CHAPTER XVII

THE QUANTITY THEORY AND "WORLD PRICES"

Some writers, who would call themselves quantity theorists, would repudiate many of the doctrines for which Fisher stands, and which the historical quantity theory involves. The recognition which Fisher's book has received from quantity theorists generally, justifies me in treating his book as the "official" exposition of the modern quantity theory, and, indeed, it is easy to show that Fisher is fundamentally true to the quantity theory tradition. With many writers, the disagreement with Fisher would be a mere matter of degree; they would hold that Fisher has set forth the central principle, that his qualitative reasoning is correct, but that the relations among the factors in his equation are less rigid than he maintains. As I reject even the qualitative reasoning by which Fisher defends his doctrine, and reject even the qualitative tendency which he maintains, my criticisms will apply as well to the position of this group of writers, though I should have less practical differences with them, to the extent that they admit qualifications and exceptions to Fisher's doctrine.

There is, however, a group of writers who seem to feel that the quantity theory remains sufficiently vindicated if it can be shown that an increase in _gold production_ tends to raise prices throughout the world, while a check on gold production tends to lower prices, and who rest their case on the necessity which bankers find of keeping reserves in some sort of relation to the expansions of bank-credit.

A view of this sort is presented by J. S. Nicholson, whose statement of the application of the quantity theory to the modern world differs almost _toto coelo_ from his original statement in the dodo-bone illustration already discussed. Nicholson[365] declares that in our modern society "the quantity of _standard_ money, other things remaining the same, determines the general level of prices, whilst, on the other hand, the quantity of _token_ money is determined by the general level of prices." Nicholson's reasoning is, substantially, as follows: Although the bulk of exchanging is carried on by means of credit devices, there is still a certain part of exchanging, especially in the matter of paying balances, for which standard money only can be used. He regards the whole credit system as based on standard money, and says that for any given level of prices there is a minimum amount of standard money, absolutely demanded. If the volume of standard money falls below this minimum, the price-level will fall to such a point that the volume of standard money is again adequate. He takes, moreover, a world-wide view, declaring that it is the relation between the volume of gold money throughout the world and the demand for standard money throughout the world which determines the relative values of money and commodities. "The measure of values or the general level of prices throughout the world will be so adjusted that the metals used as currency, or as the basis of substitutes for currency, will be just sufficient for the purpose. We see then, that the value of gold is determined in precisely the same manner as that of any other commodity, according to the equation between supply and demand."

In the consideration of this doctrine, let us note several points in which it differs fundamentally from the quantity theory proper, and from the situation assumed in the dodo-bone illustration. First, it is not a quantity theory of _money_. Money is not regarded as a homogeneous thing, each element having the same influence on prices. Rather, _token_ money is the child of prices. This doctrine would in no way fit in with the logic of the equation of exchange, as presented by Fisher. Further, the dodo-bone idea is entirely gone. _Gold_, a commodity with value in non-monetary employments, is under discussion, and it is the quantity of gold that is counted significant. This recognizes, if not the need, at least the _existence_, of a commodity standard. Nicholson definitely avows the necessity for the _redemption_ of representative money, even going so far as to say that "all credit rests on a gold basis,"[366] that all instruments of exchange derive their value from the volume of standard money which supports them, and that if this basis were cut away the whole structure would fall. Nicholson recognizes, further, that gold has value independent of its use as money.[367]

In evaluating Nicholson's doctrine, I wish to point out, first, the inaccuracy of the statement that all credit rests on a gold basis. It is true that credit instruments are commonly drawn in terms of standard money, which is commonly gold. International credit instruments may even specify gold, and the same thing happens at times within a country. But commonly, in this connection, gold functions, not as the value basis lying behind the credit instrument, the existence of which justifies the extension of the credit, but rather as the _standard of deferred payments_, by means of which the credit instrument may be made definite. The real basis of the value of a mortgage is not a particular sum of gold, but rather the value of the farm, expressed in terms of gold. The basis of a bill of exchange is not a particular sum of gold, but rather is the value of the goods which changed hands when the bill of exchange was drawn,[368] supplemented by the other possessions of drawer, drawee, and the endorsers through whose hands it has gone. Even a note unsecured by a mortgage, or not given in payment for a particular purchase, is based, in general, on the value of the general property of the man who gives it, and on the value of his anticipated income.[369] So throughout. Credit transactions, for the most part, originate in exchanges, and carry their own basis of security in the goods and securities which change hands, not in that small fraction of the world's wealth, the stock of gold, which could, Coin Harvey asserted in the middle '90's, be put in the Chicago grain-pit! And now let me extend this idea. Although coin made from the standard of value is a great convenience, there is yet no vital need, in theory, for a single dollar, pound or franc made from the standard of value. If gold should cease entirely to be used as a medium of exchange, or in bank or government reserves, if the gold dollar should become a mere formula, so many grains of gold, without there being any coins made of it, still, so long as that number of grains had a definite, ascertainable value, commensurate with the value of some other commodity which could be used as a means of paying balances and redeeming representative money, the gold dollar could still serve as a measure and standard of values. In the situation I have assumed, silver bullion, at the market ratio, could perform all the exchange and reserve functions now performed by gold, even though not so conveniently.[370] Nicholson's description of the use of gold as a reserve, while calling attention to an important fact, has led him into the error of supposing that what may be true of gold, the _medium of exchange_, and _reserve for credit operations_ is necessarily true of the _standard of value as such_.

Nicholson is correct, however, in looking to the standard of value for part of the explanation of changes in prices. And, _since it so happens_ that a considerable part of the value of the standard of value comes from its employment as medium of exchange and reserve, he is correct in looking to its use as money as part of the explanation of its value. His error comes, however, in failing to see that independent changes in the values of goods may also change the price-level, and that variations in the demand for gold as a commodity may also change the value of gold, and so change the price-level.

Further, in so far as Nicholson clings to the notion of prices as depending on a mechanical equilibration of physical quantities, he is subject to the criticisms given before of the general quantity theory, and in so far as he clings to the identity of the value of gold with the reciprocal of the price-level,--the relative conception of value--he is subject to the criticisms already urged.

Again, even for a single country, the connection between volume of reserves and volume of credit is very loose and shifting. A thousand factors besides volume of standard money in a country determine the expansions and contractions of credit, and the long run average of credit. For the whole world, this connection is even looser. To assume a fixed ratio between them for the whole world, one would have to assume that all the world was simultaneously, and normally, straining its possibility of credit expansion to the utmost, so that the minimum ratio--a notion which is far from precise[371]--should also be the normal maximum, and so that no country, in expanding its credit, could draw in new reserves from other countries which had more quiescent business conditions.

Nicholson's notion of the world price-level, moreover, is subject to the criticisms I have made in the chapter on "The Quantity Theory and International Gold Movements." How can the world level have a close connection with the volume of gold, if different elements in the world price-level, the price-levels of different countries, can vary so widely and divergently as compared with one another? Even granting--which I do not grant, and which I maintain I have disproved--that the price-level in one country has a close connection with its stock of gold, would it not be true that the average price-level for the world would vary greatly, with the same world stock of gold, depending on which countries had the gold?

There is nothing in Nicholson's doctrine which seems to me to justify in any degree the doctrine that prices, in a single country, or in the world at large, show any tendency to _proportional_ variation with the quantity of money, or with the world's stock of gold.

Is it not true, then, that there is _some_ sort of relation between gold production and world prices? It is. Gold is like other commodities. Its value tends to sink as its quantity is increased. As its value sinks, prices tend to rise. As to the elasticity in the value-curve for gold, I think it will be best to reserve discussion till a later chapter,[372] in Part III. We shall there find reason for thinking that gold has much greater elasticity in this respect than most other commodities. That its value should fall _proportionately_ with an increase in its quantity, I should not at all conclude. Even if its value did sink proportionately with an increase, prices would rise proportionately only if the values of goods remained unchanged.

But why do we need a _quantity theory_ of _money_, with all its artificial assumptions, and its law of strict proportionality, to enable us to assert the simple fact that gold, like other commodities, has a value not independent of its quantity? What theory of money would deny it? Surely not the commodity or bullionist theory. For that theory, which seeks the explanation of the value of money in the value of gold in the arts, it would go without saying that an increase in the supply of gold for the arts would lower its value there and consequently, its value as money. Surely the theory which I shall maintain in Part III of this book will not deny that increased gold production tends to lower the value of money, and consequently to raise prices. With the "quantity theorist" who is content with this conclusion, I have no quarrel--unless he claims this obvious truth as the unique possession of the quantity theory!