trade," is to put the theory

utterly beyond the pale. Seasonal calls on an inelastic money supply for

actual cash to move crops and pay agricultural wages may make a real

difference in the value of money; scarcity of money of the right

denominations for retail trade may give an agio to such money,[550] but

the money and credit used by speculators, bill brokers, dealers in

foreign exchange, investment bankers, etc., increases, rather than

decreases, the funds available for ordinary industry and commerce.

I have made clear the distinction between the direct and indirect

financing of industry by banks. Great banks in Continental Europe often

_buy_ the stocks of new corporations, hold them permanently, put bank

officers on the boards of directors, and supervise closely the

operations of the companies. In America, while officers of

commercial[551] banks often are members of boards of directors of the

companies which borrow heavily from the banks, the practice is to make

short-time loans to such companies (in form, if not in fact), and to

lend on their securities, rather than to buy them. Our banks own

securities in enormous amount, but they are chiefly seasoned bonds,

rather than stocks of new or even well-proved, enterprises.

It is commonly supposed, too, that collateral loans are chiefly or

almost wholly made to speculators, who buy securities in the expectation

of holding them only till investors take them off their hands, and that

investors buy them, not with bank-credit derived from loans, but with

money or bank-credit which they accumulate by saving out of current

income. It is particularly true of the higher grade securities, which

savings banks and insurance companies can buy, that this is the case.

The bank-credit thus serves for temporary, rather than for permanent

financing, to the extent that this is true. I think, however, that the

extent to which bank-credit serves for permanently financing industry is

underrated. A good many investors have learned that the short-time

money-rates are, on the long time average, lower than the yield on

long-time securities.[552] They have learned, too, that high-yield

securities--securities high in yield as compared with the long-time

average of money-rates--can be obtained which can safely be carried on

margins of thirty, forty and fifty points, without danger that even such

catastrophes as the slump in security prices at the outbreak of the War

will wipe the margins out. The old distinction between investors and

speculators, the former those who buy for the yield, and the latter

those who buy for an anticipated rise in capital value, no longer

corresponds to the distinction between those who buy outright and those

who buy on a margin. The investor, buying a 6 or 7% preferred stock,

carrying it on a forty point margin, with money from his bank or broker

at 4 or 5%, is making 6 or 7% on his own forty dollars, and is making

the difference between 6 or 7% and 4 or 5% on the sixty dollars lent him

by his banker or broker. He substantially increases his yield thereby,

and his risks, if he chooses his stocks carefully, and scatters them

among a number of issues, are not great. For the banker or broker, such

a loan is perfectly satisfactory. The margin of security is wider than

that demanded on more speculative securities. Such a borrower will

receive consideration when more speculative loans are being called, or

not renewed. The investor of this type is, in effect, engaging in a form

of banking business. He is lending to the corporation funds which he has

borrowed from others; he has put up his own capital for the same purpose

that the bank uses its capital--to supply a margin of safety to those

who have taken his short-term promises to pay. Like the bank, too, he

converts rights to payments at a later date into rights to payment at an

earlier date. He is one of the links in the chain whereby the wealth of

low saleability employed in industry becomes distilled and refined till

it enters the money market. His profits come in the difference in the

yield as between more saleable and less saleable forms of rights.

The extent of this practice cannot be stated, so far as any data to

which the present writer has access are concerned. The writer has met

the practice in a good many cases. One brokerage house, with whose

operations the writer has considerable acquaintance, makes a practice of

advising its more conservative customers to do this. A good many

brokerage houses sell investment securities on the "instalment plan,"

which often means, in practice, that the initial margin put up by the

investor is his only payment, and that the security is gradually paid

for by letting the yield increase the margin. During the extremely easy

money of the present War period, occasional reference has been made in

the financial papers to the practice of buying even the highest grade

bonds on this basis--the yield of the bonds being very substantially

higher than the money-rates, giving a comfortable profit to those who

hold the bonds on a margin.

That the practice is not wider spread is due primarily, probably, to the

temperamental qualities required. The investor, proper, is commonly a

very conservative person, who has an unreasoning distrust of

speculation, and to whom the word, "margin," necessarily suggests

speculation. That buying a stock on a margin is the same sort of thing

as buying the equity in a mortgaged farm, does not occur to him. On the

other hand, the man who knows the market well enough to be willing to

deal on margins, frequently is not content with the slow process of

accumulation which comes from annual yields, and prefers to take larger

chances in speculation on capital values. But there is an intermediate

class, who buy investment securities, with narrow range of fluctuation

in capital values, for the sake of the yield, and who buy them on

margins, margins ample to enable them to sleep at night, and to neglect

the daily market reports. I think that there are indications that this

class is growing larger, and more important. Doubtless much more

important than individual "bankers" of this sort, however, is the

enormous number of houses dealing in securities, "wholesalers" and

"retailers," who find profit on their "wares" even while on their

"shelves," through the differential between the yield and the charge

made by commercial banks on collateral loans. A very large percentage of

collateral loans is made to institutions of this type. As this practice

becomes more important, the result must be to widen the money market, to

increase the proportion of banking capital that goes permanently into

financing industry, and to reduce the difference in yield between

short-time paper and long-time securities--in other words, to bring the

"money-rates" closer and closer to the long-time interest rates.

This would have seemed very strange and weird to Adam Smith. It means,

in effect, that the bulk of our banking credit is, directly or

indirectly, financing our industry rather than our commerce. Adam Smith

thought that a bank could safely lend to its customers only so much as

they would otherwise keep by them in the form of money. Perhaps this

notion, as growing out of some speculations regarding the general theory

of money, should not be taken as the statement of Smith's practical

attitude on the matter, but that practical attitude, as clearly

expressed in the paragraph[553] following, is that a bank can afford to

lend only for mercantile operations that are carried through in a very

moderate time, that the bank can afford to supply only the minor part of

the circulating capital, and no part of the fixed capital, of a

merchant, or manufacturer, no part of his forge and smelting house, etc.

Such loans lack the liquidity which the bank must insist upon. Only

those persons who have withdrawn from active business, and are content

with the income upon their capital, can afford to lend for such

purposes. The theory is sound, on the basis of the facts as Smith knew

them. But modern corporate organization and modern stock markets have

changed all that. Anything that is highly saleable can come into the

money market, and the modern corporation organization of business,

coupled with organized stock exchanges and a large and active body of

speculators, has made the forge and the smelting house as saleable as

the finished product.

This is not to accept Schumpeter's doctrine,[554] so far as the United

States are concerned, that it is primarily the bankers, the

manufacturers of bank-credit, who make the decisions that turn industry

from old to new lines. They do not, on the whole. In Continental Europe,

particularly Germany, they do to a much greater extent. Criticism has

been made of our American commercial bankers, as contrasted with German

bankers, that the former are parasites, who insist on sure things, and

refuse to take chances with other business men in the development of

industry. To the present writer, our banking system seems to be rather a

more developed system than that of Germany, in that the "division of

labor" has gone further with us, and risk-bearing and the manufacturing

of bank-credit have been more sharply differentiated. We have bankers

enough who are "risk-bearers." But they are, on the whole, "private

bankers," "investment bankers," and the like, who do not manufacture a

great deal of deposit credit, but rather borrow heavily from the

commercial banks, which are the great manufacturers of bank-credit.

Under our system, the decisions which divert industry from old to new

lines are more democratically made, by speculators and investors under

the leadership of private bankers, and sometimes without that

leadership. These constitute the important intermediary which transforms

stock exchange securities into the basis of bank-loans. The commercial

banker buys, in general, not the stocks, but the note of the private

banker, broker, speculator, or investor, with the stocks as collateral.

If investment bankers, speculators and investors decide to support old

ways of doing things, the banks lend on the securities of the old kinds

of businesses; if investment bankers, speculators and investors turn to

new things, the commercial banks follow suit. Commercial banks can and

do discourage certain types of enterprises by refusing loans with their

securities as collateral, or by requiring very heavy margins with such

loans, but even these may be developed, and are with us on a large scale

developed, on banking credit, advanced by the speculators and private

bankers who borrowed it from the commercial banks with other securities

as collateral. The commercial banks of the United States may to a very

considerable degree check dynamic tendencies, but in general, they do

not lead and direct them. Bank-credit, directed by others than

commercial bankers, does, however, enormously facilitate both the

starting of new enterprises and social readjustment to them.

How far can the total wealth of the country, agricultural as well as

industrial, be brought into the circle of the money market? The full

answer to the question would go far beyond the limits of this book. If

agriculture can be brought under the control of large corporations,

there is little reason for supposing that it, too, might not come in.

There are some peculiarities of agriculture, special dangers of drought

and flood, dangers of over-production and low prices, wide seasonal

fluctuations in conditions, which make it hard to standardize in any

case. But mining and even the manufacturing of such things as primary

steel products have wide variations in prosperity too. So long, however,

as agriculture remains a matter of families on a homestead--and for

social and political reasons, we may hope that this will always be the

case--it is difficult to bring it in. Bonds of agricultural associations

or of agricultural banks have had limited sale on the bourses of Europe.

The present writer, for example, found it impossible to find in four

great libraries in New York and Boston any quotation of the bonds of the

_Bayerische Landwirtschaftsbank_. Apparently, in general, such

securities have not high saleability. While this remains true,

agriculture may expect to remain under a handicap of higher interest

rates than industry and commerce.

If, however, all forms of wealth could be made equally saleable, we

should find interest rates rising for those loans and securities which

now have the highest saleability. They would lose the peculiarity which

now enables them to perform a service as bearer of options. Money-rates

and long-time rates of interest would tend to come together. Long-time

rates on formerly unsaleable loans would fall, and rates on highly

saleable loans would rise. The present low rates in the "money market"

grow out of _differential_ advantages.

We turn now to the third important aspect of the technique of banking,

namely, the matter of cash reserves. First I would point out that this

is merely a part of the more general problem of liquid assets. The

difference between cash and liquid paper is a matter of degree. There is

large possibility of substitution of the one for the other, as it

becomes more profitable to use one or the other. When money-rates are

low, it may well be worth while to carry large reserves; when

money-rates are higher, the gains to be made by substituting paper for

cash in the bank's assets are much greater. I have pointed out the use

which great European banks, notably the Austro-Hungarian Bank, make of

foreign bills of exchange as "reserve," selling bills when money is

"easy," and the yield on bills is small, buying bills when money is

"tight," and the yield on bills is large.[555] The great Joint Stock

Banks of England, the chief sources of bank-credit in the great banking

country of the world, also make use chiefly of deposits with the Bank of

England as their "reserves." Some cash they keep, but it is "till

money," rather than reserve. They carry, also, "secondary reserves" in

highly liquid paper, stock exchange loans and commercial bills. The

differences are differences in degree. The Bank of England does keep a

large reserve in cash (including notes of the Issue Department and gold

bullion) but it denies that it has any definite ratio in mind,[556] and

it protects its reserves, when they are low, not by ceasing to loan, but

by raising its discount-rate. The whole thing is highly flexible.

This is, in general, true throughout the world,[557] where banking is

highly developed. A country which has expanding business, based on

rising values of goods and rising capital values of anticipated incomes,

which in turn grow out of increasing business confidence, etc., and out

of the development of new enterprises which make readjustment necessary,

expands its bank-credit to meet the situation. Expanding bank-credits in

time grow so large that bankers feel larger cash reserves to be

desirable. Their reserves may be also, in some measure, drawn upon by

the growing retail trade and wage-payments, which call for more money

in circulation. They meet the situation by raising money-rates. This

tends to prevent the exportation of gold, and tends to encourage the

importation of gold, which finds its way into bank reserves. Banks may

even borrow directly from banks in other countries, to get the gold they

need, or to prevent the exportation of the gold they have. The higher

money-rates, also, tend to check marginal borrowing--the borrowing by

those who see only very small profits to be made by the use of the

bank-credit they borrow. If the rising values of goods, however, and the

profits to be made by effecting exchanges, speculative and other, are

large, the volume of bank-credit will, none the less, grow. If the tide

of rising business confidence is strong, the banks will be disposed to

accept securities and rights as collateral which they would distrust at

other times. A very big difference indeed may appear between bank

reserves in active times and bank reserves in dull times. The banks need

less reserves in proportion to deposits in active times, because the

very activity itself increases the liquidity, the saleability, of their

paper assets, and so makes actual cash less necessary. Even in this

country, the practice of counting deposits in other banks as reserve is

well developed. This is not only true of country banks, or banks outside

the reserve cities. It has been, in considerable degree, the practice of

the big trust companies in New York City. It is the practice of private

bankers connected with the stock exchanges, and the practice of brokers,

who are, for many purposes, bankers, especially those who allow their

customers to check on their accounts. Such houses may carry no cash at

all. One, with whose workings the writer is somewhat familiar, makes the

rule--"We pay by check and receive only checks." None the less, this

house allows its customers to check upon it, and checks drawn on it

perform all the functions of checks drawn on banks which keep a cash

reserve. Of course, our new Federal Reserve system is built, in part, on

the principle of collecting reserves in central reservoirs, and our

banks will doubtless increase the practice of counting deposits with

other banks as reserve.[558] They will feel the need for less reserves,

also, with a wider rediscount market.

_Within a given country_, I think that we may safely generalize the

doctrine that the causal relation between reserves and deposits is

exactly the reverse of that asserted by the quantity theory, within very

wide limits indeed. That is to say, increasing reserves are a _result_,

and not a _cause_, of increasing loans and deposits. We shall further

hold that the relation between them instead of being definite, is highly

flexible. This is not to assert that reserves may not increase without a

prior increase in loans and deposits. That has happened in the United

States during the present War. It does mean, however, that increasing

loans and deposits will pull gold into a country, and that increasing

reserves do not force increasing deposits and loans.[559] If a country's

business is growing, if that business is soundly based, so that

expectations are being met, obligations being paid out of the income

which arrives, on schedule time, to meet anticipations, there need be no

effective check to the amount of gold that will come into the country to

serve as reserves, within limits that are rarely reached. It is

miscalculation, maladjustment of costs and prices in particular

enterprises, failure of "interstitial adjustments," especially failure

of particular crucial links in the business chain, as the businesses

engaged in producing iron and steel, to respond to the needs of other

expanding businesses, that check movements of expansion in business, not

inadequacies of bank reserves.[560] As long as only wise plans are made,

as long as they meet no mishaps, as long as the carrying out of the new

plans does not itself so change the facts on which the calculations of

business men have been based as to cut under anticipated profits, so

long may business, within a given country, expand without danger from

inadequate reserves. Of course, if the whole world is simultaneously

expanding, the competition for gold in the international money markets

may be so severe that all may be hampered.

That reserves will increase, as expanding credit, due to increasing

business or rising prices, requires increased reserves, can hardly be

disputed, I think, if we look at a country of small size, or (what is

the same thing from the angle of economic analysis, so far as the

present problem is concerned) if we take a particular part of a country.

Seasonal movements of cash for reserves in this country have been

obviously determined by the movements of credit, rather than the

reverse. Expanding business at crop moving seasons, requiring advances

of credit by country banks, and an unusual drain on the cash resources

of the country banks, has regularly meant that the country banks draw

cash from the New York banks. When the need for such cash in the country

banks passes, when they can no longer employ it to advantage at home,

they send it back to New York. New York, to meet the emergency caused by

the withdrawal of cash, draws to a considerable extent on Europe for

gold. It is not as easy for New York to get gold quickly from Europe as

it is for France to get gold in an emergency from England. More time is

required. Inelasticity, too, in the forms of currency most needed for

small transactions, has made very real difficulties for us. But that,

within the country, the sections whose business and credit were

expanding take cash reserves from those sections where credit is less

urgently demanded, needs no debating. This is seasonal. But the same

thing is true in the long run. As business and bank-credit have

expanded, year by year, in Oklahoma, Oklahoma's cash reserves have

grown. Bank-credit in a country cannot go on indefinitely mounting, if

bankers are making unsound loans, if the values on which the loans rest

are based on vain imaginings, if anticipated profits are not realized.

But if a country have rich resources and intelligent entrepreneurs, with

sagacious bankers who can discriminate between sound and unsound

business, it may, within very wide limits indeed, expand its bank-credit

without check from inadequate reserves, as its business expands, and as

prices, particularly prices of lands and securities, rise.[561]

If the country in question be a very large country, however,--large in

the sense that its business and volume of bank-credit are very large,

and particularly in the sense that bankers' assets are of such character

that a large volume of reserves is desirable--restraints on the process

of expansion may come. Reserves will come in, but the resistance in

stiffer money-rates will be felt. Bankers in other countries will

compete with the bankers in the country in question for reserves. Rising

money-rates will put an end to many marginal exchanges. They will lessen

the saleability of many rights which might otherwise be available as

banking collateral. The extension of bank-credit will feel a drag. There

is large flexibility here. But, in a long run period of many years, the

volume of gold in the world will impose a maximum limit upon the

possibility of expansion of bank-credit in the world as a whole. This

limit is doubtless never reached. Within the limit, the variations in

the volume of the world's credit are primarily determined by the other

concrete factors we have been discussing. Proportionality between the

world's gold and the world's volume of credit does not at all obtain.

Under certain conditions, much higher proportions of reserves to

bank-credit will be found in a given country than at other times, and

the same will be true in the world at large.

I would refer again to the discussion by J. M. Keynes, quoted in Part

II.[562] Reserves have absorbed enormous quantities of gold, easily

obtained as a consequence of abundant gold production, in the past

fifteen years. Proportions of gold reserves to bank-credit have grown.

In the preceding period, when gold production went on less rapidly than

business development, percentages of reserves were lower. Most bankers

feel better with large reserves. When they can get gold, they prefer

gold to other substitutes. When they cannot easily get gold, they use

other substitutes, of the various kinds of paper, particularly, which

have been described. Gold differs from other things, in bankers' assets,

in degree, rather than in kind. Instead, therefore, of the law of the

proportionality of reserves to volume of bank-credit, I venture the

generalization[563] that, as gold production increases rapidly, the

tendency is for the proportion of gold reserves to volume of bank-credit

to rise; with diminished gold production, the tendency is for the

proportion of reserves to fall, assuming that the factors other than

volume of gold production which make for expansion of business maintain

themselves.

Increasing volume of gold tends to increase the volume of trade. But

there are other causes for the increase or decrease of trade as well.

These causes, working in harmony with rapidly expanding volume of gold,

lead to a very rapid growth of trade.[564] Working in the face of a drag

from less rapidly growing gold supply, they strain the possibilities of

bank-credit expansion. Various substitutes for gold in bank reserves are

employed. Substitutes in the form of other forms of credit are employed.

Barter is resorted to increasingly. Methods of employing other things

than gold in the retail trade of a country are resorted to.

"Gold-exchange" standards are devised. Countries "wait their turns " to

come on the gold standard. Cooeperation, not only within countries, but

among countries, seeks to economize the scanty stock of the precious

metal. Very large slack is thus revealed. But the expansion of business

is checked, the volume of business confidence is reduced, the values of

future incomes in enterprises is lowered, production is checked, and

prices are reduced, (a) because the value of money rises; and (b)

because the values of goods and income-bearers is reduced. The exchange

side of production is hampered. Substitutes for gold, through increased

activities of bankers and other agents of exchange, are costly. Greater

tolls on values are taken by those who handle the mechanism of exchange.

It does make a difference whether or not the world's gold is abundant!

But the difference is not made solely, or even mainly, in the

price-level.[565]

The reserve function of money is essentially a _dynamic_ function. The

reserve function is merely a phase of the bearer of options

function.[566] It is the practice of quantity theorists to speak of

"normal" ratios between reserves and deposits (or reserves and demand

liabilities), and to speak of the "static" laws governing this relation.

This in true of Kemmerer, of Fisher, of A. P. Andrew, and, in general,

of contemporary quantity theorists. Kemmerer very explicitly puts it as

a matter of static theory, "If we divide the money of the country into

two parts; one, that used directly in daily cash transactions, and the

other, that kept in banks as reserves, it may be said that, _under

perfectly static conditions_ [italics mine], the proportion of the total

represented by each of these parts would be constant. Each banker would

find from experience what proportion of reserve to liabilities it was

advisable for him to maintain, and would order his business, as far as

possible, so that his reserve would neither exceed nor fall below that

most desirable proportion."[567] Kemmerer quotes the following passage

from A. P. Andrew: "In the long run, _as apart from cyclic

oscillations_, the quantity of bank-credit is governed by the quantity

of money."[568] Fisher's view we have considered at length in Part II.

It is essentially the same. He is working with the statics of the

problem of money and credit. These different writers differ greatly in

the extent to which they would insist on the validity of their static

tendency in real life. Professor Fisher, as we have seen, is exceedingly

uncompromising, holding tenaciously to his principle as subject only to

slight modification during transition periods. Professor Kemmerer, in

the chapter from which the quotation just given is taken, gives an

important realistic analysis of dynamic conditions and makes liberal

concessions to the view that the ratio is no constant in real life.[569]

Professor Taussig, whose view was summarized at length in chapter IX,

finds, in real life, so many exceptions to the doctrine of

proportionality of reserves and deposits that he virtually abandons that

doctrine. What I wish to insist on here, however, is that there are no

static laws _possible_ in this connection. The reserve function is a

dynamic function. The theory of reserves must rest in an analysis of

friction, of transitions, of dynamic uncertainty and dynamic change. It

is a part of the general theory of liquidity of bank assets, of

saleability of rights, and the like. If one can find a "normal" amount

of dynamic change, a "normal" amount of uncertainty, a norm for the

coming of technical inventions, a normal prospect of war, a normal rate

of gold production, a normal rate of growth for population, a normal

amount of Jew-baiting in Russia, with a norm for migration, and if one

can hold these norms, and a multitude of similar norms, in fixed

relation to one another, one might have justification for speaking of a

"normal ratio" of bank reserves to bank demand liabilities!

Apart from dynamic changes, from frictional elements which create

uncertainties, in general, apart from uncertainty and irregularity and

lack of "normality," there would be no occasion for bank reserves at

all! To the extent that static conditions are realized, bank cash

reserves may be, and _are_, dispensed with. It is well known that

England gets along with surprisingly little gold. The total stock in the

country has been smaller than the gold reserve of the Banque de France,

and much of the gold in England was in use among the people, since small

paper money (before the War) was not in use in England. The gold reserve

of the Bank of England has been usually only a fraction of that of the

Banque de France. Some years since, the distribution of gold as between

England and the United States, was, roughly, England six hundred million

dollars, the United States, one billion, six hundred million. A larger

proportion of gold was in reserves in the United States than in England.

Yet England was doing the banking business of the world, while we had

trouble in doing our own! The Bank of England carries virtually the only

reserve in the country. The Joint Stock Banks, with demand liabilities

vastly in excess of the demand liabilities of the Bank of England, carry

only "till money" in cash or Bank of England notes, and for the rest,

carry as their "reserve" their deposit credits with the Bank. A great

deal of criticism, from Bagehot down (to go no further back) has been

directed at the "inadequacy" of English banking reserves, and many dire

predictions have been made as to the dangers that impended unless the

reserves were increased. We shall probably hear less of this after the

War! The Bank of England still stands! It has never failed to pay out

gold over its counters, even though it has, with the aid of the

government, doubtless restricted and controlled foreign shipments of

gold. But it has met the unprecedented emergency better than any other

bank in Europe, and to-day (Sept. 1916) is in exceedingly good shape.

Sterling exchange at New York seems "pegged" at the "lower gold point,"

and apprehensions regarding the stability of the English financial

system seem definitely allayed. It is aside from our present purpose to

discuss war time conditions. I am rather interested in analyzing the

features of the English money market which have made it possible, in the

period preceding the War, for English bankers to get on with so little

gold. As will appear, it is because English business and financial

affairs have been more nearly "static," have come nearer to realizing

the assumptions of static economic theory, than is true of any other

country on earth.

The very fact, for one thing, that England is the great _international_

banker has meant a scattering of risks. Acute panics do not come in all

countries on the same date. Bad business in one country may be offset by

good business in another; drains of gold to one country may be met with

gold flowing in from others. The same considerations which tend to

stabilize the railroad business, as compared with, say, cotton-growing,

apply to the international banker as compared with the banks of a single

country or section. But further, the London market has developed

cooeperating agencies for smoothing out friction and eliminating

uncertainties to a degree unknown anywhere else. An anonymous writer in

_The Americas_ for April, 1916,[570] has given an exceedingly

interesting account of this organization of the London market,--the

product of the development of generations. Let us enumerate some of the

points: There is nowhere in the world so much expert judgment in the

grading and evaluating of hundreds of commodities from all parts of the

world. There is, coupled with this, a worldwide reputation for the

experts of absolute integrity, so that producers in remote countries

regularly ship ("consign") to London cargoes without definite

arrangements, knowing that there are in London organized facilities by

which the commodities are warehoused, expertly and fairly judged, and

either sold at once or else made the basis of a collateral loan against

which they can draw immediately. The institutions which make this

possible are (a) the system of warehousing, with its certificates or

warrants which give absolute title to the goods, and which are easily

negotiable; (b) the organized arrangements in connection with the

warehouses by which commodities are received and either graded as they

are, or separated and mixed with others to form standard blends readily

marketable--this with rigid integrity and expertness which the whole

world trusts; (c) a speculative community which has unlimited banking

credit, ready to buy at a concession in price virtually any

commodity--honey in the comb, sealing wax, pianos, farm machinery, what

not; (d) the organized markets or periodical auctions which speculation

and final purchase together support; (e) the banks, which, relying on

the standardization of the commodities and the readiness of the

speculative community, can without hesitation lend the money on which

the distant shipper is relying to conduct his business.

What comes to London is fluid. Everything comes to London! The

multiplicity of items dealt in gives stability to that business which

deals with all--the banking business. The London Stock Exchange is no

provincial affair, easily demoralized by an adverse rate decision!

Securities of every country on earth are listed there, and speculated

in. It must be a world catastrophe which really demoralizes the London

stock market!

It will doubtless seem strange to many to say that New York cannot

displace London as the centre of world finance, that the dollar cannot

displace the pound sterling in financing international trade, because

New Yorkers do not speculate enough! They do speculate enormously, but

not in many things. A restricted list of stock exchange

securities--almost wholly American; cotton--in which New York is the

world centre; coffee, in which New York has the largest volume of

speculative futures, though yielding precedence, ordinarily, to Havre,

Hamburg and Santos[571] in spot transactions. There is extensive sugar

speculation at the New York Coffee Exchange, which has, indeed, recently

changed its name to indicate the fact. There is a produce exchange in

New York, but it is a very small affair as compared with the Chicago

Board of Trade, and its operations and scope are infinitesimal when

compared with the produce speculation in London. Of course, there is a

vast deal of _unorganized_ speculation in many things in New York, as in

business everywhere, particularly in America. But, while the pecuniary

magnitudes of organized speculation in New York are very great, the

range of items dealt in is restricted. New York banks cannot possibly

get such a variety of collateral, based on standardized and readily

marketable goods and securities, as can London. New York, consequently,

cannot finance international trade, save as an auxiliary to London--and

New York banks must have vastly more gold in their vaults than London

bankers need! As goods and securities become _more_ marketable,

gold--whose services are needed because of its _superior_

marketability--becomes _less_ necessary.

The whole story of London's organization would be a long one. London

financial institutions have a degree of expertness, growing out of

specialization, in large part, which makes all manner of paper fluid in

the London money market which would lack fluidity in New York. The

Acceptance Houses are a sort of international Bradstreet and Dun. They

know intimately the standing and business of houses all over the world.

They do not give out their information, but they do put their stamp on

the paper of business houses, thus standardizing it, lending, not money,

but "pure credit," while the other banks, relieved of the necessity of

investigating the paper, can buy it as a miller might buy No. 1 wheat.

There is the extraordinary extension of insurance, so that virtually any

kind of risk may be shifted to those well able to bear it. All this

makes for liquidity, for "static" conditions in the money market, and

dispenses with the need for gold.

As we approach static conditions, we need less and less gold reserve

behind bank demand liabilities. _The static law of bank reserves is that

none are needed!_ I think we have here the real reason why writers who

have sought to give us the law for a "normal" ratio have given us such

vague phrases as "shown by experience to be necessary," and the like.

When irregularity of income and outgo in a bank's business, non-liquid

assets, business cycles, uncertainties, legislative changes affecting

business, crop failures, changes in demand, new inventions, wars, are

abstracted from, no reason can be given why a banker should keep any

reserve at all! But these things are dynamic things. And it is

characteristic of irregularities that they are irregular. To get a

"normal" ratio out of them is not easy.

On the static assumptions, an "ideal credit economy" is perfectly

possible. If everything that needs to be marketed is perfectly

marketable, if the stream of business flows regularly and without

friction in the same channels, if all contingencies are foreseen and

dated in advance, a bank needs no cash reserve. All payments can be made

by bank-credit. Banks bookkeeping becomes merely a refinement of barter,

with _money_ remaining as a measure of values, a unit for reckoning, but

not being used as a medium of exchange, or as a bearer of options, or in

reserves. The measure of values function is the great static function of

money.

To the extent that static assumptions are not realized, we need money in

bank reserves. This extent is a thing that varies from time to time, and

from place to place. It is not the same for a given place from time to

time, nor is it the same at all places at a given time. It is not the

same for the whole world from time to time.

Since friction, preventing the free marketing of goods and securities

and services, exists, since there are dynamic changes which require

readjustments through exchanges, we need the work of the banker and he

needs cash. But there are other things than money which make for the

"statification" of the market. The speculator does it. And the other

agencies of the sort represented in the London market do it. They are

substitutes for gold. Gold has no monopoly. The services performed by

gold can be performed in many other ways, and by many other agencies.

There is enormous flexibility in the matter.

PART IV. THE RECONCILIATION OF STATICS AND DYNAMICS

CHAPTER XXV

THE RECONCILIATION OF STATICS AND DYNAMICS

In the foregoing discussion of the value of money it has appeared that

the value of money is not an isolated problem! Not only have we found it

necessary to consider it as part of the general theory of value, but it

has been advisable to bring it into relation with a large number of the

special theorems of economics, including the law of supply and demand,

cost of production, the capitalization theory, the doctrine of

appreciation and interest, the theory of international gold movements,

Gresham's Law, the theory of elastic bank-credit, and the general theory

of prosperity. The book has thus become a book on general economic

theory, viewed from the standpoint of the theory of money. It has been

as contributing to the problem of the value of money that these other

doctrines have been discussed, but I trust that they, too, have gained

something of clarification from being considered in this relation, and

that the emphasis on the role of money in general economic theory has

helped in bringing the various elements in our current theory into a

closer-knit interdependence.

The present chapter seeks to carry the conclusions so far reached toward

a further unification of economic doctrine, by finding for certain

contrasts, like that between statics and dynamics, a higher synthesis,

so that it may be possible for students of dynamics and students of

statics to speak a common language, to use common measures, to find that

their phenomena are not, after all, of essentially different nature, and

to come to agreement as to the relative importance of "static" and

"dynamic" tendencies. It will appear that the theory of money and

exchange plays an important role in effecting that higher synthesis, and

is itself clarified by it.

The "theory of goods vs. the theory of prosperity," "statics vs.

dynamics," "normal vs. transitional tendencies," "long run vs. short

run" laws, "market vs. normal price," "abstract theory vs. concrete

description," "historical or evolutionary study vs. cross-section

analysis," "temporal vs. logical priority," "causation as a temporal

sequence vs. causation as timeless logical relationships"--these, and

similar contrasts have appeared frequently in the history of social

thought, and have been especially refined and elaborated in the history

of economics. We have even compounding of the notions into more

complicated distinctions, as by Seligman,[572] in his two statements of

the law of costs: in the short run, normal price tends to be the maximum

cost of production; in the long run, normal price tends to be minimum

cost of production. Seligman has illustrated his notion by an adaptation

of the familiar figure of the sea-level and the waves: for short-run

purposes, we may contrast the surface waves, the market prices, with the

sea-level, the normal price; for longer run purposes we may see the

level of the sea itself changing, under the influence of the tide, and

may have a dynamic normal, which is still to be distinguished from the

fluctuations due to the play of winds on the surface.

We have further an increasing recognition of the up and down play of

forces accelerating and retarding the processes of industry and trade.

For earlier writers, panics and crises were anomalies; since Mill's

_Principles of Economics_, to go back no further, we have had increasing

recognition of such occurrences as more or less periodic and

inevitable, bound up in the very nature of economic life itself, and of

late there has been a fairly general acceptance of the notion of the

business cycle, of an alternating rhythm of prosperity and depression.

The explanation of this alternation has been attempted by numerous

theories, one of which, that of Joseph Schumpeter,[573] rests the whole

case definitely in the distinction between static and dynamic

tendencies, and in the conflict between the opposing sets of forces

which statics and dynamics undertake to describe.

We are told by the orthodox economist that war is wasteful, destroying

laborers and goods, and lessening the wealth and productive power of

society. We are told that it diverts labor from productive employments,

that it turns huge masses of capital and labor to the production of

goods which men cannot enjoy, that it burdens the people with taxes,

etc. Static theory can see nothing but evil in war, from the standpoint

of minimizing human sacrifices, and maximizing human enjoyments. None

the less we see many war periods--notably that of our Spanish-American

War, and the present World War, so far as the United States are

concerned--periods of marked prosperity, growing out of the new

expenditures which war itself involves. Mules and other farm products

rose in price with the Spanish-American War, as the Federal Government

bought them for the army; various factories concerned particularly with

war munitions increased their activity, the gains of factory owners and

farmers led them to increase their purchases, wages rose, and rose in

part because part of the labor force was in the army. The Civil War did

spell demoralization and economic ruin for the South, but for the North

it gave a great dynamic impetus to trade, transportation and

industry--an impetus, strangely enough, that was so great that the new

industries and enterprises which had grown up were able to absorb with

little shock the million men set free from the Northern armies when the

great struggle was over.[574]

For static theory, scarcity is an evil. A general overproduction is

impossible. For the practical business man, confronted with the

momentous problem of marketing his output, overproduction is a vital

reality, and there are few times indeed when much more could not be

produced if only a satisfactory market could be found for it. Static

theory would see the whole explanation of this in maladjustment, too

much of some things being produced, too little of others. This simple

statement does explain much of the phenomenon, but it is far from

telling the whole story, and even if it were a complete explanation, it

would by no means dispose of the reality of overproduction as a constant

menace, even when not a dire reality, facing almost every business man.

Static theory at best tells what a completed adjustment would be; it

does not touch the problem of how adjustment is brought about, and

maladjustment overcome. Yet just that problem is the vital concern of

the business man.

For static theory, high or low prices are matters of no concern. And

abundance or scarcity of money and credit make no real difference in the

economic process. Abundant money and credit exhaust themselves in

raising prices, and the rest of economic life goes on unchanged. This

doctrine of the quantity theory is, as I have undertaken to show in Part

II, bad even as a matter of static theory. But it is only as a matter of

static theory that it is even thinkable.

The economic theory of the 19th Century, following the lead of Adam

Smith and Ricardo, has been accustomed to dismiss as utter folly the

notions of the Mercantilists as to the balance of trade, and the

importance of an inflow of gold, and has conclusively proved that

protective tariffs tend to divert the labor, capital and land of a

country from those lines of production they are best adapted to to lines

for which they are less well suited. Critics have pointed out, as in the

"infant industries" argument, that we cannot treat the labor capacity

and technical knowledge of a country as constants, that the temporary

encouragement of one line of industry by a tariff may so modify the data

of the situation that the country may in time become better adapted to

the protected industry than to other lines. And I think that we may well

go further, and make substantial concessions to the doctrines of the

Mercantilists as they themselves stated them, seeing in a favorable

balance of trade, and in expanding exports and diminishing imports

sources of impetus which are not subsequently neutralized by the static

process of equilibration. I do not conclude from this that protective

tariffs are commendable, any more than I conclude that war is

commendable. Both may give dynamic impetus, and lead to economic

development. Both may lead to political corruption, to iniquities in the

distribution of wealth, to waste and suffering of various kinds, in

which honest and patriotic men suffer, and cunning and unworthy men

gain. The point here is simply that static theory does not tell the

whole story regarding either tariffs or wars. It may well be true--I

think it is true--that static theory offers the more important

principles for judging the results of wars and tariffs.[575] It is the

central problem which I have set myself at the outset of this discussion

to find a way to bring static and dynamic considerations _under a common

measure_, to reduce them to homogeneity so that comparisons may be

instituted, and so that the student of statics and the student of

dynamics need not talk merely at cross-purposes. But we do not achieve

this result by ignoring considerations in either sphere.

Bastiat, with a fine show of logic, has sought to rule out of court the

doctrines that extravagance and tariffs, etc., are sources of prosperity

by his emphasis on the "Unseen," as opposed to the "Seen." The

prosperity growing out of the extravagant expenditures of one brother is

open to all eyes. The consequences of the savings of the frugal brother

men do not see so easily, and do not attribute to his frugality.

Doubtless Bastiat is right in his main theses. But one point needs

emphasis: that which is "Seen" stirs the imagination of men. And

imagination energizes human activity. The motivation of economic life is

a psychological matter.

And so at a host of points the contrast may be drawn, in one or another

form. The pure, abstract, static theory gives one conclusion; the other

approach suggests one different.[576]

How is it possible to give proper weight to considerations drawn from

such divergent spheres of thought? Indeed, how shall we weigh the

dynamic considerations at all? Static theory presents itself in

quasi-mathematical form. At times, it parades itself in equations, and

it readily enough, without arousing a feeling of incongruity, expresses

itself in mathematical curves, with ordinates and abscissae. One static

tendency finds itself in marginal equilibrium with another, and the

margin is expressed in quantitative units, commonly sums of money.

Static doctrine does, indeed, lay claim to precision and exactness, and

static tendencies may be weighed against one another. But how shall one

undertake to give quantitative measure to such a thing as the

educational influence of a tariff on silk manufacture? How measure the

dynamic impetus of a new chain of banks on the industry and trade of the

region affected? How gauge the importance of a new advertising scheme,

or a new invention? Dynamic considerations are commonly presented in

vaguer, looser form than static theories. Usually we have merely a

statement of a qualitative tendency, without effort to make the

importance of the tendency quantitative. Indeed, I think it safe to say

that one chief difference between statics and dynamics is that those

tendencies which can be most easily formulated have been recognized by

statics, while those which are less understood, and less precisely

formulated, are left to dynamics! A big part of the difference is

methodological, rather than inherent in the nature of the phenomena

themselves.

I think that it needs little argument to show that all the contrasts

listed at the beginning of this chapter do not run on all fours.

Compare, let us say, the contrast between "statics and dynamics" with

that between "historical and cross-section" study. Concrete, realistic

history is not dynamic theory. A realistic description of society viewed

at a given short period of time is not static theory. Both statics and

dynamics are _abstract_. _Laws_ are not the same thing as description

and narration. The assertions of both statics and dynamics are commonly

made on the assumption, "_caeteris paribus_." A new bank will stimulate

business in a western town if bank-robberies do not come into fashion! A

tariff on wool will tend to educate the farmers in sheep-raising if the

habit of relying on governmental assistance does not develop, and make

them more, rather than less, inert,--or sharpen their political rather

than their economic acumen. Concrete history need not always verify

dynamic laws![577] It is, above all, important to insist that the

distinction between statics and dynamics is not the same as the

distinction between theory and description, or between the abstract and

the concrete. Evolutionary study may result either in concrete history,

or generalized laws; cross-section study may be either concrete

description or abstract formulae concerning forces in equilibrium. And

there may be varying degrees of abstractness in both cases.

The contrast between long-run and short-run tendencies is not

necessarily the same as that between statics and dynamics. This former

distinction does recognize one factor which is sometimes classed as

"dynamic," namely, "friction."--"Friction," by the way, is a blanket

term which covers a multitude of sins of imperfect analysis and lazy

thinking! It is far from a simple, unitary thing. Sometimes it seems to

mean the action of the whole social order, other than the economic

values!--But dynamic, as used by the two writers who have used the term

most precisely, J. B. Clark[578] and J. Schumpeter,[579] is reserved for

those factors in economic life which make for constructive _change_.

Neither writer would call mere habit and inertia, which make

readjustments slow, or the necessities of physical nature, which retard

readjustment, by the name, "dynamic." It may be noted, in passing, that

both writers limit the term quite strictly to changes _in_ economic life

growing _out of_[580] economic causes. Schumpeter narrows the dynamic

factors to one, namely, _enterprise_, while Clark gives five general

classes of dynamic factors, all of which are primarily economic in

character. Neither extends his study to cover forces which are not

primarily economic in character, but which none the less lead to

economic changes.

Again, the "theory of prosperity" is not identical with "economic

dynamics," though the two in large measure overlap. For one thing, while

some writers, as Schumpeter, find the business cycle to be a necessary

consequence of dynamic changes, and would maintain that no business

cycle, no up and down of tempo in production, no panics or crises, are

necessary if changed methods of industry, etc., did not come in, not all

writers would so explain the business cycle. Some writers would find the

explanation in the inherent instability of a money and credit economy,

some in the inherent weakness of a capitalistic system, quite apart from

necessary dynamic change. Irving Fisher makes no use of changed methods

of production in his explanation of business cycles, though he does

mention invention as one possible cause of a disturbance in normal

equilibrium.[581] But further, dynamics is largely concerned with

problems, like invention, changes in the economic habits of a people,

methods of organizing industry, etc., which, while they may well bear on

the problems of prosperity and depression, yet have interest for their

own sake, and would be studied if there were no business cycles.

Further, the notion of statics, the other term in the static-dynamic

contrast, is not identical with the "theory of wealth," or "theory of

goods," or "theory of the wealth of nations" which such a writer as

Veblen[582] would put in contrast with his "theory of prosperity." There

is a normative, or practical, and polemical coloring in the body of

doctrine growing out of Adam Smith, which Veblen would term, the "theory

of the wealth of nations," which is lacking in the more colorless

"statics" of to-day.

I do not find any of the contrasts thus far discussed quite

satisfactory. I have been using the terms, statics and dynamics, as

general terms to cover all these contrasts. I shall try to formulate a

general contrast which includes most of the ideas passed in review, from

a somewhat different angle, and then try to show that the contrast,

while useful, is not absolute, and that it is possible to measure

considerations drawn from one viewpoint in terms of considerations drawn

from the other.

Let us take as our starting point the notion of a cross-section picture

of society. I have set forth this notion in ch. 13 of my _Social Value_,

and have elaborated it in the discussion of von Mises' theory in the

chapter on "Marginal Utility" in this book. A cross-section picture may

be made more or less concrete and descriptive, or abstract and

analytical. If one looks at the picture of society in cross-section as

given by Giddings in his _Principles of Sociology_ (Bk. II, chapters on

"The Social Population," "The Social Mind," "The Social Composition,"

and "The Social Constitution"), one finds a picture in which

organization and system are made clear, but in which vivid description

of concrete social facts is the primary concern. The account given is

largely qualitative rather than quantitative. It is a picture of flesh

and blood, as well as an account of functioning. It is, perhaps, not

easy to realize that Giddings is doing the same general sort of thing

that the pure economic theorist is doing, with his picture of a static

equilibrium of economic values. But what economic theory is concerned

with is, after all, to be found in Giddings' scheme. The pure theorist

takes for granted the physiographic environment, whose influence

Giddings takes into account. The theorist abstracts from biological and

racial factors. He assumes a social population, a social order, a

political system. He has not taken into his purview the social mind as a

whole, in his static theory. Rather, he has been concerned with only one

part of the social mind, namely, the economic values. Economic values,

and the objects of economic value, have been the data of the static

theorist. Given scales of economic value, such that for one quantity of

goods of a given kind, a given value per unit will obtain, given all of

these value-scales, and given the quantities of goods and services whose

values are in question, and static theory will furnish an equilibrium

picture, in which the price relations of different kinds of goods are

made clear, and their values are measured. The value-scales, and the

absolute magnitudes of value at different points on the scale, are

assumed, are data. Further, in order that the notions may be made

mathematically precise, a unit of value is needed, and this is commonly

the value of the money-unit, which is assumed to be constant. The

picture then becomes systematic. There is a system of values, expressed

in prices, which is stable, so long as the data do not change. It is

mechanically conceived, and illustrated by various mechanical symbols,

as balls in a bowl, or connecting reservoirs, or, best of all, by

intersecting curves. It is an abstraction from the living, pulsing,

organic whole of the social mind--the inter-mental life of men in

society. It squeezes much of the life out of the phenomena it

describes. It makes them exact, only by making them mechanical. It thus

becomes exact by becoming, in considerable degree, superficial and

abstract.[583] This is not to condemn static theory. Static theory has

proved its usefulness by solving too many problems for such a statement

of its limitations to involve a condemnation. But the statement of its

limitations will aid us in seeing its relation to that vaguer body of

doctrine which we call dynamics, or the theory of prosperity, etc.

Now this means that static theory is not _value_ theory. It assumes a

theory of value. It assumes the value-scales as data. It assumes the

value of money as a datum. Static theories of supply and demand, cost of

production, capitalization, etc., assume the value of money, as has been

shown in Part I, and static theory, resting in the notion of

accomplished transition, normal equilibrium, abstracting from the

difficulties of readjustment, abstracting from friction, etc., misses

the whole point as to the functions of money, as shown in Part II.

Static theory proceeds by assuming a change in one of the elements of

its situation, say one of the value-scales, and then tells what the new

equilibrium will be after readjustment takes place, assuming that other

value-scales remain constant, and that quantities of the objects of

value do not change. Or, it assumes a change in the quantity of one of

the objects of value, and then predicts the new equilibrium. The new

equilibrium will often involve changed values and prices all around, and

will often involve altered quantities of other objects of value. But the

initial change comes from an alteration _from outside_ the system in one

or more of the data of the system.[584]

Now dynamics, theory of prosperity, etc., are concerned with the causes

of changes in the data with which statics works, in large measure. Among

the problems with which statics has not adequately dealt, and in large

measure cannot deal, are (1) the nature of value itself, and the laws

governing changes in the value-scales; (2) the problems of readjustment,

including the problems of money, credit and exchange; (3) the psychology

of invention, of enterprise, and the like. (4) The reactions of economic

values and economic organization on the non-economic phases of social

life. (5) The reaction of the non-economic factors, as law, morals, art,

religion, etc., on economic life. (6) The problem of prosperity and

depression. I say that statics has not dealt adequately with these

problems. Statics in its present narrow form cannot deal with them. But

in considerable degree, I am convinced, statics can be made to deal more

adequately with them, if its scope be broadened, and its limitations be

made less rigid. Schematically, at least, the central ideas of statics

can be applied to a large part of these problems. I may add that my list

of six classes of problems with which statics has not adequately dealt

is not meant as a system of categories. The list is incomplete, and the

classes are not mutually exclusive. Rather, they overlap in large

measure. In a large way, it might be said that statics is concerned with

the laws of the equilibration of values, and that dynamics, theory of

prosperity, etc., are concerned with the nature and causes of variations

in the values themselves. The contrast may be put, in general, as the

contrast between the _theory of value_, and the _theory of price_,

statics being price-theory, and dynamics being value-theory. But this is

a thesis which calls for much elaboration and qualification before its

significance is made clear, to say nothing of its justification being

established.

* * * * *

We may approach the problem of bringing the two terms of the contrast

together from either of two angles: (1) we may show that dynamic factors

tend, in large degree, to submit themselves to measurement in terms of

money-prices, which obey the laws of static marginal equilibrium. (2) We

may show that all static prices presuppose values whose explanation is

in terms of the same phenomena with which dynamics, the theory of

prosperity, etc., have busied themselves, namely, considerations drawn

from the study of social psychology, including the psychology of

suggestion, imitation, mob-mind, the functional organization of minds

into a social mind, social beliefs, social values of other than economic

nature, and social institutions. (1) The evidence on the first point is

already in considerable measure worked out, particularly by Veblen, in

his _Theory of Business Enterprise_, and in his other writings on the

nature of capital, etc. Something more in this direction I have done in

my _Social Value_, and other writers have elaborated the notion. (2) The

case for the second contention has been made in detail in my _Social

Value_, and in what follows I shall rely chiefly on the discussion

presented there, and in the chapter on "Value" in this book.

I take up first the thesis that dynamic factors may come under the

static measure. Veblen has made much of the contention that modern

"capital" is not, as Smith thought, and as orthodox economists in

general have contended, a matter of physical accumulations of goods. The

volume of business capital is a pecuniary concept, and may wax and wane

with little variation in the physical stocks. "Under modern conditions

the magnitude of the business capital and its mutations from day to day

are in great measure a question of folk psychology rather than of

material fact." (_Theory of Business Enterprise_, p. 149.) And in large

measure Veblen's work is given to showing how factors of legal and

social psychological nature get a money-measure. The actual capital of a

business enterprise does not rest chiefly on the physical equipment,

stocks of raw materials, etc., etc., which it possesses. To be added is

"good will," and this includes (p. 139) established customary business

relations, reputation for fair dealing, franchises, privileges,

trade-marks, brands, patent rights, copyrights, exclusive use of

processes guarded by law or secrecy, exclusive control of particular

sources of materials, etc. Veblen contrasts things of this nature

sharply with the concrete equipment, saying that the former are

serviceable only to the owners, while the latter are serviceable to the

community at large as well. The physical, tangible, and ethically

commendable character of the physical equipment is everywhere stressed,

while the pathological, anomolous, and sinister character of the less

tangible and more recent "capital items" is always set before us--all

the more effectively because Veblen maintains a satirical attitude of

moral indifference, and presents the case with Olympian aloofness. I am

not here concerned with the social welfare aspect of the matter, though

I shall later speak of that. My present purpose is to make clear two

points in Veblen's doctrine: (1) that he does bring these intangible

things, which are the variables involved in his theory of prosperity,

under the price measure; and (2) that he considers these prices as

anomalies from the standpoint of the general laws governing the values

and prices of concrete goods. To this last point I shall later take

sharp exception. For the present, I wish to develop further the extent

to which such factors may be brought under the general static measure.

The feature of static theory which Veblen chiefly employs in giving a

money-measure to his "intangible capital" is the capitalization

theory.[585] The capital magnitude of the items of good will previously

mentioned is a capitalization of the _income_ which they are expected to

bring in. And it may be said that a large part of Veblen's doctrine of

the causes of the ups and downs of business rests on the complaint that

this capitalization process is not rationally carried through--that

incomes are overestimated, and that business men are tenacious of

capital magnitudes once built up, and refuse to mark them down properly

when the facts in the situation have changed. His theory of prosperity

thus rests on non-rational enthusiasm on the one hand, and a certain

kind of "friction" on the other hand, and apparently the difficulties in

the situation as he sees it would largely disappear if these two

elements could be rationalized, and the static theory work more

perfectly. The elements involved in the capitalization theory, as shown

in the chapter on that topic, are three: the anticipated income, the

prevailing rate of discount, and the capital value, the last named being

the child of the first two. The capital magnitude is a shadow, where the

income is the substance. Veblen seems to find the trouble arising in

that the capital magnitude takes on a substantial character, and refuses

to play the passive role of shadow. It is interesting, in passing, to

compare this theory of Veblen's with the theory of crises developed by

Irving Fisher, from the standpoint of a body of doctrine which is purely

static, and which Veblen has criticised as "taxonomic" in a high degree.

For Fisher[586] the trouble arises from friction in connection with

another element in the capitalization problem, namely, the interest

rate. Business men think that "a dollar's a dollar," and refuse

to let the interest rate be marked up in accordance with the

doctrine of "appreciation and interest." This, likewise, leads to

overcapitalization, leaves the passive shadow too big. I must confess

that it seems to me that one theory is about as "taxonomic" as the

other--that both rest on pointing out divergences from a static,

"taxonomic" norm. In general, Veblen's work in this field consists in

assimilating the "intangible" capital to the class of land, and other

long time concrete income-bearers, but that is after all classification,

systematization, "taxonomy." In saying all this, I am as far as possible

from questioning the value of Veblen's work. Rather I rate it as of

extreme significance. "Taxonomy" does not appear to me so dreadful a

word as it does to Veblen. I should rather say that some taxonomy is

good and some is bad, depending on whether or not it leads to fruitful

generalizations, and deeper insights.

It is, as I have said, chiefly the capitalization theory which Veblen

applies to these newly important intangible "capital-items." The

phenomena of the stock-market, where such things are most actively

bought and sold, and where they appear as differential portions of the

capital values of securities, doubtless first called attention to

them--though the item of "good will" as a business asset, for which a

money-price is paid when businesses change hands, is doubtless older and

wider than modern corporation finance. The capitalization theory applies

to them most readily and obviously, as compared with other elements in

the static theory of prices.

But as we become better used to the large role which these phenomena

play,--not that the phenomena are new, but that their present importance

is new, and hence our serious study of them is new--we are increasingly

able to see that other elements of static theory also apply. _Static

theory applies increasingly as understanding increases!_ The vaguely

discerned, the novel, the imperfectly analyzed, can be stated only in

qualitative terms. As things are better understood, the mind seeks

system, taxonomy, quantitative measurement. Business men to-day are well

accustomed to applying _cost_ concepts to many of these intangible

magnitudes. Advertising, for example, is being worked out with

increasing exactness, and business men are increasingly applying

accounting processes to the determination of the question of _how much_

advertising "pays." Well-known brands are capital items. Well-known

brands have cost money! Business men contemplating the marketing problem

may well balance the cost of creating a new brand against the cost of

buying an old one, and may balance the cost of creating a new brand

against the profit to be made from allowing an old one to deteriorate,

through cheapening its process of manufacture. Trade-connections are

capital items. They are also items which have been created by patient

thought and labor and expense. Franchises, since the days when the

public awoke to their value, have cost money to the corporations that

possess them, and figure in corporate bookkeeping often. Even in the old

days, they often had a cost, which commonly stayed _out_ of the

corporations' books, at least in that form,--bribes, entertainments to

legislators and members of councils, and so on. In Part II of this

book,[587] I have discussed "selling costs" as contrasted with costs of

production in the narrow sense, and have pointed out how high a

proportion of total costs these selling costs are. I have also indicated

how many of these costs tend to be "capitalized." These selling costs

are static measures of the elements of "friction" which interfere with

the smooth working of static laws! An extension of statics, however,

can in considerable degree take account of them. It is, of course, far

from true that cost doctrine will explain all of these intangible

capital magnitudes. But this is likewise true of the prices of many

tangible items. Cost doctrine does not hold universal sway even in the

confines of the strictest static theory.

I have said that dynamic factors tend to come under the rules of static

taxonomy to the extent that they become more accurately understood. The

understanding here referred to is not merely on the part of the

scientific theorist! The subject-matter of economic science is itself

psychological. It includes the psychology of the business man, as well

as the psychology of purchasers and laborers, and the general field of

social-mental life that bears on economic processes. It includes the

theories of the business men, as well as their aspirations and

"motives." It includes their methods of computation, and the accuracy or

inaccuracy of their prognostications. It has been pointed out recently

that at the current price of copper (22c. per pound in Jan. 1916) the

prices of copper stocks are very much lower than they were when copper

reached the same price some years ago. Calumet and Hecla stands some two

or three hundred points lower than it did then, and the same percentage

difference is manifest in the case of many other stocks. But the

explanation which the broker and market writer offer is that people have

awakened to the fact that mining stocks are stocks with wasting assets,

that the incomes from copper stocks cannot, therefore, be capitalized on

so high a basis as similar incomes from other securities; that people

to-day realize this fact as they did not some years ago; that the

earlier capital-prices of copper stocks were vastly exaggerated on the

basis of a careful estimate of probable total future income, etc. Japan,

little used to the great prosperity growing out of sudden great

increases of special kinds of business, found herself in such an orgy

of war stock speculation that it was necessary to close the stock

exchange in 1915. The United States, better familiar with the phenomena

of boom and depression, seasoned by many experiences of similar nature,

have found that on the whole,--at least in the opinion of many competent

judges in January of 1916,--war stock speculation has been kept in

reasonable bounds, thanks in large part to the conservatism and caution

of bankers and brokers, and that the general economic situation is in

fairly stable equilibrium, with most of the probable sources of disaster

foreseen and "discounted." To "discount" is to make "static"![588]

Whatever the business man can reduce to bookkeeping terms, and whatever

he can measure by money in the market, the economist should be able to

bring within the "orderly sequences of economic law."

In _Social Value_, I have pointed out how wide is the scope of the money

measure. Waves of public opinion, of waning or waxing hope and belief,

of patriotic fervor, of religious exaltation, of political movements of

one or another kind--all these find some sort of money measure in the

market. In the gold market in the early '60's in New York, the "bulls"

sang "Dixie," and the bears sang "John Brown's Body"! It was patriotic

to be a bear, and unpatriotic to be a bull. These considerations

affected the prices very appreciably, at times, especially at the

beginning of the speculation in Greenbacks. Waning and waxing belief in

the triumph of the Northern armies manifested itself very strikingly in

the prices in the gold market, as W. C. Mitchell has conclusively

proved, with a wealth of detailed evidence, in his _History of the

Greenbacks_. But in less systematic markets, in less organized and

regular ways, many things besides are given a money measure: "Against

what, indeed, shall wealth be measured? Where are the markets which

measure its fluctuations?

"But such markets exist, always have existed. Are there not streets

where woman's virtue is sold? Are there not commonwealths where there is

a ruling price for votes? Do not the comparative rewards of occupations

indicate what inducements will overcome the love of independence, of

safety, of good repute? We see men sacrificing health, or leisure, or

family life, or offspring, or friends, or liberty, or honor, or truth,

for gain. The volume of such spiritual goods Mammon can lure into the

market measures the power of money.... When gold cannot shake the

nobleman's pride of caste, the statesman's patriotism, the soldier's

honor, the wife's fidelity, the official's sense of duty, or the

artist's devotion to his ideal, wealth is cheap. But when maidens yield

themselves to senile moneybags, youths swarm about the unattractive

heiress, judges take bribes, experts sell their opinions to the highest

bidder, and genius champions the cause it does not believe in, wealth is

rated high." (Ross, _Foundations of Sociology_, pp. 171-172.) Ross is

here interested chiefly in the problem of measuring the varying

significance of wealth, symbolized by money, in terms of other and

non-economic, goods. But it is equally true that money measures these

goods. The range of the money measure is very wide. Nor is it confined

to the exchanging process. Gabriel Tarde[589] has pointed out that money

may function as a measure of non-material goods through gifts, public

subscriptions, etc.

It is surely no extravagant claim to make that the methods of static

economics may be extended at least as far as the money measure goes! We

shall later see reason for believing that fruitful results may come from

an even wider extension of the static notion, at least as a schematic

device.

In reducing static and dynamic considerations to common terms, we have

now gone far. We have shown that a wide range indeed of the phenomena

deemed dynamic, and largely ignored by current static theory, left to

the discussion of such innovating students of the "theory of prosperity"

as Veblen, are really in the actual practice of the business world

treated in the same way as are the "static" phenomena of the values of

physical goods and concrete services. And we have further shown how wide

indeed is the scope of the static yardstick, the dollar. But this is

only a part of the story. We have generalized statics. Can we similarly

generalize dynamics? Or has our generalization of statics merely

narrowed the field of dynamic considerations?

To this I reply that we may view the whole field likewise from the angle

of what we have called dynamics, or theory of prosperity, or similar

name. These terms are not satisfactory, in my view, and I have already

used terms that appear to me better. My exposition on this point will be

briefer than in the generalization of statics, since I may refer to what

I have said elsewhere. In stating Veblen's contrast between "business

capital" and "the wealth of nations," I quoted him as follows: "Under

modern conditions the magnitude of the business capital and its

mutations from day to day are in great measure a question of folk

psychology rather than of material fact." The capital, or the wealth in

general, of older and simpler days was a material matter, concrete goods

and services, in his view. The newer items of capital are anomalies,

presenting something strange and novel, and sinister. I should maintain

that, whether sinister or no, they are in principle at least not _novel_

or _anomalous_. _All economic values are matters of folk-psychology!_

All economic values are social values. All are to be explained on the

same general principles that explain the values of the most complicated

stock-market phenomena--except of course, that the application of the

principles involves less complication in the case of such values as that

of a loaf of bread. But value is always a matter of psychological

significance, and never a matter of mere material fact. And these

psychological significances are not explained by such simple individual

phenomena as labor-pain, or marginal utility, but always by reference to

the total social-mental system, including its laws, its mores, its

institutions, its centres of power and prestige, its modes and fashions,

etc. If Veblen has in mind the contrast between goods whose values rest

in labor-pain or marginal utility, on the one hand, and values which

rest in a folk-psychology on the other hand, the contrast is a false

one. The first class does not exist. I shall not elaborate this point. I

have developed it at length in _Social Value_, and in the chapter on

"Economic Value" in this book. I should make the contrast, then, which

seems to me to gather up the central significance of most of the

contrasts we have been discussing, as follows: on the one hand, we may

view the matter mechanically and abstractly, in terms of the

equilibration of values conceived of like physical forces, expressed in

prices; on the other hand, we may view the economic situation more

fundamentally and realistically, seeing the interplay of men's minds,

viewing economic values as parts of a social mind, a functional unity of

many minds. We may treat society as a mechanism, or we may treat it as a

living, pulsing, psychological organization. In short terms, our

contrast may be between the theory of value, and the theory of price.

And here we are back to our thesis set forth on p. 559 of this chapter.

The theory of value, as thus marked out, is still an abstraction from

the totality of our cross-section picture of social, or even of

economic, life. The essence of society is indeed psychological. But men

have bodies, and live in a material world, and have an elaborate

technology. Many of the factors which students of dynamics are concerned

with grow out of biological and technological relationships, and are

connected with physiographic influences. Can we bring all these into our

scheme? Giddings and Spencer would answer affirmatively. For Giddings

(_Principles of Sociology_, ed. 1905, p. 363): "All social energy is

transmuted physical energy." Giddings guards himself (pp. 365-366)

against a thoroughgoing monism, which would leave no distinction between

mind and matter, but in general he would hold to the scientific goal of

reducing the physical and psychical phenomena in society to a

parallelism, so that concomitant percentage variation could be

predicated of them, and so that considerations in one sphere could be

expressed by considerations in the other. In the hands of Giddings and

Spencer, such notions are handled with caution and discrimination, and

command respectful consideration. One feels, however, that the starting

point is a monistic metaphysics, and that the philosophical doctrine

does not justify itself in its scientific application. In the hands of

such a writer as Winiarski, however (_Rev. Philosophique_, vol. XLV, pp.

351-386; vol. XLIX, pp. 113-134; summarized by Ross, _Foundations of

Sociology_, pp. 156-157), who makes all mental states mere forms of

physical energy, and applies to mental processes the laws of mechanics,

the doctrine becomes merely bad poetry! From the standpoint of

the needs of social science, and from the standpoint of our present

knowledge of social facts--to say nothing of general philosophical

considerations--it seems clearly best to me to assume the common-sense

doctrine of dualism as a premise: mind and matter are two different

things; mind acts on matter, and matter acts on mind. We are then at

this position, when it comes to bringing technological and physiographic

factors into our scheme: on the one hand, the values control

technological applications, and control the course of industry. New

technological devices will be employed when the present worth of their

anticipated products is great enough to overcome the values that compete

with them. Land will be employed on that crop which gives the largest

rent, etc. Men's physical activities, and their employment of their

physical resources, are _motivated_ by values. That is the _function_ of

values. On the other hand, physiographic and technological factors

modify the lives and characters of men and peoples. _Values_ are in part

controlled by physiographic and technological conditions of life. But

these technological and physiographic factors, in order to influence

economic _conduct_, must first influence the value system. This they do,

(1) by affecting the quantities of _objects_ of value, and so modifying

the marginal relations among the value-scales and the marginal values;

(2) by affecting the lives of the people directly, and so modifying the

value-scales themselves. Similarly I see no way of bringing the vitally

important factor of heredity into our scheme in a direct manner, _in

propriore persona_, but only mediately, as it (1) affects the character

of the society, and so changes its value-system or its technological

activity and volume of products, or (2) as heredity becomes a matter of

concern to the society, and so an object of value, with its own place in

the value-system.

There remains, therefore, in the field of technological, biological, and

physiographic features affecting economic life a considerable residuum

of economic problems for which, so far as I can see, no extension of the

static method can be devised. I propose no scheme of static price

analysis for balancing the effects of poor land and good heredity on the

character of a society.[590] The problem must be approached by other

methods specially suited to it, which we need not here discuss. But,

given the values that rule in that society, we may be sure that our

static picture of that value system will sum up much of the influence of

the bad land and the good heredity, mingled with the other factors which

have determined that set of values.

Once a factor has been introduced into the value system, once it has

modified the value-scales, we may treat it by the methods of static

price theory. The analysis of the factors controlling the value-scales

is the problem of value theory. And here is, indeed, the central problem

of the "theory of prosperity." What are the causes controlling the

_mutations_ of values? What factors cause values to rise, intensifying

economic activity, stimulating trade, spreading prosperity? What brings

about the crash in economic values (and consequently in prices), in

panics and crises? Why the low values of the period of depression,

giving slight stimulus to industry and trade, leaving economic life

lethargic, inert? Increasingly it is recognized that the problems are

problems of values and prices. It is no part of my plan to give answers

in specific terms to these questions. That were the task of a large

book! And very much of it has already been done. It is my purpose here,

simply, to show that price theory, as developed on the basis of static

notions, may be extended, and has in considerable measure been extended,

to cover these problems, and that for the same reason that price theory

is unable to give really fundamental answers to them, often, it is

likewise unable to give fundamental answers to the value problem

anywhere--that the phenomena of value are of the same stuff and

substance as the phenomena treated by "dynamics" and "the theory of

prosperity," and that static theory has been busied chiefly with a

limited portion of the field only because the problems were easier

there. Much has been made, especially in such a book as W. C. Mitchell's

_Business Cycles_, of technological factors, and of factors in the

psychology of the business man and of the laborer in the ups and downs

of business, and particularly of certain elements of scarcity or

overabundance of productive resources at critical parts of the economic

system, which raise values and prices unduly at certain points,

compelling radical readjustments of values and prices elsewhere.

Virtually all of these considerations will fit into the scheme here

outlined. They work _through_ modifications of the system of values and

prices. H. L. Moore's recent _Economic Cycles_ lays heavy emphasis on

physiographic factors, particularly variations in rainfall. But these,

too, act on the economic situation through affecting the quantities of

objects of value, and so through modification of the marginal values of

goods. The psychological theory of economic value by no means excludes

any amount of influence one can find in physiographic or technological

factors.

One of the most important factors in the minds of many writers who would

treat business cycles, and a factor to which virtually all writers give

attention, is the waxing and waning of business confidence, and of the

volume of credit. I have given an extended analysis of the psychology of

confidence, and of the psychological nature of credit, in my chapters on

that topic. It is enough to say here that we have in credit phenomena

things which are of the very stuff of economic values in general.

Beliefs and hopes are factors in economic values, and values wax and

wane with them. There is little indeed in the psychological and

institutional aspects of the theory of prosperity which an adequate

theory of value would not contain.

The theory of _prices_, as an abstract formula of description, is of

primary interest to the scientist, who has nothing to do with the

manipulation of concrete values, and who has no interests at stake in

the behavior of particular values at a particular time. His purposes are

ultimately practical, no doubt, but the practical ends he has in view

are, after all, only to lay down general rules of public policy, of a

high degree of generality, and he consequently may abstract from a great

deal of the concrete causal process. The theory of _value_, in its

concrete fulness, is the special interest of the active business man,

and especially of the business man who wishes, not merely to _adapt

himself_ to changes in values, but also in part, to _control_ and

_manipulate_ those values. _He_ must study every factor which does, in

fact, bring about changes in the value system. We do not find the

market-letter of a brokerage house, or the calculations of a captain of

industry, or trust promoter, troubling themselves about marginal

utilities or labor-pains! Notions of supply and demand, and the

relations of the prevailing interest rate to the capital values of

securities, they do employ. Notions of money-costs of production they

make use of. But they also give very close attention to questions of

governmental policy, to court decisions, to movements in the field of

labor organization, to money-market phenomena, and particularly to gold

movements and the state of the exchanges, to political campaigns, to the

strength of the prohibition movement, to changing fashions and modes,

and, above all, to the general _tone_, the _consensus_, so far as it is

ascertainable, as to whether business is good or bad, whether men are

buoyant or depressed, to the ups and downs of business confidence. They

pay marked attention to the opinions expressed by certain men, great

bankers or industrial leaders, not merely because they think these men

good judges, but also, and in part primarily, because these men are

centres of power, "radiant points of social control," whose opinions

make the opinions of others, and whose statements that times are good

tend to make them good, and that times are bad tend to make them bad.

For static theory, nothing is more contemptible than the view which

"demagogues" often express in Congress that great men in Wall Street

make and unmake prosperity, bring about and check panics. For static

theory, the only way that big men can lower prices is by selling, and

the only way they can raise prices is by buying.[591] Their power to

raise and lower prices is thus limited by the amount of their wealth

which they are willing to employ in this way. As it is not likely to be

profitable to be a bull when the general condition of the "fundamentals"

calls for falling prices, and as bear operations, contrary to the

fundamentals, are likewise usually costly, the inference would be that

the big men will not, even if they could, alter the course of the

market. Their wealth is, after all, not so tremendous, as compared with

the aggregate wealth of the rest of the community. But the market takes

the big men more seriously! When they are selling heavily, other men are

often _afraid_ to buy, such is their prestige. When they give out

opinions, these opinions _become_ the opinions of a host of others,

almost automatically. When Morgan stepped into the breach in the Panic

of 1907 with $25,000,000, it was quite as much the fact that _Morgan_

had acted, as it was the millions themselves, which relieved the

situation. Indeed, it was in no small degree the prestige of Morgan

which relieved the _disorganization_, which restored the discipline, and

made it possible for the elements in the market to work in harmony and

cooeperation again. Society is a functional unity, and the "tone of

business," the ups and downs of prosperity, depend in large measure

indeed on the degree to which the lines of communication between the

different parts are kept open, on the question of whether each part does

its expected task at the right time and in the right way, on the

all-together-functioning, the _integration_, of the elements. These are

phases of the matter from which static theory abstracts. They are

organic problems, not mechanistic problems. Of course, mechanisms get

out of order too. But tightening a bolt is a very different thing from

restoring confidence and discipline to a market!

Those who wish to control values have their own technology. There

is a technology of industry, a mechanical technology, running in

terms of pistons and levers and soil-fertility-equivalents, and

butter-fat-content, and ton-miles, which is governed by the values.

But there is also a technology of _controlling_ values which involves

advertising, making sentiment, keeping up social discipline, effecting

the equilibration of values by exchange, keeping "interstitial"

adjustments smooth, which involves a different kind of activity,

thought, and ability, and which employs different instrumentalities. Its

problems are problems of human nature and social relationships, its laws

are psychological laws, particularly the laws of suggestion, imitation,

and the like, its tools are the newspaper, the sign-board, the whispered

word, the cigar and the dinner with wine, sound logic, money and credit

instruments, the prestiges of men and institutions. For men whose work

lies in controlling and making values, rather than in making passive

technical adjustments to existing values, the theory of value, as I have

defined it, is of supreme importance.

This, I may say for the critic who may consider the social value theory

a highly speculative and theoretical notion, does not mean that the

active business man or the advertising writer, has formulated the social

value theory in terms of a social mind, conceived of, in the light of

modern functional psychology, as a functional unity of individual minds!

The advertising writer is a student of modern psychology, and reads

books on the psychology of advertising, which discuss the psychology of

suggestion, and the like. But long before such books were written for

him, he studied the phenomena involved in his own way. It is not his

business to construct a theoretical economics! It is his business to

make a market for his wares. He is interested in the scientific theories

of modern social psychology only in so far as they help him in that

task. He has no occasion to construct a vast conspectus, which shall

summarize the whole economic situation, in its social setting. But my

point is, simply, that the kind of phenomena which he does study are

indicated and stressed and brought into a system in the theory of social

value which I have tried to elaborate. As his purposes are different

from those of the economist, his method of approach, and his range of

investigation, will necessarily be different.

The notion of dynamics has been in a way connected with the idea of

evolution, of historical process in time, while the notion of statics

has been essentially connected with the notion of a cross-section, a

stage, an equilibrium of contemporary forces. How, then, bring the two

together? Of course, we may conceive the evolutionary process itself as

a series of stages, and the mind does tend almost inevitably to do that.

The fact is, of course, a perpetual flow, with unceasing change. The

mind grasps such a notion with difficulty, if at all. Logic is

mechanical and mathematical, and mathematics and mechanics are

static.[592] But further, we may in large measure bring the historical

considerations into a cross-section picture, when it is a value system

that is involved. _Past_ facts exert their influence through _present_

values; and _future_ facts, which may be expected to modify future

values, come into the present equilibrium as discounted _present_

worths.

When we view the situation realistically, moreover,--which means, when

we view it as a living organic, psychological process,--our

cross-section does not need to be narrowed to a moment of time. We may

see the values not yet in stable equilibrium, but in process of

equilibration, with marginal values and prices fluctuating, tending

toward a static goal, but hindered by various cross-currents, of

"friction," of uncertainty, of momentary values which rest on beliefs

regarding the process of transition itself--as when a "bull" on the

war-stocks turns bear temporarily, because he thinks that prices may

fall before recovering themselves, and going higher. We may see

obstacles in the way of readjustment whose importance is itself subject

to static measure--labor temporarily out of work, and labor-time lost,

at so much per day; uncertainties which give rise to speculation, which

calls for the employment of extra banking credit, at such and such per

cent; capital-instruments which have to be "scrapped," representing the

loss of so many dollars. We may see the process of building up new

trade connections, at such and such a cost, to replace others which

formerly functioned, but which no longer serve, which were once worth so

much, and which now are valueless. Watching the realistic process of

transition, through a period of time, we may still apply our static

yardstick to many of its features.

Above all, do we get in this connection a realization of the fact that

the "immaterial capital" of which Veblen speaks is true social

wealth.[593] Whatever is necessary for the carrying on of economic life,

whatever, if destroyed, must be replaced, before the economic process

can go on, and will be replaced by the expenditure of labor and thought

and money, is capital. The sales-force is as truly a part of the

labor-force of a corporation as are the mechanics. The trade connections

which the sales-force has built up is as truly a part of the capital of

the business as the machines which the mechanics have made. The static

theory which abstracts from this easily leads to dangerous conclusions.

Removing a tariff may well, _after the transition is completed_, give a

greater productive efficiency to a country. But what of the cost of

transition? May not the values destroyed, and to be recreated, in the

form of trade connections, social organization, accomplished

adjustments, and the like, be greater than the new values to be gained

by better adaptation of industry to the physical resources or the

capacities of the labor supply, of the country? In large measure, this

question, in a given case, is susceptible to a quantitative answer. The

statesman who reckons only the gains which the final static adjustment

will bring, and neglects the costs of reaching it, costs not alone in

"scrapped" machines, but also, in "scrapped" social organization, has

missed a substantial part of his problem.

The theory of prosperity, and the theory of value, are largely concerned

with just this system of social control, by means of which value scales

are altered, and by means of which altered values are brought into a new

equilibrium. It is a complicated fabric of psychological relationships,

partly institutionalized, partly non-institutional. The institutions--as

banks, big corporations, speculative exchanges, and the like, are the

nuclei, about which centre much that is temporary, shifting, and

flexible. Given time, the whole system is highly flexible--it is

organic, and not mechanical.

The serious injury of this system in a country may well be a greater

disaster than the destruction of physical items. Let unscrupulous

men--or misguided men--bring about a legal repudiation of debts, and the

disaster may be greater than the destruction of a city by an earthquake.

That creditors have been robbed is a minor matter, but that credit has

been shaken, so that men will fear to lend again or to sell except for

cash, may well mean industrial paralysis.

Considerations like these enable us, in substantial degree, to reduce

"transitional" considerations to common terms with "normal"

considerations. We can apply the static measure to the "transitional

considerations," and we find the values which come into equilibrium in

the "normal" period to be generically like those whose variations

interest us in the period of transition. Indeed, the "normal

equilibrium," if it were ever reached, would also contain these

intangible capital items, though many of them would be much reduced,

since the work that they have to do would be largely gone, if the normal

equilibrium were persistent.

It does not follow from the foregoing that many of the elements in

"modern business capital" are not, as Veblen's analysis suggests,

sinister and anti-social. To say that their values are true social

economic values, generically the same as the values of wheat or corn or

whiskey or opium or Sanatogen or milk or tickets to burlesque shows, or

silver sacramental sets, or Ford automobiles, is not necessarily to give

them a good moral character! Some of these intangible capital goods are

thoroughly anti-social, and should be destroyed. This is particularly

true of monopoly power, and of popular brands whose value rests in

popular delusion. But even here, caution is needed. Is it socially wise

to destroy a wine cellar, containing an hundred thousand dollars worth

of fine wines, even assuming that Demon Rum is as black as he is

painted, and that Veuve Cliquot is his favorite daughter? Will not the

economic values which have been destroyed in this moral fervor be

recreated? And will not this tend to divert labor and capital from the

creation of a corresponding amount of more wholesome economic goods?

Might it not be wiser from the standpoint of the temperance movement

itself, to sell the wine cellar--at private sale, of course!--and use

the proceeds in the campaign fund of the prohibition party? Of course,

there is more still to the story. The destruction of the wine cellar may

be done so dramatically, and may be so well advertised, that it will

arrest public attention, and tend to create new social values, of a

moral and legal sort, which will prevent the recreating of that wine, by

changing the direction of demand, and by lessening the sources of

supply. Similarly with trade connections, and other intangible capital

items. If destroying one means merely that labor and capital will be

employed in making others no better, the social gain is very doubtful.

And some sort of system of control of interstitial adjustment, of

overcoming friction, etc., there must be.

I wish to contrast the view I have been here presenting with that

developed by Schumpeter, in his _Theorie der Wirtschaftlichen

Entwicklung_. In Schumpeter's view, the division between statics and

dynamics is much more than methodological. The phenomena of statics and

dynamics are different phenomena. Statics is concerned with the

influence of individual utility-scales, or utility-scales and psychic

cost-scales, hedonistic phenomena. Dynamics is concerned with the

influence of "_energisch_" (as distinguished from "_hedonisch_")

factors. (_Loc. cit._, 128.) Most men are moved by hedonic

considerations. Their economic activity tends toward the equilibrium

described in static theory. Seeking to maximize satisfactions, and to

minimize pains, they tend to get into the "best-possible" situation

("best-possible" under the "given conditions") and stay there. The

"energetic" type of men, moved by motives like love of activity for its

own sake, love of creative activity, love of distinction, love of

victory over others, love of the game, etc., undertake activities which

tend to alter the "given conditions" themselves, to alter the structure

and technique of economic society, to introduce new ways of doing

things, and so to break the static equilibrium. This last type of men is

small in number, but tremendously important. Schumpeter's theory of

value rests solely in an analysis of the hedonic factors mentioned,

conceived of as individual psychological magnitudes. I have discussed

his theory of value in the chapter on "Marginal Utility" in this book,

and would refer to that discussion here. He makes virtually no use of

the value concept there developed in explaining the causation of dynamic

change, but instead, as I have pointed out in that chapter, invents new

concepts, which do the work of the value concept, which he calls

"_Kaufkraft_," "_Kapital_," and "_Kredit_," which do not rest on

marginal utility, but rather on the activities of certain centres of

economic power, particularly of banks.[594] His picture of economic

evolution is that of a conflict between these static and dynamic forces,

between "utility-curves" and the psychological factors of the

"energetic" type, the former represented in a set of static

price-ratios, the latter in a set of dynamic "powers," conceived of, not

as sums of money (even though expressed in money-terms), but as

"abstract power," which grows, not merely out of the individual

psychologies of the entrepreneurs, but also, and primarily, out of the

social influence centered in the banker. This power which the banker

to-day supplies was in earlier periods supplied by the political power

of the despot, and is distinctly a matter of social organization, and

social control, an over-individual, social phenomenon, analogous to the

"social value" which I have sought to put behind all prices, whether

"static" or "dynamic." The dynamic man needs "power," either political

or financial, to "force" the "static" men out of their accustomed ways

of activity. They fear and resist him. He must coerce them. The contrast

is thus sharply made between abstract price-ratios, resting on

individual feeling-scales, and quantitative "powers," measured in money,

resting on a social basis. Between the factors underlying static prices,

and those underlying dynamic prices there is, thus, nothing in common.

Statics and dynamics are concerned with fundamentally different

phenomena.[595]

If my criticisms of the utility theory of value are sound, and if what

has gone before in this chapter holds good, we must restate Schumpeter's

contrast.[596] The static tendencies do not rest on any peculiarities of

the psychological "stuff" from which static values are derived. They

rest rather in the universal tendencies of all values, whatever the

psychological factors behind them, to come to an equilibrium. The reason

that values, whether they be the values of new and novel things, or the

values of old and familiar things, tend to come to an equilibrium is

that gains come from equilibrating them. When some values are too low,

and some are too high, the opportunities for speculative gain are

evident. Arbitraging transactions, as between different places,

time-speculation, transferring labor and capital from one enterprise to

another, increasing the supplies of some goods and reducing the supplies

of other, changing land from wheat to corn, etc., etc.,--all these

things are sources of gain, and they will be done, whatever the origin

of the values involved. The new, dynamic enterprise, before it becomes

actualized in concrete machinery, factory building, etc., and long

before its income is actualized in money-receipts from the goods it is

destined to produce, becomes an _object of value_. The value is a

_future_ value. But it comes into the present as a discounted present

worth. As such it functions like any other value, tending to attract in

its own direction the land, labor and capital necessary for its

realization. It does not differ in its functioning from the present

worths of future goods of familiar sorts.[597] It tends, after a process

of reequilibration--which Schumpeter, with his theory of crises, has

done much to elucidate--to come into equilibrium with the older,

"static" values, becomes itself a static value. Indeed, from its

inception, it comes under the static, money measure. It enters at once

into the scheme of static values and prices, even though it causes

readjustment there.

The preexisting static values are themselves to be explained, not as

growing out of individual feeling-scales, but as growing out of a

complex social psychology, in which some men and groups of men have

vastly greater social "power" than others. The preexisting static values

are of the same stuff as the dynamic values. But this has already been

made clear.

* * * * *