Part III--gives a very much looser relation indeed than the direct

relation between loans and deposits.

The quantity theory has offered no explanation of this relation between loans and deposits. What explanation could a theory offer, which rests in the notion that volume of trade on the one hand, and volume of money and bank-credit on the other hand, are independent magnitudes?[326] I do not mean that quantity _theorists_ are silent regarding the relation of loans and deposits. I mean that they do not attempt, in any discussion I have found, to apply the quantity _theory_ to the explanation of that relation. What shall we say of a theory which, ignoring these easily proved, easily explained, and vital facts regarding bank-credit, offers as its sole explanation of volume of bank-credit a theory so untenable as that of a fixed ratio between volume of bank-credit and volume of money _in circulation_, with causation running from money to deposits?

Professor Fisher says little about bills of exchange. Here, surely, we have a credit instrument which grows directly out of trade, in general, and whose volume expands and contracts with trade. When banks discount bills of exchange, and issue notes, or grant deposit credits, against such discounted bills, the connection of bank-credit and volume of trade is obvious. The same thing holds largely, however, when promissory notes are discounted. Such notes are usually given by those who plan to use the credits granted in commercial or speculative transactions. The bill of exchange differs from the promissory note in practice, however, in that it itself is often a medium of exchange, without going into the bank's portfolio. "The bill of exchange, therefore, before it gets to the bank _usually_[327] performs a series of monetary transfers, for the small dealer naturally prefers to pass on the bill, if possible, in making a payment, instead of handing it over to his bank, which would either deduct a certain percentage in the way of discount, or else accept the bill at its face value, crediting the customer with the amount on the date of maturity, while business men (other than bankers) are in the habit of taking bills of exchange as they would cash."[328] This quotation describes conditions in Germany. The same authorities (p. 176) give figures showing a rapid development in the volume of bills of exchange, rising from about 13 billions of marks in 1872 to about 31 billions in 1907. These figures show that bills of exchange are a big factor in German business life,--a conclusion that is strengthened when they are compared with the figures for giro-transfers on pp. 188-189 of the same article, or with the figures for note issue on p. 209.[329] In the United States, of course, the use of bills of exchange has become comparatively unimportant in domestic commerce,[330] though there is a movement to revive them, since the new Federal Reserve system has come in. Their chief importance is in connection with foreign trade. Is it possible that Professor Fisher's reason for wishing to minimize foreign trade[331] is the unconscious desire to get rid of the annoying bills of exchange, which so obviously tend to make bank-credit and volume of trade interdependent, and which further spoil the quantity theory by serving as a flexible substitute for both money and deposits?

I regret the necessity for this elementary exposition of familiar things. But Fisher's theory has no place for these familiar things--and Fisher has merely made very explicit the logic of the quantity theory!

As applied to modern conditions, the quantity theory is obliged to assert--and Fisher does assert:

(a) that there is a causal dependence of bank-credit on money, and "normally" a fixed ratio between them;

(b) that velocity of circulation of money and credit instruments are independent of quantity of money and credit instruments;

(c) that, in general, money and volume of credit (taken together), velocities, and trade, are independent magnitudes, each governed by separate laws, though Fisher concedes _some_ reaction of trade on velocities;

(d) in particular, that volume of money and credit has no influence on trade, and that trade has no direct influence on volume of credit.

All these doctrines are necessary if the contention that an increase of money will proportionately raise prices is to be maintained, or if it is to be maintained that a decrease in trade will proportionately raise prices. I have analyzed each of these contentions, and I find justification for none of them.

Not yet, however, have we reached the least tenable aspect of the quantity theory. There remains the contention that prices are passive, that a change, _originating_ in prices, and involving a change in the average price, or the general price-level, cannot maintain itself--that P is a passive function of the other five magnitudes of the equation of exchange. To this central fortress of the quantity theory we shall devote the next chapter.