CHAPTER XI

A SYMPOSIUM ON THE RELATION BETWEEN MONEY AND GENERAL PRICES

The form of this chapter was suggested by the proceedings of a session of the 1910 Meeting of the American Economic Association, devoted to a consideration of the causes of the rise in prices between 1896 and 1909. Selections from papers there presented, and from the relative discussion, make up a considerable part of the chapter, and it is suggested that all of the selections, except the last, may well be considered for purposes of study as having come from the papers and discussion of the session referred to, although numerous additions and substitutions have been made in order to render the treatment one of principles involved in the determination of general prices without special reference to any particular period of years.

IRVING FISHER[43]: Overlooking the influence of deposit currency, or checks, the price level may be said to depend on only three sets of causes: (1) the quantity of money in circulation; (2) its "efficiency" or velocity of circulation (or the average number of times a year money is exchanged for goods); and (3) the volume of trade (or amount of goods bought by money). The so-called "quantity theory,"[44] _i.e._, that prices vary proportionately to money, has often been incorrectly formulated, but (overlooking checks) the theory is correct in the sense that the level of prices varies directly with the quantity of money in circulation, provided the velocity of circulation of that money and the volume of trade which it is obliged to perform are not changed.

The quantity theory has been one of the most bitterly contested theories in economics, largely because the recognition of its truth or falsity affected powerful interests in commerce and politics. It has been maintained--and the assertion is scarcely an exaggeration--that the theorems of Euclid would be bitterly controverted if financial or political interests were involved.

The quantity theory has, unfortunately, been made the basis of arguments for unsound currency schemes. It has been invoked in behalf of irredeemable paper money and of national free coinage of silver at the ratio of 16 to 1. As a consequence, not a few "sound money men," believing that a theory used to support such vagaries must be wrong, and fearing the political effects of its propagation, have drifted into the position of opposing, not only the unsound propaganda, but also the sound principles by which its advocates sought to bolster it up.[45] These attacks upon the quantity theory have been rendered easy by the imperfect comprehension of it on the part of those who have thus invoked it in a bad cause.

Personally, I believe that few mental attitudes are more pernicious, and in the end more disastrous, than those which would uphold sound practice by denying sound principles because some thinkers make unsound application of those principles. At any rate, in scientific study there is no choice but to find and state the unvarnished truth.

The quantity theory will be made more clear by the equation of exchange, which is now to be explained.

The equation of exchange is a statement, in mathematical form, of the total transactions effected in a certain period in a given community. It is obtained simply by adding together the equations of exchange for all individual transactions. Suppose, for instance, that a person buys 10 pounds of sugar at 7 cents per pound. This is an exchange transaction, in which 10 pounds of sugar have been regarded as equal to 70 cents, and this fact may be expressed thus: 70 cents = 10 pounds of sugar multiplied by 7 cents a pound. Every other sale and purchase may be expressed similarly, and by adding them all together we get the equation of exchange _for a certain period in a given community_. During this same period, however, the same money may serve, and usually does serve, for several transactions. For that reason the money side of the equation is of course greater than the total amount of money in circulation.

The equation of exchange relates to all the purchases made by money in a certain community during a certain time. We shall continue to ignore checks or any circulating medium not money. We shall also ignore foreign trade and thus restrict ourselves to trade within a hypothetical community. Later we shall reinclude these factors, proceeding by a series of approximations through successive hypothetical conditions to the actual conditions which prevail to-day. We must, of course, not forget that the conclusions expressed in each successive approximation are true solely on the particular hypothesis assumed.

The equation of exchange is simply the sum of the equations involved in all individual exchanges in a year. In each sale and purchase, the money and goods exchanged are _ipso facto_ equivalent; for instance, the money paid for sugar is equivalent to the sugar bought. And in the grand total of all exchanges for a year, the total money paid is equal in value to the total value of the goods bought. The equation thus has a money side and a goods side. The money side is the total money paid, and may be considered as the product of the quantity of money multiplied by its rapidity of circulation. The goods side is made up of the products of quantities of goods exchanged multiplied by their respective prices.

The important magnitude, called the velocity of circulation, or rapidity of turnover, is simply the quotient obtained by dividing the total money payments for goods in the course of a year by the average amount of money in circulation by which those payments are effected. This velocity of circulation for an entire community is a sort of average of the rates of turnover of money for different persons. Each person has his own rate of turnover which he can readily calculate by dividing the amount of money he expends per year by the average amount he carries.

Let us begin with the money side. If the number of dollars in a country is 5,000,000, and their velocity of circulation is twenty times per year, then the total amount of money changing hands (for goods) per year is 5,000,000 times twenty, or $100,000,000. This is the _money_ side of the equation of exchange.

Since the money side of the equation is $100,000,000, the goods side must be the same. For if $100,000,000 has been spent for goods in the course of the year, then $100,000,000 worth of goods must have been sold in that year. In order to avoid the necessity of writing out the quantities and prices of the innumerable varieties of goods which are actually exchanged, let us assume for the present that there are only three kinds of goods,--bread, coal, and cloth; and that the sales are:

200,000,000 loaves of bread at $ .10 a loaf, 10,000,000 tons of coal at 5.00 a ton, and 30,000,000 yards of cloth at 1.00 a yard.

The value of these transactions is evidently $100,000,000, _i. e._, $20,000,000 worth of bread plus $50,000,000 worth of coal plus $30,000,000 worth of cloth. The equation of exchange therefore (remember that the money side consisted of $5,000,000 exchanged 20 times) is as follows:

$5,000,000 x 20 times a year = 200,000,000 loaves x $ .10 a loaf + 10,000,000 tons x 5.00 a ton + 30,000,000 yards x 1.00 a yard

This equation contains on the money side two magnitudes, viz. (1) the quantity of money and (2) its velocity of circulation; and on the goods side two _groups_ of magnitudes in two columns, viz. (1) the quantities of goods exchanged (loaves, tons, yards), and (2) the prices of these goods. The equation shows that these four sets of magnitudes are mutually related. Because this equation must be fulfilled, the prices must bear a relation to the three other sets of magnitudes--quantity of money, rapidity of circulation, and quantities of goods exchanged. Consequently, these prices must, as a whole, vary proportionally with the quantity of money and with its velocity of circulation, and inversely with the quantities of goods exchanged.

Suppose, for instance, that the quantity of money were doubled, while its velocity of circulation and the quantities of goods exchanged remained the same. Then it would be quite impossible for prices to remain unchanged. The money side would now be $10,000,000 x 20 times a year or $200,000,000; whereas, if prices should not change, the goods would remain $100,000,000, and the equation would be violated. Since exchanges, individually and collectively, always involve an equivalent _quid pro quo_, the two sides _must_ be equal. Not only must purchases and sales be equal in amount--since every article bought by one person is necessarily sold by another--but the total value of goods sold must equal the total amount of money exchanged. Therefore, under the given conditions, prices must change in such a way as to raise the goods side from $100,000,000 to $200,000,000. This doubling may be accomplished by an even or uneven rise in prices but some sort of _a rise of prices there must be_. If the prices rise evenly, they will evidently all be exactly doubled.... If the prices rise unevenly, the doubling must evidently be brought about by compensation; if some prices rise by less than double, others must rise by enough more than double to exactly compensate.

But whether all prices increase uniformly, each being exactly doubled, or some prices increase more and some less (so as still to double the total money value of the goods purchased), the prices _are_ doubled _on the average_.... From the mere fact, therefore, that the money spent for goods must equal the quantities of those goods multiplied by their prices, it follows that the level of prices must rise or fall according to changes in the quantity of money, _unless_ there are changes in its velocity of circulation or in the quantities of goods exchanged.

If changes in the quantity of money affect prices, so will changes in the other factors--quantities of goods and velocity of circulation--affect prices, and in a very similar manner. Thus a doubling in the velocity of circulation of money will double the level of prices, provided the quantity of money in circulation and the quantities of goods exchanged for money remain as before....

Again, a doubling in the quantities of goods exchanged will not double, but halve, the height of the price level, _provided_ the quantity of money and its velocity of circulation remain the same....

Finally, if there is a simultaneous change in two or all of the three influences, _i. e._, quantity of money, velocity of circulation, and quantities of goods exchanged, the price level will be a compound or resultant of these various influences. If, for example, the quantity of money is doubled, and its velocity of circulation is halved, while the quantity of goods exchanged remains constant, the price level will be undisturbed. Likewise, it will be undisturbed if the quantity of money is doubled and the quantity of goods is doubled, while the velocity of circulation remains the same. To double the quantity of money, therefore, is not always to double prices. We must distinctly recognize that the quantity of money is only one of three factors, all equally important in determining the price level....

We now come to the strict algebraic statement of the equation of exchange.... Let us denote the total circulation of money, _i. e._, the amount of money expended for goods in a given community during a given year, by _E_ (expenditure); and the average amount of money in circulation in the community during the year by _M_ (money). _M_ will be the simple arithmetical average of the amounts of money existing at successive instants separated from each other by equal intervals of time indefinitely small. If we divide the year's expenditures, _E_, by the average amount of money, _M_, we shall obtain what is called the average rate of turnover of money in its exchange for goods, _E_/_M_ that is, the velocity of circulation of money. This velocity may be denoted by _V_, so that _E_/_M_ = _V_; then _E_ may be expressed as _MV_. In words: the total circulation of money in the sense of money expended is equal to the total money in circulation multiplied by its velocity of circulation or turnover. _E_ or _MV_, therefore, expresses the money side of the equation of exchange. Turning to the goods side of the equation, we have to deal with the prices of goods exchanged and quantities of goods exchanged. The average price of sale of any particular good, such as bread, purchased in the given community during the given year, may be represented by _p_ (price); and the total quantity of it purchased, by _Q_ (quantity); likewise the average price of another good (say coal) may be represented by _p'_ and the total quantity of it exchanged, by _Q'_; the average price and the total quantity of a third good (say cloth) may be represented by _p''_ and _Q''_ respectively; and so on, for all other goods exchanged, however numerous. The equation of exchange may evidently be expressed as follows:

_MV_ = _pQ_ + _p'Q'_ + _p''Q''_ + etc.

The right-hand side of this equation is the sum of terms of the form _pQ_--a price multiplied by a quantity bought. It is customary in mathematics to abbreviate such a sum of terms (all of which are of the same form) by using "Sigma" as a symbol of summation. This symbol does not signify a _magnitude_ as do the symbols _M, V, p, Q_, etc. It signifies merely the _operation_ of addition and should be read "the sum of terms of the following type." The equation of exchange may therefore be written:

_MV_ = Sigma_pQ_.

That is, the magnitudes _E_, _M_, _V_, the _p_'s and the _Q_'s relate to the _entire_ community and an _entire_ year; but they are based on and related to corresponding magnitudes for the individual persons of which the community is composed and for the individual moments of time of which the year is composed.

The algebraic derivation of this equation is, of course, essentially the same as the arithmetical derivation previously given. It consists simply _in adding together the equations for all individual purchases within the community during the year_....

[We are now] ... prepared for the inclusion of bank deposits or circulating credit in the equation of exchange. We shall still use _M_ to express the quantity of actual money, and _V_ to express the velocity of its circulation.[46] Similarly, we shall now use _M'_ to express the total deposits subject to transfer by check; and _V'_ to express the average velocity of circulation. The total value of purchases in a year is therefore no longer to be measured by _MV_, but by _MV_ + _M'V''_. The equation of exchange, therefore, becomes:

_MV_ + _M'V'_ = Sigma_pQ_ = _PT_[47]....

With the extension of the equation of monetary circulation to include deposit circulation, the influence exerted by the quantity of money on general prices becomes less direct; and the process of tracing this influence becomes more difficult and complicated. It has even been argued that this interposition of circulating credit breaks whatever connection there may be between prices and the quantity of money.[48] This would be true if circulating credit were independent of money. But the fact is that the quantity of circulating credit, _M'_, tends to hold a definite relation to _M_, the quantity of money in circulation; that is, deposits are normally a more or less definite multiple of money.

Two facts normally give deposits a more or less definite ratio to money. The first ... [is] that bank reserves are kept in a more or less definite ratio to bank deposits. The second is that individuals, firms, and corporations preserve more or less definite ratios between their cash transactions and their check transactions, and also between their money and deposit balances.[49] These ratios are determined by motives of individual convenience and habit. In general, business firms use money for wage payments, and for small miscellaneous transactions included under the term "petty cash"; while for settlements with each other they usually prefer checks. These preferences are so strong that we could not imagine them overridden except temporarily and to a small degree. A business firm would hardly pay car fares with checks and liquidate its large liabilities with cash. Each person strikes an equilibrium between his use of the two methods of payment, and does not greatly disturb it except for short periods of time. He keeps his stock of money or his bank balance in constant adjustment to the payments he makes in money or by check. Whenever his stock of money becomes relatively small and his bank balance relatively large, he cashes a check. In the opposite event, he deposits cash. In this way he is constantly converting one of the two media of exchange into the other. A private individual usually feeds his purse from his bank account; a retail commercial firm usually feeds its bank account from its till. The bank acts as intermediary for both.

In a given community the quantitative relation of deposit currency to money is determined by several considerations of convenience. In the first place, the more highly developed the business of a community, the more prevalent the use of checks. Where business is conducted on a large scale, merchants habitually transact their larger operations with each other by means of checks, and their smaller ones by means of cash. Again, the more concentrated the population, the more prevalent the use of checks. In cities it is more convenient both for the payer and the payee to make large payments by check; whereas, in the country, trips to a bank are too expensive in time and effort to be convenient, and therefore more money is used in proportion to the amount of business done. Again, the wealthier the members of the community, the more largely will they use checks. Laborers seldom use them; but capitalists, professional and salaried men use them habitually, for personal as well as business transactions.

There is, then, a relation of convenience and custom between check and cash circulation, and a more or less stable ratio between the deposit balance of the average man or corporation and the stock of money kept in pocket or till. This fact, as applied to the country as a whole, means that by convenience a rough ratio is fixed between _M_ and _M'_. If that ratio is disturbed temporarily, there will come into play a tendency to restore it. Individuals will deposit surplus cash, or they will cash surplus deposits.

Hence, both money in circulation ... and money in reserve ... tend to keep in a fixed ratio to deposits. It follows that the two must be in a fixed ratio to each other.

It further follows that any change in _M_, the quantity of money in circulation, requiring as it normally does a proportional change in _M'_, the volume of bank deposits subject to check, will result in an exactly proportional change in the general level of prices except, of course, so far as this effect be interfered with by concomitant changes in the _V_'s or the _Q_'s. The truth of this proposition is evident from the equation _MV_ + _M'V'_ = Sigma_pQ_; for if, say, _M_ and _M'_ are doubled, while _V_ and _V'_ remain the same, the left side of the equation is doubled and therefore the right side must be doubled also. But if the _Q_'s remain unchanged, then evidently all the _p_'s must be doubled, or else if some are less than doubled, others must be enough more than doubled to compensate....

The factors in the equation of exchange are ... continually seeking normal adjustment. A ship in a calm sea will "pitch" only a few times before coming to rest, but in a high sea, the pitching never ceases. While continually seeking equilibrium, the ship continually encounters causes which accentuate the oscillation. The factors seeking mutual adjustment are money in circulation, deposits, their velocities, the _Q_'s and the _p_'s. These magnitudes must always be linked together by the equation _MV_ + _M'V'_ = Sigma_pQ_. This represents the mechanism of exchange. But in order to conform to such a relation the displacement of any one part of the mechanism spreads its effects during the transition periods [_i.e._, periods of rising or falling prices] over all parts. Since periods of transition are the rule and those of equilibrium the exception, the mechanism of exchange is almost always in a dynamic rather than a static condition....[50]

[51]It is interesting to make a quantitative comparison of the various magnitudes with the increase in the quantity of money as the most important factor in raising the price level. While it is true, as shown by the diagram, that the volume of deposits subject to check has increased greatly, the major part of the increase has to be ascribed to the increase in the quantity of money. Only so far as the volume of deposits subject to check has increased relatively to the money in circulation, can the increase of deposits be regarded as an independent cause of the rise in prices. We have thus to consider the relative importance of the five causes affecting prices:

1. The quantity of money in circulation (M).

2. The volume of bank deposits subject to check considered relatively to money (M'/M).

3. The velocity of the former (V').

4. The velocity of the latter (V).

5. The volume of trade (T).

We may best compare the relative importance of these five magnitudes by answering the question: What would the result have been had any one of these magnitudes remained unchanged, assuming that the other four changed in the same manner that they actually did change. We find (1) that if the money in circulation, M, had not changed, between the years 1896 and 1909, for example, the price level of 1909 would have been 45 per cent. lower than it actually was; (2) that if M'/M, the relative deposits, had not changed, during the same period the price level in 1909 would have been 23 per cent. lower than it actually was; (3) if the velocity of circulation of money, V, had not changed, the price level for 1909 would have been 1 per cent. lower; (4) if the velocity of circulation of deposits, V', had not changed, the price level in 1909 would have been 28 per cent. lower; (5) if T had not changed, the price level in 1909 would have been 106 per cent. _higher_.

Thus the changes in the first four factors have tended to raise prices, while the change in T has tended to lower prices. The relative importance of the four price-raising causes may be stated in terms of the per cent. already given which represents how much lower prices would have been except for each of these causes separately considered. According to this test we find the relative importance of the four price-raising factors to be as follows:

The importance of V is represented by 1,

The importance of M'/M is represented by 23,

The importance of V is represented by 28,

The importance of M is represented by 45.

That is, the increase in the quantity of money had an importance nearly double that of any other one price-raising factor, during the period mentioned.

INDIRECT INFLUENCES ON PURCHASING POWER[52]

Thus far we have considered the level of prices as affected by the volume of trade, by the velocities of circulation of money and of deposits, and by the quantities of money and of deposits. These are the only influences which can _directly_ affect the level of prices. Any other influences on prices must act through these five. There are myriads of such influences (outside of the equation of exchange) that affect prices through these five. It is our purpose ... to note the chief among them....

We shall first consider the outside influences that affect the volume of trade and, through it, the price level. The conditions which determine the extent of trade are numerous and technical. The most important may be classified as follows:

1. _Conditions affecting producers._

(a) Geographical differences in natural resources.

(b) The division of labor.

(c) Knowledge of the technique of production.

(d) The accumulation of capital.

2. _Conditions affecting consumers._

(a) The extent and variety of human wants.

3. _Conditions connecting producers and consumers._

(a) Facilities for transportation.

(b) Relative freedom of trade.

(c) Character of monetary and banking systems.

(d) Business confidence.

1 (a). It is evident that if all localities were exactly alike in their natural resources, in other words, in their comparative costs of production, no trade would be set up between them.... Cattle raising in Texas, the production of coal in Pennsylvania, of oranges in Florida, and of apples in Oregon have increased the volume of trade for these communities respectively.

1 (b). Equally obvious is the influence of the division of labor....

1 (c).... The state of knowledge of production will affect trade. Vast coal fields in China await development, largely for lack of knowledge of how to extract and market the coal. Egypt awaits the advent of scientific agriculture, to usher in trade expansion. Nowadays, trade schools in Germany, England, and the United States are increasing and diffusing knowledge of productive technique.

1 (d). But knowledge, to be of use, must be applied; and its application usually requires the aid of capital. The greater and the more productive the stock or capital in any community, the more goods it can put into the currents of trade....

Since increase in trade tends to decrease the general level of prices, anything which tends to increase trade likewise tends to decrease the general level of prices. We conclude, therefore, that among the causes tending to decrease prices are increasing geographical or personal specialization, improved productive technique, and the accumulation of capital. The history of commerce shows that all these causes have been increasingly operative during a long period including the last century. Consequently, there has been a constant tendency, from these sources at least, for prices to fall.

2 (a).... An increase of wants, by leading to an increase in trade, tends to lower the price level. Historically, during recent times through invention, education, and the emulation coming from increased contact in centers of population, there has been a great intensification and diversification of human wants and therefore increased trade. Consequently, there has been from these causes a tendency of prices to fall.

3 (a). Anything which facilitates intercourse tends to increase trade. Anything that interferes with intercourse tends to decrease trade. First of all, there are the mechanical facilities for transport. As Macaulay said, with the exception of the alphabet and the printing press, no set of inventions has tended to alter civilization so much as those which abridge distance,--such as the railway, the steamship, the telephone, the telegraph, and that conveyer of information and advertisements, the newspaper. These all tend, therefore, to decrease prices.

3 (b). Trade barriers are not only physical but legal. A tariff between countries has the same influence in decreasing trade as a chain of mountains. The freer the trade, the more of it there will be....

3 (c). The development of efficient monetary and banking systems tends to increase trade. There have been times in the history of the world when money was in so uncertain a state that people hesitated to make many trade contracts because of the lack of knowledge of what would be required of them when the contract should be fulfilled. In the same way, when people cannot depend on the good faith or stability of banks, they will hesitate to use deposits and checks.

3 (d). Confidence, not only in banks in particular, but in business in general, is truly said to be "the soul of trade." Without this confidence there cannot be a great volume of contracts. Anything that tends to increase this confidence tends to increase trade....

We see, then, that prices will tend to fall through increase in trade, which may in turn be brought about by improved transportation, by increased freedom of trade, by improved monetary and banking systems, and by business confidence. Historically, during recent years, all of these causes have tended to grow in power, except freedom of trade....

Having examined those causes outside the equation which affect the volume of trade, our next task is to consider the outside causes that affect the velocities of circulation of money and of deposits. For the most part, the causes affecting one of these velocities affect the other also. These causes may be classified as follows:

1. _Habits of the individual._

(a) As to thrift and hoarding.

(b) As to book credit.

(c) As to the use of checks.

2. _Systems of payments in the community._

(a) As to frequency of receipts and of disbursements.

(b) As to regularity of receipts and disbursements.

(c) As to correspondence between times and amounts of receipts and disbursements.

3. _General causes._

(a) Density of population.

(b) Rapidity of transportation.

1 (a). Taking these up in order, we may first consider what influence thrift has on the velocity of circulation. Velocity of circulation of money is the same thing as its rate of turnover. It is found by dividing the total payments effected by money in a year by the amount of money in circulation in a year. It depends upon the rates of turnover of the individuals who compose the society. This velocity of circulation or rapidity of turnover of money is the greater for each individual the more he spends, with a given average amount of cash on hand; or the less average cash he keeps, with a given yearly expenditure....

1 (b). The habit of "charging," _i.e._, using book credit, tends to _increase_ the velocity of circulation of money, because the man who gets things "charged" does not need to keep _on hand_ as much money as he would if he made all payments in cash. A man who pays _cash_ daily needs to keep cash for daily contingencies. The system of cash payments, unlike the system of book credit, requires that money shall be kept on hand _in advance_ of purchases. Evidently, if money must be provided in advance, it must be provided in larger quantities than when merely required to liquidate past debts....

But we have seen that to increase the rate of turnover will tend to increase the price level. Therefore, book credit tends to increase the price level....

1 (c). The habit of using checks rather than money will also affect the velocity of circulation; because a depositor's surplus money will immediately be put into the bank in return for a right to draw by check....

We see, then, that three habits--spendthrift habits, the habit of charging, and the habit of using checks--all tend to raise the level of prices....

2 (a). The more frequently money or checks are received and disbursed, the shorter is the average interval between the receipt and the expenditure of money or checks and the more rapid is the velocity of circulation.

This may best be seen from an example. A change from monthly to weekly wage payments tends to increase the velocity of circulation of money. If a laborer is paid weekly $7 and reduces this evenly each day, ending each week empty-handed, his average cash ... would be a little over half of $7, or about $4. This makes his turnover nearly twice a week. Under monthly payments the laborer who receives and spends an average of $1 a day will have to spread the $30 more or less evenly over the following 30 days. If, at the next pay day, he comes out empty-handed, his average money during the month has been about $15. This makes his turnover about twice a month. Thus the rate of turnover is more rapid under weekly than under monthly payments....

Frequency of disbursements evidently has an effect similar to the effect of frequency of receipts; _i.e._, it tends to accelerate the velocity of turnover, or circulation.

2 (b). _Regularity_ of payments also facilitates the turnover. When the workingman can be fairly certain of both his receipts and expenditures, he can, by close calculation, adjust them so precisely as safely to end each payment cycle with an empty pocket. This habit is extremely common among certain classes of city laborers. On the other hand, if the receipts and expenditures are irregular, either in amount or in time, prudence requires the worker to keep a larger sum on hand, to insure against mishaps.... We may, therefore, conclude that regularity, both of receipts and of payments, tends to increase velocity of circulation.

2 (c). Next, consider the synchronizing of receipts and disbursements, _i. e._, making payments at the same intervals as obtaining receipts.... This arrangement obviates the necessity of keeping much money or deposits on hand, and therefore increases their velocity of circulation....

3 (a). The more densely populated a locality, the more rapid will be the velocity of circulation.

There is definite evidence that this is true of bank deposits. The following figures give the velocities of circulation of deposits in ten cities, arranged in order of size:

Paris 116 Berlin 161 Brussels 123 Madrid 14 Rome 43 Lisbon 29 Indianapolis 30 New Haven 16 Athens 4 Santa Barbara 1

Madrid is the only city seriously out of its order in respect to velocity of circulation.

3 (b). Again the more extensive and the speedier the transportation in general, the more rapid the circulation of money. Anything which makes it easier to pass money from one person to another will tend to increase the velocity of circulation. Railways have this effect.... Mail and express, by facilitating the transmission of bank deposits and money, have likewise tended to increase their velocity of circulation.

We conclude, then, that density of population and rapidity of transportation have tended to increase prices by increasing velocities. Historically this concentration of population in cities has been an important factor in raising prices in the United States....

[SUMMARY]

[53]The purchasing power ... of money has been studied as the effect of five, and only five, groups of causes. The five groups are money, deposits, their velocities of circulation, and the volume of trade. These and their effects, prices, we saw to be connected by an equation called the equation of exchange, _MV + M'V' = SigmapQ_. The five causes, in turn,... are themselves effects of antecedent causes lying entirely outside of the equation of exchange, as follows: the volume of trade will be increased, and therefore the price level correspondingly decreased by the differentiation of human wants; by diversification of industry; and by facilitation of transportation. The velocities of circulation will be increased, and therefore also the price level increased by improvident habits; by the use of book credit; and by rapid transportation. The quantity of money will be increased and therefore the price level increased correspondingly by the import and minting of money, and, antecedently, by the mining of the money metal; by the introduction of another and initially cheaper money metal through bimetallism; and by the issue of bank notes and other paper money. The quantity of deposits will be increased, and therefore the price level increased by extension of the banking system and by the use of book credit. The reverse causes produce, of course, reverse effects.

Thus, behind the five sets of causes which alone affect the purchasing power of money, we find over a dozen antecedent causes. If we chose to pursue the inquiry to still remoter stages, the number of causes would be found to increase at each stage in much the same way as the number of one's ancestors increases with each generation into the past. In the last analysis myriads of factors play upon the purchasing power of money; but it would be neither feasible nor profitable to catalogue them. The value of our analysis consists rather in simplifying the problem by setting forth clearly the five proximate causes through which all others whatsoever must operate. At the close of our study, as at the beginning, stands forth the equation of exchange as the great determinant of the purchasing power of money.

J. Laurence Laughlin[54]: To my mind, the following propositions contain the essence of the theory of prices.... As every one will appreciate, only general statements, without any limiting qualifications to speak of, can be given in so small a compass.

1. The price of a commodity is measured by the quantity of a given standard for which it will exchange.

2. A change of prices may be due to changes in the conditions affecting the supply (thus including expenses of production) of goods, as well as to changes in the demand for and supply of gold. A statistical statement of a change of price is not a statement of the cause of the change.

3. Probably there is not so much difference of opinion regarding the theory of prices as is sometimes supposed. Other causes being supposed constant, an increased supply of gold would tend to raise prices. No one can fail to see that, if by "money" is meant gold, a change in its quantity would, other things being equal, be a factor affecting prices. An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of prices occurred, their cause must be sought in the influences touching the producing and marketing of goods.

4. The effective demand for goods (granting their utility) is limited by the buyer's purchasing power. This purchasing power is not identical with the quantity of the media of exchange in circulation, any more than the value of the total exchangeable wealth of the community is identical with the value of the total money in circulation.

5. The general level of prices is not independent of particular prices; since there can be no such thing as a general level, or average, of prices which is not the resultant of a number of particular prices each arrived at by individual buyers and sellers. The causes of price changes must be sought in the forces settling particular prices. This does not exclude the consideration of any causes affecting the value of the standard in which the prices of goods are expressed, because the standard is itself a particular commodity.

6. In particular cases, competitive prices in this country are arrived at by the higgling of the market, which depends on buyers' and sellers' judgment of the demand and supply of the commodity (_e. g._, wheat); and, when the price is fixed, the credit medium by which the commodity is passed from seller to buyer comes easily and naturally into existence and, of course, for a sum exactly equaling the price agreed upon, multiplied by the number of units of goods. Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed (cf. 10).

7. The offer of "money" for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods (cf. 6). That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process. The supposed offer of money has no money as its basis, but is only the offer of a purchasing power, previously existing, based on saleable goods, which at the moment of payment appears expressed in terms of the standard. By credit devices the actual transfer of the standard is reduced to an inconsiderable minimum. In reality (as in foreign trade) goods are exchanged against goods.

8. The effect of credit on prices is to be found mainly in banking facilities by which goods are coined into means of payment, so that, expressed in terms of the standard gold, they may be exchanged against each other. Thus credit devices relieve the standard to an incredibly great degree from the demand for the use of gold as a medium of exchange, and thus remove a demand, as trade increases, which would otherwise have enormously affected the value of gold. Thus the effect of credit on the general level of prices in considerable periods of time is shown by a tendency to reduce the demand on the standard gold, and hence to prevent the tendency toward falling prices.

9. A general proposition is that banks are limited in making loans by the possession of capital, a bank of large capital and deposits being able to make large loans, a bank of small capital and deposits, small loans. A second proposition is that the demand for legitimate loans varies with the exchanges of goods and collateral and the opportunities for investment. With an increasing activity in business, however--either sound or speculative--the expansion of loans is limited by the resources of the bank. Next, a bank trying to carry a certain amount of loans, must hold a specified proportion of reserves to demand liabilities under the rule of banking experience or law. The amount of its capital and the funds left with it determine the relative size of its loan item; and the sum of its loans and resultant deposits determine the amount of its reserves. The reserves of a bank are thus a consequence of the loan operations. This conclusion, however, as it affects the practical problem of the present day, is not, in my opinion, invalidated by the conceivable cases arising, when business tends to outrun banking facilities, in which anything that makes increasing reserves possible would increase the power of the banks to lend. When gold becomes increasingly abundant, the banks having large resources more easily get the gold reserves needed for their operations. It still remains true that the fact of an increased supply of gold does not of itself increase loans, unless conditions of business demand an increase in loans. Therefore, the expansion of business is not a necessary consequence of an increasing supply of gold, any more than an expansion of railway traffic is the necessary consequence of an increasing supply of cars. If increasing goods are in existence to be transported, then, of course, there is an increasing demand for cars. Likewise, if there are more bank resources and loans, there is an increasing demand for that which is lawful reserve; from which it is claimed that the use of new gold in bank reserves, under present conditions, is not the significant causal force which expands business and raises prices (although it may be contemporary with it).

10. The problem of explaining the general level of prices is one of arriving at the adjustment between two terms of a ratio (the standard on the one side, and goods on the other), each of which is influenced by supply and demand. Gold being one, and goods being many, a cause working on gold alone, and important enough to show an appreciable effect, might explain a general movement of prices. In practical operation, however, because of the large existing stock of gold, very considerable additions may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of prices are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....

In the problem of discovering the causes of changes in the level of prices, it is necessary first to reach a conclusion as to those causes which operate on the gold standard in which our prices are expressed. By so doing we may locate the general level--so far as the standard is concerned--or the one thing which might work as a cause common to all goods. The relation between gold and goods might be illustrated by the familiar mechanical illustration: a rod balanced on a fulcrum, on one end of which works the forces affecting the value of gold, and on the other end the forces affecting the value of particular goods. The relation between goods and gold being a ratio, as one end of the rod goes up, the other necessarily goes down.

There are, as we all know, various forces at work to produce the resultant price level. We may here start from a proposition on which we can all agree. An increase in the quantity of the monetary standard in the world--such as gold--would tend, _other things being equal_, to lower its value and thus raise prices. In trying to find the causes in the price level at any given time (as in 1896-1909) it is necessary, therefore, after stating the facts as to the increase of gold, to examine into the influence of "the other things."

To begin, we may take up the demand for gold, which, of course, is both monetary and non-monetary. First as to the non-monetary uses, such as abrasion, shipwreck, and disappearance in the arts: The statistics of consumption in the arts are unsatisfactory; at the best they are only estimates. Although the total production of the world, 1493-1850, was $3,158,000,000, there is no evidence as to the available stock in 1850. My belief is that there was not more than $2,000,000,000.[55] In the period of 1851-1895, the production was $5,641,000,000, and the consumption in the arts, at the average rate of $50,000,000 a year requires a deduction of $2,250,000,000, which leaves $3,391,000,000. The arts in recent years are estimated to use more than $100,000,000.[56] In the period, 1896-1905, if $1,000,000,000 be deducted from the production of $2,899,000,000 we have $1,899,000,000. Thus the total available stock in 1905 would be about $7,690,000,000. The production of the last four years, 1906-1910, is about $1,600,000,000, or, less the consumption in the arts, about $1,200,000,000.

The monetary demand for gold, on the other hand, has shown certain definite characteristics. Whether it be prejudice, or enlightened business judgment, the commercial nations of the world have shown a persistent and continuing disposition to adopt a gold monetary system as soon as their own means, or the forthcoming supply of gold, has made it possible. The United States led in 1853, when we declined to change the ratio in order to bring silver into circulation when only gold was in use. From 1871-3, Germany, the countries of the Latin Union, Austria-Hungary, the United States (with the resumption in gold in 1879), and India (in 1893), in response to the preferences of the commercial world, placed themselves on the gold standard by legal enactments. The demand for gold all through this period was based upon considerations independent of the movement of prices. For this was a time of falling prices when much was heard of the appreciation of gold and the need of silver. In spite of this tendency toward falling prices, the movement toward the adoption of gold went on.... It was precisely this large new supply of gold which enabled the commercial nations to gratify their desire for what they believed was a more stable standard.

As we enter the present period (1896-1909) we find this momentum towards the gold standard still in force: and other countries in emulation planned to put themselves on an equally stable standard with those whose means had permitted an earlier action--quite irrespective of the fact that this last was a period of rising prices, while the former was one of falling prices. In this period, Russia, Japan, various states in South America, such as Peru, Argentina, and Brazil, and recently Mexico, have emphasized the movement away from silver to gold. Moreover, as backward lands, like Turkey, parts of Asia, Egypt, and various districts of Africa, have developed their resources and increased their trade, they have taken on gold in their monetary systems. With increasing trade also there are more exchanges of goods; hence, even in countries (like Great Britain and the United States) that do not use gold to speak of, except in reserves, there are increasing loans and deposits and thus a demand for more gold reserves. Consequently, in countries long ago established on the gold standard there will be a steadily increasing demand for gold as exchanges expand. We find thus a special characteristic of the demand for gold (certainly not existing in the demand for silver). The power of developing countries to soak up new gold is as marked a part of present conditions as is the power of a porous and sandy soil to soak up a heavy rainfall. We must, therefore, take full account of the noticeable fact that the recent demand for gold seems about to keep pace with the new supply; that a shipment of gold from the mines to London is to-day eagerly competed for, not only by European countries, but by Egypt, India, Turkey, Argentina, and Brazil.

Consequently it may be of interest to see which countries have taken the largest amounts of gold into their stocks since 1895:

United States $994,000,000 Russia 427,000,000 Germany 419,000,000 South American States 213,000,000 British Empire 194,000,000 Austria-Hungary 163,000,000 Italy 160,000,000

Besides the demand for gold in the arts, and the apparent monetary demand, as thus already presented, we must not omit to take into account also the large stocks of gold held by banks and institutions which publish no statements. In the hands of large private institutions like those of the Rothschilds, Bleichroders, and others, great amounts of gold are carried. It is from such stores that the needs of states, such as Austria-Hungary, France, Italy, and even the United States (in Cleveland's administration), have been supplied without drawing down visible reserves.

Thus far, then, we have examined the one factor of demand for gold, among the "other things" (which were supposed to remain equal). There is abundant evidence to show that the demand for gold, in this recent period of rising prices (1896-1909) has been as strong as, or even stronger than, the demand for gold in the previous period (1873-1896) of falling prices.

It looks very much as if we must seek for the causes of rising prices since 1896 in some of the "other things" not yet examined. There is no time, however, for extended discussion on these points....

The effects of Tariffs and Taxation, Unionism and higher Wages, and changing Agricultural Conditions in increasing expenses of production in all industries are so patent as to require no enlargement. Immediately after the passage of the Dingley Act in 1897, a large list of articles rose in price precipitously. Moreover, just so far as higher money wages for the same work, or the same money wages for a reduced number of hours, have been granted without a corresponding increase in the efficiency of the labor, the expenses of producing goods in general--and consequently prices--have risen. But, without doubt, one of the most important factors in raising prices--directly and indirectly--has been the increased price of food due to the changing conditions of agriculture. This most influential cause of higher prices is one of the "other things" which has been at work quite independent of the quantity of new gold. Moreover, the indirect effect of high prices of food produces the most serious practical problem. It wipes out all the gain of previous increases of wages, and drives laborers to repeat their demands for higher pay, thus working again to increase expenses of production. It is not too much to say that the gains of industry, shown by the fall in prices, as they stood about 1890 have been lost to us by the high tariffs of 1897 and the wastes of bad farming and the recent high costs of agriculture.

Our analysis would be inadequate, however, if we stopped here with our examination of expenses of production. The really practical problem is still before us in trying to analyze the forces at work fixing prices in that vague and dangerous margin between actual expenses of production and the prices in fact paid by the consumer....

The whole _raison d'etre_ of monopolistic combinations is to control prices, and prevent active competition. As every economist knows, in the conditions under which many industries are to-day organized, expenses of production have no direct relation to prices. In such conditions, there is a field in which the policy of charging "what the traffic will bear" prevails; and this includes industries that are not public utilities.

Furthermore, we must face the fact of increasing riches not only in this country, but all over the world. New wealth makes a liberal spender. The retail dealer finding his expenses increasing and--even when they are not--tries the experiment of charging his richer customers an increasing price. The newly rich pay and do not feel it. But what can the poorer unorganized buyer do when retail prices are raised? What can he do if his meat bill, or his plumbing-repairs bill, rises enormously? The extravagance of the rich has increased the cost of traveling, the rates at hotels, the fees, the luxury of steamships and automobiles, the consumption of fruits and vegetables out of season once never thought of, and has generally raised the standard of expenditure. Those of smaller income find they also must pay the higher prices. Thus we have reached a point where we have to pay almost whatever any one asks. Organized buyers are the only offset to organized sellers.

Moreover, rising prices due to high expenses of production, or to combinations of sellers, present a paradise for speculation. A movement upward based on facts can be easily converted into a further rise based only on speculative manipulation. A rise of prices which brings large profits to a combination, thus directly affects earnings and gives especial opportunity to speculation in the securities of industrials. Hence, the field of speculation spreads from commodities to securities. The facts as to the movement of prices of securities are well shown in Brookmire's Economic Charts since 1885; and, while the presence of gold serves as a fund of lawful money in reserves, the spread of speculation has gone on seemingly unaffected by the new supplies of gold. That is, speculative conditions may arise and disappear antecedent to and seemingly independent of the gold supplies.

* * * * *

D. F. Houston[57]: The discussion of money and prices to-day reminds one very strongly of the discussion forty years ago. Now, as then, the opinion is that prices have risen; but now, as then, there is wide difference as to the explanation. Now, as then, a highly respectable body of economists attribute the rise mainly to the new gold; and now, as then, a number of economists attribute the rise to influences immediately affecting the cost of production of commodities in general, instancing such things as labor unions, monopolies, extravagance, the tariff, general prosperity, etc....

That the tariff has played a part in the situation, I should of course not deny. By preventing us from securing supplies where they can be more economically produced, and by making it possible for domestic manufacturers to monopolize the market, and by tending to compel the payment for exports in gold, it has unquestionably played a part and is a notable factor.... In considering the tariff as a factor, however, we must not forget that we have had the tariff since the beginning, and that the rates have been nearly as high since the Civil War as they are to-day; and we must remember, further, that in one of the great countries which has no protective tariff the tendency of price has been upward; furthermore, we must not overlook the fact that many of the tariff rates, which are very high now, are not effective or not nearly so effective as they were in the earlier period, and also that its influence is probably greater in things in which the rise of price has been less marked.

I should not deny that labor unions and monopolies have had an influence in increasing price. The evidence seems to justify the conclusion that monopolies have had some effect in increasing price. I am not sure that there is sufficient evidence in regard to labor unions to enable us to form a conclusion....

Much has been said in discussion about the influence of extravagance. This has played a part in similar discussions at all times; every era has its cry of extravagance, and it is not clear that it has been more marked in our time than in former times. And one thing is quite clear, that the extravagance, or economic waste, resulting from the prosecution of war and its after effects, has been conspicuously absent during the last fifteen years....

The stock of gold in the leading western commercial nations, with which we are concerned in discussing prices, probably did not exceed $5,000,000,000 at the end of 1895. During the next fourteen years there was added to the stock of gold of these countries an amount nearly equal to the existing stock. In addition, a number of these countries enormously developed their credit devices. According to all economic law, these facts create a strong presumption that gold has been the main factor affecting price. No sufficient evidence has been presented to overthrow this presumption.

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E. W. Kemmerer[58]: An adequate discussion of the papers presented by Professors Fisher and Laughlin would require much more time than the few minutes at my disposal. I shall accordingly limit myself to a few points and support my conclusions principally by footnote references. This procedure is perhaps the more justifiable in view of the fact that my own philosophy of the relationship between money and prices is given in detail in the book[59] on money and prices to which Professor Fisher has so generously referred.[60]

I have had the opportunity of reading in manuscript Professor Fisher's forthcoming book on Price Levels, of which his paper to-day represents one chapter, and find myself in substantial agreement with his main contentions. His discussion is a permanent contribution to monetary science of very great value. To a number of minor points, however, it seems to me, exception must be taken....

Professor Fisher's formula expressing the relationship between the circulating media and prices is essentially the same as my own,[61] but he pays little attention to the factor of business confidence, which is a most important consideration in the interpretation of the formula. The ratio of deposit currency to bank reserves is a function of business confidence.[62]

The distinction Professor Fisher draws between the prices of individual commodities and the general price level appears to me, as to Professor Laughlin, to be untenable. It is, moreover, contradictory to his general philosophy of money. His index numbers recognize no general price level distinct from individual prices. He illustrates the point that the price of any individual commodity presupposes a general price level by saying that "the position of a particular wave in the ocean depends on the general level of the ocean." I can conceive of no such distinction between the general price level and individual prices as his statements seem to imply. General prices "are but a combination, or composite photograph, as it were, of individual prices."...[63]

Passing to Professor Laughlin's paper, which has been presented to me merely in the form of an abstract, we find ten propositions, which to a considerable extent are repetitious. His first five propositions are rather commonplace generalizations and few economists will be disposed to dissent from their essential soundness. They place him much closer to the quantity theory of money than most of us, judging him from his previous writings, were disposed to think he would go; and in his third proposition he says, "Probably there is not so much difference of mind regarding the theory of prices as is sometimes supposed."

With reference to Professor Laughlin's fourth proposition it may be said that no economist of standing claims that purchasing power is "identical with the quantity of the media of exchange in circulation." Effective purchasing power, however, in our modern business communities, does depend upon the possession of money or of the right to demand money. The amount of deposit currency which can be used at any time in purchasing goods is limited by bank reserves because commercial deposits are payable in money on demand at the order of the depositor. Other assets, no matter how good, cannot be used for the purpose of meeting deposit obligations, except when the entire credit machinery breaks down and suspension is resorted to under the euphemistic name of clearing house loan certificates.

Professor Laughlin's sixth and seventh points are essentially the same and may be considered together. He says:

... Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed.... The offer of money for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods.... That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process....

This contention appears to me to result from a superficial view of the price-making process. The offer of money for goods and the offer of goods for money are of course not the first steps. Each person has his own individual or subjective prices on all sorts of commodities; these subjective prices represent the valuations which he places upon the respective commodities in terms of the valuation which he places upon the money unit. The more of a particular commodity he has the lower his subjective valuation of a unit of that commodity; the more money he owns the lower his estimation of a dollar and the higher his subjective prices; and _vice versa_. Through a process of competition, selection, and adaptation, some of these subjective prices develop into market prices, that is, prices at which both buyer and seller benefit, and at which therefore an exchange takes place. To paraphrase an old adage, the proof of the market price is in the exchange. It is a common observation that stock quotations to be of much value must show the number of sales effected at the prices quoted. A stock for which the maximum bids were 100 and the minimum offers were 110, would not possess a market price in the strict sense of the word. The fact that sales have recently been made at a certain price, or are now being so made, is of course presumptive evidence that intending purchasers can buy at about that price. A market price, however, is the amount of money paid for a commodity, not the amount asked, offered, or promised.

Professor Laughlin's ninth proposition I find very difficult to follow. His premise that reserves are "a consequence of the loan operations" is a dangerous half truth; they are also a consequence of most other kinds of banking operations, cash deposits, cash withdrawals and clearing house balances, foreign and domestic exchange operations, etc. His other premise, that "the fact of an increased supply of gold does not _of itself_ [the italics are mine] increase loans, unless the bank possesses the control of the capital which is a condition precedent to the loans," contains an element of truth, but is misleading. While an increased supply of gold does not of itself increase loans it normally has that result; and the bank's discount rate and the condition of its reserve are powerful factors in influencing its loan account. His premises, I believe, are not sound, and his conclusion, namely, that "the expansion of business is not a direct consequence of an increasing supply of gold, any more than an expansion of railway traffic is the direct consequence of an increasing supply of cars," would not follow from his premises, even if they were sound. The normal causal chain is more nearly this: increased gold production results in greatly increased amounts of gold coming into the monetary uses.[64] This gold comes into the hands of individuals and is to a large extent deposited in banks; increased money incomes on the part of individuals lower their estimations of the value of the money unit, raise subjective prices, and as a consequence market prices; larger money deposits in banks result in larger reserves, banks do not make interest on money held in reserves, and accordingly take measures to invest such surplus money, keeping these reserves as low as is consistent with law and their ideas of safety;[65] inducements to borrowers are made in the form of more favorable discount rates; collateral is not scrutinized so carefully; the speculative market is stimulated by increasing supplies of call money; confidence everywhere increases; new enterprises spring up and old ones are expanded; and in a short time the new gold is absorbed by a higher price level and an overstimulated business activity. This was the situation after the Californian and Australian gold discoveries of the last century and it has been the result of the greatly increased gold production of the last few years.

Professor Laughlin's final point is that since 1895 the new demand for gold has roughly equalled the new supply, and that the changes in prices since 1896 must be sought mainly in the "other things," which have not remained equal. In support of this conclusion he offers two principal arguments. The first is as follows:

... Because of the large existing stock of gold, very considerable changes may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of price are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....

In reply it may be said that the production of gold since 1895 represents a very large percentage of the total supply. The Soetbeer figures as supplemented by those of the Director of the Mint show that the world's gold production for the 405 years 1492-1896 inclusive was in round numbers $8,982,000,000,[66] and that for the eleven years 1897-1907, was $3,513,000,000; in other words, for these eleven years it was over 39 per cent. of the total for the preceding 405 years. Probably the effective supply represents a much larger proportion of recent gold because of (1) the large amount of loss chiefly by abrasion of the gold produced in the earlier years, and of (2) the greater degree to which this early gold has assumed specialized forms, such as jewelry, plate, etc.

Satisfactory index numbers of prices for recent years are not available for all the principal countries of the world. Such as we have, however, point to a decided rise of prices in all gold standard countries since about 1897. Comparing standard price index numbers in six of the chief countries of the world for the years 1897 and 1907, we find the general price level to have risen as follows:[67]

United States--Bureau of Labor figures 44.4% Canada--Coats figures, (weighted) 43.7% England--Sauerbeck figures 29.0% France--de Foville, figures for export prices[68] 13.3% Germany--Hamburg figures 30.8% Italy--Necco figures for export prices 23.4%

If we average these figures together, assigning the same importance to the figures of each country, in order to get a _rough_ idea of the movement of world prices in gold standard countries during the eleven years in question, we find that the average increase was 30.8 per cent. If we follow Professor Laughlin and compare the years 1895 and 1907, we find the average increase in prices to have been 25.8 per cent., and the world's gold production for the 13 years 1895 to 1907 to have been about 42 per cent. of that for the preceding 404 years. When to this is added the fact that the evidence points to a smaller percentage of the world's annual gold production going into the industrial uses than formerly, and the further fact that during the period in question the increase and improvements in the world's banking facilities have greatly economized the uses of money, we see that a very substantial increase in general prices would be expected, despite a great expansion of business. World prices in fact have not increased nearly as rapidly as the flow of gold into monetary uses since 1897, not to mention the enormous development of deposit currency. The Director of the Mint estimates each year the amount of the world's new gold used in the industrial arts. Computations I have made based upon these figures show a tendency for a decreasing percentage of the annual production to be used in the arts, although there is considerable irregularity. For the seven years 1895-1901 the average percentage was 27.1, and for the seven years 1902-1908 it was 25.3.[69]

Professor Laughlin's second argument in favor of the proposition that the recent rise in prices has not been due primarily to the increased gold production is one of the most beautiful examples of begging the question that I have seen in economic literature. He says:

"In recent discussions one of the 'other' factors which has been slighted is the demand for gold since 1895. The examination shows that the new demand in countries turning to the gold standard, and in those already using gold and extending their demand, amounts in round numbers to about $3,000,000,000. Hence the new demand has roughly equalled the new supply, since 1895--a fact which jumps with the known conditions in the great financial markets like London, where new arrivals of gold are eagerly competed for by European banks."

Of course the demand for gold equals the supply, as does the demand for wheat or any other commodity, when one interprets demand and supply as one should, in terms of market prices. The general price level is the very thing which equilibrates the demand for gold and the supply. The higher price level about which we are talking is an expression of the absorption of most of this new gold into the world's circulation. Banks and merchants eagerly compete for it, because higher prices require more money to do a given amount of exchange work, and rising prices stimulate business.

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Joseph French Johnson[70]: I am glad to observe that there appears to be a tendency toward agreement with regard to the fact that the value of money depends upon the demand for it and supply of it. Professor Laughlin likes the word standard better than I do. It suggests something permanent and fixed, whereas money is a very changeable thing. While I am in agreement with Professor Laughlin in the conclusion that the general level of prices depends upon the demand for and supply of money, I am unable to give assent to many of the propositions which he puts forward as links in the chain of reasoning leading to that conclusion.

For example, Professor Laughlin says, "A change of prices may be due to changes in the demand for and supply of (thus including the expenses of production) goods as well as to changes in the demand for and supply of gold." This proposition is true with regard to changes in the prices of particular commodities. The price of wheat may rise or fall as a result of a change in the demand for or in the supply of wheat. The proposition, however, is not true with regard to a change in the general level of prices. An increase in the supply of goods will lower the level of prices for the simple reason that it will increase the demand for gold. I am not certain that I have understood Professor Laughlin's exposition of his theory, but he certainly seemed to me to argue that there could be a change in the general level of prices without any change whatever in the demand for or supply of gold. Such a position, it seems to me, is absolutely untenable.

That Professor Laughlin seeks to hold this untenable position, it seems to me, is made evident by the qualification with which he accepts the statement that a change in the quantity of money, other things being equal, would be a factor affecting prices. He says, "An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of price occurred, their cause must be sought in the influences touching the producing and marketing of goods." The second conditional clause in that last sentence introduces an impossible supposition, for if a new supply of gold is offset by a new demand for it, there could be no change in the general level of prices, so that no cause for any change would have to be sought in the "influences touching the producing and marketing of goods." Professor Laughlin appears to have in mind forces affecting the general level of prices which are entirely hidden from my sight. A change in the level of prices means a change in the value of gold, and how can there be a change in that if the new demand for gold just offsets the new supply?

Professor Laughlin's analysis of the price-making process is incomplete and misleading. He is correct when he says that the causes of price changes must be sought in the forces settling particular prices, but he is manifestly wrong when he states that the price of wheat is "arrived at by the higgling of the market, which depends on the buyers' and sellers' judgment of the demand for and supply of wheat." Such higgling would determine only the value of wheat. The price of wheat is not fixed until buyer and seller have reached an agreement in their estimates as to the value not only of wheat, but also of money. If wheat is comparatively easy to get, the price falls. If money is easier to get, the price rises. The demand for and supply of money is evidently just as important in the determination of the price of wheat as is the demand for and supply of wheat itself. When Professor Laughlin says that the offer of money for goods is only a resultant of price-making forces previously at work, he must have in mind some price-making process and price-making forces of which I have never heard. I know of no market in which goods are lowered in price except for the reason that at the higher price not enough money is offered to absorb the supply; nor of any market in which goods are raised in price except for the reason that buyers are willing to offer more money for the goods.

In his analysis of credit and its relation to the value of money, Professor Laughlin seems to me to have in mind a hypothetical financial world, the like of which does not and could not exist on earth. He strives to show that a bank's ability to make loans depends upon the amount of its capital and deposits, and that therefore any increase in the supply of gold would not in itself lead to an increase of loans. "Expansion of business," he remarks, "is not a direct consequence of an increasing supply of gold any more than an expansion of railway traffic is the direct consequence of an increasing supply of cars." He is quite right if he means that an increase in the amount of gold will not necessarily cause the exchange of more goods. But this does not appear to be his meaning. He holds that the use of new gold in bank reserves cannot be a causal force raising prices, for the bankers cannot increase their loans, in his opinion, unless the condition of business demands such an increase. In his hypothetical financial world bankers are willing to carry idle stocks of gold and to wait until business conditions make necessary an increase in their loans. In the real financial world, of course, bankers do nothing of the sort. Bankers with surplus gold immediately tempt borrowers by lowering the rate of discount and thus increasing the money demand for goods in the markets. As a result there is an irregular and general rise of prices. More goods may not be bought and sold and there may be no expansion of business, but expressed in terms of money the totals are bigger. There is no analogy between dollars and freight cars. The carrying capacity of a car is fixed and unchangeable, but the carrying capacity of a dollar is elastic--so elastic, in fact, that dollars are always fully loaded no matter how small the supply of goods. As Professor Laughlin points out, although he apparently does not see its significance, the new demand for gold since 1895 has "roughly equalled the new supply." Surely it could not have been otherwise, and no statistics are necessary to prove the fact.

* * * * *

Murray S. Wildman[71]: My comments on these interesting papers will be directed upon the methods employed, and certain assumptions involved, in the arguments of both. Granting that Professor Fisher's analysis shows a perfect correspondence between the course of prices on the one hand and the quantity of money and credit instruments on the other hand, I am still unable to see which magnitudes are properly to be regarded as causes and which as effects. That variations in the value of gold and in the price level must be reciprocal, all will admit. If we regard M as denoting the gold supply for the present, a causal relation between M and P cannot be denied. But may it not be possible that variations in M', or credit, and V and V', the velocity of circulation of both money and credit, be simply in consequence of the variation in M and P? Why is P the only passive term or why is it passive at all?

Suppose that the problem set was to discover the cause of credit expansion from 1896 to 1910. Would we not seek at once to explain it by reference to rising prices and greater volume of goods, making a broader basis for credit, while along with that is a greater gold supply which promotes the convertibility of an extended credit? Then might we not invoke Professor Fisher's algebraic formula, with terms rearranged, and show by this method of reasoning, supported by statistical verification, that the high prices afford an adequate cause for the present expansion of credit?

But we are seeking the cause or causes of rise in the price level. This is equivalent to seeking the cause of decline in the value of gold. Does the "quantity theory" as newly expounded give us the solution? I think not. Rather it shows us that as gold has grown in supply, and fallen in value, credit has grown in magnitude and in rapidity of circulation, and that these changes in values and volumes have gone hand in hand with proportional changes in the price level and in the magnitude of commodity exchanges.

This view of the case brings me to substantial approval of Professor Laughlin's method of analysis and argument. That is, we must seek the facts regarding supply and demand as applied to gold, and those which bear upon supply and demand as touching goods, in so far as the demand for goods is expressed in offers of gold and gold representatives. Here the algebraic formula would be invoked to support his reasoning since M' and V and V' may be regarded as factors in the demand for gold.

To accept Professor Laughlin's method does not involve the necessity of his conclusions. The terms, by this method, do not lend themselves to exact mathematical statement and statistical proof, so conclusions cannot be exact and definite. This may be illustrated in a consideration of demand for gold. Some say that demand has grown step by step with supply and therefore gold has not been cheapened. Others say that supply has grown more rapidly than demand, and so gold has been cheapened and to that extent prices are raised.

Either statement may be wrong. I do not believe we have yet any reliable data regarding the demand for gold in the sense of a value-making factor. Most efforts to measure demand are based on statistics of gold in use. If one can show that consumption of gold in the arts, in the circulation, and in greater bank reserves, has increased _pari passu_ with production, we are told that the value of gold has not been lowered by the greater supply.

But statistics of consumption give no clue to demand in the value-determining sense. We have many staple commodities, such as wheat and cotton, whose price drops sharply when the supply exceeds a certain normal volume, even though the whole crop is consumed. Statistically speaking, the demand for a cotton crop always rises as supply rises, and falls as supply falls, but that is because demand and supply become equated through a variation in price. Demand, in this sense of quantity demanded, is in part a result rather than a cause of value.

When we can properly speak of demand as potent for the determination of value, we are thinking of demand from the point of view of _intensity_ rather than the point of view of _magnitude_. But the demand which makes for value--demand intensively considered--is only measured by the purchasing power offered. Applied to gold, I know of no measure of demand except in the goods and services offered in exchange. To say that goods and services offered for an ounce of gold in 1910 are less than are offered for an ounce of gold in 1896, is simply to say that prices are higher. But it is these prices that we are trying to explain by giving the effect for the cause, when we say that demand has risen with supply.

Those staple commodities whose value falls off abruptly with any increase of supply beyond a customary stock are said to be subject to an inelastic demand, and those whose value declines uniformly with excessive supplies are said to have an elastic demand. Is the demand for gold elastic, or is it inelastic? And is it possible by independent analysis to construct the curve of elasticity which properly belongs to gold, and so avoid circular reasoning from the very prices we are trying to explain?

If the demand for gold is inelastic and the demand curve drops off abruptly after a certain supply is in evidence, the presumption is that in the conditions of gold production, rather than in the conditions of commodity production, lies the cause of our high prices. Moreover, if this be the case, we can readily see the cause of cheapening of gold, even though the product of a single year bears a small proportion to the existing stock.

If on the other hand the demand for gold be very elastic, so that it expands with growing supplies with no substantial alterations in value, then we are driven to seek the cause of high prices in influences directly touching the goods and services rather than in those directly affecting gold.

It would seem therefore that both methods of treatment have left something to be desired. The algebraic analysis, even as verified, presents the relations between magnitudes without showing the cause of high prices. The argument directed immediately at the value of gold of necessity involves consideration of the demand for gold, which, as a price-making factor, remains an unknown quantity.

* * * * *

T. N. Carver[72]: Professor Fisher ... has demonstrated beyond all question the accuracy of his formula. The question remains, however, whether his formula supports his own conclusion or Professor Laughlin's. If, for example, it should be found that P is the cause of M, the formula would to that extent support Professor Laughlin's position. I believe that to a certain extent P is actually the cause of M. If the growing scarcity of agricultural land, or the increase in population and the increased demand for agricultural products without an increase in land, should increase the marginal cost of producing agricultural products to supply this larger demand, that would tend to increase the exchange value of these products, even according to the formula of Cairnes as quoted by President Houston.[73] Even without any increase in the gold supply, this would cause each unit of product to exchange for a little more gold; then, in order that a given number of exchanges in agricultural products could be carried on, it would be necessary to have a larger number of ounces of gold, or a larger number of gold coins, or some other form of money of given denominations to do the money work. This, in other words, would necessitate a larger supply of money: and, if other forms than gold were not forthcoming, it would necessitate that a larger proportion of the stock of gold should be coined into money in order to do the work. Thus, without any increase whatever in the world's total gold supply, there would come to be an increase in the proportion of that supply used as money, or in the amount of gold coin actually used in circulation. I believe that this has taken place, and that it is one of the factors in the problem, although there has also been a very large increase in the gold supply to still further accentuate the tendency.

* * * * *

F. W. Taussig[74]: I congratulate Professor Fisher on his admirable paper. I am in accord with him in his method of reasoning and in all his essential results. His investigation of this subject adds another to the brilliant studies with which he has enriched economic science.

It deserves to be said, perhaps, that the term M' (deposits) in his equation is not entirely independent, but is in some degree a function of T. I say to some degree; it is dependent on T in part only, and not for very long periods. Professor Fisher has here treated it as dependent simply on M.... He has indicated the qualifications which must be attached to this dependence of deposits on bank reserves. He has pointed out that though a general dependence appears over long periods of time, it is affected by changes in banking ways, and by the tendency to build up a higher superstructure of deposits in times of active business. But there is also a connection between T, volume of trade, and M'. That is, for short periods--nay, for periods of some years--an increasing volume of trade tends of itself to bring about an increasing volume of deposits. (I may say, parenthetically, that "volume of trade" does not seem to me an apt expression; "units of commodities," the other phrase used by Professor Fisher, is better.) Though I would by no means go the length of Professor Laughlin's reasoning, which seems to imply that every act of exchange supplies automatically its own medium of exchange, it does seem to me that our modern mechanism of deposit banking supplies an elastic source of deposits, which, for considerable periods, enables them to run _pari passu_ with the transactions and loans resting on them. In the end, an increase of deposits finds its limit in the volume of cash held by the banks. But there is some elasticity of adjustment, by which loans and deposits increase as fast as transactions or faster; and this accounts in no small degree for the rise in prices during periods of activity. The phenomenon shows itself most strikingly in stock exchange loans, especially in a center like New York. There the business creates for itself quasi-automatically its own medium of exchange. I suspect it is undue generalization from operations of this sort that has led Professor Laughlin to take his extreme position--a position which I can not but think untenable. Some allowance for the temporary interaction between M' and T is necessary for the completeness of Professor Fisher's reasoning.

* * * * *

Ralph H. Hess[75]: Professor Fisher's formula (MV + M'V' = PT) approximately expresses the mathematical equality of purchase and payment which cannot be questioned. I say _approximately_ because M' (defined by Professor Fisher as "bank deposits subject to check"), if it be made to express an accurate measure of circulating credit, should include not only open bank accounts, but certain other values which constitute _current means of payment_, such as bankers' bills, trade bills, cashiers' checks, and certified checks....

The relation which Professor Taussig has pointed out between M' and T (the _value of negotiable credit_ and the contemporary _volume of trade_) is not only possible, but, in any community of modernized commerce, is actual. Moreover, a knowledge of the process by which commerce is financed by the existing mechanism of discount, loan, deposit, and draft justifies the conclusion that, if the volume of trade (T) be resolved into its factors, namely, _materials of trade_ and their _frequency of exchange_, the latter factor of T is quite commensurate with the velocity of credit (V').

To me it seems incontestable that the volume and velocity of credit currency, as represented by bank deposits and other circulating media, vary directly as the volume and value of the materials of trade in the process of exchange, and are, mathematically speaking, dependent functions thereof. Granting this relation, an analysis of the equation of exchange establishes PT as the major determinant of M'V', and, in so far as paper money may be authorized and issued upon the security of commercial assets, of M. That part of the money in circulation which does not derive its circulating powers from actual and potential commercial values is itself material of barter incorporating so-called intrinsic values.

The conclusion is clear that P (price) is independent of all other terms and factors of Professor Fisher's equation, that V and V' are determined by the mechanical circumstances and organization of exchange, and that the value of M and M', taken collectively, is a spontaneous derivative of PT. The fundamental determinants of prices and of "price levels," therefore, are to be found outside of monetary and credit agencies _per se_.

As to the nature and order of the price-making process and the actual forces behind price movements, I am in substantial accord with Professor Laughlin. That prices, individually and collectively considered, express the value-proportion of demand for and supply of goods on the market to demand for and "visible supply" of the standard commodity is fundamentally logical. Nor is there occasion to quibble over the paradox of disturbed equilibrium of demand and supply. Physically considered, the goods which objectify these terms are, of course, identical; but, in the valuation process, demand and supply denominate, respectively, _desire_ and _utility_--the generally acknowledged antecedents of value. Price is the equalizing factor between the effective demand for gold and the effective demand for other goods, each taken in conventional units; and price changes are resultants of, and commensurate with, net variations in the value-factors of the standard and of the objects of exchange.

Referring to the nature of credit and the economic qualities of credit instruments, the somewhat figurative expression "goods coined into a means of payment" is a striking and accurate characterization. It is possible that all legitimate market values, under normal trade conditions, may be liquidized through credit agencies, and the goods in which they are incorporated be thus rendered immediately and conveniently exchangeable. This process may be consummated independently of prices and with slight regard to the actual supply of money. The truth of this assertion is, in fact, demonstrated daily in the marts of trade.

* * * * *

J. Laurence Laughlin[76]: There is time to answer briefly only a few of the points raised by several speakers. First, Professor Fisher's equation of MV + M'V' = PT is to my mind not a solution, but only a statement, of the problem of price levels. It can be read backward as well as forward. For instance, it does not follow that the level of prices (P) will rise with an increase of M', since--as Professor Taussig has pointed out already--an active development of trade and industry (T) would itself be a reason for an increase of banking loans and deposits subject to check (M'), thus equalizing effects on both sides of the equation without necessarily increasing P. This result is, in fact, one of the points on which I have steadily insisted in my own exposition of the theory of prices and credit; and Professor Fisher's equation allows it to appear distinctly. His equation does not show causes; it states a static situation, into which various causes may be read. The facts between 1876 and 1896 disclose an increase of bank deposits of 500 or 600 per cent., and yet that period was distinguished as one of falling prices. Therefore M' cannot be regarded as having been proved to be a cause of higher prices.

Second, Professor Fisher ... seeks to establish a causal relation between the amount of money in circulation (M) and the amount of deposits (M') which, in my judgment, is wholly unfounded. He has developed this in his paper in the _Royal Statistical Journal_. The error consists in supposing that a man's deposit account at any time varies with the amount of money in his possession. Rather, the deposit account varies with a man's wealth. The rich man does not carry much more money to pass from hand to hand than the man of moderate means. Monetary habits in the community require a certain level of circulation for all persons, but the deposits of an individual may soar above the common level without regard to the money he keeps in circulation. His bank deposits are rather a measure of the saleable goods he has sold, "coined into means of payment."

Third, I well recognize the high position Professor Fisher occupies in the mathematical school of Walras and others; but has he not made an error in stating the essence of the price relation in his mathematical symbols? So far as I understand him, he seems to deny the fundamental value-concept (on which there has hitherto been general agreement) that price is a ratio between goods and gold. In furtherance of that idea, he thinks that, before individual prices can be arrived at, the general price level must be ascertained. Now, in my exposition using the ratio-concept, I explained in detail how the general level of prices might be affected by causes affecting the gold side of the ratio. Therefore, I did not neglect to account for the general level and that too without doing violence to the accepted value-concept. But the ratio-concept (which Professor Fisher seems to deny) allows the forces acting on goods also to affect the general level of prices as I have shown. In my opinion, he wrongly works from a general level of prices to particular prices; while I hold that particular prices, or actual quotations, are the bases from which all averages, or price levels, are always and inevitably computed. Moreover, in his diagrams, the level of prices he used was the one computed from individual quotations. Hence his whole reasoning on the conformity of the statistics to the terms of his equation is vitiated. Indeed the better agreement he finds--after elaborate statistical computations--between the elements and their result on prices ...--is due, I think, to relying on an equation which is nothing more than a statement that the whole is equal to the sum of its parts....

Finally, when Professor Johnson suggests that I am wrong in stating that forces affecting the goods side of the price ratio have an influence on prices, he certainly cannot mean that conditions affecting the producing, marketing, and financing of goods have no effect on prices. How else, for instance, can we explain the rise of the prices of agricultural products? The special causes affecting them have little to do with the quantity of "money." Moreover, the term "money" itself is used so loosely and vaguely that we can come to agreement on price theories only by first agreeing upon what we mean by "money." In my paper, I have discussed the relations of goods, and their prices, to gold. But, in this country, we use gold little as a medium by which goods are exchanged. Thus the relation of the prices of goods to our media of exchange has been practically omitted. And yet the price-making process generally precedes the creation of the usual banking media of exchange by which most goods are exchanged.

* * * * *

Irving Fisher[77]: In connection with the statement and explanation of the equation of exchange it was shown (1) that prices vary directly as the quantity of money, provided the volume of trade and the velocities of circulation remain unchanged; (2) that prices vary directly as the velocities of circulation (if these velocities vary together), provided the quantity of money and the volume of trade remain unchanged, and (3) that prices vary inversely as the volume of trade, provided the quantity of money--and therefore deposits--and their velocities remain unchanged.

Let us now inquire how far these propositions are really _causal_ propositions. An examination of the influence of each of the six magnitudes on each of the other five will afford answers to the objections which have been raised to the quantity theory of money.

To set forth all the facts and possibilities as to causation we need to study the effects of varying, one at a time, the various magnitudes in the equation of exchange.

Our first question is: given (say) a doubling of the quantity of money in circulation (_M_) what are the normal or ultimate effects on the other magnitudes in the equation of exchange, viz.: _M'_, _V_, _V'_, the _p_'s and the _Q_'s?

We have seen that normally the effect of doubling money in circulation (_M_) is to double deposits (_M'_) because under any given conditions of industry and civilization deposits tend to hold a fixed or normal ratio to money in circulation. Hence the ultimate effect of a doubling in _M_ is the same as that of doubling both _M_ and _M'_. We propose next to show that this doubling of _M_ and _M'_ does not normally change _V_, _V'_ or the _Q_'s, but only the _p_'s. The equation of exchange of itself does not affirm or deny these propositions.

For aught the equation of exchange itself tells us, the quantities of money and deposits might even vary inversely as their respective velocities of circulation. Were this true, an increase in the quantity of money would exhaust all its effects in reducing the velocity of circulation, and could not produce any effect on prices. If the opponents of the "quantity theory" could establish such a relationship, they would have proven their case despite the equation of exchange. But they have not even attempted to prove such a proposition. As a matter of fact, the velocities of circulation of money and of deposits depend, as will be seen, on technical conditions and bear no discoverable relation to the quantity of money in circulation. Velocity of circulation is the average rate of "turnover", and depends on countless individual rates of turnover. These depend on individual habits. Each person regulates his turnover to suit his convenience. A given rate of turnover for any person implies a given time of turnover--that is, an average length of time a dollar remains in his hands. He adjusts this time of turnover by adjusting his average quantity of pocket money, or till money, to suit his expenditures. He will try to avoid carrying too little lest, on occasion, he be unduly embarrassed; and on the other hand to avoid encumbrance, waste of interest, and risk of robbery, he will avoid carrying too much. Each man's adjustment is, of course, somewhat rough, and dependent largely on the accident of the moment; but, in the long run and for a large number of people, the average rate of turnover, or what amounts to the same thing, the average time money remains in the same hands, will be very closely determined. It will depend on density of population, commercial customs, rapidity of transport, and other technical conditions, but not on the quantity of money and deposits nor on the price level. These may change without any effect on velocity. If the quantities of money and deposits are doubled, there is nothing, so far as velocity of circulation is concerned, to prevent the price level from doubling. On the contrary, doubling money, deposits, and prices would necessarily leave velocity quite unchanged. Each individual would need to spend more money for the same goods, and to keep more on hand. The ratio of money expended to money on hand would not vary. If the number of dollars in circulation and in deposit should be doubled and a dollar should come to have only half its former purchasing power, the change would imply merely that twice as many dollars as before were expended by each person and twice as many kept on hand. The ratio of expenditure to stock on hand would be unaffected.

If it be objected that this _assumes_ that with the doubling in _M_ and _M'_ there would be also a doubling of prices, we may meet the objection by putting the argument in a slightly different form. Suppose, for a moment, that a doubling in the currency in circulation should not at once raise prices, but should halve the velocities instead; such a result would evidently upset for each individual the adjustment which he had made of cash on hand. Prices being unchanged, he now has double the amount of money and deposits which his convenience had taught him to keep on hand. He will then try to get rid of the surplus money and deposits by buying goods. But as somebody else must be found to take the money off his hands, its mere transfer will not diminish the amount in the community. It will simply increase somebody else's surplus. Everybody has money on his hands beyond what experience and convenience have shown to be necessary. Everybody will want to exchange this relatively useless extra money for goods, and the desire so to do must surely drive up the price of goods. No one can deny that the effect of every one's desiring to spend more money will be to raise prices. Obviously this tendency will continue until there is found another adjustment of quantities to expenditures, and the _V_'s are the same as originally. That is, if there is no change in the quantities sold (the _Q_'s), the only possible effect of doubling _M_ and _M'_ will be a doubling of the _p_'s; for we have just seen that the _V_'s cannot be permanently reduced without causing people to have surplus money and deposits, and there cannot be surplus money and deposits without a desire to spend it, and there cannot be a desire to spend it without a rise in prices. In short, the only way to get rid of a plethora of money is to raise prices to correspond.

So far as the surplus deposits are concerned, there might seem to be a way of getting rid of them by cancelling bank loans, but this would reduce the normal ratio which _M'_ bears to _M_, which we have seen tends to be maintained.

We come back to the conclusion that the velocity of circulation either of money or deposits is independent of the quantity of money or of deposits. No reason has been, or, so far as is apparent, can be assigned, to show why the velocity of circulation of money, or deposits, should be different, when the quantity of money, or deposits, is great, from what it is when the quantity is small.

There still remains one seeming way of escape from the conclusion that the sole effect of an increase in the quantity of money in circulation will be to increase prices. It may be claimed--in fact it has been claimed--that such an increase results in an increased volume of trade. We now proceed to show that (except during transition periods) the volume of trade, like the velocity of circulation of money, is independent of the quantity of money. An inflation of the currency cannot increase the product of farms and factories, nor the speed of freight trains or ships. The stream of business depends on natural resources and technical conditions, not on the quantity of money. The whole machinery of production, transportation, and sale is a matter of physical capacities and technique, none of which depend on the quantity of money. The only way in which the quantities of trade appear to be affected by the quantity of money is by influencing trades accessory to the creation of money and to the money metal. An increase of gold money will, as has been noted, bring with it an increase in the trade in gold objects. It will also bring about an increase in the sales of gold mining machinery, in gold miners' services, in assaying apparatus and labor. These changes may entail changes in associated trades. Thus if more gold ornaments are sold, fewer silver ornaments and diamonds may be sold. Again the issue of paper money may affect the paper and printing trades, the employment of bank and government clerks, etc. In fact, there is no end to the minute changes in the _Q_'s which the changes mentioned, and others, might bring about. But from a practical or statistical point of view they amount to nothing, for they could not add to nor subtract one-tenth of 1 per cent. from the general aggregate of trade. Only a very few _Q_'s would be appreciably affected, and those few very insignificant.

We conclude, therefore, that a change in the quantity of money will not appreciably affect the quantities of goods sold for money.

Since, then, a doubling in the quantity of money: (1) will normally double deposits subject to check in the same ratio, and (2) will not appreciably affect either the velocity of circulation of money or of deposits or the volume of trade, it follows necessarily and mathematically that the level of prices must double. While, therefore, the equation of exchange, of itself, asserts no causal relations between quantity of money and price level, any more than it asserts a causal relation between any other two factors, yet, when we take into account conditions known quite apart from that equation, viz., that a change in _M_ produces a proportional change in _M'_, and no changes in _V_, _V'_, or the _Q_'s, there is no possible escape from the conclusion that a change in the quantity of money (_M_) must _normally_ cause a proportional change in the price level (the _p_'s).

While the equation of exchange is, if we choose, a mere "truism," based on the equivalence, in all purchases, of the money or checks expended, on the one hand, and what they buy, on the other, yet in view of supplementary knowledge as to the relation of _M_ to _M'_, and the non-relation of _M_ to _V_, _V'_, and the _Q_'s, this equation is the means of demonstrating the fact that normally the _p_'s vary directly as _M_, that is, demonstrating the quantity theory. To throw away contemptuously the equation of exchange because it is so obviously true is to neglect the chance to formulate for economic science some of the most important and exact laws of which it is capable.

We may now restate, then, in what causal sense the quantity theory is true. It is true in the sense that one of the _normal effects of an increase in the quantity of money is an exactly proportional increase in the general level of prices_.

I have no desire, as some one has humorously suggested, to hide behind an equation, but I do find it necessary to take refuge behind my book on the _Purchasing Power of Money_. So many new questions have been asked that, in the few moments at my disposal, I could not answer them all satisfactorily. I believe they have all been answered in the book referred to. For instance, a chapter has been devoted to transition periods in which it has been shown, as Professor Taussig has suggested, that during transition periods an increase in _T_ may cause an increase in _M'_.

THE TESTIMONY OF RICARDO

[78]Let us suppose that the circulation of all countries were carried on by the precious metals only, and that the proportion which England possessed were one million; let us further suppose, that, at once, half of the currencies of all countries, excepting that of England, were suddenly annihilated, would it be possible for England to continue to retain the million which she before possessed? Would not her currency become relatively excessive compared with that of other countries? If a quarter of wheat, for example, had been both in France and England of the same value as an ounce of coined gold, would not half an ounce now purchase it in France, whilst in England it continued of the same value as one ounce? Could we by any laws, under such circumstances, prevent wheat or some other commodity (for all would be equally affected) from being imported into England, and gold coin from being exported? If ... the exportation of bullion were free, gold might rise 100 per cent.; and for the same reason, if 35 Flemish schillings in Hamburgh had before been of equal value with a pound sterling, 17-1/2 schillings would now attain that value. If the currency of England only had been doubled, the effects would have been precisely the same.

Suppose, again, the case reversed, and that all other currencies remained as before, while half that of England was retrenched. If the coinage of money at the mint was on the present footing, would not the prices of commodities be so reduced here that cheapness would invite foreign purchasers, and would not this continue till the relative proportions in the different currencies were restored?

If such would be the effects of a diminution of money below its natural level, and that such would be the consequences the most celebrated writers on political economy are agreed, how can it be justly contended that the increase or diminution of money has nothing to do either with the foreign exchanges, or with the price of bullion?

Now, a paper circulation, not convertible into specie, differs in its effects in no respect from a metallic currency, with the law against exportation strictly executed.

Supposing, then, the first case to occur whilst our circulation consisted wholly of paper, would not the exchanges fall, and the price of bullion rise in the manner which I have been representing; and would not our currency be depreciated, because it was no longer of the same value in the markets of the world as the bullion which it professed to represent? The fact of depreciation could not be denied, however the Bank Directors might assure the public that they never discounted but good bills for bona fide transactions; however they might assert that they never forced a note into circulation; that the quantity of money was no more than it had always been, and was only adequate to the wants of commerce, which had increased and not diminished;[79] that the price of gold, which was here at twice its mint value, was equally high, or higher, abroad, as might be proved by sending an ounce of bullion to Hamburgh, and having the produce remitted by bill payable in London bank notes; and that the increase or diminution of their notes could not possibly either affect the exchange or the price of bullion. All this, except the last, might be true, and yet would any man refuse his assent to the fact of the currency being depreciated?

Could the symptoms which I have been enumerating proceed from any other cause but a relative excess in our currency? Could our currency be restored to its bullion value by any other means than by a reduction in its quantity, which should raise it to the value of the currencies of other countries; or by the increase of the precious metals, which lower the value of theirs to the level of ours?

FOOTNOTES:

[43] _The Purchasing Power of Money_, pp. 14-71. The Macmillan Company. New York. 1911.

[44] This theory, though often crudely formulated, has been accepted by Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter, Kemmerer and most writers on the subject. The Roman Julius Paulus, about 200 A. D., stated his belief that the value of money depends on its quantity. See Zuckerkandl, _Theorie des Preises_: Kemmerer, _Money and Credit Instruments in their Relation to General Prices_, New York (Holt), 1909. It is true that many writers still oppose the quantity theory. See especially, Laughlin, _Principles of Money_, New York (Scribner). 1903.

[45] See Scott, "It has been a most fruitful source of false doctrines regarding monetary matters, and is constantly and successfully employed in defense of harmful legislation and as a means of preventing needed monetary reforms." _Money and Banking._ New York, 1903, p. 68.

[46] [For a method of determining the velocity of the circulation of money, see Appendix A.]

[47] It is important to bear in mind that wherever _P_ is used in this chapter it represents the index number, or scale of prices, at which the trade, _T_, is conducted.--EDITOR.

[48] An almost opposite view is that of Laughlin that normal credit cannot affect prices because it is not an offer of standard money and cannot affect the value of the standard which alone determines general prices. See the _Principles of Money_, New York (Scribner), 1903, p. 97. Both views are inconsistent with that upheld ... [here].

[49] This fact is apparently overlooked by Laughlin when he argues that there is not "any reason for limiting the amount of the deposit currency, or the assumption of an absolute scarcity of specie reserves." See _Principles of Money_, p. 127.

[50] Interesting changes in the magnitudes of the equation of exchange between 1896 and 1914 are given in the appended diagram, which is taken from a reprint of Professor Fisher's article, _The Equation of Exchange for 1914, and the War_, the _American Economic Review_, Vol. V, No. 2, June, 1915.--EDITOR.

[51] Adapted from Irving Fisher. _Recent Changes in Price Levels and Their Causes_, Bulletin of the American Economic Association. Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 43-44.

[52] Irving Fisher, _The Purchasing Power of Money_, pp. 74-88.

[53] _Ibid._, pp. 149, 150.

[54] _Causes of the Changes in Prices since 1896._ Bulletin of the American Economic Association, Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 27-36.

[55] There is a possible error here of perhaps $500,000,000.

[56] The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director of Mint, 1909, p. 80.

[57] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52.

[58] _Ibid._, pp. 52-61.

[59] _Money and Credit Instruments in their Relation to General Prices_, 2d edition, 1909. New York: Henry Holt & Company.

[60] The passages referred to are omitted.--EDITOR.

[61] Kemmerer, _Money and Credit Instruments_, pp. 9-18, 74-82.

[62] _Ibid._, pp. 82-8, 121-6, 145-8.

[63] _Ibid._, p. 9. [See Fisher: _Purchasing Power of Money_, pp. 175-180.]

[64] The value of gold bullion deposited at the United States mints and assay offices increased from $87,924,000 for 1897 to $205,036,000 for 1907. Figures furnished by the Director of the Mint.

[65] It is noteworthy that the reserves of the New York associated banks for example are usually kept very close to the legal reserve requirements. Cf. Sprague, _Crises under the National Banking System_, p. 222.

[66] Gold produced before 1492 represents an insignificant part of the existing supply.

[67] Useful tables summarizing all of these index numbers, except those of Canada, are given by Achille Necco, in his article on _La curva dei prezzi delle merci in Italia negli anni 1881-1909_, in _La Riforma Sociale_, Sept.-Oct., 1910.

[68] Comparison is for 1897 and 1906, figures for 1907 not being available.

[69] De Launay thinks that the industrial consumption averages somewhere between 40 and 50 per cent. of the annual output, but believes that for several years past the industrial uses have been absorbing a decreasing proportion, though an increasing amount. (_The World's Gold_, pp. 176-7.)

[70] Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61.

[71] _Ibid._, pp. 61-63.

[72] _Ibid._, p. 64.

[73] The quotation here referred to is omitted.--EDITOR.

[74] _Ibid._, pp. 64-65.

[75] _Ibid._, pp. 65-67.

[76] _Ibid._, pp. 67-69.

[77] Adapted from _The Purchasing Power of Money_, pp. 150-157; and Bulletin of the American Economic Association, Fourth Series, No. 2. Papers and Discussions of the Twenty-third Annual Meeting, December, 1910. p. 70.

[78] David Ricardo, _Reply to Mr. Bosanquet's Practical Observations on the Report of the Bullion Committee_, Works, pp. 326-328. John Murray. London. 1888.

[79] The Bank could not on their own principles, then urge that most erroneous opinion, that the rate of interest would be affected in the money market if their issues were excessive, and would therefore cause their notes to return to them, because, in the case here supposed, the actual amount of the money of the world being greatly diminished, they must contend that the rate of interest would generally rise, and they might therefore increase their issues. If, after the able exposition of Dr. Smith, any further argument were necessary to prove that the rate of interest is governed wholly by the relation of the amount of capital with the means of employing it, and is entirely independent of the abundance or scarcity of the circulating medium, this illustration would I think afford it.