CHAPTER VI
THE QUANTITY THEORY OF PRICES. INTRODUCTION
The quantity theory, in its usual formulations, is a theory, not of the value of money, in the absolute sense of value, but of the general price-level, the average price of goods exchanged for money. It is not a psychological theory. It does not deal with psychological quantities, or psychological forces. It is a mechanical theory, concerned simply with quantities, and the relations between them. The essence of the quantity theory comes out in the following brief statement: given a number of units of money; given a number of units of goods to be exchanged; assume these two numbers to be independent[105] of each other; assume all the goods to be exchanged for all the money; then the average price will be a simple function of the quantities of goods and of money respectively, such that an increase in the amount of money will increase the average price per unit of goods proportionately, if goods remain unchanged in amount, or an increase in goods will lower the price per unit proportionately, money being assumed to remain unchanged in amount. The qualification is commonly added that if goods have to be exchanged more than once, the effect is the same on prices as if there were an added number of goods equal to the added number of exchanges, and that if money is used more than once in exchanging a given number of goods, the effect is the same as if there were proportionately more money. Both quantity of goods and quantity of money are commonly defined as actual quantity multiplied by "rapidity of circulation." Rapidity of circulation, however, for both money and goods, is commonly thought of as a constant, so that the original formula remains unaffected by the qualification, so far as a prediction as to the effect of increase or decrease of money or goods on prices is concerned. Involved in the quantity theory, and explicitly stated by many writers, is the doctrine that the substance of which money is made is irrelevant, that it is the number, and not the quality or size of the money-units that counts. "In short, the quantity theory asserts that (provided velocity of circulation and volume of trade are unchanged) if we increase the number of dollars, whether by renaming coins, or by debasing coins, or by increasing coinage, or by any other means, prices will be increased in the same proportion. It is the number, and not the weight, that is essential. This fact needs great emphasis. It is a fact which differentiates money from all other goods and explains the peculiar manner in which its purchasing power is related to other goods. Sugar, for instance, has a specific desirability dependent on its quantity in pounds. Money has no such quality. The value of sugar depends on its actual quantity. If the quantity of sugar is changed from 1,000,000 pounds to 1,000,000 hundredweight, it does not follow that a hundredweight will have the value previously possessed by a pound. But if money in circulation is changed from 1,000,000 units of one weight to 1,000,000 units of another weight, the value of each unit will remain unchanged." (Irving Fisher, Purchasing Power of Money, pp. 31-32.) To the same effect is Nicholson's exposition, in which the money is assumed to consist of dodo-bones, the most useless substance that Nicholson could think of. For the quantity theory, prices are determined by the numbers of goods and dollars that are to be exchanged for one another, and not by the values of the goods and dollars;—indeed, for the quantity theory, "value" commonly has no meaning apart from the prices which are supposed to be adequately explained by the mechanical relations of numbers.
In the critical study which follows, virtually every doctrine and every assumption of this preliminary statement will be challenged. I shall deny, first, that the quantity of goods to be exchanged and the quantity of money to be exchanged for the goods, are independent quantities, maintaining, rather, that an increase in either of them tends normally to be accompanied by an increase in the other. Quantity of goods and quantity of money exchanged are not simple physical stocks, given data. Rather, they are consequences of human choices and human relationships, and vary from a large number of highly complex psychological causes, many of which are common to both. I shall deny, second, that "rapidity of circulation," either of goods or of money, is a simple constant, independent of quantity of goods or of quantity of money. I shall maintain, rather, that rapidity of circulation of money is a phenomenon which calls for psychological explanation: that the rapidity of money really means the activities of men; that these activities are complex, and obey no simple law; that instead of being an independent factor, constant, in the situation, the rapidity of circulation of money is bound up with the quantity of money, the quantity of goods to be exchanged, the rapidity of circulation of goods, and the prices of the goods, and that the rapidity of circulation of goods is likewise causally dependent on the factors named—or better, on the causes which control them; that rapidity of circulation, whether of money or of goods, is not a causal factor independent of prices, but rather in part depends on prices. In the third place, I deny the doctrine that the question as to what the money-unit is made of is irrelevant. On the contrary, I shall maintain that the quality of money, rather than its quantity, is the determining factor. I shall not maintain that only money made of or redeemable in valuable bullion can circulate, nor shall I maintain that the value of money depends wholly on the value of its bullion content when money is made of valuable metal. I recognize that value can come from other sources. But I shall maintain that value from some source other than the monetary employment is an essential precondition of the monetary employment, even though recognizing that that monetary employment may, in a way later to be analyzed, add to the original value of the money. The doctrine that only physical quantities, or abstract numbers, of goods are relevant I shall challenge especially, maintaining, on the contrary, that the psychological significances, the values, of goods are the really important thing, so that an increase in the number of one sort of goods may have a very different effect on the average of prices from an increase of the same number of units of some other good, and so that an increase in the number of goods exchanged under one set of conditions may have a very different effect on prices—or may be accompanied by a very different movement in prices, for the question of causal relations is a complicated one—from the change in prices that might accompany the same increase in the amount exchanged of same goods under other circumstances. Finally, the doctrine of the quantity theory that the price-level is a passive result of the other factors named: quantities of goods and money, and their respective velocities; that prices cannot initiate a change in the situation, will also be challenged. I shall undertake to show that the first change in the situation may appear in prices themselves, and that the quantities of goods exchanged, and of money, and their velocities, may then be altered to correspond with the change in prices.
I shall further maintain, as against the whole spirit of the quantity theory, that it does not seize hold of essentials in the causes lying behind prices. I shall contend that the factors with which it deals, instead of being independent foci to which converge the causes governing the price-level, and through which causation flows in one direction, are really not true "factors" at all, but rather are blanket names for highly complex and heterogeneous groups of facts concerning which few general statements are possible. Quantity of goods exchanged, for example, may be in some of its parts caused by rising prices, in others of its parts may be causing falling prices and is chiefly caused by fluctuating prices. The net change in prices in this case is not the result of any one movement from "quantity of goods" as a whole. Changes in the price-level are not one result, but rather, are the mathematician's average of many changes, due to a host of causes, in many individual prices. The quantity theory is an effort to simplify phenomena highly complex. Of course, the simplification of complex phenomena in thought is a laudable scientific goal, but when the simplification goes so far as to group things only superficially related, and to leave out the really vital elements, it is worthless. Value theory, with all the value left out, is like Hamlet with no actor for the title rÔle. Simplification in the explanation of general prices has gone as far as we can legitimately take it when we seek to summarize all the factors involved in the foci of, on the one hand, the value of money, and, on the other hand, the values of the particular goods. The general price-level is an average of many concrete prices. Each of these individual prices has a concrete causal explanation. The general price-level has, not a few simple causes, but an infinite host of causes. Indeed, the general price-level has no real existence. It is a convenient mathematical concept, by means of which we may summarize the multitude of concrete facts. It is useful as a device for measuring changes in the value of money, on the assumption that changes in the values of goods neutralize one another. This assumption is never strictly true, and often is demonstrably false. The general price-level is neither a cause nor a result. Particular prices, in general, are results of two causes, namely, the value of money and the value of the good in question, and particular prices may then become causes, changing the quantity of money involved in a given set of exchanges. Neither quantity of money, nor quantity of goods exchanged, nor rapidity of circulation, nor general price-level is a simple, homogeneous quantity, obeying definite laws.
I shall also undertake to show that in many important cases the quantity theory leads to conclusions regarding the price-level which contradict other laws of prices, notably the capitalization theory, the cost of production doctrine, and the law of supply and demand. I have previously pointed out that these three doctrines are inapplicable to the problem of the value of money itself. On the assumption of a value of money, however,—using value in the absolute sense—they are applicable to the problem of prices, and, since the price-level is merely an average of particular prices, they should be applicable to the problem of the price-level also. It will be shown, in the course of the criticism which follows, first that the quantity theory contradicts each of these doctrines, in certain situations, and second, that in these cases, the conclusions based on the cost theory, the supply and demand theory, and the capitalization theory are right, and the conclusions based on the quantity theory are wrong. It has been maintained by certain writers, as Knut Wicksell[106] and Irving Fisher,[107] that cost of production and supply and demand are inapplicable to the problem of the general price-level. I shall maintain the contrary, holding that while these doctrines are inapplicable to the problem of the value of money, they are applicable to the problem of general prices, on the assumption of a fixed value of money. By the value of money I mean its absolute[108] value, and not—what the quantity theorists commonly mean—its "purchasing power," or the "reciprocal of the price-level."
I shall undertake to show that no sound conclusion reached on the basis of quantity theory reasoning is the peculiar property of the quantity theory school; that every valid conclusion which may be based on the quantity theory may also be deduced from the theory maintained in this book, and, indeed, that most of them may be deduced from several other theories of money, notably the commodity or bullionist theory. I shall show a number of false and misleading doctrines which logically spring from the quantity theory, and shall undertake to show that the quantity theory fails to give an adequate basis for several important parts of the theory of money, among them Gresham's Law, the theory of international gold movements, and the theory of elastic bank-notes and deposit-currency.
So much for the theses to be maintained. The detailed proof of these contentions will best be given in connection with a critical account of various versions of quantity theory doctrine. Attention will be given in this summary to the expositions of Nicholson, Mill, Taussig, and Kemmerer, and very special attention to I. Fisher, though some other writers will also be taken into account.
CHAPTER VII
DODO-BONES
Must money have value from some source outside its money-functions? It is a part of the quantity theory that this is unnecessary. I have cited, in the preceding chapter, Irving Fisher and J. S. Nicholson to this effect. Nicholson's statement is interesting and picturesque, exhibiting the quantity theory in all the nakedness of its poverty, and I shall present it at some length. "For simplicity," to isolate his phenomenon, he assumes a hypothetical market, in which the following conditions obtain: (1) No exchanges are to be made unless money (which he assumes to consist of counters of a certain size made of dodo-bones) actually passes from hand to hand. No credit or barter. (2) The money is to be regarded as of no use whatever except to effect exchanges, so that it will not be withheld for hoarding, i. e., will be actually in circulation. (3) There are ten traders in the market, each with one kind of commodity and no money, and one trader with all the money (one hundred pieces), and no commodities. Further, let this moneyed man put an equal estimation on all the commodities. Now let the market be opened according to the rules laid down; then all the money will be offered against all the goods, and, every article being assumed of equal value, the price given for each article will be ten pieces, and the general level of prices will be ten. It is perfectly clear that, under these suppositions, if the amount of money had been one thousand pieces, the price-level would have been one hundred per article, etc. Under these very rigid assumptions, then, it is obvious that the value of money varies exactly and inversely with the amount put into circulation.—The rapidity of circulation he regards as coÖrdinate, in fixing the price-level, with the volume of money. To illustrate this, he assumes again his hypothetical market, and "dodo-bones," assuming as before that one merchant has all the money (one hundred pieces), and that ten have commodities of equal value. Instead, however, of the merchant with the money desiring all the commodities equally, he is made to desire only the whole of that of trader one, who in turn desires the whole of number two's stock; and so on to the ninth merchant, who wants the commodity of number ten, who wants the dodo-bones. In this case, each article will be exchanged only once, as formerly, but the money will change hands ten times, and the price of each article will be one hundred instead of ten. "We now see that, under these circumstances, with the same quantity of money, and the same volume of transactions, the level of prices is ten times as great as before, and the reason is that every piece of money is used ten times instead of once." Whence he concludes: "The effect on prices must be the same when, in effecting transactions, one piece of money is used ten times as when ten pieces of money are used once."[109]
Ricardo, too, expresses the dodo-bone theory very explicitly. "If the state charges a seigniorage for coinage, the coined piece will generally exceed the value of the uncoined piece of metal by the whole seigniorage, because it will require a greater quantity of labour, or, which is the same thing, the value of the produce of a greater quantity of labour, to procure it.
"While the state alone coins, there can be no limit to this charge of seigniorage; for, by limiting the quantity of the coin, it can be raised to any conceivable value. It is on this principle that paper money circulates; the whole charge for paper money may be considered a seigniorage. Though it has no intrinsic value, yet, by limiting its quantity, its value is as great as an equal denomination of coin, or of bullion in that coin."[110]
Would the dodo-bones circulate? Nicholson chose the illustration to throw into the sharpest relief the absence of any value from a non-monetary employment. Nobody has any use for them as dodo-bones. What economic force is there, then, to make them circulate? Nicholson says nothing about an agreement among the traders, assigning a significance[111] to the dodo-bones, so that they might function in the same way that poker chips do—indeed, any such notion would vitiate his illustration, for he proposes to explain an adjustment of prices by natural economic laws. Why then, will any of the traders give up his valuable commodities for the worthless dodo-bones? Will you say that he will take them, not because he wants them himself, but because he knows that others will take them from him? But why would the others want them? Because they in turn can unload them on still others? But this seems a plain case of the vicious circle. It is, in effect, saying that the dodo-bones will circulate because they will circulate. A will take them because B will take them; B will take them because C will take them, C because ... N will take them; N takes them because A will take them.[112] I do not deny that if the traders used the dodo-bones as counters, agreeing that such dodo-bones should represent some other commodity chosen as a standard of values, that the dodo-bones would circulate. But, in that case, they would be, not primary, self-sustaining money, but merely representative, or token money. And just here let me lay down two general propositions[113] respecting the two main functions of money: to serve as a standard, or common measure, of values, the article chosen must, as such, be valuable. The thing measured must be either a fraction or a multiple of the unit of measurement. But this quantitative relation can exist only between homogeneous things. The standard, or measure, of values, then, must be like the commodities whose values it is to measure, at least to the extent of having value.[114] The second proposition is respecting the medium of exchange. The medium of exchange must also have value, or else be a representative of something which has value. There can be no exchange, in the economic sense—I abstract from disguised benevolences, accidents, and frauds—without a quid pro quo, without value balancing value, at least roughly, in the process. Now when it is remembered that the intervention of the medium of exchange, taking the place of barter, really breaks up a single exchange under the barter system into two or more independent exchanges, and that the medium of exchange is actually received in exchange for valuable commodities, it follows clearly that the medium of exchange must either have value itself, or else represent that which has value. These two propositions seem almost too obvious to require the statement, but they contradict the quantity theory, and they are not, on the surface, reconcilable with certain facts in the history of inconvertible paper money. It is necessary, therefore, to state them, and to examine further some of the phenomena which seem to contradict them. If they are true, Nicholson's dodo-bones will perform neither of the primary functions of money. They have no value, per se—they cannot, then, measure values; they are neither valuable nor titles to valuable things—they are not quid pro quo in exchange, and will not circulate.
I shall not pause long to discuss the doctrine that money needs no value itself, because it is really a sort of title to, or claim on, or representative of, goods in general. The notion, first, would not pass a lawyer's scrutiny. There are no such indefinite legal rights. A system of legally fixed prices, with a socialistic organization of society, would be necessary to give it definiteness—and in such a situation there would be no room for a quantity theory of prices! Economic goods, as distinct from money, are not generally "fungible" to the extent that would make them indifferent objects of legal rights. Besides, whether or not the thing is logically thinkable, it is legally false. Legal factors enter into the economic value of money, as will later be shown, but it is economic, and not legal, value, which makes money circulate. Helfferich has taken the trouble to give the notion of money as a mere title to things in general a somewhat more fundamental analysis, and I would refer the reader who is not satisfied by the foregoing on this point to his discussion.[115]
I wish to make very clear precisely how much I mean by the foregoing argument that circular reasoning is involved in saying that A will take the dodo-bones because B will take them. The same question arises for B, and for the others. The real question is as to the cause for any general practice of the sort. Why should A suppose that B will take them? What could bring about such a system of social relations that a general expectation of this sort could arise?
Kemmerer undertakes to give an answer in a hypothetical case by the following ingenious assumption (Money and Credit Instruments, p. 11): the money consists of an article which formerly had a high commodity value, which has lately entirely disappeared, but the money continues to circulate, through the influence of custom, and because of the demand for a medium of exchange.
In this illustration Kemmerer recognizes the historical fact that money has originated from some commodity which had value because of its significance as a commodity. Historically, a great many different commodities have served, and gold and silver finally emerged victors for reasons which need not just now concern us. These historical facts, coupled with the idea that value is, essentially, "something physical,"[116] or coupled with the notion that value arises only from marginal utility, or from labor, have been accepted by the Commodity or Metallist School as sufficient proof that standard money is only possible when made of some valuable commodity. Professor Laughlin seems to think of the whole thing as depending on the value of gold bullion, and to recognize the money-employment as a factor in affecting the value of money only in so far as it draws gold away from the arts, and so raises its value there by lessening the supply.[117] If money originated in a commodity, how is it possible for the commodity value to be withdrawn, and for money still to retain its value?
This brings us to a question I have raised before, namely, whether the genetic, or historical account of a social situation, and the cross-section analysis of the same situation, necessarily agree.[118] Is it possible that when a commodity basis was necessary to start the thing, and when even in the modern world gold bullion, interconvertible with gold coin, remains the ultimate basis of the money-systems of all great commercial peoples, that you could withdraw the commodity support and keep money unchanged in value? Or could you even have any value left at all? Now in answer, I propose to admit the possibility of so doing. The forces which a cross-section analysis reveals are not necessarily identical with those which a theory of origins sets forth. Once the thing is set going, the forces of inertia favor it. A new theory, fixed in the minds of the people, say the quantity theory itself, might give them such confidence in their money that its value might be maintained. A fiat of the government, making the money legal tender, supplemented by the loyalty of the people, might keep up its value. I think there is reason to believe that this is a source of no little importance of value for the German paper money to-day, and, to a less extent, of the notes of the Banque de France. All these possibilities I admit. Value is not physical, but psychological. And the form of value with which we are here concerned, economic value par excellence, is a phenomenon of social, rather than individual psychology. Many and complex are the psychical factors lying behind it. Belief, custom, law, patriotism, particularly a network of legal relationships growing out of contracts expressed in terms of the money in question, the policy of the state as to receiving the money for public dues, the influence of a set of customary or legally prescribed prices, which tie the value of money to a certain extent to the values of goods—factors of this character can add to the value of money, and can, conceivably, even sustain it when the original source of value is gone. Social economic value does not rest on marginal utility. In general, utility is essential, as one of many conditions, before value can exist, even though the intensity of the marginal want served by a good bears no definite relation to its value. But in the case of the value of a money of the sort here considered, marginal utility is in no sense a cause of the value. Rather, the marginal utility[119] of such money to an individual is wholly a reflection of its social value, and changes when that social value changes. It is quite consistent with the general theory of economic value which I have set forth in Social Value, for me to admit possibilities of this kind. The value of money in such a case has become divorced from its original presuppositions. The paper, originally resting on a commodity basis, or the coins originally valued because they could be transformed into non-monetary objects of value, have become objects of value in themselves. Analogous phenomena are common enough in the general field of values, and are less common in the field of economic values proper than one might suppose. Thus, most moral values tend to become independent of their presuppositions. Moral values of modes of conduct have commonly arisen because those modes of conduct were, or were supposed to be, advantageous in furthering other ends. Morality, in its essence, is teleogical. Yet so far have the moral ideals become ends in themselves that it is possible to have great thinkers, like Kant and Fichte, setting them up as eternal and unchangeable categorical imperatives, regardless of consequences. Thus Fichte declares, "I would not tell a lie to save the universe from destruction." Older still is the dictum, "Fiat justitia, ruat coelum." Yet truth and justice, in the history of morals, and, in the view of most moral thinkers to-day, are of value primarily because they tend to preserve the universe from destruction, and would never have become morally valuable had they had the other tendency! Legal values manifest this tendency even more—one needs only to point to our vast body of technical rules of procedure in criminal cases, which persist long after their original function is gone, and after they have become highly pernicious from the standpoint of the ends originally aimed at. In the sphere of the individual psychology the phenomenon is very common. The miser's love for money is a classical example. The housewife who so exalts the cleanliness of her home that the home becomes an unhappy place in which to live, is an often-described type. The man who retires from business that he may enjoy the gains for the sake of which he entered business often finds that the business has become a thing of value in itself, and longs to be back in the harness, while many men, long after economic activity is no longer necessary, continue the struggle for its own sake. Activities arise to realize values. The value of the activity is derived from the value aimed at. But consciousness is economical, and memory is short. The activities become habits. The habits gather about themselves new psychological reactions. The interruption of habitual activities is distasteful. Life in all its phases tends to go on of its own momentum. The activities tend to become objects of value in themselves, whether or not their original raison d'Être persist. In both the social and the individual sphere, apart from blind inertia and mechanical habit, active interests tend to perpetuate the old activities, whose raison d'Être is gone. The judge who continues to apply the outgrown absurdities of adjective law may do it from timidity or from being too lazy to think out the new problems whose solution must precede readjustment to present social needs, but the criminal lawyer who can free his guilty client by means of these technicalities has an active interest in their perpetuation. The individual who would readjust his conduct in the light of changed interests finds that active opposition is met in the emotional accompaniment of the old habits. The economic society may wish to be free from a money whose original value is gone, but there is a powerful debtor interest which approves of that money, and whose support tends to maintain its value.
All these possibilities I admit. My own theory of value, which finds the roots of economic value ramifying through the total social psychological situation, rather than in utility or labor-pain alone, involves possibilities like these. But—and this is a point I wish especially to stress—we are out of the field of mechanics, and in the field of social psychology, when we undertake to explain the value of money that way. No longer is there any mathematical necessity about the matter. There is no such a priori simplicity as the quantity theory deals with. Factors like these might maintain the value of money for a time, and then wane. These factors might vary in intensity from day to day, with changing political or other events, leading the value of money to change from day to day, quite irrespective of changes in its quantity.[120] In so far as you have a people ignorant of the nature of money and of monetary problems, a people in the bonds of custom, with slightly developed commercial life, whose economic activities run in familiar grooves unreflectively, you will most nearly approximate a situation like that which Professor Kemmerer assumes. But that means that what might be true in India, or to a less degree in Austria—countries to which the quantity theorists are accustomed to refer—need not at all be true in the United States. Here everybody was talking about the theory of money in 1896—not necessarily very intelligently!—and here, moreover, such phrases as "good as gold," and propositions like that which came from Mr. J. P. Morgan in his testimony before the Pujo Committee that "gold is money, and nothing else," would seem to indicate that a very great part of our people might utterly distrust such a money as Professor Kemmerer describes. The banker's tendency to look behind for the security, to test things out, to seek to get to bed-rock in business affairs, holds with a great many people. An overemphasis on this is responsible for the doctrine of Scott[121] and Laughlin[122] that the sole source of the value of inconvertible paper money is the prospect of redemption, and that inconvertible paper money differs from gold in value by an amount which exactly equals the discount at the prevailing rate of interest, with allowance for risk, for the period during which people expect the paper money to remain unredeemed. We have not the banker's psychology to any such extent as that. Apart from the fact that the money function adds to the value of money, under certain circumstances,—a point to be elaborated shortly—other, non-rational factors, contagions of depression and enthusiasm, patriotic support, "gold market" manipulations, etc., entered to break the working of the credit theory of paper money as applied to the American Greenbacks. I may here express the opinion that the credit theory is the fundamental principle in the explanation of the value of the Greenbacks, however. But we have not the banker's psychology to any such extent as the extreme forms of that theory would assume. "Uncle Sam's money is good enough for me," is a phrase I have heard from the Populists,—who, by the way, were pretty good quantity theorists! "The government is behind it." There are plenty of men for whom that assurance would be enough. Indeed, the general notion that in some way, not specified, perhaps not yet known to anybody, the government will do what is necessary to maintain the value of its money is a ground which might well influence even the most sophisticated banker. I think such a general confidence in the English government has clearly been a factor in the price of Sterling exchange since the balance of trade turned so overwhelmingly against England in the present War.[123] Our monetary history, I may add, has been in considerable measure a struggle between these two opposing psychological reactions on that point. The utter breakdown of the fiat theory came in Rhode Island, and in connection with the Continental Currency, in the days before the Constitution was adopted. On the other hand, I do not believe that those who put a banker inside every one of us can prove that their principle has been a complete explanation at any stage of our monetary history. But clearly considerations like these take away all mathematical certainty from the matter.
The foregoing analysis makes clear, I trust, that the notion that the money function alone can make an otherwise valueless money circulate is untenable. There must be value from other sources as well. All that is conceded is that there need not be a physical commodity as the basis of the money. Value is not necessarily connected with a physical commodity.
There is a disposition on the part of many quantity theorists to beg the question at the outset, to assume money as circulating, without realizing how much this assumption involves. The assumption involves the further assumption that there are causes for the circulation of money. But the same causes which make money circulate will also be factors in the determination of the terms on which it circulates, i. e., the prices. To seek then, by a new principle, the quantity theory, to explain these prices without reference to these causes, is a remarkable procedure. There is sometimes a disposition to do the thing quite simply indeed: define money as the circulating medium, and, by definition, you have it circulating! A rather striking case of this, which is either tautology or circular reasoning, appears in Fisher's Purchasing Power of Money (p. 129): "Take the case, for instance, of paper money. So long as it has the distinctive characteristic of money,—general acceptability at its legal value,—and is limited in quantity, its value will ordinarily be equal to that of its legal equivalent in gold." (Italics mine.)
It is not quite easy to construct, even ideally, a social psychology which would perfectly fit the quantity theory. One would have to assume that money circulates purely from habit, without any present reason at all. The assumption must be that the economic life runs in steady grooves, so that quantity of goods exchanged will always be the same, or at least, that it will always be the same proportion of the goods produced—there must be no option of speculative holding out of the market allowed the holder of exchangeable goods. The individuals must have constant habits as to the proportions of the money they receive to be spent and to be held for emergencies. All the factors affecting "velocity" of both money and goods must be constant—Professor Fisher maintains very explicitly that velocities, both of money and of bank-deposits are fixed by habit (loc. cit., p. 152),—and, in any case, the assumption is necessary. A thoroughly mechanical situation must be assumed, where there is the rule of blind habit. Given such a mechanism, you pour in money at one end, and it grinds out prices at the other end, automatically. But, strangely enough, in this social situation where blind habit rules, prices are perfectly fluid! In India, or in other countries where the assumptions of the quantity theorist come most nearly to realization, so far as the general rule of habit is concerned, one finds also many customary prices. In a country completely under the rule of habit, the prices would, as a matter of psychological necessity, be also fixed. What might then be expected to happen in such a country, if an economic experimenter should disturb them in their habitual quantity of money? Which habits would give way, those relating to prices, or those to velocities, or those relating to quantities of goods exchanged?[124] I shall not trouble to solve this problem, as it seems to me not the most useful way to approach the problem of the value of money, but I submit it to the consideration of advocates of the quantity theory. My present purpose is accomplished in pointing out the psychological assumptions which the quantity theory makes: a psychology of blind habit, in a situation where the price-level is free from control by customary prices.
Now at another point I wish to mediate between the quantity theorists and their extreme opponents. Representatives of the Metallist of Commodity School—like Professor Laughlin, and Professor Scott in his earlier writings—seem to deny that the money-employment has any direct effect in increasing the value of money. The money-employment affects the value of money only indirectly, by withdrawing the money metal from the arts, so raising the value of the money metal, and consequently raising the value of the coined metal. The quantity theory, on the other hand, would utterly divorce the value of money from causal dependence on the stuff of which the money is made. Both these views seem to me extreme. Unless money has value from some source other than the money employment, it cannot be used as money at all. Nobody will want it. On the other hand, the money use is a valuable use. Exchange is a productive process. Money, as a tool of exchange, enables men to create values. And you can measure the value of the money service very easily at a given time if you look at the short time "money-rates," i. e., rates of discount on prime short term paper. These are properly to be considered, not interest on abstract capital, but the rent of a particular capital-good, namely, money. The money is hired for a specific service, namely, to enable a man to get a specific profit in a commercial transaction. Money is not the only good which can be thus employed, and which is paid for for this purpose. Ordinarily a man will pay for money for this purpose. Sometimes, however, one needs the temporary use of something else more than one needs money, and the holder of money pays a premium for the privilege of temporarily holding the other thing. I refer especially here to the practice of "borrowing and carrying" on the stock exchange. The "bear" sells stock which he does not possess, and must deliver the stock before he is ready to close his transaction by buying to "cover." He goes to a "bull" who has more stock than he can easily "carry," and who is glad to "lend" the stock in return for a "loan" of its equivalent in money. Ordinarily the bull is glad to pay a price for the money, as it is of service to him. Sometimes, however, the situation is reversed, and the service which the temporary loan of the stock performs for the hard-pressed bears is greater than the service which the money performs for the bulls, and the payment is reversed. When the bull pays a premium to the bear, for the use of the money, the amount paid is called "carrying charge," "interest charge for carrying," "contango," (London) or (in Germany) "Report." This is the usual case. But sometimes the bear pays the bull a premium for the use of the stock, and the charge is then called "premium for use," "backwardation," (London) or "Deport" (Germany).[125] Money is, thus, not the only thing which has a "use" in addition to the ordinary "uses" which are the primary source of its value.[126] In the case of other things, however, this kind of "use" is unusual. In the case of money it is the primary use. The essence of this use is to be found in the employment of a quantum of value in highly saleable form in facilitating commercial transactions. Commercial transactions, in this sense, are not limited to ordinary buying and selling. I think it best to defer further analysis of the money service to a later chapter, on the functions of money, which will best be preceded by a consideration of the origin of money. For the present, it is enough to note that money has certain characteristics which enable it to facilitate exchanges, and to pay debts, better than anything else, and that this fact makes an addition to its value. It is possible, I think, to measure this addition to value rather precisely in certain cases. Thus, in the case of the American Greenbacks, we find them at a discount, say from the beginning of 1877 on, as compared with the gold dollar in which they were to be redeemed in Jan. 1879. I think it safe to contend that the country was practically free from doubt as to their redemption after the early part of 1877. The discount steadily diminished as the time of redemption approached. Laughlin's theory is thus far beautifully vindicated. The central fact governing the value of the Greenbacks during this period was the prospect of redemption. But, and here I think we see the influence of the money-use, the discount was not as great as would have been called for by the prevailing rate of interest, as measured by the yield on other obligations of the Federal Government, at this time. And the discount completely disappeared some little time before the actual redemption. I see no cause for the absence of a discount in the later months of 1878 except the additional value which came from the money use. This additional value is, ordinarily, not very great. And money is not alone in possessing it. In extraordinary circumstances it may become quite large. Thus, in 1873, in the midst of the panic, the gold premium fell sharply. At this time the significance of the Greenbacks as a legal tender, a means of final payment of obligations (Zahlungs- or Solutions-mittel), as distinguished from medium of exchange (Tauschmittel), attained an unusual significance. In ordinary times, the marginal value of this function of money sinks to zero, but in emergencies it may become very great. In ordinary times, during the Greenback period, uncoined gold bullion, or gold coin used, not as money, but simply by weight in exchanges, played an important rÔle, competing with the Greenbacks in various employments, particularly as bank reserves, and as secondary bank reserves, and so reducing the marginal value of the money-employment of the Greenbacks themselves. Gold bullion is not the only thing which can thus serve, however. To-day, and generally, securities with a wide market, capable of being turned quickly into cash, without loss, or capable of serving as the basis of collateral loans, up to a high percentage of their value, have a much higher value, for a given yield, than have other securities, equally safe, but less well-known and less easily saleable. The "one-house bond" (i. e., the bond for which only one banking house offers a ready market) must yield a great deal more to sell at a given price than the bond of equal security which is listed on the exchanges, and has a wide market. Part of this is in illustration of another function of money, the "bearer of options" function, which enables the holder to preserve his wealth, and at the same time keep options for increasing its amount when bargains appear in the market. Foreign exchange performs many of these functions of money in European countries, particularly Austria-Hungary.[127]
The notion that the whole value of gold coin rests on its bullion content arises most easily in a situation where free coinage has long been practiced, and where there are no legal obstacles to the melting down of coin for other uses. Where free coinage is suspended, the peculiar services which only money can perform—or rather, the services which money has a differential advantage in performing—may easily lead to an agio for coined over uncoined metal. The mere fact that coined metal is of a definite fineness well known and attested is often of some consequence, though the attestation of well-known jewelers may give this advantage to metal bars as well, for large transactions. But for smaller transactions, nothing can easily take the place of money. A high premium on small coins, apart from redemption in standard money, may easily arise from the money-use alone. And standard coin may well attain, in greater or less degree, a premium. If it is scarce, as compared with the amount of business to be done, this premium may well be greater than if it is abundant. But that an indefinite premium is possible, or that this premium varies exactly and inversely with the quantity, I see no reason at all for supposing. If the premium be great enough, men, especially in large transactions, will make use of the uncoined metal—just as they did use gold in this country during the Greenback period. The advantages of money are not absolute. Money is simply more convenient for many purposes than other things. The possibility of a premium is limited by the possibility of substitutes. It is further limited by the fact that a high premium would awaken a distrust which would bring the premium to destruction, by destroying trade, and so destroying the money-use on which the premium is based.
A detailed discussion of the Indian Rupee since 1893 lies outside the scope of this chapter. I think it may be well, however, to recognize at this point that the limitation in the quantity of the rupee, through abrogation of free coinage, was a factor in the subsequent rise in its value. It was not the only factor, by any means. But it was a factor. It may be also recognized as a factor in the value of Austrian paper money.
The doctrine just laid down, as to the influence of the money-use in adding to the value of money, is in no sense the same as the quantity theory. For one thing, it is easily demonstrated that the value-curve for the uses of money is not described by the equation, xy = c. This curve expresses, in terms of value, the idea of proportionality which is an essential part of the quantity theory. Put in terms of the money market, we have a demand-curve for money, not for the long-time possession of money, but for its temporary use—a rental, rather than a capital value, is expressed in the price which this curve helps to determine. This curve is highly elastic. When money-rates are low, transactions will be undertaken which will not be undertaken when the rate is a little higher. In the second place, the method of approach is very different. It is not the whole volume of transactions which must employ money, but only a flexible part. In the third place, the money-use is here conceived of as a source, not of the whole value of money, but only of a differential portion of that value. In the fourth place, the argument runs in terms of the absolute value of money, and not in terms of the level of prices.
It is not the legal peculiarity of money, as legal tender, which is necessarily responsible for this agio when it appears. In the first place, not all money is legal tender. In the second place, we find the same phenomenon in connection with "bank-money" at times—I would refer especially to the premium on the marc banko of the Hamburg Girobank. (Cf. Knapp, Staatliche Theorie des Geldes, p. 136.) The legal tender peculiarity may, however, in special circumstances be a source of a very considerable temporary agio.
It is possible, however, to frame a hypothetical case in which, barring temporary emergencies, the money-use will add nothing to the value of money, and in which the whole value of money will come from the value of the commodity chosen as the standard of values. Assume that the standard of value is defined as a dollar, which is further defined as 23.22 grains of pure gold. Assume, however, that no gold is coined. Let the circulating money be made of paper. Let this paper be redeemable, not in gold, but in silver, at the market ratio, on the day of redemption, of silver to gold. This will mean that varying quantities of silver will be given by the redeeming agencies for paper, but always just that amount required to procure 23.22 grains of gold. Let us assume, further, that the government issues paper money freely on receipt of the same amount of silver. Assume, further, that the government bears the charges which the friction of such a system would entail, by opening numerous centres of issue and redemption, by providing insurance against fluctuations in the ratio of silver to gold for a reasonable time before issue and after redemption, meeting transportation charges, brokerage fees, etc. In such a case, the standard of value would not be used as money at all. It would have no greater value than it would if it were not the standard of value—abstracting from the fact that in the one case it might be used in its uncoined form as a substitute for money more freely than in the other. In any case, it would form no part of the quantity of money. Its whole value would come from its commodity significance. The value of the paper money, however, would be tied absolutely to the value of gold. As gold rose in value, the paper money would rise in value, and vice versa. The quantity of money would be absolutely irrelevant as affecting its value. The quantity of silver would be likewise irrelevant. The causation as between quantity of money and value of money would be exactly the reverse of that asserted by the quantity theory. A high value of money would mean lower prices. With lower prices, less money would be needed to carry on the business of the country. Paper would then be superabundant. But in that case, paper would rapidly be sent in for redemption, and the quantity of money would be reduced.[128] The value of money would control the quantity of money. The standard of value, which was not the medium of exchange, would control the value of money, and so the level of prices, in so far as the level of prices is controlled from the money side.
In this hypothetical illustration, we have the extreme case of what the Commodity or Metallist School seems to assert. In this case, barring temporary emergencies too acute to admit of increasing the money-supply by the method described, their theory that the value of money comes wholly from the commodity value of the standard, would offer a complete explanation. I offer this illustration as the antithesis of the dodo-bone illustration of Nicholson. That illustration sets forth the extreme claims of the quantity theory, and purports to be a case in which the quantity theory would work perfectly. The case illustrative of the commodity theory clearly brings out the fact that that theory rests on exclusive attention to the standard of value function of money. The dodo-bone theory gives exclusive attention to, but very imperfect analysis of, the medium of exchange function. But I submit that the extreme case of the commodity theory, in the illustration I have given, is a thinkable and consistent system. It would work—even though not conveniently. Indeed, it resembles in essentials the plan actually proposed by Aneurin Williams, and later by Professor Irving Fisher[129] for stabilizing the value of money. Substitute a composite commodity for gold, and gold for silver, in the illustration, and you have the essentials of that plan. The dodo-bone hypothesis, however, as I have been at elaborate pains to show in the foregoing, is unthinkable. It would not work. It is, thus, possible to construct a system for which the commodity theory would offer a complete explanation. It is not possible to do this for the quantity theory.
But the limiting case for the commodity theory is not the actual case. Standard money is also commonly a medium of exchange. Standard money is particularly desirable in bank and government reserves. Its employment in these and other ways is a valuable employment, and adds directly to its value both as money and in the arts. There is a marginal equilibrium between its values in the two employments. The notion that the only way in which the money employment adds to the value of money is an indirect one, by withdrawing gold from the arts, so lessening its supply and raising its value there, may be proved erroneous by this consideration: what, in that case, would determine the margin between the two employments? What force would there be to withdraw gold from the arts at all? Why should more rather than less be withdrawn? There must be ascending curves on both sides of the margin. Gold money in small amount has a high significance per unit in the money employment. A greater amount has a smaller significance per unit. The marginal amount of gold put to work as money has a comparatively low significance in that employment—a significance just great enough to secure it from the competing employments in the arts.
We conclude, then, that money must have value to start with, from some source other than the money function, and that there must always be some source of value apart from the money function, if money is to circulate, or to serve as money in other ways. But this is not to assert the doctrine of the commodity school, that its value must arise from the metal of which it is made, or in which it is expected to be redeemed. Nor is it to deny that the money function may add to the original value. On the contrary, the services which money performs are valuable services, and add directly, under conditions which we shall analyze more fully in a later chapter on the functions of money, to the value derived from non-pecuniary sources. Value is not physical, but psychical. And value is not bound up inseparably with labor-pain or marginal utility.
In Professor Irving Fisher's Purchasing Power of Money[130] we have the most uncompromising and rigorous statement of the quantity theory to be found in modern economic literature. We have, too, a book which follows the logic of the quantity theory more consistently than any other work with which I am acquainted. The book deals with the theory more elaborately and with more detail than any other single volume, and sums up most of what other writers have had to say in defence of the quantity theory. Professor Fisher's book has, moreover, received such enthusiastic recognition from reviewers and others as to justify one in treating it as the "official" exposition of the quantity theory. Thus, Sir David Barbour cites Professor Fisher as the authority on whom he relies for such justification of the theory as may be needed,[131] while Professor A. C. Whitaker declares that he adopts "without qualification the whole body of general monetary theory" for which Professor Fisher stands.[132] Professor J. H. Hollander has recently referred to Professor Fisher's work on money and prices as a model of that combination of theory and inductive verification which constitutes real science.[133] The American Economic Review presents as an annual feature Professor Fisher's "Equation of Exchange."
Not all, by any means, of those who would call themselves quantity theorists would concur in Professor Fisher's version of the doctrine—Professor Taussig, notably, introduces so many qualifications, and admits so many exceptions, that his doctrine seems to the present writer like Professor Fisher's chiefly in name. But there is no other one book which could be chosen which would serve nearly as well for the "platform" of present-day quantity theorists as The Purchasing Power of Money. Partly for that reason, and partly because the book lends itself well to critical analysis, I shall follow the outline of the book in my further statement and criticism of the quantity theory, indicating Professor Fisher's views, and indicating the points at which other expositions of the quantity theory diverge from his, setting his views in contrast with those of other writers. We shall find that this method of discussion will furnish a convenient outline on which to present our final criticisms of the quantity theory, and parts of the constructive doctrine of the present book.
First, Professor Fisher presents in the baldest possible form the dodo-bone doctrine. The quality of money is irrelevant. The sole question of importance is as to its quantity—the number of money-units.[134] I shall not here discuss this point, as a previous chapter has given it extended analysis, except to repeat that it is in fact an essential part of the quantity theory. If the quality of money is a factor, a necessary factor, to consider, then obviously we have something which will disturb the mechanical certainty of the quantity theory. Professor Fisher is thoroughly consistent with the spirit of his general doctrine on this point.
Second, Professor Fisher has no absolute value in his scheme. By the value of money he means merely its purchasing power, and by its purchasing power he means nothing more than the fact that it does purchase: the purchasing power of money is defined as the reciprocal of the level of prices, "so that the study of the purchasing power of money is identical with the study of price levels." (Loc. cit., p. 14.) In this, again, Professor Fisher is absolutely true to the spirit and logic of the quantity theory doctrine. The equilibration of numbers of goods, and numbers of dollars, in a mechanical scheme, gives prices—an average of prices, and nothing else. Any psychological values of goods or of dollars would upset the mechanism, and mess things up. They are properly left out, if one is to be happy with the quantity theory. Fisher, in discussion of Kemmerer's Money and Credit Instruments, has criticised the exposition of the utility theory of value with which Kemmerer prefaces his exposition of the quantity theory, as "fifth wheel." I agree thoroughly with Fisher's view in this, and would add that the only reason that it has made Kemmerer little trouble in the development of his quantity theory is that he has made virtually no use of it there! The two bodies of doctrine, in Kemmerer's exposition, are kept, on the whole, in separate chapters, well insulated. Coupled with this purely relative conception of the value of money, however, there is, in Fisher's scheme, an effort to get an absolute out of it: the general price-level is declared to be independent of, and causally prior to,[135] the particular prices of which it is an average. I mention this remarkable doctrine here, reserving its discussion for a later chapter.[136]
A further feature of Professor Fisher's system, to which especial attention must be given, is the large rÔle played in it by the "equation of exchange." This device has been used by other writers before him, notably by Newcomb, Hadley, and Kemmerer, receiving at the hands of the last named an elaborate analysis. But Fisher, basing his work on Kemmerer's, has made even more extensive use of the "equation of exchange," and has given it a form which calls for special consideration.[137] The "equation of exchange," on the face of it, makes an exceedingly simple and obvious statement. Properly interpreted, it is a perfectly harmless—and, in the present writer's opinion, useless—statement. It gives rise to complications, however, as to the meaning of the algebraic terms employed, which we shall have to study with care. The starting point is a single exchange: a person buys 10 pounds of sugar at seven cents a 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."[138] The money employed in these transactions usually serves several times, and hence the money side of the equation is greater than the total amount of money in circulation. In the preliminary statement of the equation of exchange, foreign trade, and the use of anything but money in exchanges are ignored, but later formulations of the equations are made to allow for them. "The equation of exchange is simply the sum of the equations involved in all individual exchanges in a year.... 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."
Letting M represent quantity of money, and V its velocity or rapidity of circulation, p, p´, p´´, etc., the average prices for the period of different kinds of goods, and Q, Q´, Q´´, etc., the quantities of different kinds of goods, we get the following equation:
MV = pQ + p´Q´ + p´´Q´´ + etc.[139]
"The right-hand side of this equation is the sum of terms of the form pQ—a price multiplied by the quantity bought."[140] The equation may then be written,
MV = S pQ (Sigma being the symbol of summation). The equation is further simplified[141] by rewriting the right-hand side as PT, where P is the weighted average of all the p's, and T is the sum of all the Q's. "P then represents in one magnitude the level of prices, and T represents in one magnitude the volume of trade."
It may seem like captious triviality to raise questions and objections thus early in the exposition of Professor Fisher's doctrine. And yet, serious questions are to be raised. First, in what sense is there an equality between the ten pounds of sugar and the seventy cents? Equality exists only between homogeneous things. In what sense are money and sugar homogeneous? From my own standpoint, the answer is easy: money and sugar are alike in that both are valuable, both possess the attribute of economic social value, an absolute quality and quantity. The degree in which each possesses this quality determines the exchange relation between them. And the degree in which each other good possesses this quality, taken in conjunction with the value of money, determines every other particular price. Finally, an average of these particular prices, each determined in this way, gives us the general price-level. The value of the money, on the one hand, and the values of the goods on the other hand, are both to be explained as complex social psychological forces. But when this method of approach is used, when prices are conceived of as the results of organic social psychological forces, there is no room for, or occasion for, a further explanation in terms of the mechanical equilibration of goods and money. Professor Fisher, as just shown, very carefully excludes this and all other psychological approaches to his problem of general prices, and has no place in his system for an absolute value. In what sense, then, are the sugar and the money equal? Professor Fisher says (p. 17), that the equation is an equation of values. But what does he mean by values in this connection? Perhaps a further question may show what he must mean, if his equation is to be intelligible. That question is regarding the meaning of T.
T, in Professor Fisher's equation, is defined as the sum of all the Q's. But how does one sum up pounds of sugar, loaves of bread, tons of coal, yards of cloth, etc.? I find at only one place in Professor Fisher's book an effort to answer that question, and there it is not clear that he means to give a general answer. He needs units of Q which shall be homogeneous when he undertakes to put concrete figures into his equation for the purpose of comparing index numbers and equations for successive years. "If we now add together these tons, pounds, bushels, etc., and call this grand total so many 'units' of commodity, we shall have a very arbitrary summation. It will make a difference, for instance, whether we measure coal by tons or hundred-weights. The system becomes less arbitrary if we use, as the unit for measuring any goods, not the unit in which it is commonly sold, but the amount which constitutes a 'dollar's worth' at some particular year called the base year" (p. 196). If this be merely a device for the purpose of handling index numbers, a convention to aid mensuration, we need not, perhaps, challenge it. The unit chosen is, in that case, after all a fixed physical quantity of goods, the amount bought with a dollar in a given year, and remains fixed as the prices vary in subsequent years. That it is more "philosophical" or less "arbitrary" than the more common units is not clear, but, if it be an answer, designed merely for the particular purpose, and not a general answer, it is aside from my purpose to criticise it here. If, however, this is Professor Fisher's general answer to the question of the method of summing up T, if it is to be employed in his equation when the question of causation, as distinguished from mensuration, is involved, then it represents a vicious circle. If T involves the price-level in its definition, then T cannot be used as a causal factor to explain the price-level. I shall not undertake to give an answer, where Professor Fisher himself fails to give one, as to his meaning. I simply point out that he himself recognizes that the summation of the Q's is arbitrary without a common unit, and that the only common unit suggested in his book, if applied generally, involves a vicious circle.
What, then, is T? Perhaps another question will aid us in answering this. What does it mean to multiply ten pounds of sugar by seven cents? What sort of product results? Is the answer seventy pounds of sugar, or seventy cents, or some new two-dimensional hybrid? One multiplies feet by feet to get square feet, and square feet by feet to get cubic feet. But in general, the multiplication of concrete quantities by concrete quantities is meaningless.[142] One of the generalizations of elementary arithmetic is that concrete quantities may usually be multiplied, not by other concrete quantities, but rather by abstract quantities, pure numbers. Then the product has meaning: it is a concrete quantity of the same denomination as the multiplicand. If the Q's, then, are to be multiplied by their respective p's, the Q's must be interpreted, not as bushels or pounds or yards of concrete goods, but merely as abstract numbers. And T must be, not a sum of concrete goods, but a sum of abstract numbers, and so itself an abstract number. Thus interpreted, T is equally increased by adding a hundred papers of pins,[143] a hundred diamonds, a hundred tons of copper, or a hundred newspapers. This is not Professor Fisher's rendering of T, but it is the only rendering which makes an intelligible equation.
We return, then, to the question with which we set out: in what sense is there an equality between the two sides of Professor Fisher's equation? The answer is as follows: on one side of the equation we have M, a quantity of money, multiplied by V, an abstract number; on the other side of the equation, we have P, a quantity of money, multiplied by T, an abstract number. The product, on each side, is a sum of money. These sums are equal. They are equal because they are identical. The equation asserts merely that what is paid is equal to what is received. This proposition may require algebraic formulation, but to the present writer it does not seem to require any formulation at all. The contrast between the "money side" and the "goods side" of the equation is a false one. There is no goods side. Both sides of the equation are money sides. I repeat that this is not Professor Fisher's interpretation of his equation. But it seems the only interpretation which is defensible.
A further point must be made: Sigma pQ, where the Q's are interpreted as abstract numbers, is a summary of concrete money payments, each of which has a causal explanation, and each of which has effected a concrete exchange. Mathematically, PT is equal to SpQ, just as 3 times 4 is equal to 2 times 6. But from the standpoint of the theory of causation, a vast difference is made. Three children four feet high equal in aggregate height two men six feet high. But the assertion of equality between the three children and the two men represents a high degree of abstraction, and need not be significant for any given purpose. Similarly, the restatement of SpQ as PT. One might restate SpQ as PT, defining P as the sum (instead of the average) of the p's, and T as the weighted average (instead of the sum) of the Q's. Such a substitution would be equally legitimate, mathematically, and the equation, MV = PT equally true. SpQ might be factorized in an indefinite number of ways. But it is important to note that in PT, as defined by Professor Fisher,[144] we are at three removes from the concrete exchanges in which actual concrete causation is focused: we have first taken, for each commodity, an average, for a period, say a year, of the concrete prices paid for a unit of that commodity, and multiplied that average by the abstract number of units of that commodity sold in that year; we have then summed up all these products into a giant aggregate, in which we have mingled hopelessly a mass of concrete causes which actually affected the particular prices; then, finally, we have factorized this giant composite into two numbers which have no concrete reality, namely, an average of the averages of the prices, and a sum of the abstract numbers of the sums of the goods of each kind sold in a given year—a sum which exists only as a pure number, and which, consequently, is unlikely to be a causal factor! It may turn out that there is reason for all this, but if a causal theory is the object for which the equation of exchange is designed, a strong presumption against its usefulness is raised. Both P and T are so highly abstract that it is improbable that any significant statements can be made of either of them. As concepts gain in generality and abstractness, they lose in content; as they gain in "extension" they lose (as a rule) in "intension." On the other side of the equation, we also look in vain for a truly concrete factor. V, the average velocity of money for the year, is highly abstract. It is a mathematical summary of a host of complex activities of men. Professor Fisher thinks that V obeys fairly simple laws, as we shall later see, but at least that point must be demonstrated. Even M is not concrete. At a given moment, the money in circulation is a concrete quantity, but the average for the year is abstract, and cannot claim to be a direct causal factor, with one uniform tendency. Of course Professor Fisher himself recognizes that his central problem is, not to state and justify, mathematically, his equation[145]—that is a work of supererogation, and the statistical chapters devoted to it seem to me to be largely wasted labor. Professor Fisher recognizes that his central problem is to establish causal relations among the factors in his equation of exchange. It is from the standpoint of its adaptability as a tool in a theory of causation that I have been considering it. It should be noted that "volume of trade," as frequently used, means not numbers of goods sold, but the money-price of all the goods exchanged, or PT. It is in this sense of "trade" that bank-clearings are supposed to be an index of volume of trade. The sundering of the p's and Q's really is a big assumption of many of the points at issue. Indeed, it is absolutely impossible to sunder PT. It is always the p aspect of the thing that is significant, Fisher himself finally interprets T, statistically, as billions of dollars.[146] As a matter of mathematical necessity, either P must be defined in terms of T or T defined in terms of P. The V's and M and M´ may be independently defined, and arbitrary numbers may be assigned for them limited only by the necessity that MV + M´V´ be a fixed sum.[147] But P and T cannot, with respect to each other, be thus independently defined. The highly artificial character of T has been pointed out by Professor E. B. Wilson, of the Massachusetts Institute of Technology, in his review of Fisher's Purchasing Power of Money in the Bulletin of the American Mathematical Society, April, 1914, pp. 377-381. "Various consequences are readily obtained from the equation of exchange, but the determination of the equation itself is not so easy as it might look to a careless thinker. The difficulties lie in the fact that P and T individually are quite indeterminate. An average price-level P means nothing till the rules for obtaining the average are specified, and independent rules for evaluating P and T may not satisfy [the equation.] For instance, suppose sugar is 5c. a pound, bacon 20c. a pound, coffee 35c. a pound. The average price is 20c. If a person buys 10 lbs. of sugar, 3 lbs. of bacon, and 1 lb. of coffee, the total trading is in 14 lbs. of goods. The total expenditure is $1.45; the product of the average price by the total trade is $2.80; the equation is very far from satisfied." Wilson thinks it necessary, to make the matter straight, to define T, arbitrarily as (MV + M´V´)/P in which case, the equation is true, but so obviously a truism that no one would see any point in stating it. T no longer has any independent standing. Fisher has, however, an escape from this status for T, but only by reducing P to the same position. He defines P as the weighted average of the p's (27), and fails, I think, to see how completely this ties it up with T. The only method of weighting the p's that will leave the equation straight is to weight the different prices by the number of units of each kind of good sold, namely, T. Thus, in Wilson's illustration, we would define P as [(5c.×10) + (20c.×3) + (35c.×1)]/14 P is then 105/14 c., while T is 14. PT is, then, equal to $1.45, which is the total expenditure, or MV + M´V´. Be it noted, here, that P is defined in terms of T, i. e., P is defined as a fraction, the denominator of which is T. No other definition of P will serve, if T is to be defined independently.
But notice the corollary. P must be differently defined each year, for each new equation, as T changes in total magnitude, and as the elements in T are changed. The equation cannot be kept straight otherwise. Suppose that the prices remain unchanged in the next year, but that one more pound of coffee, and two less pounds of sugar are sold. P, as defined for the equation of the preceding year would no longer fit the equation. P, as previously defined, would be unaltered, since none of the prices in it had changed. P, defined as a weighted average with the weights of the first year, would, then, still be 105/14 cents. The T in the new equation is 13. The product of P and T is $1.349/14. But the total expenditure, (MV + M´V´) is $1.70. The equation is not fulfilled. To fulfill the equation, it is necessary to get a new set of weights for P, in terms of the new T of the new equation. From the standpoint of a causal theory, this is delightful. P is the problem. But you are not allowed to define the problem until you know what the explanation is! Then you define the problem as that which the explanation will explain!
Fisher, however, appears unaware of this. At all events, he does not mention it. And he ignores it in filling out his equation statistically, for he assigns one set of weights to the particular prices in his P throughout.[148]
The causal theory with which the equation of exchange is associated is as follows: P is passive. A change in the equation cannot be initiated by P. If P should change without a prior change in one of the other factors, forces would be set in operation which would force it back to its original magnitude. M and T are independent magnitudes. A change in one does not occasion a change in the other. An increase or decrease in M will not cause a change in V. Therefore, an increase in M must lead to a proportionate increase in P, and a decrease in M to a proportionate decrease in P, if the equation is to be kept straight. Changes in T have opposite proportional effects on P.
Before examining the validity of the causal theory, and the arguments by which it is supported, it will be best to state the more complex formula which Professor Fisher advances as expressing the facts of to-day. The original formula ignored credit, and ignored the possibility of resort to barter. It also failed to reckon with certain complications which Fisher deals with as "transitional" rather than "normal."
The formula which includes credit is as follows:
Here, MV and PT have the same significance as before. M´ is the average amount of bank-deposits in the given region for the given period, and V´ is the velocity of circulation of those deposits. M, money, consists of all the media of exchange in circulation which are generally acceptable, as distinguished from those which are acceptable under particular conditions, as by endorsement. M excludes money in bank reserves and government vaults. Money, specifically, includes gold and silver coin, minor coins, government paper money, and bank-notes; M´ consists of deposits transferable by check. This version would not satisfy such a writer as Nicholson,[149] who would limit money to gold coin, and would include in M´ not only deposits, but also bank-notes, and other credit instruments. I may suggest here, what I shall later emphasize, that Fisher's "money," though he doubtless is using the most common definition of money, is really a pretty heterogeneous group of things, concerning which it is possible to make few general statements safely. In economic essence, e. g., bank-notes are much more like deposits than like gold, and if one wishes to separate money and credit, bank-notes belong with M´ rather than with M. But we must take the theory as we find it! Again, credit is by no means exhausted when bank-deposits are named. Why should not book-credits, and bills of exchange be included? Why not postal money-orders, why not deposits subject to transfer by the giro-system? M´ is defined[150] as "the total deposits subject to transfer by check," and would, thus, exclude the giro-system of Germany. It is surely a very provincial equation of exchange, with which Fisher and Kemmerer seek to set forth the universal laws of money! Fisher's reason for excluding book-credits is that book-credits merely postpone, and do not dispense with, the use of money and checks.[151] Book-credits, unlike deposits, have no direct effect on prices (Ibid., 82, n.; 370), but only an indirect effect, by increasing the velocity of money. (Ibid., 81-82; 370-371.) Book-credit, indeed "time-credit" in general thus has no direct effect on prices, and is properly excluded from the equation of exchange. These distinctions seem to me highly artificial. In the first place, the use of checks, in part, merely postpones the use of money: money is moved back and forth from one part of the country to another, and from one bank to another, to the extent that checks fail to offset one another, and in the case of book-credit, while there is less of this offsetting, there is a good deal of it, especially between stockbrokers in different cities, and in small towns and at country stores, and particularly in the South, where the country storekeeper and "factor" are also dealers in cotton, etc., and where they advance provisions during the year to the small farmers, receiving their pay, in considerable degree, not in money, but in cotton, which they credit on the books in terms of money to the customer—a point which Fisher mentions in an appendix. (Ibid., p. 371.) The difference on this point is a difference in degree merely.[152] Further, Fisher makes the same point with reference to deposits subject to check that he makes with reference to book-credits, namely, that their use increases the velocity of money. To say that one has a direct effect on prices, and the other only an indirect effect is absolutely arbitrary. If buying and selling are what count, if prices are forced up by the offer of money or credit for goods, and forced down as the amount of money and credit offered for goods is reduced, then one exchange must count for as much as any other of like magnitude in fixing prices. The same is true of transactions in which bills of exchange or other credit devices serve as media of exchange. Of course these considerations do not render the equation of exchange, as presented by Fisher, untrue. The equation simply states that the money and bank-deposits used in paying for goods in a given period are equal to the amount paid for those goods in a given period. It makes no assertion concerning payments for other goods, and makes no assertion as to the amount of other transactions which are paid for in other ways. General Walker, presented with the problem of credit phenomena, simplifies the thing even more.[153] He rules out all exchanges which are effected by credit devices, counting only those performed by coin, bank-notes and government paper money, and insists that the general price-level is determined in those exchanges in which money alone (as thus defined) is employed. His equation—if he had considered it worth while to use one—would then have been simply
where T would be merely the number of goods exchanged by means of money. One could make a similar equation, equally true, by defining money as gold coin, and reducing T correspondingly. Is there any reason for limiting the equation at all?[154] Is there any reason for supposing that any one set of exchanges is more significant for the determination of the price-level than any other set of exchanges? Does not the logic of the quantity theory require us to include all exchanges which run in terms of money?—If one wishes a complete picture of the exchanges, some such equation as this would be necessary:
MV + M´V´ + BV´´ + EV´´´ + OV´´´´ = PT,
where B represents book-credit, V´´ the number of times a given average amount of book-credit is used in the period, E bills of exchange, and V´´´ their velocity of circulation, and O all other substitutes for money, with V´´´´ as their velocity of circulation. Even then we have not a complete picture, if direct barter or the equivalents of barter can be shown to be important.
For the present, I waive a discussion of the comparative importance of these different methods of conducting exchanges. The situation varies greatly with different countries. Fisher's and Kemmerer's equations are at best plausible when presented as describing American conditions, are much less plausible when applied to Canada and England, and are caricatures when applied to Germany and France.
So much for the statement of the equation of exchange, except that it is important to add that the period of time chosen for the equation is one year. Just why a year, rather than a month or two years or a decade should be chosen, may await full discussion till later. I shall venture here the opinion that the yearly period is not the period that should have been chosen from the standpoint of Fisher's causal theory, and that it probably was chosen, if for any conscious reason at all, because of the fact that statistical data which Fisher wished to put into it are commonly presented as annual averages. The question now is, however, as to the use to be made of the equation in the development of a causal theory.
CHAPTER IX
THE VOLUME OF MONEY AND THE VOLUME OF CREDIT
John Stuart Mill, who first among the great figures in economics gives a realistic analysis of modern credit phenomena, thought that credit acts on prices in the same way that money itself does[155] and that this reduces the significance of the quantity theory tendency greatly, and to an indeterminate degree. The quantity theory is largely whittled away in Mill's exposition of the influence of credit. In Fisher we have a much more rigorous doctrine. The quantity of money still governs the price-level, because M governs M´. The volume of bank-deposits depends on the volume of money, and bears a pretty definitely fixed ratio to it. Just how close the relation is, Professor Fisher does not say, but the greater part of his argument, especially in ch. 8,[156] rests on the assumption that the ratio is very constant and definite indeed. At all events, the importance of the theory, as an explanation of concrete price-levels, will vary with the closeness of this connection, and the invariability of this ratio. It is not too much to say that the book falls with this proposition, to wit, that M controls M´, and that there is a fixed ratio between them. We would expect, therefore, a very careful and full demonstration of the proposition, a care and fullness commensurate with its importance in the scheme. But the reader will search in vain for any proof, and will find only two propositions which purport to be proof. These are: (1) that bank reserves are kept in a more or less definite ratio to bank deposits; (2) that individuals, firms and corporations preserve more or less definite ratios between their cash transactions and their check transactions, and between their cash on hand and their deposit balances.[157]
If these be granted, what follows: the money in bank-reserves is no part of M! M is the money in circulation, being exchanged against goods, not the money lying in bank-vaults![158] The money in bank-vaults does not figure in the equation of exchange. As to the second part of the argument, if it be granted, it proves nothing. The money in the hands of individual and corporate depositors is by no means all of M. It is not necessarily the greatest part. The money in circulation is largely used in small retail trade, by those who have no bank-accounts. A good many of the smallest merchants in a city like New York have no bank-accounts, since banks require larger balances there than they can maintain. Enormous quantities of money are carried in this country by laborers, particularly foreign laborers. "The Chief of the Department of Mines of a Western State points out that when an Italian, Hungarian, Slav or Pole is injured, a large sum of money, ranging from fifty dollars to five hundred or one thousand, is almost always to be found on his person. A prominent Italian banker says that the average Italian workman saves two hundred dollars a year, and that there are enough Italian workmen in this country, without considering other nationalities, to account for three hundred million dollars of hoarded money."[159] I do not wish to attach too great importance to these figures, taken from a popular article in a popular periodical. It is proper to point out, too, that these figures relate to hoarded money, rather than to M, the money in circulation. But in part these figures represent, not money absolutely out of circulation, but rather, money with a sluggish circulation. And they are figures of the money in the hands of poor and ignorant elements of the population. Outside that portion of the population—larger in this country than in any other by far[160]—which keeps checking accounts, are a large body of people, the masses of the big cities, the bulk of rural laborers, especially negroes, the majority of tenant farmers, a large proportion of small farm owners, especially nominal owners, and not a few small merchants in the largest cities, who have no checking accounts at all. A very high percentage of their buying and selling is by means of money. Kinley's results[161] show that 70% of the wages in the United States are paid in cash, and, of course, the laborers who receive cash pay cash for what they buy. (Not necessarily at the time they buy!) Money for payrolls is one of the serious problems in times of financial panics.[162] To fix the proportion between money in the hands of bank depositors and non-depositors is not necessary for my purposes—a priori I should anticipate that there is no fixed proportion. But it is enough to point out that money in the hands of depositors is not the whole of Fisher's M. Of what relevance is it, then, to point out, even if it were true, that an unascertainable portion of M tends to keep a definite ratio to M´, when the thing to be proved is that the whole of M tends to keep a definite ratio to M´? Fisher's argument is a clear non-sequitur. If it proves anything, it proves that a sum of money,[163] not part of M, and another sum of money, an unknown fraction of M, each independently, for reasons peculiar to each sum, tends to keep a constant ratio to M´. This gives us l'embarras des richesses from the standpoint of a theory of causation! Two independent factors, bank-reserves and money in the hands of depositors, each tending to hold bank-deposits in a fixed ratio, and yet each moved by independent causes! By what happy coincidence will these two tendencies work together? Or what is the causal relation between them? And if, for some yet to be discovered reason, Professor Fisher should prove to be right, and there should be a fixed ratio between M as a whole and bank-deposits, would it not indeed be a miracle if all three "fixed ratios" kept together? Bank-deposits, indissolubly wedded to three independent variables[164] (independent, at least, so far as anything Professor Fisher has said would show, and independent in large degree, certainly, so far as any reason the present writer can discover), must find their treble life extremely perplexing. May it not be that Professor Fisher has pointed the way to the real fact, namely, that bank-deposits are subjected to a multitude of influences, no one of which is dominant, which prevent any fixed ratio between bank-deposits and any other one thing? At a later point, I shall maintain that this is, indeed, the case.
Be it noted further, however, that even if we grant a fixed ratio, on the basis of Fisher's argument, between M and M´, Fisher has offered no jot of proof that the causation runs from M to M´. He simply assumes that point outright. "Any change in M, the quantity of money in circulation, requiring as it normally does a proportional change in M´, the volume of deposits subject to check." (Ibid., p. 52, Italics mine.) For this, no argument at all is offered. A fixed ratio, so far as causation is concerned, might mean any one of three things: (a) that M controls M´; (b) that M´ controls M; (c) that a common cause controls both. Fisher does not at all consider these alternative possibilities. I shall myself avoid a sweeping statement as to the causal relations among the factors in the equation, because I do not think that any of the factors is homogenous enough, as an aggregate, to be either cause or effect of anything. But if a generalization concerning these magnitudes were required, I should be disposed to assert that the third alternative is the most defensible, and that to the extent that M and M´ vary together it is under the influence of a common cause, namely, PT! That is to say, that the volume of bank-deposits and the volume of money tend to increase or decrease in a given market—and Fisher's theory is a theory of the market even of a single city[165]—because of increases or decreases in PT (considered as a unitary cause rather than as two separate factors) in that market. But I shall not put my proposition in quite that form, as I find the factors in the equation of exchange too indefinite for satisfactory causal theory.
So much for the validity of Fisher's argument, assuming the facts to be as he states them. Are the statements correct? Do banks tend to keep fixed ratios between deposits and reserves? Do individuals, firms, and corporations tend to keep fixed ratios between their cash on hand and their balances in bank? Regarding this last tendency, Professor Fisher says in a footnote on p. 50, "This fact is apparently overlooked by Laughlin." I think it has been generally overlooked. I have found no one who has discovered it except Professor Fisher. Certainly no depositor whom I have consulted can find it in his own practice—and I have put the question to "individuals, firms, and corporations." The further statement which Professor Fisher adduces in its support does not prove it, namely, that cash is used for small payments, and checks for large payments.[166] It would be necessary to go further and prove that large and small payments bear a constant ratio to one another, and further, that velocities of money and of bank-deposits employed in these ways bear a constant relation. If Fisher has any concrete data, of a statistical nature, to support the doctrine of a constant ratio between bank-balance and cash on hand in the case of individual depositors, he has failed to put them into his book. Nor is there any statistical evidence offered in the case of banks. It should be noted here that finding a general average for a whole country or community would not prove Fisher's point. General averages give no concrete causal relations. Fisher's argument, moreover, starts with individual banks and individual deposit-accounts (pp. 46 and 50) and generalizes the individual practice into a community practice. He would have to offer data as to individual cases.
While general averages could not prove the contention of a constant ratio between reserves and deposits for individual banks, general averages can disprove the contention. A constant general average would be consistent with wide variation in individual practices, on the principle of the "inertia of large numbers." But if the general average is inconstant, it is impossible that the individual factors making it up should be constant. This disproof is readily at hand, both for the ratio of deposits to reserves in the United States, and for the ratio of demand obligations to reserves among European banks (most of which do not make large use of the check and deposit system).
For the United States, from 1890 to 1911, taking yearly averages, we have a variation in the ratio of reserves to deposits of over 73% of the minimum ratio. The ratio was 26% in 1894, and 15% in 1906. "The juxtaposition of these extreme variations shows how inaccurate is the assumption that the deposit currency may be treated as a substantially constant multiple of the quantity of money in banks."[167] For New York City, the annual average percentage of reserves of Clearing House banks to net deposits varies from 24.89% in 1907 to 37.59% in 1894.[168] The extreme variations[169] in weekly averages are (for the sixteen years, 1885-1900) 20.6% in August, 1893 and 45.2% in February, 1894. These figures are extreme, since the number of occurrences is small for them, but there are numerous occurrences of deviations from the mean as wide apart as 24% and 42%.[170] The yearly fluctuation in all these ratios is very great.
The ratio of money held by the banks and money held by the people also shows wide variation, and considerable yearly fluctuation. There is a further complication, for the United States, of varying proportions of the total monetary stock held by the Federal Treasury. As between the banks and the public, the banks held about a third in 1893 (average for the year), and nearly half in 1911.[171] Whatever may be the relations between money in the hands of the people, money in banks, and volume of deposits, in "the static state," there is no statistical evidence whatever to justify the notion of fixed relations among them in real life.[172] We shall later show that there can be no static laws whatever governing the relations of credit and reserves.[173]
For European banks, the case is equally clear. European bankers deny any intention of keeping any definite reserve ratio. This appeared very clearly in the "Interviews" obtained for the Monetary Commission with leading European bankers.[174] The Banque de France increased its gold reserves, between 1899 and 1910, by 75%, but increased its discounts and advances during the same period by only 5%.[175] J. M. Keynes[176] points out that the reserves of the great banks of the world, and of Treasuries which act as central banks, have absorbed an enormous part of the gold produced in the fifteen years before the War, increasing their holdings from about five hundred million pounds sterling in 1900 to one billion pounds sterling at the outbreak of the War. "The object of these accumulations has been only dimly conceived by the owners of them. They have been piled up partly as the result of blind fashion, partly as the almost automatic consequence, in an era of abundant gold supply, of the particular currency arrangements which it has been orthodox to introduce.... The ratios of gold to liabilities vary very extremely from one country to another, without always being explicable by reference to the varying circumstances of those countries.... The contingencies, against which a gold reserve is held, are necessarily so vague that the problem of assessing the proper ratio must be, within wide limits, indeterminate. It is natural, therefore, that bankers, who must act one way or the other, should often fall back on mere usage or accept that amount of gold as sufficient which, if they are chiefly passive, the tides of gold bring them. [Italics mine.] At any rate, the management of gold reserves is not yet a science in most countries. There is no ideal virtue in the present level of these reserves. Countries have got on in the past with much less, and under force of circumstances could do so again."
It will be noticed that Keynes, in the passage cited, is speaking of gold reserves, while Fisher's contention relates to all kinds of money available for reserves, which in this country would include gold, silver dollars, greenbacks, and, for many State banks, the notes of national banks. He is also talking of the relation of reserves to demand liabilities, which for most great European banks are primarily notes, rather than of reserves to deposits. But as an exposition of the theory of the ratio of reserves to deposits (the chief liability of American banks), it is applicable to American conditions, and as a statement of the facts, it of course gives a basis for testing Fisher's doctrine generally. I do not think that Fisher's fixed ratio, as between reserves and deposits, or even the ratio which more moderate quantity theorists might seek to find between gold and demand liabilities, will find any justification in the facts of banking history.[177]
A factor which has developed on a grand scale in recent years has tended still further to weaken any tendency that may be supposed to exist toward a fixed ratio between money-reserves and demand-liabilities. I refer to the gold exchange-standard, in India, the Philippines, and elsewhere, and to the practice of the great banks of the continental countries of Europe, particularly the Bank of Austria-Hungary, of holding foreign gold bills, rather than gold exclusively, as reserve to cover note issue. In the case of the Austro-Hungarian Bank, which has carried this practice to the extreme, all possibility of a fixed ratio between gold reserves and demand-liabilities has vanished. The ratio is highly flexible. When bills are cheap, i. e., when the exchange is "in favor" of Austria-Hungary, the Bank buys bills with gold; when bills are high, when the exchanges have turned "against" Austria-Hungary, the Bank sells bills for gold. Commonly, the holder of a note of the Austro-Hungarian Bank does not ask for it to be redeemed in gold, but in foreign exchange. The reason for this practice on the part of the Bank is primarily economy. A large holding of gold would represent idle capital—a heavy burden for the Bank of a debt-ridden and poorly developed country. Foreign bills, however, serve equally well for maintaining the value of the bank-notes, and at the same time bear interest.[178] A similar practice has been employed by the Reichsbank, by the National Bank of Belgium,[179] by virtually all the debtor countries of Europe, and the great trading countries of Asia.
Confidence in these conclusions is much increased by a study of the views of Professor Taussig.[180] Professor Taussig is, in his initial formulations of his doctrine, a quantity theorist. In a situation where only money is used, credit being excluded, in effecting exchanges, he would hold that the quantity theory correctly accounts for prices. He is fond of the old formulation, as a first approximation, even in dealing with the complex facts of modern banking. But he does not dodge the complex facts, and his theory becomes, substantially, first, a general formula, and second, an elaborate body of qualifications and exceptions, the latter making up the major part of the theory. His doctrine regarding the relation of money and credit is as follows: there is, in the long run, a real limitation on elastic credit instruments in the quantity of specie. (This is very different from the assertion that there is a fixed ratio between deposits and money in circulation, including paper, bank-notes, etc., in money. The present writer has no quarrel with the doctrine that the gold supply of the world imposes outside limitations on the possible expansion of credit.) The limitation, Taussig holds, comes in two ways: (1), in the connection between prices in any one country, and prices in the world at large; (2), in various links of connection between the volume of deposits (and of notes elastic like deposits) and the quantity of specie. I shall consider at a later point the relation between prices in different countries.[181] I shall there maintain that the quantity theory, which explains gold movements on the basis of price-levels in different countries, is inadequate; that not price-levels, but particular prices, of goods most available for international trade, are of primary importance, and that of these particular prices, one, namely the "price of money," or the short time money-rate, is most significant of all. For the present, I wish to analyze the linkages which Taussig finds between elastic credit instruments and specie, and to see how far they would go, not in proving Taussig's point (with which I have little quarrel) but in proving Fisher's contentions. The points involved are: (a) Direct necessity constrains the bankers to keep some cash on hand.[182] This fixes a minimum limit (Taussig's contention), but does not at all suggest a "normal ratio" (Fisher's contention). (b) Binding custom, as to the proper amount of reserve that banks should carry, particularly important in connection with the Bank of England, but also in evidence in the Banque de France and the Reichsbank. Here again, however, minimal, rather than fixed, ratios are suggested. Limitations on the expansion of credit these customs may impose, but they by no means determine a normal, or average amount of credit expansion—in England least of all, since there is so large a flexible element in the deposits of the Joint Stock Banks, whose reserves are largely secret. The statement supra quoted from Keynes, together with the testimony of European bankers, may be considered in connection with this point, also, as to the factors determining the reserve policies of the great European banks. The extent to which custom really binds is doubtful. (c) Direct regulation by law, peculiar to the United States. Here again, a minimum, rather than a fixed ratio, is indicated. Some limitation on credit expansion by the banks is caused by this at times, but Fisher's argument would require vastly more. (d) The interaction in the use of deposits, notes, and other constituents in the circulating medium. The point involved here is that different kinds of business call for different kind of media. Small retail business is not done with hundred dollar bills, nor are stocks and bonds bought with pennies. Limiting the size of bank-notes to five pounds in England compels the use of a large amount of gold for smaller transactions, and keeps a larger amount of gold in use than would otherwise be the case. Expanding business draws cash from the banks for circulation, trenching on reserves. That Professor Taussig has a point here is not to be doubted, but how closely it limits the expansion of credit will depend on the degree to which different kinds of media of exchange really are thus specialized. In a country like the United States, where checks may be used for virtually any transaction of over a dollar, and where small change for less than a dollar will be increased by the Government to meet the demands of trade, the point would not seem to involve a practically serious limitation.
Finally, Professor Taussig recognizes a coefficient with the quantity of specie in the temper of the business community. Whether or not deposits are to expand, depends not only on reserves, but also on the attitude of borrowers.
Taussig concludes: "Thus there is only a rough and uncertain correspondence of bank expansion with bank reserves; much play for ups and downs which have no close relation to the amount of cash in bank vaults, and still less direct relation to the amount of money afloat in the community at large. Where bank media, whether in the form of deposits or notes, are an important part of total purchasing power, the connection between general prices and quantity of 'money' is irregular and uncertain." (Italics mine.)
This conclusion would be of little service in supporting Fisher's rigorous contentions! Our constructive theory concerning the relations of reserves and deposits, or reserves and demand liabilities, must wait for later discussion, in the chapter on "Bank Assets and Bank Reserves" in Part III. It will there be maintained that there are no "normal" or "static" laws governing the percentage of reserves to demand liabilities, or to deposits, that the reserve function of money is a dynamic function, and that its whole explanation must be found in dynamic considerations. For the present, I am content to have analyzed two widely divergent views, one the extreme view of Professor Fisher, representing the quantity theory in its utmost rigor, and the other, the view of Professor Taussig, who virtually surrenders the quantity theory in complex modern conditions.
In between these two writers, verging more toward Fisher than toward Taussig, will be found, with great individual variation, the rest of the quantity theorists. The quantity theory, as an instrument of prediction, becomes important only to the extent that Fisher's view is maintained.
CHAPTER X
"NORMAL" VS. "TRANSITIONAL" TENDENCIES
The Quantity Theory, as a causal theory, is, then, little altered by the passage from a hypothetical, creditless economy to the actual world, where a vast deal of credit is used,—particularly in Professor Fisher's hands. Of the different kinds of credit, only deposits subject to check are recognized as directly influencing prices, and deposits subject to check are controlled by the volume of money. The causal theory[183] remains, then, as follows: if M be increased, it will increase M´ proportionately; it will not change the V's; it cannot increase T; to keep the equation straight, therefore, P must rise in proportion to the rise in M. A decrease of M, reducing M´ proportionately, leaving V's and T unchanged, must proportionately reduce P. P is passive. A change in P cannot sustain itself, unless it be due to a prior change in T, the V's, M or M´.
This theory is set forth with the qualification that these effects are the "normal" effects of the changes in question. The proportion between quantity of money and price-level is not strictly maintained during "transition periods." I now approach the most difficult question which I shall have to answer as to the meaning of Fisher's terms. The same problem arises for all quantity theorists. Precisely what is the distinction between "transition periods" and "normal periods"? What limitations and qualifications does he admit to the rigorous statement of his theory so far given? I may first express the opinion that the line shifts greatly in his own mind, or at least shifts greatly in the exposition. I do not find an explicit statement in which definitions are given. The matter is chiefly discussed by Fisher in ch. 4,[184] which is called "Disturbance of Equation and of Purchasing Power during Transition Periods." There we find, as I have stated, no definitions, but the initial statements would suggest the following: a transition period is the period following a change in any one of the factors in the equation during which a readjustment among all the others is taking place; the normal period is the period preceding such a change, or following the transition after such a change, and is characterized by the fact that all the factors are at rest, in stable equilibrium. Equilibria during transition periods are unstable. During the transition, the relations among the factors vary: M and M´ need not keep their fixed ratio; P need not be wholly passive; M and P need not keep the same proportion. But until M and M´ get back into the normal ratio, until P becomes proportional to M (in the proportion prior to the initial disturbance), there is no rest; the equilibrium is unstable. How long is a transition period? How realistic is the notion of a transition period? Is the transition period a theoretical device, to aid in isolating causes, or is it supposed to be a real period in time? Is the normal period a real period in time, or is it merely a theoretical hypothesis? It is not easy to answer these questions. Thus (p. 72) the seasonal fluctuations are declared to be "normal and expected," and, at the same time, one gets the impression that Fisher considers them illustrations of his "transitions," in which the normal theory does not strictly hold (pp. 72, 169). What is described chiefly in the chapter on transition periods is the business cycle—a theory of the business cycle, based primarily on the notion that the failure of interest to rise as fast as prices rise causes the "boom," and that the draining of bank reserves precipitates the crisis. I shall not discuss this theory, as a theory of business cycles, further than to say that Wesley Mitchell's study would indicate that the interest rate is a minor factor, and that, while as a theoretical possibility, the drains on bank reserves may check prosperity if something else doesn't do it first, practically something else always does come in ahead, so far as his studies have gone.[185] My interest here is primarily in seeing the limitations Fisher imposes on his theory, and the qualifications he admits. If the business cycle is the typical transition period, during which his normal theory doesn't hold, when does the normal theory hold? When are the "normal periods"? There is no concrete period during which prices are neither rising nor falling, during which no important changes are taking place among the factors.[186] At times, Fisher seems to indicate that the normal period is imaginary (pp. 56, 159). Is, then, the contrast between a realistic "transition period" and a hypothetical "normal period" or are both hypothetical? Is the equation of exchange, too, a mere hypothesis? It should be, if it is to set forth a merely hypothetical theory. But no, Fisher insists on putting concrete data into it, and, indeed, gives an elaborate statistical "proof" of the equation. It, at least, is realistic. I confess that my certainty as to Fisher's meaning grows less, as I study his book with greater care. If the typical transition period be the business cycle, then the normal period could come only once, say, in ten years—or whatever period, regular, or irregular, one chooses to assign to the business cycle. The concrete price-levels for the greater part of the time are then surrendered to other causes. And the one-year cycle described in the equation of exchange is quite irrelevant. The equation of exchange should cover the whole business cycle, to fit in with the theory. Indeed, a realistic equation of exchange would then have no meaning at all, as the average price-level during the business cycle, played upon by a host of causes other than the factors described in the quantity theory, would not be the same as the average price-level which would have obtained had only the "normal" causes been in operation.[187]
The distinction between "normal" and "transition" periods suggests a dangerous fallacy: namely, that during one period one sort of causation is working, with the other in abeyance. In fact, whatever causes there are are working all the time. The only legitimate thing is to abstract from one set of causes, and see what the other set, if left to themselves, will bring about. But this sort of abstraction has many dangers, one of which is that the causes abstracted from are frequently thought of as non-existent. The chemist, in his laboratory, can in actual physical fact abstract impurities from his chemicals, and see what they will do. He can even perform experiments in what is practically a vacuum. But the economist has no right to think in vacuo! All that he has a right to do is to assume the factors which he does not wish to study constant. And even that he must not do if (1) changes in the factors which he wishes to study do in fact lead to changes in the factors abstracted from, or (2) if the factors which he wishes to study can only change because of prior or concomitant changes in the factors from which he is abstracting. Is it, for example, legitimate to assume an increase in M´ apart from its usual accompaniment, an increase in PT?
The notion, too, that causation can be seen in a state of stable equilibrium should be critically analyzed. Causation is only revealed by a course of events, when mechanical causation is involved. The relation of cause and effect may be a contemporaneous relation in fact, and it is possible, where conscious, psychological phenomena are involved, to discern causal relations among the elements in a mental state by direct introspection. It is the not uncommon practice, also, in the theory of mechanics, or in theoretical economics, where the method of investigation is deductive rather than inductive, to abstract from the temporal sequence, and to construe causal relations as timeless, logical relations. But even here, the cause of a change in the general situation precedes the change in time, and it is only by abstraction that the time element is left out. If there is no question as to the causal relations, this abstraction is legitimate, but if all that one knows about the situation be that in a stable equilibrium certain constant ratios obtain, then the question as to which term in the ratio is cause and which is effect remains unanswered. In Fisher's situation, then, assuming that it be true—which I shall deny—that the only stable equilibrium is that which the normal theory requires, it still remains true that the causal relations among the factors can only be revealed by a study of the transitions, by seeing the temporal sequence of changes in the factors of the equation. Even if it be granted that M, M´ and P tend to keep a constant relation to one another, the quantity theory falls if, for instance, it can be shown that a change may first occur in P, spread to M´, and finally reach M last of all, leading to a new normal equilibrium which is stable. I shall later show cases of this sort.[188]
The abstract formulation of Fisher's contrast will not, I believe, give us an answer as to the extent to which he thinks his quantity theory realistic. I find myself particularly in genuine uncertainty as to the point mentioned above: would an actual equation of exchange for the whole business cycle, made up of the averages of M, M´, V, V´, P and T for the whole period, exhibit the "normal" relations among these factors? Or would this "normal" relation only emerge concretely at some moment of time in the course of the cycle when the abnormal causes affecting the price-level happened to offset one another? Or is it true that no actual figures which might be found, either for a moment of time, or as averages for any given period, will exhibit the relations required, and that only a hypothetical equation, based on the figures for M, M´, V, V´, P and T that would have been realized had there been no "disturbing" causes, will show these "normal" relations? If, as Fisher at times indicates—as in his reference to Boyle's Law (p. 296)—he is stating only an abstract tendency, which may be neutralized by other tendencies in the situation, so far as concrete results are concerned, then it is this last doctrine which we must take, and the concrete equation of exchange has little if any relevance. If, moreover, this last interpretation be given, then the whole of Fisher's elaborate statistical "proof" is pointless. The only sort of statistical proof which would be relevant would be of a much subtler sort, not a mere filling out of the equation of exchange by means of annual figures, but an effort to disentangle and measure the importance of his tendency, as compared with other tendencies. But we have the other tendencies merely mentioned in qualitative terms, and we never find any definite statement, of mathematical character, as to how important they are.
It seems pretty clear, however, that on the whole, despite occasional suggestions that his theory is abstract, Fisher means his theory to be the overwhelmingly important point in the explanation of actual price-levels. He is particularly insistent on the high degree of the generality of his contention that P is passive. Thus: "So far as I can discover, except to a LIMITED extent during transition periods, or during a passing season, (e. g., the fall) (capitals mine, italics Fisher's), there is no truth whatever in the idea that the price-level is an independent cause of changes in any of the other magnitudes, M, M´, V, V´, or the Q's."[189] On p. 182 he enumerates in a series of propositions his general normal theory, and adds, as the first sentence of proposition 9: "Some of the foregoing propositions are subject to SLIGHT modification during transition periods." (Italics and capitals mine.) And the general drift of the argument, particularly in chapter 8, where the heart of Fisher's causal theory is presented, would indicate that the concessions he is disposed to make are very slight, indeed.
The question as to how long a time is required, in Fisher's view, for a transition to occur, and for his normal tendencies to dominate, is nowhere made clear. The quantity theory, in the hands of some writers, is a very long run theory, for others, it is a short run theory. Thus, Taussig would make the "run" exceedingly long.[190] Mill makes it a short run theory. "It is not, however, with ultimate or average, but with immediate and temporary prices, that we are now concerned. These, as we have seen, may deviate widely from the standard of cost of production. Among other causes of fluctuation, one we have found to be, the quantity of money in circulation. Other things being the same, an increase of the money in circulation raises prices, a diminution lowers them. If more money is thrown into circulation than the quantity which can circulate at a value conformable to its cost of production, the value of money, so long as the excess lasts, will remain below the standard of cost of production, and general prices will be sustained above the natural rate."[191] I pause to note that it is really strange that a single name should describe theories so different, resting on such essentially different logic. Long run or short run theories, all are "quantity theories," whether "money" be defined as gold, or as all manner of media of exchange, or as only those media of exchange which pass from hand to hand without endorsement. Fisher would doubtless call his theory a long run theory. From the standpoint of the notion that "prices ... lag behind their full adjustment and have to be pushed up, so to speak, by increased purchases,"[192] however, we get a short run quantity theory doctrine. The logic of these two is very different. The short run doctrine seeks to explain the actual process of price-making in the market. Money is offered against goods, and the actual quantities on each side determine the momentary price-level, concretely. Or, when credit is considered, money and credit offered against goods, at a given time, or in a given short period, determine the actual price-level reached. This is the logic of the equation of exchange—actual money paid is necessarily equal to actual money received. The long run doctrine is fundamentally based on a different notion. Surrendering the actual or average of price-levels to other causes, in part, it still asserts that, given time enough, and barring new disturbing tendencies, a price-level will ultimately be reached which will bear it out. I find no recognition, on Fisher's part, of the fact that these two doctrines are different, and, in fact, I find them blended and confused in the course of his argument. He would doubtless maintain that his is a long run doctrine. But how long is the "run"? Sometimes it seems to be, as already shown, a whole business cycle. Sometimes a passing season, as the fall. When he undertakes to apply his theory to a practical proposal for regulating the value of money, he relies on the quantity theory tendency to bring about adjustments so quickly that it is worth while to make monthly adjustments in anticipation of it.[193] When discussing the changes in gold premium on the Greenbacks during the exciting times of the Civil War, he relies so thoroughly on his theory that he will not allow even the rapid change of four per cent in a single day following Chickamauga to occur except in conformity with the quantity theory. This last statement is so remarkable that I must quote Fisher himself: "It would be a grave mistake to reason, because the losses at Chickamauga caused greenbacks to fall 4% in a single day, that their value had no relation to their volume. This fall indicated a slight acceleration in the velocity of circulation, and a slight retardation in the volume of trade" (263). It would be indeed remarkable if the changes in the gold market, which got war news before the newspapers got it, and where changes in gold premium occurred before the rest of the country could possibly react to the war news, should be controlled by V and T! I had not supposed that the most rigorous of short run quantity theorists would make any such demands on his theory as that. Indeed, I had not supposed that the quantity theory would feel called on to explain the gold premium, as such, except in so far as the gold premium is an index of general prices.
Finding it impossible to limit Fisher to any single statement of the quantitative importance of his normal theory as compared with the other tendencies at work, but concluding that, on the whole, he considers it of high importance, I shall now proceed to an analysis of the reasoning by which he seeks to justify it as a qualitative tendency. I shall maintain that, however long or short the period required, however strong or weak the tendency he defends, the reasoning by which he seeks to justify it is unsound, and that even as a qualitative tendency, the quantity theory is invalid. At a later part of the book, as in an earlier part,[194] I shall undertake to find the modicum of truth which the quantity theory contains, and shall show that no quantity theory is needed to exhibit this modicum of truth.
CHAPTER XI
BARTER
In the statement of the quantity theory, the proviso is commonly made that all exchanges must be made by means of money, or of money and bank-credit. Barter is excluded by hypothesis. If resort to barter were possible, then people might avert the fall in prices due to scarcity of money, or increase in trade, by dispensing with money in part of their transactions, and the proportional decrease in prices which the quantity theory calls for would be lacking. Is this assumption true? Is barter banished from the modern world, or does it remain reasonably possible, and, to a considerable degree, actual?
Fisher maintains the thesis—the failure of which he admits would spoil the quantity theory[195]—that barter is practically impossible, and negligible in modern business life. "Practically, however, in the world to-day, even such temporary resort to barter is trifling. The convenience of exchange by money is so much greater than the convenience of barter, that the price adjustment would be made almost at once. If barter needs to be seriously considered as a relief from money stringency, we shall be doing it full justice if we picture it as a safety valve, working against a resistance so great as almost never to come into operation, and then only for brief transition intervals. For all practical purposes and all normal cases, we may assume that money and checks are necessities for modern trade."[196]This contention seems to me untenable. I think it can easily be shown that barter remains an important factor in modern business life, especially if one extends the term barter, a little, to cover various flexible substitutes for the use of money and checks in effecting exchanges. Clearly from the standpoint of the present issue, such an extension of the meaning of barter is legitimate, as any such substitutes would equally spoil the proportionality in the supposed relation between prices and money, or prices and trade.
Where does one find barter? Well, not to be ignored would be the advertisements which fill many columns of such a paper as the New York Telegram in the course of a week; "Wanted: to trade a well-trained parrot for a violin"—a trade that might, or might not, be a wise one! There is a good deal of such simple barter among the people. Then, perhaps more important, is the regular practice of sewing machine, piano, automobile, and other similar companies of taking part of the payment for a new machine, piano,[197] or automobile in the similar thing which the owner is discarding. The old machine, piano, etc., are then repaired, repainted, and sold again. This is a very extensive practice. Again, there are companies which combine the business of wrecking old houses and building new ones, who regularly take the old materials as part of their pay. This is a highly important feature of the organized building trade in great cities, and is frequently done in small towns. The building trade is no negligible matter. The "horse-trade" still thrives in rural regions, and barter of various kinds, of live stock, of grain and hay, of fresh and cured meat, and of labor, is an important feature in rural life in many sections. Much of agricultural rent in the South is still paid in kind, under the "share system." Much labor, especially farm and domestic labor, is still paid for partly in kind. Where payments for labor are made in orders on company stores, we have again what is virtually barter, from the standpoint of the point at issue. Real estate transactions make large use of barter. Farms are exchanged for one another, with some cash (or more usually, a promissory note) "to boot." The writer has repeatedly heard real estate men say to customers: "I can't sell it for you very easily, but I can trade it off, and maybe you can sell what you trade it for." This is perhaps more frequent in rural real estate transactions, and in the smaller cities, than in large cities, but it is very extensive in New York City.[198]
Again, when corporations are to be combined, various plans are possible. There may be a merger; there may be a holding corporation; there may be a lease. If the money market is easy, one of the former methods will be used,—most frequently, for legal reasons, the holding corporation, if there are any valuable franchises involved. But mergers and holding corporations commonly involve buying out the interests which are to be absorbed, and call for the use of checks. If the money market is tight, therefore, the promoter of the combination may frequently find the lease the more advantageous form of consolidation.[199] The great advantage of the lease is that, when the money market is tight, it involves no financial plan, no underwriting, no outlay of "cash." This is, therefore, an equivalent of barter, so far as the point at issue is concerned. Even where a holding corporation is formed, however, there may be considerable barter: the stockholders of the corporation which is absorbed may receive payment for their stocks, in whole or in part, in the securities of the holding company, rather than in checks. An era of financial consolidation, such as we have been passing through, and through which we have not by any means gone, though the movement toward monopoly has been in great degree checked, presents a great deal of this sort of barter, or equivalents of barter.[200] A striking thing to notice here, moreover, is the flexible margin between use of bank-credit and barter, a margin depending primarily upon the condition of the money market, and particularly upon the money-rates.
Not yet has the most important element in modern barter been mentioned. I refer to the "clearing-house" arrangements of the stock and produce exchanges. Under these arrangements, brokers who have sold ten thousand shares of Westinghouse El. and M. Common during the day, and bought seven thousand shares, buying and selling being in smaller lots, with a number of different houses, no longer are obliged to deliver ten thousand shares, receiving therefor $700,000, and to receive seven thousand shares, paying therefor $490,000. Instead, they deliver three thousand shares only to the clearing house, and receive from the clearing house only $210,000 when the transaction is, from the standpoint of the particular broker involved, completed. This is a far remove, in technical perfection, from primitive barter, but it is barter, and it saves the using of a vast deal of bank-credit as between brokers. How important it is, from the standpoint of the stock exchange, may be judged from the following statement in Sprague's Crises Under the National Banking System: "A much more fundamental change in the organization in the New York money market came with the establishment of the stock exchange clearing house in May, 1892. It led to a very considerable reduction in the clearing-house exchanges of the banks and also, and more important, in the volume of certified checks. [Italics mine.] Overcertification of checks ceased to be a factor of the first magnitude in the banking methods of the city. Had not this arrangement for stock-exchange dealings been set up, it is probable that it would have been necessary to close the stock exchange in 1893 and in 1907, and it is also probable that the volume of business transacted in the years after 1897 could not have been handled." (P. 152.)
The same arrangements have been widely introduced in other stock exchanges, and in the produce exchanges.[201]In general, with reference to barter, this point is significant. The money economy has made barter easier rather than harder. It has made possible a host of refinements in barter, which make it at many points more convenient and cheaper than check or money exchanges. It is common to find our present methods of conducting foreign trade described as a "system of refined barter," which indeed, from the standpoint of the present issue, it is: bills of exchange are neither money nor bank-credit! Where bills of exchange are used in internal trade extensively—as in Germany, where they pass from hand to hand in several transactions before being discounted at banks[202]—we have a highly important substitute for money and deposits, which functions as barter,—flexibility of substitutes for money and deposits is strikingly evident. The feature of the money economy which has thus refined and improved barter is the standard of value (common measure of value) function of money.[203] This standard of value function, be it noted, makes no call on money itself, necessarily. The medium of exchange and "bearer of options" functions of money are the chief sources of such additions to the value of money as come from the money-use. But the fact that goods have money-prices, which can be compared with one another easily, in objective terms, makes barter, and barter-equivalents, a highly convenient and very important feature of the most developed commercial system. And so we reject another essential assumption of the quantity theory.[204]
CHAPTER XII
VELOCITY OF CIRCULATION
For the quantity theory, it is important to treat velocity of circulation of money and of deposits, as self-contained entities, really independent factors. This is true of Fisher's theory. It is particularly necessary that V and V´ should vary from causes unconnected with M and M´. The V's are to be a sort of inflexible channel, through which M and M´ run in their influence on the passive P, which is to rise or fall proportionately with them. If an increase of M or M´ should lead to a reduction in the V's, if people, having more money available, should be less assiduous in using every bit of it in effecting exchanges, then P would not rise in proportion to the increase in M. Complete demonstration of Fisher's thesis, therefore, requires the proof of the negative proposition that V does not change as a consequence of changes in M or M´. This proof Fisher finds in the contention that the V's are fixed by the habits and conveniences of individuals, whence they are not influenced by such a cause as a change in the amount of money.[205]
V is defined,[206] not as the number of times a given dollar is exchanged in a given year (the "coin-transfer" notion), but as a social average based on the average number of coins which pass through each man's hands, divided by the average amount held by him (the "person-turnover" concept of velocity.) V´ is similarly defined. Fisher asserts that both concepts, if correctly employed, lead to the same result. I would point out one important difference between them here: if money is short-circuited, if, i. e., a part of the economic community loses its incomes, or finds its incomes reduced, then the "velocity of money," on the "coin-transfer" basis is reduced, provided the "person-turnover" average remains the same, while on the "person-turnover" basis the velocity will remain unchanged. It is clearly the "coin-transfer" concept which is fundamental, from the standpoint of the equation of exchange, and Fisher feels justified in using the other method only because he considers it an equivalent of the "coin-transfer" concept. I shall later show cases where the distinction between the two concepts is all-important, particularly in the case where T is reduced by the elimination of middlemen.[207]
The conception of velocity of circulation as a real, unitary entity, a cause, in the process of price-determination, is, I suppose, almost as old as the quantity theory itself. It is an essential part of the quantity theory. To me "velocity of circulation" seems to be a mere name, denoting, not any simple cause or small set of causes, which can exert a specific influence, but rather a meaningless abstract number, which is the non-essential by-product of a highly heterogeneous lot of activities of men, some of which work one way, and others of which work in another way, in affecting prices. It is at best a passive resultant of conflicting and divergent tendencies, and has, to my mind, no more causal significance than the average of the abstract numbers of yards gained by both sides, heights and weights of players, kick-offs, and minutes taken out for injuries, would have on the result of the Yale-Harvard game. The real causes of changes in prices lie deeper! I should expect V and V´ to be the most highly flexible factors in the equation of exchange, and should expect to be able to keep the equation straight, in a great variety of situations, by allowing the V's to vary.
Before undertaking detailed analysis of the causes governing V, I shall discuss Fisher's specific argument, typical of the quantity theory, that an increase of money cannot change the V's. "As a matter of fact, the velocities of circulation of money and deposits depend, as we have 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, as we have seen, depend on individual habits. Each person regulates his turnover to suit his individual convenience.... 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 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." (Italics mine.[208]) He proceeds to assume that money is doubled with a halving of the V's, instead of a doubling of P. Everybody now has on hand twice as much money and deposits as his convenience has taught him to keep on hand. He will then try to get rid of this surplus, and he can only do it by buying goods. But this will increase somebody else's surplus, and he will likewise try to get rid of it. This will raise prices. "Obviously this tendency will continue until there if found another adjustment of quantities to expenditures, and the V's are the same as originally."[209] The foregoing argument rests in part, it will be seen, on the assumption that a fixed ratio between M and M´ obtains, else the increase of money in everybody's hands would not mean a corresponding increase in their deposits. I have already criticised this doctrine. For the contention that the V's will finally be just the same as before, I find no specific argument at all—"obviously" presumably making that unnecessary.
As the point immediately at issue is that V's will be unchanged by the increase in M (otherwise P would not increase proportionately—let us see if considerations can be adduced which will make this a little less "obvious." First, it will be noticed that Fisher, in the foregoing, in one sentence speaks of the matter as resting on habit, and in the next sentence, on convenience. He speaks, also, of business custom. Now it is important to note that habit and custom, on the one hand, and considerations of convenience on the other, do not necessarily coincide. Many habits and customs are highly inconvenient. And it is not at all likely that habit and custom should govern so highly complex a thing as the ratio between cash on hand and the price-level. Rather, in so far as custom and habit rule, one would expect them to relate to a simpler matter, namely, the amount of cash on hand. If the amount of cash kept on hand should remain controlled by habit, while the amount of money is increased, then V, instead of remaining unchanged, would actually be increased, unless the habits should be broken in on. I shall show in a moment that considerations of convenience would probably lead to a reduced V, in so far as individual turnover is concerned. But which tendency will prevail? Well, that will depend on the degree to which custom and habit rule as compared with considerations of convenience—i. e., there would be no rule valid for all communities. That convenience would lead to a larger amount of money on hand—and I am following Fisher's temporary hypothesis that there has been no rise in prices prior to the movement to restore the V's to their old magnitudes—will appear from considerations like these. Few men have as much on hand as they would like to have, including both their cash in hand and their deposit balances. Most people have the tendency to hoard, though it is usually held in check by necessity. If money on hand be increased suddenly, without prices being increased, and without any prospect of increased incomes in the future—and there is nothing in Fisher's provisional hypothesis to call for increased incomes, as they could, in fact, come only from an increase in prices—why might not there be a considerable saving of money, with a corresponding reduction in V? If it be objected that people, in saving their money, will in considerable degree put it into the banks, and that the banks, with larger reserves, will increase loans and deposits, I would urge, that it is on the part of banks that this tendency to increase hoards in times of abundant money is particularly marked, and for proof would point to the figures quoted from Keynes[210] for the great banks and treasuries of Europe in the last fifteen years. It is not necessary for my purpose at this point to do more than show that there is reason to expect an increase in money to change the V's. Fisher's argument rests on the contention that the V's will be neither increased or reduced—otherwise an increase in money will not proportionately raise prices. The appeal to habit and custom in the matter is particularly unsatisfactory. Custom and habit could not possibly regulate things so complex as velocities of money and bank-deposits.
Whatever be the ultimate effect of an increase in money, the immediate effect is commonly to reduce the money-rates. Banks have less inducement to pay interest on deposits, and charge lower rates for loans. Now merchants, especially small merchants, are often embarrassed in making change for customers. The man who has tried to make payment with a ten dollar bill in a country store has not infrequently put the storekeeper to much inconvenience. To offer a ten dollar bill, or even a five dollar bill, to a storekeeper on Amsterdam Avenue in New York City may well mean that the one clerk in the establishment, or the proprietor's wife will run out with the bill to three or four neighboring stores before finding change with which to break it. If money is more abundant, if money-rates are easier, for a time, it may easily happen that many small merchants will experience the superior convenience of having a more adequate amount of change in the till, and will, even after the money-rates have risen—if they do rise again to the old figure—find a new reason for keeping more cash on hand. There is a marginal equilibrium between the interest on the capital invested in cash in the till, and the wages of the clerk,[211] whose active legs assist the velocity of money. Not only banks and small dealers, however, find it advantageous to increase their supply of ready funds, held idle for special occasions. The United States Steel Corporation has kept as much as $50,000,000.00 to $75,000,000.00 in idle cash or idle deposits, as a means of being independent of banks in times of emergency.[212] The motive for accumulating reserves and hoards, either of cash or deposit accounts, is at all times strong. In times of financial ease, it may easily find the difficulties which ordinarily repress it give way, and, by being gratified, grow stronger.
I conclude that there is positive reason for expecting an increase of money to reduce the velocity of money.
Horace White, in his Money and Banking, in the earlier editions, speaks of the velocity of money, "alias the state of trade." Is not this the truth? Is not money circulating rapidly, when business is active, and slowly when business is dull? Is not the velocity of circulation a highly flexible and variable average, a cause of nothing, and an index of business activity? Or, better, perhaps, are not the V's and T both governed, in large degree, by more fundamental causes which are largely the same for both? Fisher would admit something of this for transition periods. Even for normal adjustments, he admits that an increase in T, unaccompanied by an increase in M, leads to some increase in the V's, though he doesn't say how much.[213] He denies, however, that an increase in the V's will increase T.[214] In general, it is clear that he regards the V's and T as governed by different causes. The control of the V's by T is not the only or the chief control of the V's. The V's can increase greatly without an increase of T, in his scheme. That this is so, will appear from a comparison of the list of causes which he gives as governing the V's and T respectively:
Causes governing V's:
1. Habits of the individual.
(a) As to thrift and hoarding.
(b) As to book credit.
(c) As to use of checks.
2. Systems of payments in the community.
(a) As to frequency of receipts and 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.
Compare this list with the causes governing T:[215]
1. Conditions affecting producers: Geographical differences in Natural Resources; the division of labor; knowledge of technique of production; accumulation of capital.
2. Conditions affecting consumers: the extent and variety of human wants.
3. Conditions connecting consumers and producers:
(a) Facilities for transportation.
(b) Relative freedom of trade.
(c) Character of monetary and banking systems. (Not their extent.)
(d) Business confidence.
These two lists are quite different, and indicate that in Fisher's mind the magnitudes, T and the V's, in general obey different laws. The only factor in both lists is facilities for transportation ("rapidity of transportation," in the first list). Strangely enough, T, though later recognized as having influence on the V's[216] is not included in these lists in ch. 5. The "character of the monetary and banking systems" in the second list is evidently not the same as "use of checks" in the second list, though it will doubtless affect that factor, as also the "habits as to thrift and hoarding," in some degree. "Business confidence," which is, in the view I am maintaining, as in the view, I should take it, of Horace White, the great variable affecting both T and the V's, does not appear in the first list. Indeed, one wonders why business confidence appears in either list, if only "normal," and not merely "transitional" causes are to be considered, but it appears from the fuller discussion on p. 78 that Fisher is not thinking of business confidence as a variable at all—his normal theory has nothing to do with variables—but as a thing which either is or is not present, a sort of Mendelian unit, not a thing of degrees.[217] It will be noted, further, that most of the causes which Fisher lists as affecting T are really causes affecting production—they would be just as important under a socialistic as under an exchange economy.
Now I propose to show, on the basis of Fisher's own list of causes, that most, if not all, of the factors affecting the V's, will also affect T, and in the same direction. He admits this as to transportation facilities. It is surely true of thrift and hoarding. The miser neither circulates money nor buys goods. It is emphatically true—though Fisher's theory, as will later appear, is obliged to deny it,—of both book credit and banking facilities. Without the use of credit, much of the business now done simply would not be done at all. For Fisher, and the quantity theory in general, the contention would be simply that the same business would be done on a lower price-level. I reserve a full discussion of this fundamental point till later, noting here, in passing, that the function of banks is to assist in effecting transfers, that that is why, from the social standpoint, banks are encouraged, and that the extension of banking would be folly if they did not, in fact, do this. As to book credit, let us suppose that, for example, in the great cotton section of the South the stores should cease to give advances of supplies on credit to negroes and small white farmers, pending the "making" of the crop. The outcome would be starvation for many of them, and no cotton crop at all. Under a system of private enterprise, the very division of labor itself, including the specialization of the capitalist, involves credit, and it is difficult to conceive a form of credit which does not either dispense with the use of money, or increase its "velocity." Admittedly, the division of labor increases trade.
The three factors listed under "Systems of payment in the community" also affect trade. To the extent that receipts are frequent, regular, and synchronous with outgo, we have a smoothly working economic system, which facilitates commerce.
Finally, density of population enormously increases trade. The concentration of men in cities is essential for modern factory production, and the great cities have necessarily grown up about good harbors, or at strategic points for connecting lines of railroads. It seems almost trivial to insist on so obvious a point, but Fisher seems totally to ignore it, for he says: "We conclude, then, that density of population and rapidity of transportation have tended to increase prices by raising velocities. Historically this concentration of population in cities has been an important factor in raising prices in the United States."[218] (P. 88. Italics mine.)
This is an astounding proposition. It is not merely that the concentration of population in cities has tended to raise prices through raising velocities. It is a statement that this has been an important historical cause of the actual increase in prices. For Fisher's own theory, if the same cause had tended to increase T,[219] that would have offset the rising V's on the other side of the equation, and left prices little affected. But he sees in the V's an independent cause here, divorces them from their connection with T, and follows his logic fearlessly where it leads. I do not see how one could more strikingly illustrate the essential vice of erecting the V's into causal entities.
In concluding the discussion of the rÔle of velocity of circulation, I think it worth while to mention Fisher's own efforts to measure them. I examine his statistics in a later chapter. I do not regard the points at issue as points which can properly be handled by inductive methods, primarily. I do not accept his conclusions with reference to the magnitudes of V, the velocity of money, partly because I do not accept his doctrine that "banks are the home of money" (p. 287).[220] He finds for V a fairly constant magnitude during the thirteen years from 1896 to 1909, the range being from 19 to 22, the figures for all the years except 1896 and 1909 being interpolations.[221] For V, however, which is much the more important magnitude, from the standpoint of his equation of exchange for the United States, since deposits do so much more exchanging than does money, he finds a wide range of variation, from 36 to 54, and he states: "We note that the velocity of circulation has increased 50% in thirteen years and that it has been subject to great variation from year to year. In 1899 and 1906 it reached maxima, immediately preceding crises" (285). I think Fisher's own statistical results show that V´, at least, is a child of the "state of trade."[222] Critical analysis of these statistics show that they greatly underestimate the variability of the V's.[223]
In summary: V and V´ are not, as Fisher contends, independent of the quantity of money. Instead of resting on "technical conditions," and having large elements of constancy and rigidity, they are highly flexible, and vary, on the whole, with the same highly complex and divergent sets of causes which govern the volume of trade. The biggest factor affecting the variations of the V's on the one hand, and volume of trade on the other is business confidence—a factor which Fisher's normal theory is not concerned with, so far as it is considered as a variable, but which, more than anything else, does affect the concrete figures which go into the equation of exchange, either for a single year, or for an average of a good many years. The V's are not true causal entities, but merely abstract summaries of a host of heterogeneous facts. I have indicated before, and shall later demonstrate more fully, that the same is true of T. Even the "normal" causes governing the V's, however, are factors which likewise affect T, and in the same direction.
Among the factors affecting both V and T, there is one which sometimes makes them move in opposite directions, and that is the value of money itself. This is so well stated in Wicksteed's interesting criticism of the quantity theory that I content myself with a quotation:[224] "Again, the history of paper money abounds in instances of sudden changes, within the country itself, in the value of paper currency, caused by reports unfavorable to the country's credit. The value of the currency was lowered in these cases by a doubt as to whether the Government would be permanently stable and would be in a position to honor its drafts, that is to say, whether this day three months, the persons who have the power to take my goods for public purposes will accept a draft of the present Government in lieu of payment. It is not easy to see how, on the theory of the quantity law, such a report could affect very rapidly the magnitudes on which the value of the note is supposed to depend, viz., the quantity of business to be transacted, and the amount of the currency. Nor is it easy to see why we should suppose that the frequency with which the notes pass from hand to hand, is independently fixed. On the other hand, the quantity of business done by the notes, as distinct from the quantity of business done altogether, and the rapidity of the circulation of the notes may obviously be affected by sinister rumors. Two of the quantities, then, supposed to determine the value of the unit of circulation, are themselves liable to be determined by it."
CHAPTER XIII
THE VOLUME OF MONEY AND THE VOLUME OF TRADE—TRADE AND SPECULATION
In proving that an increase of money must proportionately increase prices, it is necessary to prove that the volume of trade is independent of the quantity of money and credit instruments by means of which trade is carried on. Money on the one hand, and quantity of goods to be exchanged on the other, are the two great independent magnitudes, whose equilibration mechanically fixes the average of prices. This notion, as to the essence of the quantity theory, finds expression in Taussig,[225] "The statement of a quantity theory in relation to prices assumes two independent variables: total money or purchasing power on the one hand, total supply of goods or volume of transactions on the other." Taussig, though he would maintain that this independence holds, so far as money and trade are concerned, admits that it breaks down so far as trade and elastic bank credit, bank-notes and deposits, are concerned. Trade and elastic bank-credit are largely interdependent.[226] This concession on Taussig's part means virtually giving up the quantity theory for Western Europe and the United States and Canada, though Taussig still sees something left of the quantity theory tendency in view of the "irregular and uncertain" connection which he finds between money and bank-credit.[227] Fisher, however, makes no such surrender. He is quite as uncompromising as to the independence of deposits and trade as he is with reference to the independence of money and trade. He does, indeed, make the concession that increasing trade tends to increase deposits indirectly, by increasing the ratio of M´ to M, by modifying the habits of the people as to the use of checks as compared with cash (p. 165),[228] but he denies stoutly that there is any direct relation between them. (P. 168.) Trade acts only via a modification of the ratio between M and M´, and M still remains controlled, not by trade, but by quantity of money. As to any control over T by M´, he repudiates it explicitly, (P. 163.) Increasing M´, either through an increase of M, or through an increase in the normal ratio between M and M´, will have no effect on T,—or, for that matter, on the V's. The introduction of credit, therefore, leaves the quantity theory intact: an increase of M, increasing M´ proportionately, leaving the V's unchanged, and having no effect on T, must exhaust its influence on P, raising P proportionately, if the equation of exchange is to remain valid.
The argument set forth to prove that T is not influenced by M or M´ is as follows: "An inflation of the currency cannot increase the products of farms or 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 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.... From a practical or statistical point of view they amount to nothing, for they could not add to nor subtract one-tenth of 1% from the general aggregate of trade." (Loc. cit. p. 155. Italics mine.) Something similar is said on p. 62, where "transitional" influences of M on T are being discussed: "But the amount of trade is dependent, almost entirely, on other things than the quantity of currency, so that an increase of currency cannot, even temporarily, very greatly increase trade. In ordinarily good times practically the whole community is engaged in labor, producing, transporting, and exchanging goods. The increase of currency of a "boom" period cannot, of itself, increase the population, extend invention, or increase the efficiency of labor.[229] These factors pretty definitely limit the amount of trade that can reasonably be carried on. So, although the gains of the enterpriser-borrower may exert a psychological stimulus on trade, though a few unemployed may be employed, and some others in a few lines induced to work overtime, and although there may be some additional buying and selling which is speculative, yet almost the entire effect of an increase in deposits must be seen in a change in prices. Normally the entire effect would so express itself, but transitionally there will be also some increase in the Q's." (Pp. 62-63. Italics mine.)
Fisher is here exceedingly uncompromising, even where transitional periods are concerned, and it is not necessary, in order to do his position full justice, to make much distinction between "normal" and "transitional" effects in my counter-argument. I shall, however, take account of the distinction as I proceed, in justice to other, more moderate, quantity theorists.
It is a familiar doctrine that the quantity of money is irrelevant, that things go on in much the same way whether money is abundant or scarce, the only difference being that in the one case prices are high and in the other, low; that, in particular, it is a gross fallacy to connect the rate of interest with the amount of money, since (as many writers would put it) the rate of interest depends on the amount of capital rather than money. At the opposite extreme, we have writers like Brooks Adams (Law of Civilization and Decay), who see the fate of nations and the progress of civilization resting on the abundance or scarcity of money. Fisher takes the first position in its extremest form.[230]
The truth, I think, is intermediate. The effects of the New World discoveries of gold and silver after the voyage of Columbus on trade and industry were tremendous. Trade was enormously increased. Walker, in his International Bimetallism,[231] asking, from the standpoint of a quantity theorist, why prices only increased 200% while money increased 470%, admits that the chief reason was the increase in trade, due in large part to the very increase in money itself. Sombart, in his Der Moderne Kapitalismus,[232] finds in this influx of money a tremendous source of capitalistic accumulations, (a) for the Conquistadores, (b) for the handicraftsmen whose prices rose faster than their costs, (c) for tenants whose rents were fixed in money, (d) for landowners, whose rents were fixed in kind [a point not obviously true], and (e) for bankers, as the Fugger. An increase of capital, savings that would otherwise not have been made, must have profoundly modified the whole industrial system, and greatly increased both industry and commerce. If it be objected that effects of this sort are not usual, that they came in a world which had been starved for money, and which, by means of the enormous increase in money was able to pass from a "natural" to a money economy, I reply that the difference between such a case and the usual effects of an increase of money are in degree rather than in kind. The world of Columbus' day was in part on a money economy, and the world to-day, despite Professor Fisher's emphatic denial,[233] still employs a great deal of barter, or equivalents of barter. I shall revert to this point later. But even this consideration would not rob Sombart's points of their significance for modern conditions. Further, we have an even more striking case, on Walker's own showing, in the effects of the Californian and Australian[234] gold discoveries in the 19th Century on trade, industry, and speculation.[235]
Nor is the tremendous agitation over bimetallism, involving a literature so great that no man could dream of reading it all, involving great political movements, Presidential campaigns, great Congressional debates, repeated legislation, international conferences, etc., for twenty years, to be explained on any other ground than that the world felt practical, important, and unpleasant effects on industry and trade from the inadequacy of the money supply.
The view of Hartley Withers[236] is interesting here. He says: "any such great addition to currency and credit would have a great effect in stimulating production, and so would lead to a great addition to the number of real goods which humanity desires and consumes when it can get them.... Trade would be more active." On p. 23 he speaks of the enormous expansion of trade made possible by paper representatives of gold. On p. 83 he speaks of the attitude of the money-market toward gold, which the orthodox economist is apt to think of as a survival of Mercantilism. Withers thinks that the money market is right in a large degree.
As illustrating Withers' statement about the views of "practical men" on this point, the following extract from a recent address by Theodore Price, quoted with approval in a "market letter," written by Byron W. Holt,[237] is interesting: "The fact seems to be that the exigencies of war in Europe are leading to an extension of credit such as would not have been possible in peace, because the hesitant conservatism of bankers would have then prevented it, and we are finding that instead of working harm it is doing good, because huge masses of fixed capital are thereby made productive, and are circulating with the increased velocity that always quickens enterprise and accelerates the wheels of industry.... All the precedents of history indicate that accelerated activity will come with peace and continue until the exuberance of success has led men to build faster than the world has grown and to demand credit upon the basis of future rather than of present values."
What is the essential causation in the matter? Well, viewed merely as a matter of mechanical equilibration, the quantity theory view is not strictly true, by any means. For a given country—and Fisher's quantity theory is always a theory for a given country, and, indeed, for any separate market, even a single city[238]—an increase of banking credit means an increase in non-monetary capital, because, to a greater or less extent it dispenses with the use of gold, which goes abroad, bringing back wealth in other forms in exchange. Adam Smith saw this clearly, and phrased it strikingly, likening gold and silver coins to the wagon-roads of Scotland, which are necessary for transportation, but which none the less prevent the use of the roadways for raising grain; whereas bank credit is like a wagon-road through the air, which restores the roadbeds to cultivation. Increased non-monetary capital, other things equal, should mean increased trade.
But, more fundamentally, an increase in gold itself within the country, if not bought by the export of an equivalent amount of other goods, is an increase of capital. Not all capital is money, but standard coin is capital. Money is a tool of exchange, and exchange is part of the productive process. More money means more exchanging. That is what money is for. Part of the mechanism is in the money rates, which go down as money becomes more abundant, making it profitable to effect exchanges which would not have been profitable had the money rates been higher. Granted that the money-rates and the general rate of interest tend, in the long run, to keep—I will not say at the same figure[239]—a certain fairly definite relation to one another, it still does not follow that the new "normal" equilibrium will give us an interest rate which is the same as the general rate of interest was before the influx of gold. On the strictest static theory, this is not to be expected. Because the total amount of capital in the country is increased, and this means a lowered interest rate all around, in the marginal employment of capital. The margin of the use of capital will be lowered everywhere, including the margin for the use of money. This means permanently lowered money rates in the country, even though the permanent level be higher than the initial money rates immediately following the access of new gold. I have put the argument in terms that suggest the productivity theory of interest, because it is more simply stated that way. I do not accept the productivity theory, as a fundamental explanation of interest, but for many purposes, the results to be obtained by it coincide with the psychological time theories,—which also, in their present form, seem to me imperfectly developed. I need not try to construct a theory of interest here, however, as the familiar theories lead to no trouble at this point. It is enough to point out that the increased amount of capital, meaning better provision for present wants—wants concerned with gold in the arts and with money for productive exchanges, as well as goods generally since part of the new gold will be exported for other things—will lessen the pressure of present as compared with future wants, and so lessen the rate of interest on the time-preference theory. The final outcome will be an extension of the marginal use of money, and a greater volume of exchanges. Of course, the increase in the supply of any kind of capital good, apart from a prior increase in the demand for its services, will, on the mechanical view of economic causation, necessarily lead to some fall in its capital value. Gold money will be no exception to this rule. As to how much the increase in its quantity will lead its capital value to fall, however, we are unable to say. For the quantity theory, the fall will be in proportion to the increase. For the theory just outlined, the fall will depend on the elasticity of demand for gold in the arts, and on the elasticity of "demand" for money, meaning by demand for money simply the demand for the short-time use of money as a tool of exchange, a demand which governs directly, not the capital value of money, but rather the "money-rates." The relation between the money rates and the capital value of money will best be discussed at another point.[240] We have no reason at all to suppose that either of these demands[241] exhibits the tendency to obey the law of proportional variation which the quantity theory requires of money.
It is further important to note that as a country gets more abundant capital, there seems to be a tendency to extend the use of money rather more than the use of many other capital goods. Where the interest rate is 10 and 12%, as in Arizona and New Mexico, money, even when brought in, tends to leave in large degree to bring in other forms of capital which the situation calls for more imperatively. The early American colonies, needing money pressingly, and making shift with a great variety of substitutes for good metallic money, thoroughly acquainted with the advantages of a money-economy from their European experience, and having "habits" as to the carrying and using of money which they had brought with them from Europe, still found it impossible to keep a great deal of metallic money, in view of the still greater importance of other forms of capital. It is in the most highly developed commercial communities, commercial centres, and par excellence, in the speculative centres, that the demand for the money-service is most elastic.[242] A country where the rate of interest is low, loses other forms of capital, and gains money, in the process of reËquilibration, as compared with a new and undeveloped section, although the new section also extends the margin of the money service, in effecting a greater number of exchanges, when money is increased.
And this leads to a vital distinction, which quantity theorists almost always lose: the distinction between the volume of production, and the volume of trade. Even in the mechanical system of causation which they describe, it is true only of production and transportation that technical and physical[243] factors are of primary significance, and that money is of minor significance. For trade and commerce, money is always highly important. To the extent that a region is primarily given over to the primary productive activities, mining, and agriculture, such trading as is necessary can be done by means of a small amount of money, supplemented by barter and long-time book-credit. A region or a city whose chief business is commerce, however, needs a large part of its capital in the form of money, and of banking capital, which is largely invested in money for banking reserves. Trade, as distinguished from industry (and it is after all trade that is under discussion), is helped or hindered as its tools are more or less abundant. These considerations would suggest that the elasticity of the demand for the use of money is greater than the elasticity of demand for the use of capital in almost any other form. Production is, indeed, limited by labor supply and natural resources, in considerable degree. Trade,[244] however, even from the standpoint of mechanical causation, is limited chiefly by the relation between the profits to be made in commercial transactions, and the "price" that must be paid for the money and credit that are required to put them through. There are enormous numbers of transfers that could be made to advantage if there were no cost at all involved. They are not made, because exchanging requires pecuniary capital. Let the pecuniary capital increase, however, and sub-marginal exchanges become worth while, the general margin is lowered. Commerce is the most highly flexible and elastic portion of the whole productive process. The elasticity of demand for commercial capital is, thus, greater than the elasticity of demand for any other form of capital.
How widely the volume of trade differs from the volume of production, and how great is the element of speculative transactions in trade, will best appear, I think, from an analysis of the figures which Fisher gives[245] for the volume of trade in the United States. His figure for the volume of trade in the year 1909 is $387,000,000,000.00, three hundred and eighty-seven billions of dollars! This figure is reached by equating the figures he has reached for MV plus M´V´ to PT, and assuming P to be one dollar, by making the "unit" of T, arbitrarily, a dollar's worth of each sort of commodity, at the prices of 1909. I have already commented on the legitimacy of this method of summarizing T,[246] and need not say more here, beyond calling attention to the fact that "volume of trade," as commonly used, does in fact mean, not T alone, but PT. Fisher for years other than 1909, however, makes use of a different method of getting at T: he takes certain indicia of relative amounts of trade, compares them with the same indicia for 1909, and estimates the trade for other years as being such a percentage of the trade for 1909 as their indicia are of the indicia of 1909. The indicia chosen are: (1) quantities of certain commodities, cotton, fruit, cattle, etc., received at principal cities of the United States, taken as typical of the variations of the internal commerce of the United States; (2) quantities of 23 articles of import and 25 articles of export, for each year, taken as typical of variations in the foreign trade of the United States; (3) sales of stocks. These three indicia, weighted in a manner to be described in a moment, are then averaged. There is a second element in the index, made up by taking the figures for railroad tonnage, and the figures for receipts on first class mail, which are averaged. The first average and the second average are then combined into a third average, which is the final index. The relation between this index for every year other than 1909 and the same index for the year 1909 determines the amount of T for each year—the two indicia, together with the figure, $387,000,000,000.00, giving the required amount by the "rule of three." I shall not go into details with the method of constructing these averages, but I wish to make clear the comparative weight given to each element in the final index: The first three elements count twice as heavily as the last two, and so constitute the biggest factor. In the first average, based on the first three elements, the item taken as typical of internal trade is weighted by 20, the item taken as typical of foreign trade is weighted by 3, and sale of stocks by 1. It appears from Fisher's figures (p. 479), that the one really big variable among all the indicia is the sale of stocks, but the weight given it is so small that it makes virtually no difference in the final result. Thus, as between 1898 and 1899, stock sales increased over 50%, but total trade, as shown by Fisher, increased only 5%. In the following year, stock sales decreased over 21%, but total trade, on Fisher's figures, increased. The following year, 1901, stock sales virtually doubled, but Fisher's final figure shows only an increase around 13%. Two years later, in 1903, stock sales fell off about 40%, from the figures for 1901, but again, as compared with 1901, total trade on Fisher's figures shows an appreciable gain. The influence of stock sales on Fisher's index is, virtually, negligible. The dominating factor is the receipts of selected staples, cattle, cotton, rice, pig iron, etc., in the principal cities of the United States. There is not a single year in which his final figure for T does not move in harmony with this factor (p. 479). He gets, thus, for the volume of trade through the fourteen years under consideration, a surprising steadiness, and a pretty uniform progressive development.
In defence[247] of his method of weighting, Fisher says, simply: "These weights are, of course, merely matters of opinion, but, as is well known, wide differences in systems of weighting make only slight differences in the final averages." (Italics mine.)[248]
Are these figures valid? Well, first one is struck with the absolute magnitude assigned to T. The figures seem vastly greater than would have been anticipated. The method of calculating it, for 1909, I shall discuss in detail in the chapter on "Statistical Demonstrations of the Quantity Theory." For the present, it is enough to note that the absolute magnitude is derived from figures collected by Dean David Kinley for the National Monetary Commission,[249] of deposits, exclusive of deposits made by one bank in another, made in about 12,000 banks (out of 25,000) on March 16, 1909. These deposits were classified as (1) money (with subdivisions) and (2) checks and other credit instruments. A cross-classification divided them into (1) retail deposits; (2) wholesale deposits; (3) all other deposits. Kinley's object was to determine the extent to which checks are used, as compared with money, in payments, particularly in wholesale and retail business. Fisher's total, briefly, was obtained as follows: Kinley's figures, for the one day, were increased to make an allowance for the non-reporting banks; they were further increased on the assumption that March 16 was below the average for the year; the figure finally obtained for the day was then multiplied by 303, assumed as the number of banking days in the year, and the product, 399 billions, was taken as representing the total circulation of money and checks in trade. For some reason not made clear, this total was subsequently reduced to 387 billions. Counting the average price, P, as $1, T was considered to be 387 billions.[250]
In the statistical chapter to follow, it will be shown that this estimate is a very decided exaggeration. Deposits made in banks greatly overcount trade. Very many payments represent duplications, loans and repayments, taxes, etc., and are in no sense trade. This is true of all classes of deposits, wholesale and retail, as well as "all other." But for the present, I am concerned with the question, not of the absolute magnitude of the volume of trade, but rather, the questions of its character, of the elements that enter into it, and, above all, of the extent to which it is physically determined by technical conditions of production, and the extent to which it is flexible, a matter of speculation, etc.
We may approach this question from the angle of several bodies of statistical information. First, the question may be raised: what is there in the country which could be bought and sold enough in the course of a year to give us anything like so great a total? The subtractions which we shall find it necessary to make will still leave us an enormous total.
The United States Census Bureau[251] in 1904 reached the conclusion that the total wealth of the country was only $107,000,000,000. Of this, over $62,000,000,000 was in real estate; $11,000,000,000 in railroads; street railways, over $2,000,000,000; telephone, telegraph, water and light, and similar enterprises total nearly $3,000,000,000 more. None of these things enter into ordinary wholesale and retail trade. The items that one would ordinarily think of are agricultural products, $1,900,000,000; manufactured products, $7,400,000,000; mining products, $400,000,000. Can these things be exchanged often enough in the course of a year to account for $387,000,000,000!
These figures are for 1904,[252] whereas Fisher's figures are for 1909. If the Census Bureau had taken an inventory in 1909, the figures would doubtless be larger. The inventory for 1912 made by the Census Bureau does show a very considerable increase, the largest item being due to a rise in real estate values. The figures for agricultural, manufacturing, and mining products are, also, figures for a given time rather than for total production through the year. But, making all the allowance one pleases, it is quite incredible that one should reach a figure of $387,000,000,000 by taking only the exchanges necessary to bring raw materials through the various stages of production to the consumer. The greater part of the $387,000,000,000 is to be explained in another way!
A detailed analysis of Kinley's figures, on which the estimate of total trade is based, leads clearly to the same conclusion. Kinley's figures for the banks that reported on March 16, 1909, are as follows:
The "all other deposits" are vastly greater than retail and wholesale deposits combined! Notice, too, with reference to the question as to how often goods need to be turned over in getting to the consumer: wholesale trade uses only about twice as much money and checks as does retail trade. Goods are not, if these figures are in any way typical of actual trade, turned over many times in the process of reaching the consumer. The "necessary," or "physically determined" number of exchanges, in the routine of trade, is small, per item.
Retail deposits of 60 millions make up less than one-eleventh of the total. Retail and wholesale deposits together make up about three-elevenths. What is the other eight-elevenths, represented by the "all other deposits"? It will help if we see where these "all other" deposits are located. If we find them scattered evenly throughout the country, in rural regions as well as in cities, we might be at a loss. If, however, we find them bunched in the big speculative centres, we may conclude that speculation accounts for a large part of them. We do in fact find this.
The following figures show the different classes of deposits (1) in the South Atlantic States; (2) in reserve cities; (3) in New York City alone:
| | Per Cent. |
| South Atlantic States: |
| Retail deposits | $ 3,300,000 | 19.0 |
| Wholesale deposits | 4,900,000 | 29.0 |
| "All other" deposits | 8,900,000 | 52.0 |
|
| Reserve Cities (including New York City): |
| Retail deposits | $ 24,000,000 | 5.6 |
| Wholesale deposits | 78,000,000 | 18.2 |
| "All other" deposits | 326,000,000 | 76.1 |
|
| New York City: |
| Retail deposits | 9,000,000 | 3.7 |
| Wholesale deposits | 34,000,000 | 14.0 |
| "All other" deposits | 198,000,000 | 82.2 |
It is difficult, with Kinley's figures, to get figures which exclude returns from cities of substantial size, except for a State like Nevada, where the mining and divorce industries complicate the figures. As near an approach as can be made, perhaps, is to take the State of Louisiana, excluding New Orleans from the totals. Even here, however, we include five cities of over ten thousand, among them Shrevesport, with 28,000 people. The following figures are for the State and national banks in Louisiana, exclusive of New Orleans:
| Retail deposits | $ 179,915 | 24.1 |
| Wholesale deposits | 246,647 | 33.1 |
| "All other" deposits | 318,915 | 42.8 |
We cannot tell, in these figures for Louisiana, how many banks are represented, or what the average figures per bank are. For the whole State of Arkansas, however, including five cities of over 10,000, with two over 20,000, and one of 45,000, we can get an average for ninety reporting banks. Even here we do not know where these banks are located within the State; though it is probable that they are in the larger places, and so exceed the average deposits for the banks in the State as a whole, to say nothing of the average for the smaller places. The ninety banks are almost wholly State and national banks.
| | Per Cent. |
| Arkansas: |
| Retail deposits | $ 232,017 | 25+ |
| Wholesale deposits | 231,614 | 25+ |
| "All other" deposits | 456,544 | 49+ |
The average for all deposits, per bank, in Arkansas is $10,224; the average for all the 11,492 banks reporting for the whole country is, approximately, $60,000; the average for the 659 banks reporting from New York State is $502,136; the average for the banks in New York City alone is doubtless much higher, but cannot be stated, as Kinley's figures do not tell how many banks reported by cities.[253]
The "all other deposits" in Arkansas are 27.8% cash, and 72.2% checks; the "all other" deposits in the country as a whole are only 4.1% cash, with 95.9% checks; the "all other deposits" of New York City are only 1% cash, with 98.9% checks.
Several facts are very clear from these comparisons: (1) the proportion of "all other deposits" increases very rapidly as we get closer to the great centres of speculation, and is lowest in rural regions; (2) the great bulk of all the deposits is in the cities. The average for Arkansas banks, for example, is only one-sixth the average of the whole country, and is only one-fiftieth the average for the banks of New York State. It is a much smaller fraction of the average for New York City, but we cannot give an exact figure. The totals reported from the rural regions are trifling, as compared with the totals reported from the big cities. This, as will be made clear in the chapter on "Statistical Demonstrations of the Quantity Theory," is not because the country reports were less complete that the city reports. New York was probably less complete than the country as a whole. It is simply because the activity of country accounts is small, the amount of trading in the country districts small, and (as shown) the average for country banks is small. (3) The character of the "all other" deposits in Arkansas differs substantially from that of the "all other" deposits in New York City, as indicated by the fact that the proportion of cash is high in Arkansas—substantially higher, in fact, for the "all other" deposits in Arkansas than for all deposits, or even for retail deposits, in the country as a whole. The percentage of checks in total retail deposits in the United States, in Kinley's figures, was 73.2; the percentage of checks in the "all other" deposits in Arkansas was 72.2. We may count these Arkansas "all other" deposits as, in considerable degree, deposits made by farmers. What were the "all other deposits" made in New York City?
Dean Kinley's list of the miscellaneous elements that enter into the "all other deposits," given on p. 151, contains only two that might be expected to bulk large in New York without appearing in Arkansas. These are: brokers, and stock and bond financial corporations. Of course, theatres, hotels, publishing houses, railroads, public funds, "those who have no specific business," and rich churches, will all be absolutely much larger in New York City than in Arkansas. But these things may be found in many places, scattered throughout the cities of the country, without making anything like such "all other" deposits as New York shows. It is not New York's foreign commerce that does it, because that is represented in New York's "wholesale deposits," which make up only 14% of New York City's total deposits for the day. It cannot be the supposed "clearing house" function of New York City,[254] whereby banks in different parts of the country pay their balances due one another in New York exchange, because such transactions would appear in New York chiefly in the figures for deposits made by one bank in another, and these figures are excluded from Kinley's totals. It cannot be the deposits of the "idle rich" for current expenses that swell New York's "all other deposits" so greatly—these could not equal the total retail deposits of the city, which are only 3.7% of the total in New York. Moreover, similar deposits are made in many other cities, without, in proportion to population, making any such totals. Figures, moreover, for the aggregate yearly income of the United States, and for the distribution of that income between rich and poor, make it clear that any such items must be bagatelles in comparison with these enormous figures. The only explanation that will really explain is the speculative and investment and financial transactions that centre in New York, and, in less degree, in the other great financial cities of the country.
This is Dean Kinley's opinion. In the "all other" deposits he makes a 50% allowance for speculative transactions. "A large proportion of deposits in this 'all others' class undoubtedly represents speculative transactions, all of which, or practically all of which, are settled with credit paper."[255] It is also the opinion of General Francis A. Walker, expressed concerning similar figures from earlier inquiries.[256]
Various kinds of evidence converge toward this conclusion. Thus, the evidence of clearings, total items presented by banks to the clearing houses of the country. New York clearings are usually nearly twice as great as total clearings for the rest of the country. New York clearings fluctuate in general harmony with transactions on the New York Stock Exchange. This has been commented on many times. The extent to which it holds has recently been carefully measured by Mr. N. J. Silberling, whose results appear in the Annalist for August 14, 1916, under the title, "The Mystery of Clearings." Mr. Silberling applies the "coefficient of correlation" to the problem, getting in one significant figure a measure of the extent to which two variables, as share sales on the New York Stock Exchange and New York clearings, vary together. This coefficient has been used enough by economists not to require detailed explanation here. It is a figure always between +1 and -1. +1 indicates that the two variables in question are perfectly correlated, whereas 0 indicates no correlation whatever. -1 indicates an inverse correlation, such that two variables vary exactly and inversely with reference to one another.[257]Mr. Silberling's studies show the following correlations: New York share sales (numbers of shares, not values) to New York clearings, using weekly figures, for the years 1909-10, r = .628. This is a high correlation. Limiting the observations to the middle weeks of the month for the same period, he gets r = .731(46). The reason for taking only middle weeks in the month is that thereby the disturbing factor of monthly settlements is avoided. The monthly settlements may be for stock transactions, or may be for other things, but as they are not dependent on the stock transactions of the week in which they occur, their effect is to lessen the evident degree of connection between stock sales and clearings. Thus the middle weeks show a closer correlation between the two variables than do all the weeks taken as they come. If figures for the month were taken, this complication would be smoothed out, and a fairer result might be expected to appear. The middle weeks, eliminating monthly settlements, probably eliminate more other things than they do share sales (which are in large degree paid for in 24 hours[258]), and so exaggerate somewhat the relation between shares and clearings. Monthly figures avoid both complications, though they lose something of the concrete causation. An intermediate figure might be expected for the monthly correlation, and this we find: r = .718(23).
A striking single fact in connection with these figures, giving them point as less extreme variations could not do, is found in the behavior of clearings when the Stock Exchange was closed, during the crisis of 1914. At that time, New York clearings, which had been about twice as great as country clearings, fell suddenly below country clearings. When the Stock Exchange was opened, the old proportions suddenly reappeared.
That speculation spreads far beyond New York, New York being the centre for dealings in securities, etc., which involve the whole country, is, of course, well known. The extent of this Mr. Silberling seeks to measure by correlating clearings outside New York with New York share sales. His weekly correlation for these two variables for 1909-10 gives r = .368(103), and the correlation for the mid-weeks gives a higher figure, r = .424(46). The monthly correlation shows r = .257(23), a lower figure, "which is perhaps due in part to the fact that the bulk of the outside monthly clearings show relatively moderate fluctuations, because of their diverse composition, and are less sensitive than the periods of shorter length."
Seeking an index of the variations of that trade which is, in Professor Fisher's phrase, governed by "physical capacities and technique"—a law which Professor Fisher,[259] as we have seen, would apply to the great total of 387 billions which he has constructed—Mr. Silberling chooses the gross earnings of the principal railways as the best available test. Railways deal with all manner of other enterprises. He correlates this with clearings outside New York. "The question might arise at once whether changes in traffic are strictly concomitant with changes in payments involved by it, and therefore with the clearings resulting. The preliminary hypothesis that a 'lag' ensued between traffic and the bulk of the payments was first tested by correlating the railway figures with clearings of one month[260] and two months later, but no correlation was obtained. The direct month-to-month correlation yielded, however, a result r = .524(23)." This suggests that outside clearings are, in substantial degree, an index of physical trade, but Mr. Silberling calls attention to certain chance agreements between railway traffic and speculation in cotton and produce and grain, speculation in the crops which are in current movement, and regularly recurring concomitances between traffic and speculation in March, when the railway traffic revives after the February lull, and when there is a large mass of dealing in Spring deliveries in Chicago. In view of the facts later to be developed, with reference to the small actual value of the necessary physical exchanges (partially covered already) as compared with clearings, this query is well put. We may easily have here a "spurious" correlation. Taking it at its face value, however, and taking the correlation as indicating the influence of physical trade on bank transactions, we get the following results, when total clearings for the country are compared with (a) New York share sales, and (b) with railway gross earnings: (a) r = .607(23); (b) r = .356(23). "Physically determined trade" is at best a minor factor in that total "trade" represented by bank transactions!
Mr. Silberling has buttressed his results with a consideration of various alternative possibilities which might give them a different interpretation. I need not, for present purposes, go further into his figures.[261] Taken in conjunction with the other data presented, and to be presented, together with the theoretical discussion of the nature of trade, and its relations to money and credit, which the present volume contains, they give the present writer abundant confidence in the thesis that the great bulk of trade in the United States is SPECULATION, rather than that sort of trade which is determined "by physical capacities and technique."
The figures given above, of the inventory of wealth at a given moment of time, by the Bureau of the Census, show only trifling magnitudes, as compared with the estimated 387 billions of deposits made in 1909, of items which could enter into ordinary trade, as distinguished from speculation and dynamic readjustments. An effort to calculate ordinary trade on the basis of figures running through the year may throw further light on the problem. Railway, gross receipts for the year ending June 30, 1909, were less than two and a half billions. This is six-tenths of 1% of the total. Receipts of the Western Union Telegraph Company were $30,451,073—less than one-hundredth of 1%. The Post Office in the fiscal year ending in 1909 took in $203,562,383. This is something over one twentieth of 1%. These are gigantic sums. But they are insignificant indeed in this computation. Millions of smaller items simply do not count at all—ten million items of $387 each would give only 1%. The total net income of the United States, as estimated by W. I. King for 1910, including all forms of income, dividends, interest, wages, rents, profits, salaries, etc., is $30,500,000,000[262]—around 7% of the 387 billions.
Let us sum up the major items of ordinary trade. From Kinley's figures, we may get some idea of the proportions of wholesale and retail trade to the total for 1909, assuming that the deposit figures indicate that total. Retail deposits make up less than one-eleventh of the total, and wholesale deposits about two-elevenths. The figures were: retail, 60 millions, wholesale, 124 millions, and "all other," 502 millions. But the "all other" deposits were lower than normal. New York City was, in the first place, probably less complete than the rest of the country, in the figures returned, and, in the second place, New York City, as shown by the clearings of March 17 (the next day, when checks deposited in New York would get into the clearings) was 28% below normal. The rest of the country was within 3% of normal.[263] Not to refine matters too much, we shall, on the assumption that the variable element in New York deposits is connected with the Stock Exchange (as shown by Mr. Silberling's correlations and other considerations), and on the assumption that deposits connected with the stock market appear in the "all other" deposits, add a little over 20% of New York's total of 198 millions, or 40 millions, to the "all other" deposits for the country, leaving the wholesale and retail deposits unchanged. What error there is in this is favorable to the wholesale and retail deposits. Our proportions, then, are: retail, 60, wholesale, 124, "all other," 542, total, 726. If the retail deposits correctly represented retail trade, we could then say that retail trade was a little less than one-twelfth of the whole, and wholesale trade about one-sixth. But there are many speculative transactions engaged in by wholesalers, and a good many by retailers. The writer knows a small delicatessen dealer on Amsterdam Avenue, in New York, who frequently speculates in eggs and canned goods. A colleague in the Harvard Graduate School of Business Administration is authority for the statement that speculation in canned goods and some other things is quite common among retailers, particularly "hedging" by the use of "futures," in canned goods. Speculation among wholesalers is very extensive. The same is true of manufacturers. The same authority cited some cotton manufacturers whose profits from cotton speculation are greater than their profits from manufacturing. We shall see reason to suppose that a very substantial part of manufacturers' deposits were included in the wholesale deposits. That the figures for retailers' deposits exaggerate the retail trade may appear from several considerations: (1) The proportion of checks to cash reported is too high: 73.2%. Dean Kinley allows 5% of the checks deposited to be "accommodation checks,"[264] cashed for customers, rather than taken in in trade. (2) If retail deposits are taken as exactly representative of retail trade, we should get a retail trade for the year of over 32 billions (1/12 of 387 billions), which would exceed the total income of the country as calculated by King for 1910. Dean Kinley reached the conclusion that the retail deposits reported in 1896 also exceeded the probable retail expenditures.[265] Of course, not all of retail trade is in consumption goods. Hardware stores, lumber stores, and some other retail establishments sell, not only to householders for domestic use, but also things which enter into further production, and so do not come out of annual income. If we include in retail trade various items which were not included there in Kinley's figures, such as hotels, theatres, newspaper receipts from subscription and street sales, physicians' fees, etc.—all those items which enter into the domestic budget, including domestic service, we should still not be justified in reaching a total as great as the total income of society, since there would then be no allowance for savings, which we should not count in trade, or for life insurance, which we shall count separately. The items sold at retail which enter into further production cannot make a great total, since large producers buy such things at wholesale. Total retail trade, therefore, and, in addition all the other items in the domestic budget, must be held below the figure for total national income. Suppose, to be very liberal, we allow 29 billions[266] for all these items, under the general head of "retail trade."
For wholesale trade, if we take the figures at face value, the estimate would be 65¾ billions (124/726 of 387 billions, or 17% of 387 billions). But we have seen that there is a great deal of speculation among wholesalers. Not all of their deposits, by any means, represent receipts from ordinary business. Moreover, there is much overcounting here, several checks being used for one transaction, especially where wholesalers have branch houses, and checks connected with loans and repayments, and transfers of funds from one bank to another. How much we should subtract for this there is no way to tell. In the case of retail figures, we have the additional check of the figures for total net income, but there is no such check here. We shall, therefore, make no subtraction, but shall content ourselves with pointing out that we are allowing many billions[267] to "ordinary trade" to which it is not entitled, which will much more than offset errors in the opposite direction which the reader may find in our computations.
Do manufacturers' receipts from first sales belong in the wholesale deposits, or must they be counted as a separate item? Dean Kinley does not say. In his list of items, as reported by banks, that go in the "all other" deposits,[268] he does not mention manufacturers, and the item is far too important not to have been mentioned by so careful a writer had he supposed that it belonged there. If manufacturers' first receipts belong, not in the wholesale deposits, but in the "all other" deposits, then we should expect manufacturing cities to show a high percentage of "all other" deposits as compared with wholesale deposits. The city of Pittsburg should be a good test case. The figures there, for State and national banks and trust companies, are:
| | Per Cent. |
| Retail deposits | $ 1,061,420 | 9.6 |
| Wholesale deposits | 3,368,004 | 29.7 |
| "All other" deposits | 6,672,378 | 60.6 |
For Pittsburg, the percentage of "all other" deposits is lower decidedly than the percentage for the country as a whole (about 75%), much lower than for cities where there is active speculation, as Chicago and St. Louis, to say nothing of New York, and is closer to the percentage of the South Atlantic States, 52%, than to the average for the country. The wholesale deposits of Pittsburg, however, rise to 29.7%, as against an average for the country of 17%. There is nothing in these figures to suggest that manufacturers' first receipts are exclusively in the "all other" deposits. I should think it safe to hold that a substantial part of them were included in wholesale deposits, and so already accounted for in our estimate. The total value of products manufactured in 1909 was $20,672,051,870. I shall allow $5,672,051,870 of this to have been already accounted for in our estimate of wholesale trade, and count 15 billions of it as a separate item. If there is an error here, it is very much more than offset by our failure to subtract anything from the wholesale figures for speculation. I think it probable that much more of the figures for manufactures should be assigned to the wholesale figures than I have assigned.
To these figures, we may add a number of other items, absolutely great, but insignificant, in comparison with the 387 billions not only, but also with the figures for retail and wholesale trade already reached. These are: total farm value of farm products (not nearly all of which is sold off the farm) $8,760,000,000; total mineral products, $1,886,772,843; total mill value of lumber, $684,479,859; total life insurance premiums (much of which is savings, and in no proper sense trade), $748,027,892; total fire, marine, casualty and miscellaneous insurance, $362,555,850; total wages and salaries, $14,303,000,000; total land rent, $2,673,000,000;[269] and the items for railway gross receipts, post office, telegraph, already mentioned. The total of these items, together with retail and wholesale trade and manufactures, is $141,860,618,000. This is only 36.6% of the total of 387 billions. It leaves over 245 billions unexplained. What can the 245 billions represent? There is really no way in which ordinary trade can make up more than a very few more billions, so far as I can see. There remain no items as big as 1% of the total, and, as we have seen, small items, of hundreds of dollars each, are like "infinitesimals of the second order"—they simply do not count at all when such staggering figures are involved.[270]There remains, then, a total of 245 billions of check and money payments which are for something other than the ordinary trade of the country. What do these payments represent? Much of this total represents overcounting and duplications of various kinds, which we shall consider in a later chapter. Much of it also represents speculation and dealings other than speculative in securities. When we seek to find actual figures of transactions in any field, retail, wholesale, or speculative markets, or anything else, it is exceedingly difficult to find anything that approaches the amounts indicated by the banking transactions connected. I do not think that a record of all sales would show retail sales or wholesale sales anything like so great as the figures as we have allowed for them on the basis of the retail and wholesale deposits. When we look at the recorded figures of transactions on the speculative exchanges (or at estimates which competent observers make when records are not available), the figures, though very large, do not begin to equal the banking figures with which we have to deal. The New York Stock Exchange in 1909 showed sales, recorded on the ticker, of nearly 215 million shares of stock, with an approximate value of over 19 billions[271] of dollars. This was not an extraordinary year. In 1901 nearly 266 million shares were sold, in 1905, over 263 millions, in 1906, over 284 millions. A number of other years have approached the figures for 1909. If stock sales be a good index of general speculation, 1909 is a very satisfactory year from which to have got figures, as showing neither extreme speculation, nor extreme dullness—which latter was the case in 1896 when Kinley's other big investigation was made. The figures for shares sold, however, do not exhaust the business done at the New York Stock Exchange. "Odd lots," i. e., sales of less than 100 shares, are not recorded on the ticker. Mr. Byron W. Holt estimates that from 25 to 30% would be added if they were counted. DeCoppet and Doremus, of New York, who handle at least as much of the "odd lot" business as any other New York house, have given me the following information about the "odd lot" business: (1) the volume of odd lot sales is, roughly, from 20 to 25% of the volume of hundred share sales; (2) the odd lot business fluctuates in conformity to the hundred share market; (3) the odd lot speculator is just as likely to be a "bear" as is the hundred share speculator, and, in general, odd lot business is like the hundred share business. If we take the figure on which these two estimates agree, 25%, we may add 53¾ million shares to our 215, getting 268¾ million shares for 1909, with a value of about 24 billions. Bond sales recorded would add about 1 billion more. There are, further, some unrecorded sales, indeterminate in amount, but sometimes very substantial, when brokers have a number of "stop loss" orders. They match these before the market opens, and, if the prices are reached in the actual trading, these sales become effective automatically, without getting on the ticker. How extensive this is cannot be stated. It may sometimes add very substantially.[272] Thus, on the floor of the New York Stock Exchange we have dealings in excess of 25 billions for 1909. This is nearly as large as the figure we have assigned, on the basis of the bank figures, to total retail trade of the country, and it may well exceed the retail trade in fact. Recorded sales on other stock exchanges do not, in the aggregate for the country, bulk very large. For 1910, when New York shares reached 164 millions, the total for Boston, Philadelphia, Chicago, and Baltimore was something over 21 million shares.[273] The New York Curb has had "million share" days, but the average value of shares is low. But the dealings on the floors on the exchanges and "curbs" are far from all of the dealings in securities! Only securities which have been admitted by the authorities are dealt in on the exchanges. The volume of unlisted securities is enormous. Moreover, not all, by any means, of the sales of listed securities take place on the floors of the exchanges. The bond expert of a large banking house in Boston informs me that the "over-the-counter" business in Boston, both for stocks and for bonds, much exceeds the business in the Boston Stock Exchange, and others among Boston brokers have expressed the same opinion. The statement has been repeatedly made in the financial press that of the bonds listed on the New York Stock Exchange, ten are sold over the counter for one sold on the floor. Evidence on this point is not to be had in definite figures, of course, but I have found no one in Wall Street who regards it as extravagant. A single big bank in New York sold $550,000,000 in bonds in 1911—more than half the recorded bond sales on the Stock Exchange.[274] I should not know how to estimate the volume of outside dealings within many billions of "probable error." If ten billions of listed bonds are sold over the counter in New York alone, we may well suppose that the volume of over-the-counter sales of listed and unlisted securities at least is not smaller than the recorded sales on the floors of the exchanges. But this is all guess work. There are no definite data.
For produce, cotton, and grain speculation we have, in general, estimates rather than records. For the Board of Trade, in Chicago, there is one quite striking piece of information. That is that the Federal War Tax of 1 cent per hundred dollars on grain and provision futures on the exchanges produced $2,000,000 in Chicago alone in 1915.[275] For the purposes of the tax, deliveries within thirty days were counted, not as futures, but as "spot" transactions. The tax was collected almost wholly on grain. If the above figure is correct, then it is clear that dealings in these futures of over thirty days aggregated 20 billions of dollars worth. This gives no estimate of spot transactions, which are, however, very great. All this trading involved less than 400,000,000 bushels of grain received at Chicago—a little over a billion bushels were received at all primary markets. The grain received at Chicago was, thus, (at 80c. per bushel), sold sixty-two times over in these futures, and an unknown number of times in spot transactions. There are further enormous spot transactions in provisions of various kinds at Chicago.
Chicago is the great centre, of course, for this kind of speculation in the United States. It may well be the world's chief market, so far as futures are concerned, though evidence to establish such a thesis is not at hand. London and Liverpool are gigantic centres of commodity speculation. But we have numerous cities in the United States where such speculation is very great. St. Louis, Kansas City, Minneapolis, New Orleans, and other cities are active speculative centres. New York, while small in its volume of grain and produce speculation as compared with Chicago, is the world's centre for cotton speculation, and the world's centre for futures in coffee, though yielding precedence to Havre, Santos and Hamburg,[276] ordinarily, in the volume of spot coffee transactions, and though handling only a very small amount of spot cotton. The volume of cotton sold in an ordinary year in New York is 50,000,000 bales,[277] though only about 160,000 bales are ordinarily received there, in a year.[278] In the five years preceding 1909, the sales on the New York Coffee Exchange averaged over 16 million bags of 250 pounds each.[279] In 1915, 32 million dollars were deposited as margins in connection with this speculation in coffee, and in ordinary years this runs from 25 to 30 millions, according to the Treasurer of the Exchange. The relation between the margins put up and the total pecuniary volume of trading is not indicated, but in most exchanges the actual depositing of margins is a small fraction of the pecuniary magnitude of the turnovers. Both the Cotton and the Coffee Exchanges are international centres. The Coffee Exchange now handles large transactions in sugar, also.
Contacts between the organized exchanges and ordinary business are very numerous. Producers in every line who can do so protect themselves by "hedging" in the exchanges which deal in their raw materials. This is a commonplace, so far as millers are concerned. The writer has found millers in a town off the main lines of the railroads in Missouri who regularly sell short a bushel of wheat on the St. Louis Merchants' Exchange for every bushel they buy to grind. The business man who does not sometime take a "flier" in the market for other than hedging purposes is rare! But, apart from the organized markets there is an immense volume of speculation. If a wholesaler buys only what he can sell to retailers, it is not speculation. But if he buys in excess of the anticipated demands of his retailers, expecting to sell the excess at an advance to other wholesalers, he is speculating. If a farmer buys cattle to feed, he is not speculating, but if he buys them thinking to sell them at an advance in a short time, and does so, the transactions are speculative. The line is not easy to draw, in practice. Intention is shifting and uncertain. There is chance in every industrial, commercial, and agricultural operation. But for the point at hand, the test is simple: do more exchanges take place than are necessary, under the existing division of labor, to advance the materials of industry through the stages of production, and get things finally to the consumer? If so, the excess of exchanges is speculative. Trading between men in the same stage of production is speculation. It represents trading to smooth out dynamic changes, to bring about readjustments which would have been unnecessary had conditions really been static, and had the initial plans of enterprisers been adequate. Trading in anticipation of further trading with men in the same stage of production is speculative. This sort of thing, in the wholesale business, especially, is exceedingly common. This has been noted by Professor Taussig, and made by him an important point in the theory of crises. Dean Kinley[280] called attention to it as a matter of importance in connection with his investigation in 1896. The coming of cold storage, and the development of the canning industry have, I am informed by a colleague in the Harvard Business School, enormously increased this speculation among both wholesalers and retailers, and it is very important in most wholesale lines. There is short-selling in materials for construction purposes, and in metals, apart from organized exchanges, and, where possible, contractors in the building trade often protect themselves by means of future contracts with speculators who are selling short.
Land speculation, in varying volume, is found in every part of the country. There is speculation in leases, in options on real estate, and in options on leases.[281] It may be noticed, too, that sales of "rights," of puts and calls and straddles, and other contract rights, are regular factors in the organized exchanges. Wherever profits are to be made by leveling values as between different places or different times, speculation arises, and, with dynamic change, this means everywhere, in every business, and all the time! The shifting of labor and capital from industry to industry, leveling returns to capital and labor, involves an enormous amount of trading that would not occur in a "normal equilibrium." Much of this the Stock Exchange does. That is what it is for. But much of it has to do with unincorporated industry, and a vast deal of speculative exchanging takes place to this end apart from the organized exchanges.
Speculation in bills and notes, by note-brokers and particularly by dealers in foreign exchange, occurs on a large scale, and accounts for a great deal of the banking figures. This has nothing to do with physically determined trade. From the standpoint of Professor Fisher's "equation of exchange," it must be barred, if the contention that "trade" is determined by "physical capacities and technique" is to be adhered to. Speculation in demand finance bills is barred in any case, since "money against checks," and "checks against checks," are excluded by his definition.[282] But as an explanation of no small part of our unexplained 245 billions of dollars, these items must be brought in. They are "double counting" from the standpoint of Professor Fisher's equation. They are, however, speculation. An official in a great New York banking house, in charge of the foreign exchange department, writes that in times when exchange rates are fluctuating, enormous quantities of drafts on Europe will be bought and sold, during a period of a couple of weeks or months, whereas under other conditions such transactions might amount to little with the same volume of imports and exports. The part of this which is between banks, a very big item, would not count in the 245 billions, but to the extent that foreign exchange brokers outside the banks participate, their activity helps to explain our 245 billions.
If it be true that speculation, including all manner of readjustment to dynamic changes, makes up the overwhelming bulk of trade in the country, then Fisher's indicia of variation in trade, weighted as they are, are totally misleading. The same is true of Kemmerer's indicia of "growth of business."[283] These are: population, tonnage entered and cleared, exports and imports of merchandise, postal revenues, gross earnings of railways, freights carried by railways, receipts of the Western Union Co., consumption of pig iron, bituminous coal retained for consumption, consumption of wheat, consumption of corn, consumption of cotton, consumption of wool, consumption of wines and liquors, market values of reported sales on the New York Stock Exchange. Only the last of these is in any sense an index of speculation. It is swallowed up by being put on a par with the other fourteen items. Its influence on the final index, made by averaging the others is, as inspection shows, virtually nil. Out of the twenty-six years his figures cover, the general index moves counter to the share sales 14 times! Utterly random figures would have come nearer to the facts in the case. It is particularly striking that Professor Kemmerer, whose total figures, as Professor Fisher's, rest for their absolute magnitude on Kinley's investigation,[284] should assign 89% of his estimated trade (183 billions in 1890) to wholesale commodities,[285] (with 3% to wages, and 8% to securities), when Kinley's figures show that wholesale deposits are a minor fraction of the total!
The constancy in the figures of these two writers for trade from year to year, a general steady, upward growth, does indeed suggest that trade is determined "by physical capacities and technique," and that it does stand as a great, independent, inflexible factor, independent of money and deposits, constituting a real causal coefficient with them in determining prices. If, however, speculation is as big a factor as our analysis would indicate, then trade is a highly flexible thing, varying enormously from year to year, moved by a multiplicity of causes, among them fluctuations in particular prices, and the ease and tightness in the money market—the quantity of money and deposits.
But quite apart from speculation, it is not true that trade is a mere matter of physical capacities and technique, a passive function of production. Rather, one would almost have to reverse the relation. Production waits on trade!
Production, as now carried on, is primarily conducted in the expectation of sale, and of profitable sale. Trade does not go of itself, automatically. Rather, it is a highly difficult matter, calling for the highest order of ability, and the labor of innumerable men. In general, I think it safe to say that in ordinary times, the manufacturer loses vastly more sleep over the question of how he shall market his output, than he does over the question of how he shall produce it. A clerk in the Westinghouse Air Brake Company, engaged in the accounting department, spoke recently to the writer of the "productive end" of the business. On inquiry, it developed that he meant the selling department! He stated that the manufacturing department also, in the language of the employees, in that corporation, would also be termed "productive," but that the selling department was the productive department.
If one reflects a little as to the proportion of "costs" that go into selling, as compared with technical "production," I think my point will be clearer. Advertising has developed so enormously that it needs little discussion. It has been stated that the "Sapolio" people once tried, after their reputation seemed thoroughly established, to stop advertising, with such disastrous results that very extraordinary efforts were required to reËstablish the brand. Number 2 wheat is not advertised, in the great magazines, but innumerable brands of flour get newspaper and magazine advertising,—some of them in such a periodical as the Saturday Evening Post, and even those which are locally consumed are commonly advertised in the local press. Nor is it only finished products, of the sort that must be sold to the fickle public, that involve these heavy selling costs. The writer has in mind a corporation producing a high-grade type of glazed retort, in the production of which it has virtually a monopoly, since the clay with which it is made does not coexist with the skill to make it in any other place. The particular product is an indispensable part of many important technical processes. Substitutes made of other clays, and by other companies, are known by the trade to be unsatisfactory. The buyers are all highly trained business men. Here, if anywhere, selling costs should be slight. But the chief selling agent of the corporation has found it necessary, in order to keep the business going, to incur huge expenses for entertaining his customers, finds it necessary to incur great travelling expenses, to use only the most expensive hotels, and, incidentally, to drink a great deal more than his personal inclinations would call for, in keeping the business for his house. I waive discussion of the extraordinary fees which a trust promotor makes, in effecting a consolidation of big business units,—a process of exchange. I am speaking now of the ordinary costs involved in ordinary trade. The army of travelling salesmen, the body of stenographers, who write letters, with various "follow-ups," in the effort to get more business, the growing complexities of such letter writing, in which all suspicion of "circularizing" must be allayed, one-cent stamps being absolutely taboo!—these things are the commonplaces of business. They are in the primers in the "commercial colleges" and "schools of commerce." Only the orthodox economist, with his doctrine of the impossibility of general overproduction, is ignorant of them!
This feature of modern business has been much elaborated in a recent book which has not received the attention it merits—though its strength is rather in criticism than in constructive doctrine. I refer to Dibblee, The Laws of Supply and Demand.[286] Dibblee makes an interesting contrast between commercial and manufacturing cities, maintaining that the former necessarily outgrow the latter—a contention which London, New York, Chicago and other places strikingly illustrate. He presents a truly remarkable fact about London:[287] a recent report of the Commission on London Traffic states that there were in London 638 factories registered as coming under the Factory Acts, with an average horse-power of 54. The total power employed within the London area under the Factory Acts, chiefly used in newspaper printing, was 34,750 horse-power—just one-half of what is required for the steamship, Mauretania! This is the greatest city in the world. What do its millions do for a living?[288] The town of Oldham,[289] he asserts, with 100,000 inhabitants, has spindle capacity enough to supply more than the regular needs of the whole of Europe in the common counts of yarn. To market the output of Lancashire, "the merchants and warehousemen of Manchester and Liverpool, not to mention the marketing organization contained in other Lancashire towns, have a greater capital employed than that required in all the manufacturing industries of the cotton trade." Accurate estimates of the proportion of "selling costs" to costs of technical production are doubtless impossible, for the general field of trade, and precision is unnecessary for my purposes. Dibblee's conclusion, after contrasting retail and wholesale prices, and analyzing the expenses incurred in selling prior to the wholesale stage, is that the cost of marketing is at least equal to "real cost of production," occasionally only slightly below it, and often far above it (62).[290] If one considers how large the item of "good will" often bulks in the value of "going concerns"[291]—good will being in large degree often just a capitalization of prior costs of this nature—Dibblee's estimate need not be exaggerated. Trade connections, trade-marks that have reputation, etc., often represent enormous output in thought, work, and expense. Selling costs may, like other costs, be divided into "prime" and "overhead" costs. Some of the latter lead to long-time consequences, pay for themselves only in the long run. These may be "capitalized" in "good will."[292] Of course, not all good will is got at a cost. Much of it is adventitious.
In the light of the doctrine that trade is independent of money and credit, one wonders why it should be thought necessary to extend branches of American banks to the South American markets which we are now reaching out toward. And why have Americans, from the beginning, been constantly increasing commercial banks?[293] It is easy to sneer at the efforts of the successive frontiers in our history to provide themselves with banks of issue as based on a delusion, the delusion that bank-notes are "capital," and to say that their real need was, not more bank-credit, but more real capital. They needed more tools and live-stock, doubtless, but is that the whole story? And were their banks of no assistance in getting the additional capital of various sorts? And was it a matter of no consequence that they had an abundant medium of exchange? It seems almost childish to put such questions, but the quantity theory has as its logical corollary that to multiply banks is quite useless and wasteful, since the only result is to raise prices. If increasing bank-credit cannot increase trade or production, this corollary is inevitable. Indeed, the case may be more strongly stated. Quite apart from the wasted labor of bank-clerks and the waste of banking capital, the effect of increasing bank-development, on quantity theory reasoning, is harmful. If increasing bank-credit is to raise prices without increasing trade, then, on quantity theory reasoning, it must depress business. The reason is that rising prices in a given region make that region a bad place to buy in, and so curtail its exports. This is, indeed, the quantity theory explanation of international trade, to which attention is later to be given. The country which is expanding its banking facilities most rapidly will suffer most in competition in the world markets. This is why the United States have so little foreign trade! It also explains the rapid strides that China and Central Africa have recently made in capturing the world's markets. I submit that there is no flaw in this argument, if the premise of the independence of volume of trade and volume of bank-credit be granted. It follows from the quantity theory. That it is no caricature of Fisher's argument will appear, I think, from the following quotation,[294] which very nearly states what I have just been saying, though it does not draw the conclusion that banking is a bad thing: "The invention of banking has made deposit currency possible, and its adoption has undoubtedly led to a great increase in deposits and consequent rise in prices. Even in the last decade the extension in the United States of deposit banking has been an exceedingly powerful influence in that direction. In Europe deposit banking is in its infancy."[295] Happy Europe, troubled only by war! It is greatly to be hoped, in the interests of American agriculture, that the efforts to increase agricultural credit facilities will fail!
We are driven to one of the most fundamental contrasts in economic theory, which appears under various guises and in different forms: statics vs. dynamics; transition vs. equilibrium, theory of prosperity vs. theory of goods; normal tendency vs. "friction."[296] Perhaps Professor Fisher, and the quantity theorist in general, would dismiss many of these considerations as not applicable to the general principle, which is a "normal" or "static" or "long run" law, not subject to considerations of this sort. It is scarcely open to Fisher to defend himself this way, because of his exceedingly uncompromising statement regarding even "transitional" relations between volume of trade and money and credit. I shall not reply to anyone who offers such an objection by a general tirade against "static economics." I believe thoroughly in the method of economic abstraction, and in reaching general principles by ignoring, provisionally, in thought the "friction" and "disturbing tendencies" which often make the first approximations look somewhat unreal. But I raise this question: to what feature of our economic order do we chiefly owe it that we can make such abstractions? By virtue of what does friction disappear? What is it that makes our abstract picture of economic life, as a fluid equilibrium, with its nice marginal adjustments, its timeless logical relations, correspond as closely as it does to reality? The answer is: MONEY and CREDIT.[297]
It is the business, the function, of money and credit, as instruments of exchange, to bring about the fluid market, to overcome friction, to effect rapid readjustments, to give verisimilitude to the static theory, to make the assumptions of the static theory come true. Where exchange is easy and friction slight, there will not be two prices for the same good in the same market. Speculators, seeking profits of fractions of a point, will prevent that. By multiplying exchanges, they will level off values and prices. Because money and credit have done their work so thoroughly in the "great market," it is possible for men to talk about static theory, and to work out economic laws in abstraction from friction, transitions, and the like.
In the static state, all speculation is banished. There are no price-fluctuations to be smoothed out, no new prospects to be "discounted," no uncertainties to be guarded against by "hedging." Seasonal goods will, of course, have to be carried over from one season to the next, but this will involve merely warehousing and the use of capital—"time speculation," involving many sales, does not come in. One sale to the capitalist who carries the seasonal goods, with a sale by him to the man who means to use them, will suffice. It has been shown before that the great bulk of trade is speculation. But speculation is banished from the static state. Speculation is a function of dynamic change, waxing and waning with the degree of uncertainty that exists, the new conditions to which readjustments have to be made, the "transitions" that have to be effected. In other words, the laws governing the volume of trade are dynamic laws, laws of "transition periods," and so the whole notion which underlies the quantity theory, of "normal periods," "static" relations, etc., is here irrelevant. Volume of trade, as distinguished from volume of production, is controlled by the number and extent of the "transitions" that have to be made. The chief work of money and credit is done in, and because of, "transition periods." Assume a normal equilibrium accomplished, and you have little trading left to do. It will still be necessary, if you have the division of labor, and private enterprise, for goods to pass through as many different hands as there are different independent enterprisers in the stages of production, and on, through merchants, to the consumer. It will still be necessary to pay wages, rents, dividends and interest. But there will be no selling of lands, of houses, of factories, of railroads, or of securities representing these. By hypothesis these are already in the hands best qualified to hold them. The "static equilibrium" presents "mobility without motion, fluidity without flow."[298] The static picture is a picture of completed adjustment, where no one has an incentive to change his work, or his investments, because he has already done the best that he can for himself. It is, therefore, a picture of a situation where there is little incentive for those exchanges which make up the great bulk of the volume of trade in real life.
Hence the curious phenomenon that very much of static theory has been developed in abstraction from money and credit. Mill's theory of international values, for example, abstracts from money. "Since all trade is in reality barter, money being a mere instrument for exchanging things against one another, we will, for simplicity, begin by supposing the international trade to be in form, what it is in reality, an actual trucking of one commodity against another. So far as we have hitherto proceeded, we have found the laws of interchange to be essentially the same, whether money is used or not; money never governing, but always obeying, those general laws."[299] Other writers have similarly held that money is a mere cloak, covering up the reality of the economic process. Schumpeter, for example, holds that money is, in the static analysis, merely a "Schleier," and that "man nichts Wesentliches Übersicht, wenn man davon abstrahiert."[300] On the static assumptions, of the fluid market, with friction, etc., banished, money is, indeed, anomalous and inexplicable. It is a cloak, a complication, a vexatious "epi-phenomenon." There is nothing for it to do, and there can be, consequently, no "functional theory" developed for it. Static theory may be ungracious in ignoring its own foundation. But static theory is grotesque when it seeks to support its own foundation! Static theory is possible only on the assumption that the work of money and credit has been done. What, then, shall we say of static theory which seeks to explain the work of money and credit? Yet precisely this is what is undertaken by the quantity theory, with its "normal" or "static" laws of money and credit. A functional theory of money and credit must be a dynamic theory. To talk about the laws of money, "after the transition is completed" is to talk about the work money will do after it has finished working. For a functional theory of money and credit, we must study the obstacles that exist to prevent the fluid market. We must study friction, transitions, dynamic phenomena.
To this problem we shall come in Part III. For the present, I am content to have disproved the quantity theory contention that the volume of trade is independent of the quantity of money and credit.
APPENDIX TO CHAPTER XIII
THE RELATION OF FOREIGN TO DOMESTIC TRADE IN THE UNITED STATES[301]
The word, "trade," as used in connection with statistics of foreign and domestic trade has been irritatingly ambiguous. Few writers, in speaking of domestic trade, have meant the same thing by trade that they have meant by the word when speaking of foreign trade, and hence we have had many pointless efforts to institute comparisons between the two, and some very misleading statements about the matter. Thus, figures have been offered which would show that the foreign trade of the United States is only a fraction of 1% of the domestic trade. This conclusion is reached by taking the figures for banking transactions discussed in Chapters XIII and XIX as representative of domestic trade, and comparing them with the annual figures for exports and imports. This procedure is fallacious for several reasons:[302] the figures thus reached for domestic trade exceed even the total trading within the country, as shown in Chapter XIX. In the second place, as shown in Chapter XIII, the bulk even of these deposits which do represent real trading grow chiefly out of speculation. Even in ordinary trade, goods are counted several times before reaching the final consumer. It is clear, therefore, that even an accurate figure for total trading within the country would have little relevance when we are seeking a figure to compare with exports and imports. Nor, if a comparison of the actual trading in which foreigners participate with the trading exclusively between Americans is sought, can we take the export and import figures as representative of the foreign trading—they do not include a multitude of highly important transactions in which foreigners participate. Very much of the business of the New York Cotton Exchange, the New York Stock Exchange, the Chicago Board of Trade, and other speculative markets represents foreign buying and selling, especially arbitraging transactions, and the other "invisible items" of foreign trade need merely to be mentioned for the economist to recognize the fallacy of a comparison which omits them.
What figures are relevant when we wish to compare foreign and domestic trade? First we must make clear the purpose for which the comparison is to be made. If we are concerned with the calls made by foreign and domestic trade on the money market, we should make use of a different method of comparison than that which will be here employed. The purpose of the comparison here undertaken is to determine how much of our American labor, land and capital is at work producing for the foreign consumer, as compared with the land, labor and capital in America producing for the American consumer. The comparison here undertaken is concerned with the question which is usually uppermost in the minds of those who undertake such a comparison, namely, how important is our foreign market to us? Obviously, for such a comparison as this, we should not count a given case of eggs twelve times merely because it changed ownership twelve times in getting from farm to breakfast table. Items of export and import count only once in the figures for export and import. We must find a figure for domestic "trade" in which items count only once, allowing no turnovers of the same goods to swell the total, if we wish to make our figures comparable.
The method proposed for making this comparison, for a long series of years, is a modification of the method used by the writer in an article in the Annalist of Feb. 7, 1916. A figure based on the bank deposits of retail merchants in Kinley's 1909 investigation was there taken as properly comparable with the export and import figures. The final sale to consumer by retailer is "the one far off divine event" toward which the whole productive process moves. Everything else in production and exchange looks forward to this. Ultimately, from the demand of the final consumer comes all the demand that is directed toward the agencies of production, even though the laborer sees his immediate market in the person of the employer, and the capitalist or landlord sees his immediate market in the person of the active business man. The figure reached for retail trade by the method then employed was $34,500,000,000 for 1909. This figure was too high, as shown in Chapter XIII above, and the figure reached now for retail deposits by the same method is $32,000,000,000. Even this figure is too high, however, as I there concluded, to represent retail trade, and I shall use it only as a check on King's figure for the total income of the United States in 1910, which I shall use as a base figure instead of my own. King's figure for the total income of the United States in 1910 is $30,500,000,000.[303] I take this figure as including all that the American people spend for consumption, with retailers, physicians, hotels, theatres, etc., and also their net savings for the year. Part of this they spent for foreign products. The rest they spent at home. This residue spent at home gives us a figure which we may properly compare with the amount the foreigner spends in America, as indicating the ratio of foreign to domestic trade for the purpose in hand. We subtract, in other words, from the figure for total income the figure for imports. Then we compare the residue with the figure for exports, and get our ratio of foreign to domestic trade. The export and import figures must first, however, be reduced to a retail basis. That is, assuming that wholesale prices are two-thirds of retail prices, we add 50% to the figures for exports and imports (which are wholesale figures) before making the subtraction and the comparison. The ultimate consumer, both in Europe and America, pays for imports and exports on a retail basis.[304] This method, applied to the figures for 1910, gives us a ratio of about 10:1 for domestic to foreign trade—the lowest percentage for foreign trade which we shall find for any year in the period investigated, 1890-1916.
This comparison is still unfavorable to foreign trade. Domestic trade, in our figures, includes savings and investments, including investments made by Americans abroad. Import figures are marred by undervaluations, exports are not all counted, and the figures for exports and imports do not include foreign investments in America. American investments abroad should not be counted as part of domestic trade. Moreover, our figures take no account of travellers' expenditures, or of services performed by professional men of one country for men in another, or of certain other "invisible items." But while this makes our percentage for foreign trade too low for all years, it probably does not greatly upset the results for yearly variations in the ratio except for the year 1916, when the figure for domestic trade is left decidedly too high, and the ratio for foreign trade is too low, as compared with previous years.
For years other than 1910, indirect calculations must be resorted to for domestic trade. I have substantial confidence in the rough accuracy of the figure chosen for 1910 in view of the convergence of two widely different sets of data. My figure for retail deposits in 1909 is $32,000,000,000. King's figure for total income is $30,500,000,000 for 1910. King's figure seems to me a better figure to use for the purpose in hand. I use my own merely as a rough check on his. For years other than 1910, the figure for net income is calculated as a percentage of King's figure for 1910, by means of an "index of variation." It is assumed that the net income of 1905, for example, bears the same relation to the index for 1905 that the absolute figure for net income of 1910 bears to the index for 1910, and net income for 1905 is then computed by "the rule of three." The index of variation chosen is railway gross receipts weighted by wholesale prices. I think that railway gross receipts are, on the whole, the most dependable and easily manageable index of physical volume of production that we have, though recognizing difficulties, later to be discussed, in using them for the purpose in hand. Railroads touch virtually every kind of business in the country. Variations in the pecuniary volume of production and consumption, however, if due to rising or falling prices, rather than to changing physical volume, would not be indicated by changes in railway gross receipts. The same volume of transportation might represent widely varying pecuniary values of goods transported. Railway rates do not vary from year to year with prices of goods, even though high-priced goods are normally charged higher rates than low-priced goods. The index, therefore, must include prices as well as physical volume of transportation. For 1910, therefore, railway gross receipts and an index of prices are multiplied together, and counted as 100%. The same thing is done for railway gross receipts and prices for other years, and the results reduced to percentages of the result for 1910. The figure for net income in any other year is then readily computed as a percentage of the figure for 1910. The results, for the years 1890-1916, appear in the tables below.[305]
It may be noticed that my figures for net income in 1900 and 1890 do not correspond very closely with the figures for the same years as independently estimated by King. My figure for 1900 is $12,900,000,000, where his is $17,965,000,000; for 1890, my figure is $9,300,000,000, where his is $12,082,000,000. I am inclined to the view that the figures in my tables come closer to the facts for these years than do his figures, assuming that his figure for 1910 is correct. It will be noticed that on his figures there was an increase of about 50% from 1890 to 1900, and an increase of only about 66% in the decade following. This seems to be an unlikely relation. One would expect a much greater rate of increase for the decade 1900-10, as compared with the preceding decade, than King's figures show. The period from 1890 to 1900 included the terrible panic of 1893 and the prolonged depression ensuing. The panic in 1907 was trifling in comparison, and recovery, as shown by our index numbers in the tables below, was very much quicker. Moreover, falling prices characterized much of the earlier decade. The highest prices of the whole ten years were in 1891. The period from 1900 to 1910 is a period of rapidly rising prices, on the whole. On the basis of our general knowledge of the two periods, one would expect a greater percentage gain by far for the second decade, and I therefore trust the results of the index of variation here chosen, which show that. Similar results are obtained by applying to the base figure for 1910 an index of variation derived from Kemmerer's and Fisher's figures for trade[306] and prices. My figure for 1890 may, moreover, be checked by comparison with the figure given by C. B. Spahr in The Present Distribution of Wealth in the United States (p. 105) for the net income of the country for that year: $10,800,000,000. It may be that my figure for 1890 is too low, but I have not sought to "doctor" it by an arbitrary "correction factor" to make it correspond more closely than it does with the other estimates. It is striking enough that a figure derived from an index of variation, twenty years away from its base, should come as close as this to figures calculated from wholly different data.
One brief comment may be made on the significance of these figures. It may be questioned if figures showing the proportions of our industry devoted to supplying goods for the foreign market correctly indicate the importance of the foreign market to us. It may be urged that if we should lose our foreign market, we should merely turn to producing more for the domestic market, and that the loss would not be the whole of our receipts from foreign trade, but merely the cost of transition, and the loss that comes from shifting to production to which we are less suited. This is, doubtless, true. But the loss reckoned this way may well be greater than the loss reckoned on the basis of my figures! It is equally true, moreover, that our domestic trade is not important to the extent indicated by my figures, since if we lose part of our domestic trade, our producers will turn to supplying more for the foreign market. But one must not regard the cost of transition as a negligible matter! The cost may easily be prolonged depression. Certain parts of our foreign trade are really vital to us, both on the import and (to a less degree) on the export side. The most important practical use to which the figures here given may be put are in connection with short-run problems. Foreign trade is so important to us that any sudden alteration in its amount may bring great adversity or great prosperity—as the course of the present War abundantly testifies.[307]
An application of our method to the years 1850 and 1860 gives a percentage for foreign trade of 12.7 in 1850, and 16.0 in 1860.[308]
Certain other cautions are needed in presenting these figures. For one thing, variations in railway rates will make a given volume of gross earnings mean different things in different years as to the physical volume of traffic. In the writer's opinion, which is confirmed by Professor W. Z. Ripley, there is no possible way of making allowance for this, as the cross-currents affecting railway rates are altogether too numerous and obscure. Nor has any effort been made to allow for variations in the proportions of freight and passenger receipts, or of different classes of freight traffic.
Again, the proportions of railway traffic connected with foreign trade may vary greatly, and it may happen that a big increase in railway gross receipts is due to increasing foreign trade, primarily. There is reason to suppose that much of the increase of 1916 is to be explained that way. This makes our comparison for 1916 particularly adverse to foreign trade, since we count as domestic trade what is really foreign trade. The figures, however, are presented as they stand. Moreover, for 1916, the great increase in foreign trade is in exports. Merchandise imports are not much greater than in previous years.[309] Our exports have been chiefly paid for by "invisible items," gold and securities, and short term credits. These do not appear anywhere in our figures. A substantial source of error appears from this cause in our 1916 figure. I should think it safe to put the ratio for foreign trade to domestic trade for 1916 at above 20%, instead of the 17.9% our table shows.
The reader will wish to know for a given year how much of the increase or decrease is due to physical growth of business, as represented by railway gross receipts, and how much is due to changes in prices. To give this information, and to make it easy for a critic to check the results, a table showing the index numbers from which the figures for net income are computed is subjoined.[310]
TABLE I[311]
| 1 | 2 | 3 | 4 |
Calendar
Years | Net Income of the
United States | Domestic Trade of
United States =
Net Income minus
Imports at Retail Prices | Foreign Trade of
United States =
Exports at Retail Prices | Ratio of Foreign
to Domestic Trade |
| 1890 | $ 9,300,000,000 | $ 8,100,000,000 | $1,300,000,000 | 16.1% |
| 1891 | 10,400,000,000 | 9,200,000,000 | 1,400,000,000 | 15.2% |
| 1892 | 10,000,000,000 | 8,700,000,000 | 1,400,000,000 | 16.1% |
| 1893 | 10,100,000,000 | 8,900,000,000 | 1,300,000,000 | 14.6% |
| 1894 | 8,300,000,000 | 7,300,000,000 | 1,200,000,000 | 16.5% |
| 1895 | 8,400,000,000 | 7,200,000,000 | 1,200,000,000 | 16.7% |
| 1896 | 7,900,000,000 | 6,900,000,000 | 1,500,000,000 | 21.8% |
| 1897 | 8,000,000,000 | 6,900,000,000 | 1,600,000,000 | 23.2% |
| 1898 | 9,100,000,000 | 8,200,000,000 | 1,900,000,000 | 23.2% |
| 1899 | 10,900,000,000 | 9,700,000,000 | 1,900,000,000 | 19.6% |
| 1900 | 12,900,000,000 | 11,700,000,000 | 2,200,000,000 | 18.8% |
| 1901 | 14,600,000,000 | 13,300,000,000 | 2,200,000,000 | 16.5% |
| 1902 | 15,600,000,000 | 14,200,000,000 | 2,000,000,000 | 14.1% |
| 1903 | 17,700,000,000 | 16,200,000,000 | 2,200,000,000 | 13.6% |
| 1904 | 18,000,000,000 | 16,500,000,000 | 2,200,000,000 | 13.3% |
| 1905 | 19,600,000,000 | 17,800,000,000 | 2,400,000,000 | 13.5% |
| 1906 | 21,500,000,000 | 19,500,000,000 | 2,700,000,000 | 13.8% |
| 1907 | 26,600,000,000 | 24,500,000,000 | 2,900,000,000 | 11.8% |
| 1908 | 23,000,000,000 | 21,300,000,000 | 2,600,000,000 | 12.2% |
| 1909 | 27,600,000,000 | 25,400,000,060 | 2,600,000,000 | 10.2% |
| 1910 | 30,500,000,000 | 28,200,000,060 | 2,800,000,000 | 9.9% |
| 1911 | 29,600,000,000 | 27,300,000,000 | 3,100,000,000 | 11.4% |
| 1912 | 33,800,000,000 | 31,100,000,000 | 3,600,000,000 | 11.6% |
| 1913 | 34,800,000,000 | 32,100,000,000 | 3,700,000,000 | 11.5% |
| 1914 | 32,600,000,000 | 29,900,000,000 | 3,200,000,000 | 10.7% |
| 1915 | 35,400,000,000 | 32,700,000,000 | 5,300,000,000 | 16.4% |
| 1916 | 49,200,000,000 | 45,800,000,000 | 8,200,000,000 | 17.9% |
TABLE II. INDEX NUMBERS FROM WHICH THE FIGURES FOR NET INCOME ARE DERIVED
| 1 | 2 | 3 | 4 |
Calendar
Years | Dun's Prices with
base in 1910 | R. R. Gross Receipts,
reduced to base of 1910 | Composite Index,
R. R. Gr. Rcts.
multiplied by Prices.
(Column 1 × column 2.) | Net Income[312] of
the United States
in billions of dollars:
100:30.5::(3):$ |
| 1890 | 76.5 | 39.8 | 30.8 | $ 9.3 billions |
| 1891 | 81.5 | 42.0 | 34.2 | 10.4 |
| 1892 | 75.6 | 43.5 | 32.8 | 10.0 |
| 1893 | 77.3 | 42.9 | 33.2 | 10.1 |
| 1894 | 71.5 | 38.1 | 27.2 | 8.3 |
| 1895 | 68.0 | 40.7 | 27.8 | 8.4 |
| 1896 | 63.8 | 40.6 | 25.9 | 7.9 |
| 1897 | 62.2 | 42.4 | 26.4 | 8.0 |
| 1898 | 66.4 | 45.1 | 29.9 | 9.1 |
| 1899 | 72.3 | 49.6 | 35.8 | 10.9 |
| 1900 | 78.1 | 54.0 | 42.1 | 12.9 |
| 1901 | 80.6 | 59.4 | 47.8 | 14.6 |
| 1902 | 84.0 | 62.6 | 51.3 | 15.6 |
| 1903 | 83.1 | 70.1 | 58.2 | 17.7 |
| 1904 | 84.0 | 70.3 | 59.0 | 18.0 |
| 1905 | 84.0 | 76.4 | 64.2 | 19.6 |
| 1906 | 88.1 | 85.0 | 70.5 | 21.5 |
| 1907 | 94.0 | 92.9 | 86.3 | 26.6 |
| 1908 | 92.4 | 81.8 | 75.6 | 23.0 |
| 1909 | 99.0 | 91.7 | 91.0 | 27.6 |
| 1910 | 100.00 | 100.00 | 100.0 | 30.5 |
| 1911 | 98.1 | 99.0 | 97.0 | 29.6 |
| 1912 | 104.1 | 106.9 | 111.0 | 33.8 |
| 1913 | 101.7 | 112.5 | 114.0 | 34.8 |
| 1914 | 102.5 | 104.5 | 107.0 | 32.6 |
| 1915 | 106.0 | 110.0 | 116.0 | 35.4 |
| 1916 | 125.0 | 129.0 | 161.2 | 49.2 |
CHAPTER XIV
THE VOLUME OF TRADE AND THE VOLUME OF MONEY AND CREDIT
In the argument so far I have said nothing of the reverse relationship, the dependence of the volume of money and the volume of credit on trade. The two are indeed interdependent. Interdependence suggests circular theory, and is often a phrase to cover circular reasoning.[313] In the case of the relation under discussion, however, I have, I trust, already abundantly protected myself against the charge of circular reasoning by denying that either volume of money and credit on the one hand, or volume of trade on the other hand, is a true cause at all. Both are mere abstract names, designating highly heterogeneous individual occurrences, which, individually are cause or effect. In general, both volume of money and credit, on the one hand, and volume of trade on the other hand, are results of common causes, which are the verÆ causÆ of economic phenomena—values, psychological phenomena. The whole thing is to be explained immediately and primarily in terms of social relationships and mental processes,—in terms of social values.
To show that increasing trade tends to increase money and credit is not difficult. If one may venture a hypothetical illustration—and the sort of hypothetical illustrations, like the dodo-bone case, of which quantity theorists are fond make one hesitate to do so—let us assume a communistic community, isolated from other markets, with a developed system of production, including an extensive use of gold in the arts. Let the communistic rÉgime gradually pass over to an individualistic rÉgime. Assume that the inhabitants are acquainted with the use of gold as money, and that their government is willing to coin it freely. As individualism spreads, and trade grows, will not more and more gold be taken to the mints? I am not here concerned with the principles determining the apportionment of gold between the money employment and the arts. It is enough to show that expanding trade tends to increase the volume of money.
Assume that the money supply meets difficulties in its expansion. Is there not at once an incentive to extend credit? The seller finds his customers unwilling to buy for cash, in amounts as great as before. In order to sell as much as before (assuming that the use of credit is known, to avoid trouble with historical origins), he extends credit,—which, when practiced generally, lightens the strain on the money supply.
I have so far said nothing of the case where there are stocks of the money metal to be got from outside markets. But if a country is expanding its trade, does not money come in? The quantity theorists would, indeed, admit this, in general, though their reason is a bad one, namely: that expanding trade lowers prices, and lower prices make the market attractive to foreign buyers, who then send in money for the goods. I shall later discuss this aspect of the theory.[314] For the present, I merely interject the question as to the probability of an expansion of trade when prices are falling. Increasing stocks of particular goods may well mean lower prices for these goods and if they be articles of export the lower prices may well increase the export trade, and bring money in. But this increase in stocks of articles of export is very different from total trade within the country; and lower prices in articles of export are very different from a generally lower price-level.[315]
Will expanding trade in a country increase credit? I come here to one of the striking features of Fisher's doctrine—a feature in which I think he is fundamentally true to the quantity theory. He finds no way in which expanding trade can directly increase credit. Expanding trade can increase credit, (a) only by changing the habits of the people, so as to alter the ratio, M to M´, or (b) by reducing the price-level, and so bringing in money from abroad, whence, as M is now increased, M´ rises proportionately. "An increase in the volume of trade in any one country, say the United States, ultimately increases the money in circulation (M). In no other way could there be avoided a depression in the price-level in the United States as compared with foreign countries. [He should say, from the standpoint of his theory, that increasing trade will cause a fall in the price-level, and so bring in more money.] The increase in M brings about a proportionate increase in M´.[316] Besides this effect, the increase in trade undoubtedly has some effect in modifying the habits of the community with regard to the proportion of check and cash transactions, and so tends somewhat to increase M´ relatively to M; as a country grows more commercial the need for the use of checks is more strikingly felt."[317] In a footnote to this paragraph, he defines the issue still more sharply. "This is very far from asserting as Laughlin does that 'The limit to the increase in legitimate credit operations is always expansible with the increase in the actual movement of goods'; see Principles of Money,[318] New York (Scribner), 1903, p. 82. We have seen, in Chapter IV, that deposit currency is proportional to the amount of money; a change in trade may indirectly, i. e., by changing the habits of the community, influence the proportion, but, except for transition periods, it cannot influence it directly."[319]
My own explanation of the causal sequence whereby expanding trade brings money into a country would be radically different from that given by Fisher in the first quotation. I should expect, first, that rising prices would encourage rising trade; I should then expect the rising volume of trade, with higher prices, to lead borrowers to need, and secure, larger loans from the banks, with, as loans and deposits rise in proportion to reserves, some slight increase in "money-rates," just enough to draw to the country the extra gold which bankers felt desirable to add to their reserves. I should expect the causal sequence to be the exact reverse of that which Fisher indicates. With falling prices, or waning volume of trade—which would usually come together,[320]—I should expect loans to be reduced, deposits to be reduced, money-rates to fall, and gold then to leave the country again. I should expect this sort of thing to happen normally, and not infrequently, and I should expect gold to come in and go out many times in the course of a business cycle. This would seem to be the sort of explanation which our modern theory of elastic bank-credit would give in connection with this problem. I shall not here go into details with the theory of elastic bank-credit. The theory has been too well established in the debates between the "Currency School" and the "Banking School"[321] in regard to bank-notes to need elaboration and defence here, and the essential identity of deposits and elastic bank-notes from this angle is one of the commonplaces of the literature of banking. What I am here concerned with is the highly significant fact that Fisher's "normal" theory finds no place for this highly important phenomenon. The quantity theory has no explanation of elasticity to give. On the basis of the quantity theory, and for all that the quantity theory can say, the Currency School was right! Fisher offers us, virtually, a "currency theory" of deposits. "Suppose, as has actually been the case in recent years, that the ratio of M´ to M increases in the United States. If the magnitudes in the equations of exchange in other countries with which the United States is connected by trade are constant, the ultimate effect on M is to make it less than what it would otherwise have been, by increasing the exports of gold from the United States or reducing the imports. In no other way can the price-level of the United States be prevented from rising above that of other nations in which we have assumed this level and the other magnitudes in the equation of exchange to be quiescent." (P. 162.) If "bank-notes" be substituted for "M´", in this quotation, we have here a perfect statement of the position of the "Currency School" in that great debate. Must this old issue be fought all over again? And yet, I defy any consistent quantity theorist to find any flaw in Fisher's argument on this point. There is no place for a theory of elastic bank-credit within the confines of the quantity theory. Fisher's recognition of this seems full and complete. He relegates all mention of elastic bank-credit to "transitions." The footnote quoted above, in which Laughlin's (somewhat extreme) doctrine based on the theory of elasticity is stated, denies categorically that there is any validity in it, except for transition periods. There is nowhere in the book any explanation of the theory of elasticity.[322] The references to it are few and grudging, and always in connection with the notion of transitions. The most important statement regarding elasticity (less than a page long) is on page 161, where again transitional influences are under discussion. What is a theory of money worth which can offer no explanation of so fundamental, important, and notorious a feature of modern money and banking?
There is a further, related, feature of banking for which the quantity theory can find no explanation. Among the items in a bank's balance sheet, the quantity theorist seizes upon reserves on the assets side, and deposits on the liability side, and builds his theory on the supposed close relation between them. We have seen that this close relation does not, in fact, exist. The range of variation is enormous.[323] But there is one close relation in the balance sheet of the bank concerning which the quantity theory is silent, and that is the relation between deposits and loans. For individual banks and for banks in the aggregate, for long run periods and for short run periods, for reasons that are clear and inevitable, these two magnitudes (or for banks of issue on the Continent of Europe, notes and loans), vary closely together. The relationship between them is the only relationship which does stand out as clearly beyond dispute, among all the items in the banking balance sheet. No assumptions of a "static state" are needed for its demonstration! The relation varies, of course. As banks increase or reduce their capital, as their reserve-percentages rise or fall, as they increase or decrease their holdings of bonds, we find reasons which alter the proportion between deposits and loans. But, despite this, the variation, as shown by figures for the United States, is slight. Assume, for example, a statement showing "loans and discounts" of $1,000,000, deposits, $1,000,000, cash reserve, $200,000. Reserves are then 20% of deposits, and loans are 100% of deposits. If reserves be increased by $100,000 and loans and discounts reduced, to compensate, by $100,000, we have a 50% variation in the ratio of reserves to deposits, with only a 10% variation in the ratio of loans and discounts to deposits. Since cash reserve is much the smaller item, almost always, the same absolute variation in it will affect it, in percentage, vastly more than it will affect loans and discounts. It is strange that a theory should seize on this highly variable ratio of reserves to deposits, and ignore the much more constant ratio[324] of loans and discounts to deposits.
That this close relation between deposits and loans should obtain follows naturally from the theory of elastic bank-credit. The two are built up together. When there are expanding business and rising prices, men borrow more from the banks; as they borrow, they receive deposit credits; the individual who receives the deposit credit may check against it, but it is redeposited by another man, and so, while the deposits of one bank need not grow out of its loans, still, for banks in general, deposits are large because loans are large. For a given bank, the relation holds closely, because the bank lends, in general, to active business men, who will have income as well as outgo, and whose income will, on the average, at least balance their outgo. Thus, through loans, deposits are linked with volume of trade and prices. Trade and deposits wax and wane together.[325] On the other hand, in the absence of rising prices and increasing trade, reserves may increase greatly without forcing an increase in deposits. Loans cannot increase without an increase in deposits. The linkage between deposits and trade is definite, causal, positive, statistically demonstrable. The linkage between reserves and deposits is, at most, negative—if reserves get too low, deposits and loans may be checked in their expansion. But this—to the extent that it is true, which we leave, for detailed analysis, for 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.
CHAPTER XV
THE QUANTITY THEORY: THE "PASSIVENESS OF PRICES"
Is the price-level passive? Is it true that while change may occur from causes outside the equation of exchange in volume of money, volume of trade, and velocities of circulation, a change in the price-level from causes outside the equation is impossible? Must the average of prices be a passive function of M, the V's, M´ and T? Such is the general contention of the quantity theory, and such, very explicitly, is Fisher's contention. The price-level is always effect, and never cause (with slight modifications of the doctrine for transition periods) in its relations to the other magnitudes in the equation of exchange.
Now in one sense, it is my own contention that the price-level can never be a cause of anything. The price-level is an average. Averages may be indicia of causation, but they are not themselves causes. They are not, in reality, anything at all. Causation is a matter which pertains to the particulars of which the average is made. But this is not the doctrine of the quantity theory. The quantity theory does, in certain connections, assign causal influence to the level of prices, particularly in the theory of foreign exchange, where the explanation of international gold movements rests on the doctrine that a price-level in one country, higher than the price-level of another country, drives money away.[332] It will be seen, in a moment, that Fisher relies on this principle to prove that the price-level of a country cannot rise without an increase of money—if it did so rise, it would drive out the money, and so be forced down again. The point at issue may be stated in terms of particular prices. The quantity theory is that, while particular prices may rise from causes affecting them, as compared with other prices, without a change in money, velocities, etc., still there cannot be a rise in the general average, because other prices will be obliged to go down to compensate. The issue is as to the possibility of a rise in particular prices, uncompensated by a corresponding fall in other particular prices, without a prior increase in money, or velocities, or decrease in trade. I take up the issue in this form. I shall maintain that particular prices can, and do, rise, without a prior increase in money or bank-deposits, or change in the volume of trade, or in velocity of money or deposits and also without compensating fall in other particular prices. Putting it in terms of Fisher's equation, I shall maintain, as against Fisher, that P can rise through the direct action of factors outside the equation of exchange, that as a consequence of such rise the other factors readjust themselves, and that a new equilibrium is reached which, in the absence of new disturbances from causes outside the equation, tends to be as permanent and stable as the old equilibrium was.
In the argument which follows, I shall respect thoroughly the distinction between "normal" and "transitional" effects. I do not think that this distinction is properly drawn by Fisher. In my discussion of the relation between the volume of bank-credit and the volume of trade, and in other connections, I have shown that Fisher leaves out of his normal theory most of the concrete factors which do affect both the concrete magnitudes, and the long run averages, of the factors in his own equation. But for the present, I shall meet him on his own ground, give his distinctions their fullest weight, and carry my argument through the "transition" to a point where no further change among the factors in the equation can be expected as a consequence of the initial change assumed.
Fisher's argument to show the passiveness of prices takes the form of a reductio ad absurdum. "To show the untenability of such an idea let us grant for the sake of argument that—in some other way than as effect of changes in M, M´, V, V´, and the Q's—the prices in (say) the United States are changed to (say) double the original level, and let us see what effect this will produce on the other magnitudes in the equation."[333] Then, if the equation of exchange is to be maintained, either M or M´ or their velocities must be increased, or trade must be reduced. But he holds that none of these is possible. (1) Money will be reduced. High prices drive money away to other countries. Nor can gold come in via the mints. "No one will take bullion to the mints when he thereby loses half its value."[334] On the contrary, men will melt down coin. Nor will high prices stimulate mining. Rather, by raising the expenses of mining, they will discourage mining. (2) Bank-deposits cannot increase. Bank-deposits depend on the amount of money, and as that is reduced, they must be reduced, to keep their normal ratio to the volume of money. (3) The appeal to velocities is no more satisfactory. These have been already adjusted to individual convenience.[335] (4) Nor can trade be decreased. Since the average person will not only pay, but also receive, high prices, there is no reason why he should reduce his purchases. "The price-level is normally the one absolutely passive element in the equation of exchange."[336]
"But though it is a fallacy to think that the price-level in one community can, in the long run, affect the money in that community, it is true that the price-level in one community may affect the money in another community. This proposition has been repeatedly made use of in our discussion, and should be clearly distinguished from the fallacy above mentioned. The price-level in an outside community is an influence outside the equation of exchange of that community, and operates by affecting its money in circulation and not by directly affecting its price-level. The price-level outside New York City, for instance, affects the price-level in New York City only via changes in the money in New York City."[337]...
"Were it not for the fanatical refusal of some economists to admit that the price-level is in ultimate analysis effect and not cause, we should not be at so great pains to prove it beyond cavil." To explain this "fanatical refusal," Fisher alludes to the "fallacious idea" that the equation of exchange cannot determine the price-level, because the price-level has already been determined by other causes, usually alluded to as "supply and demand." He urges, however, that supply and demand, cost of production, etc., relate, not to the price-level, but only to particular prices: that the price-level is a factor prior to, and independent of, the particular prices, and is presupposed by theories like supply and demand, cost of production, etc.[338]
The reductio ad absurdum, at first blush, looks impressive. One obvious criticism suggests itself, however, and it will be found to give a clue to a much more fundamental criticism: is it reasonable to assume a doubling of all prices? Above all, must the assumption involve the doubling of the price of gold bullion? Part of the argument to show that gold bullion would not be minted rests on that assumption. But, more fundamental, for such an all round doubling of prices, no cause could be assigned. Of course the hypothesis of an increase in prices without any cause is absurd, and Fisher easily disposes of it. But suppose we assign some concrete causes, outside the equation of exchange, which might affect prices, and see how the thing works then!
Fisher states on p. 95 that "other elements in the equation of exchange than money and commodities[339] cannot be transported from one place to another." And in the passage quoted above he maintains that price-levels in one country can influence price-levels in another country, or even price-levels in one city can influence price-levels in another city, only via changes in money, in the second country or city. But other elements in the equation are directly transferable, in fact. Deposits, e. g., in London, to the credit of New York bankers, may be transferred to Paris, directly, by cable or by letter, and prices are constantly being directly passed from one country or market to another by the same media. Let us suppose a strong case, to put our principle in relief. Assume an island, which produces a staple widely used, whose chief centre of production is outside the island. Assume that this staple, an agricultural product, rises greatly in price, owing to a blight, which promises to be permanent, in the main producing region. The blight does not affect the island, however. Let this product be the main product of our island, which we shall assume to be small. Let the island have communication with the outside world by boat only once in three months. Let it be, however, in constant communication by cable. Word comes by cable of the rise in the price in the staple. The staple at once rises in the island. No new money has come in to cause it. Will this be a rise in the price-level? Will there be compensating reductions in the prices of other things to leave the price-level unchanged? What prices can fall? Not the prices of goods that have been imported to the island, surely. They will rather tend to rise, because everybody on the island will feel richer than before, and will be disposed to buy more freely. Meanwhile, merchants and bankers on the island will be more ready to extend credit than before, so that they will be able to buy more freely. What else can fall? Not the prices of the land! Rather, the land will rise in price greatly, because the increased price of the staple, expected to be permanent, will promise bigger rents, and the price of the land, being a capitalization of the annual rental, will rise very much more than anything else—it will rise to the extent of the capitalized price of the increase in the rents. Wages, likewise, will rise, since the price of the product of labor has risen. And the capital instruments in use in producing the staple will also rise, though not so much as land and wages, inasmuch as they can be brought in from outside at the end of three months. What is there that can fall—except, perhaps, such goods as are exclusively designed for the construction of poorhouses! A significant particular price rises—that is the first step; then, from causes familiar to all students of economics, other related prices rise; there is a general sympathetic rise in prices, the price-level has risen independently, from causes outside the equation of exchange. But now, can this rise sustain itself? Well, what can bring it down? When the ship comes, at the end of three months, it will bring in additional supplies of the articles of import, and they will go down to their old level. Will they go any lower than the old level? What is there to cause them to do so? The outside price-level should be higher now, rather than lower, since the stock of the staple in question is reduced, and nothing else increased to compensate. Nor can any reason be assigned why other prices on the island: the staple in question, lands, wages, etc., should fall at all from the level they reached when the news first came.
Incidentally, our ship may also bring in more gold. The bankers, finding their deposits expanding, may feel it well to cable orders for more gold to increase their reserves, especially as they have been subject to somewhat unusual calls for cash for hand to hand circulation—though this last need they might well have been meeting by expanding their note issue.
Is there anything else to be said? Is not the new equilibrium stable? And is not the causal sequence precisely the reverse of that assigned by the quantity theory? First. a rise in prices; second, an expansion of credit, book-credit, notes and deposits; third, money comes in. If anyone is particularly anxious about the equation of exchange in this process, he may add to my expansion of credit an increase in velocities to keep it straight!
I may add that I see nothing in the "transition" I have described to cause trade to be reduced. Rather, I should expect the rising prices to make trade more active—or better, I should expect the rising values of goods, etc., of which rising prices are the symptom, to make trade more active, particularly as there would be an increase in speculation to bring about readjustments, and to "discount" the prosperity. Nor can I find any reason why trade should be reduced below the old level in the new normal equilibrium. It would make no difference, however, if trade were reduced either transitionally or normally, since the point at issue is the possibility of a rise in prices originating from causes outside the equation of exchange, and compelling a readjustment of a permanent character in the other factors of the equation. The quantity theorist is at liberty to make this readjustment in any way he pleases. My point is made if he has to make the readjustment, and if the price-level stays up!
I have put my illustration in an extreme form to throw the whole thing in relief, and to make the demonstration free from a host of complexities. But is not the causal process essentially the same if we substitute, say, the Southern States for our island, and cotton for our staple? So long as the telegraph bringing news of the ruin of cotton production in India and Egypt, with the higher price of cotton, can come in ahead of the money that the quantity theorist might imagine rushing in a race with it on the train to be offered for the cotton, my point is made. In point of fact, there would be a general rise in prices and wages in the South, which, leading to an expansion of credit, would only gradually and in no definite ratio lead to an increase in money drawn from outside. Buyers outside would pay, not with money, but with checks drawn on New York, and Southern bankers would use their discretion as to how much actual cash they would bring in. With the elastic note issue of our Federal Reserve system, I see no reason to anticipate that money would be drawn to the South in an amount proportionate to the increase in prices. Even if it were, the causation would not run from money to prices, and that is the point at issue. If rising prices can cause increasing money, the whole quantity theory is upset, whatever the proportions involved.
It will be noted that my illustration might be put partly in the form of the supply and demand argument. Increasing demand for cotton in the South leads to higher price of cotton; higher price of cotton makes cotton-growers richer, and enables them to increase their demand for imported goods, for land, and for labor. Supply and demand comes into conflict with the quantity theory, and does not suffer in the conflict! Supply and demand determine particular prices, and particular prices determine the price-level!
Now I wish to generalize this point. I shall show that the quantity theory conflicts with most of our doctrines of prices, as worked out in our systems of economics. I shall show that, in important cases, the quantity theory conflicts with the law of supply and demand, with the doctrine of cost of production, with the capitalization theory, and with the doctrine of imputation as worked out by the Austrians, whereby the prices of labor, land, and other agents of production rise or fall with the prices of the consumption goods which they produce. I shall show the conflict in important cases, and shall show also, in those cases, that it is not the quantity theory which can be sustained.
The general form of the conflict may be stated for all these theories. They are theories of the relations of particular prices, concerned with showing that individual prices are so related that they tend to vary together. A rise in one price, according to these theories, tends to bring about rises in others, and vice versa. The quantity theory, on the other hand, asserts a relation among individual prices such that a rise in one tends to bring about a fall in others—it requires a compensatory fall at one point, if there has been a rise somewhere else.
Let us take some cases. I shall take, first, the conflict between the quantity theory and the capitalization theory, as I can use the illustration just given in connection with it. I have, in a preceding chapter, given a statement of the capitalization theory. It is a theory concerned with the prices of long-time goods and income-bearers, as lands, houses, capital goods of various sorts that give forth their services through a series of years, stocks, bonds, etc. The prices of things of this sort, according to the capitalization[340] theory, depend on two factors: one, the money income expected from the income-bearer, the other, the prevailing rate of interest. This money income, except in the case of bonds, commonly depends on the prices of the products of the income-bearer, or (in the case of stocks) of the products of the concrete capital-goods to which the income-bearer gives title. If we may follow the Austrian division of goods into higher and lower "orders," or "ranks," we may say that the prices of the goods of higher ranks are the capitalizations of the prices of the goods of lower ranks specifically produced by them. Thus, concretely, if the price of wheat rises, we may expect the prices of land to rise, if the rate of interest remains the same. If the price of steel rises, we may expect the stocks of the U. S. Steel corporation to rise, also. If the prices of smokeless powder, and other war munitions soar, we may expect the prices of the stocks of the corporations involved to do precisely what they have done in the recent course of the stock market. All this, on the assumption that the rate of interest does not change, and that the risk factor remains constant. If these factors vary, the results will not present the mathematical exactitude that the formula calls for, but the general tendency will remain the same. On the other hand, if the incomes remain unchanged, but the rate of interest rises, then we may expect the capitalized prices to fall, and if the rate of interest falls, we may expect the capitalized prices to rise. From the standpoint of the present discussion, I suppose it might be fairest and best to state the capitalization theory on this point as Fisher himself states it. In his Elementary Principles of Economics (ed. 1912) after giving a table showing in figures the difference made in different capital prices by different rates of interest (p. 125) he states (126): "If the value of the benefits derivable from these various articles continues in each case uniform, but the rate of interest is suddenly cut down from 5% to 2½%, there will result a general increase in the capital values, but a very different increase for the different articles. The more enduring ones will be affected the most." And in his book, The Rate of Interest: "The orchard whose yield of apples should increase from $1,000 worth to $2,000 worth would itself correspondingly increase in value from, say, $20,000 to something like $40,000 and the ratio of the income to the capital value, would remain about as before, namely, 5%." (P. 15.) On the next page, he generalizes his notion: "One cannot escape this conclusion (as has sometimes been attempted) by supposing the increasing productivity to be universal. It has been asserted, in substance, that though an increase in the productivity of one orchard would not affect the total productivity of capital, and hence would not appreciably affect the rate of interest, yet, if the productivity of all the capital in the world could be doubled, the rate of interest would be doubled. It is true that doubling the productivity of the world's capital would not be entirely without effect upon the rate of interest; but this effect would not be in the simple direct ratio supposed. Indeed, an increase of the productivity of capital would probably result in a decrease, instead of an increase, of the rate of interest. To double the productivity of capital might more than double the value of the capital." (Rate of Interest, p. 16.)[341] Fisher reiterates this doctrine in his reply to Seager, in the American Economic Review, Sept. 1913, pp. 614-615.
Now my concern here is not with the points at issue as between Fisher and Seager: the "impatience" vs. the "productivity" theories of interest. For the present, I shall accept Fisher's doctrine on that point as true.[342] I am here interested in Fisher's doctrine that a doubling of the general productivity of capital would double, or more than double, the prices of capital instruments, including land. How is such a general rise in prices possible, if the quantity theory be true? Is not this a rise in general prices from causes outside the equation of exchange? That Fisher means the money-prices of capital goods when he speaks of capital-values is perfectly clear. In the second quotation, he speaks of "capital-value of $40,000", and in general, his definition of value runs in terms of price (e. g., Purchasing Power of Money, pp. 3-4, and Elementary Principles, p. 17). Fisher has no absolute value concept in his system. We have in the passages cited two doctrines, both of which contradict the quantity theory: (1) that a reduction in the rate of interest will raise capital-prices (which are the largest factor by far in the price-level), and (2) that an increase in the product of capital goods means, not only more money paid for the products, but also more money paid for the production-goods. Incidentally, the general imputation theory would call for more money paid to laborers as well. How can all this be, on the quantity theory? And what can the poor equation of exchange do in such a case, if money does not increase, if bank-credit is limited by money, if velocities of circulation are fixed by individual habits and convenience, if trade increases as a consequence of the increased number of goods produced, and if prices rise? It will not help much to assume that the productivity of gold mines is doubled also. The quantity of money does not depend very much on the annual production of gold. Besides, money need not, from the standpoint of the quantity theory, be made of gold. It might be irredeemable Greenbacks, fixed in quantity by law, or even dodo-bones! Would not the capitalization theory apply in the Greenback Period? I shall not try to solve the riddle. I am not responsible for it!
The conflict between the capitalization theory and the quantity theory may be more simply stated. Assume that the prices of consumers' goods and services rise, quantity of money and volume of exchanges remaining unchanged. On the quantity theory, other prices, the prices of producers' goods and services, lands, and securities, would have to come down enough to compensate, in order that the price-level might remain unchanged. For the capitalization theory, however, the prices of lands, securities, and long time capital goods in general would have to rise, since the incomes on which they are based have risen. Wages of labor engaged in making consumers' goods would also have to rise, on the general imputation theory.
The quantity theory conflicts with the capitalization theory. The quantity theory as presented by Fisher conflicts with the capitalization theory as presented by Fisher. Which theory is true? Would prices rise thus, or would they be held down in some way by the limitations on the quantity of money? I hold that I have already proved, in the reasoning given in connection with my hypothetical island, and in the case of the South with its cotton, that the capitalization theory tendency would prevail. The prices of products rise, and then the prices of the labor, land, and other capital goods which have produced them, rise, the rise in the prices of the capital goods behaving in accordance with the laws of the capitalization theory, and all of the rises after the initial rise in products being in accordance with the imputation theory of the Austrians.
This conflict suggests an interesting point. Various elements in our economic theory, added from time to time by different writers, have necessarily come from different philosophical and sociological view-points, and have behind them different philosophical, psychological, and sociological assumptions. The quantity theory, developing, as shown in the chapter on "Supply and Demand and the Value of Money," largely in isolation from the general body of economic theory, has a background of psychological and sociological assumptions quite different from that of many other doctrines. In the chapter on "Dodo-Bones," I stated these assumptions. The quantity theory rests in a psychology of blind habit. It assumes a rigidity in the social system such that it might be likened to a machine, with a hopper into which money is poured, which grinds out prices at the other end. I set this in contrast with the psychological assumptions underlying the commodity theory of money. That theory rests on the "banker's psychology." It assumes a highly reflective and calculating attitude on the part of economic men, with the disposition to look behind appearances for the security, to test things out, to get to bedrock in business affairs. Now the capitalization theory likewise assumes this banker's psychology. In its refinements, as represented by the mathematical formulÆ in the appendices of Fisher's Rate of Interest, it assumes a degree of precision in business calculation which few experts in bond departments apply, and which the highly fluid and alert dealers in Wall Street certainly have not time for, even if they had that degree of mathematical knowledge! In practice, it need not be said, particularly in the case of the prices of lands, the capitalization theory finds its predictions very imperfectly realized! But the two theories, resting in such divergent psychological assumptions, may be expected, a priori, to conflict. That they do conflict is not remarkable.
I shall show a similar conflict between the quantity theory and the law of costs. In general, the quantity theorist thinks that he has reconciled his theory with cost theory by pointing out that reduced costs manifest themselves in increasing production, which means increasing trade, which should, on the quantity theory, mean lower prices.[343] I need not, for my purposes, analyze this doctrine in detail, though I am disposed to consider it an accident that the two theories converge at this point. For the present, I shall analyze a case where reducing costs actually come as a consequence of the reduction in the volume of trade, and inquire whether such a case will lead, as the cost theory would assert, to lowered general prices, or, as the quantity theory would assert, to higher general prices. The case is that where by improved methods of handling goods, it is possible to dispense with middlemen. Concretely, assume that retailers of milk get in direct touch with dairymen, so that middlemen are eliminated, and that as a consequence the price of milk is reduced two cents a quart. What of the general price-level? T (trade) is reduced. There are less exchanges. Volume of trade does not mean volume of goods produced, but volume of exchanges. With a reduced trade, the quantity theory must assert that prices of commodities other than milk must, on the average, rise, not merely enough to compensate for the fall in milk, but more than that, enough to compensate for the reduced trade as well. But how can the other prices rise? Well, a point comes up obviously: the buyers of milk save two cents a quart. They can spend it for something else. This will raise the prices of other things. But, on the other hand, the middlemen now have less to spend. They have exactly as much less as the others have more, the extra money that milk buyers have being, in fact, the money that the middlemen would otherwise have had. The one offsets the other. There is, then, no reason for the average of other prices to rise. Suppose we carry the process one step further. After a while, the middleman will find other work to do. Then they will have incomes again to spend. But in going to work again, they will be engaged in production, and so will, in general, be increasing the volume of trade. The quantity theorist could not expect a rise in prices from this!
And here we are given a clue to a fundamental confusion in the quantity theory, a confusion which, accepted by the reader, gives the quantity theory much of its plausibility. I refer to the confusion between volume of money, and volume of money-income.[344] The two need not be the same. The two generally are not the same. In the case I have described, the one has changed without a change in the other. Now if one wishes to view the process of price-causation from the standpoint of money offered for goods,—an essentially superficial,[345] but frequently useful, view-point—it is clearly money-income, rather than mere quantity of money in the country that is important. Into the determination of volume of money-income, however, come factors of a high degree of complexity, among them, prices for which there is no possible place within the confines of so simple and mechanical a doctrine as the quantity theory.
In passing, I notice a point to which I called attention in discussing Fisher's factors in the equation of exchange. I refer to his definition of velocity of circulation as the average of "person-turnovers" of money.[346] In the illustration given, there is no reason to suppose that this average is changed. The middlemen simply drop out of the average. They have no money to turn over! But velocity of circulation, defined as "coin-transfer," (cf. supra, p. 204) has clearly changed. The course of money has been short-circuited. It goes through fewer hands in the course of a given period. This last concept of velocity of circulation is clearly the one that must be used, if the equation of exchange is to be kept straight. But this fact should make it clear that velocity of circulation, instead of being the inflexible thing that Fisher has described, resting in individual habits and practices, a true causal factor in the price making process, is really a highly flexible thing, in large degree a passive function of trade and prices.
With this distinction between volume of money and volume of money-income[347] clearly held, we are prepared to go further in our attack on the quantity theory, granting the quantity theorist all his most rigorous assumptions, and still demonstrating that prices can vary independently, without prior change in quantity of money, volume of trade, or velocity of money. Let us assume the extreme case of the quantity theory: a closed market; no credit; no barter; a fixed supply of money; a fixed volume of trade; a fixed set of habits affecting velocity, namely, that everyone spends, in the course of the month, all that he has accumulated by the first of the month. The quantity theorist could not ask a more iron-clad set of assumptions than this! If the quantity theory is not valid here, if the price-level is not absolutely fixed, helpless to change, with these assumptions, then the quantity theory, even as a minor tendency, must be surrendered, and the quantity theorist must admit that the whole line of thought has been fallacious. But is the price-level passive? Suppose we assume a combination of employers of maid-servants, which forces down the wages of maid-servants from $20 to $10 per month. Assume further that there is no alternative employment for the maid-servants, so that they all remain at work.[348] So far, we have made a change in one price, the price of domestic service. What of the general average of prices, the price-level? Well, so far, the price-level is down. If nothing else takes place, we have reduced the price-level by reducing one price. What else can take place? Two things: (1) the masters now have $10 per month each more to spend for other things than before. That tends to raise prices in their other channels of expenditure. (2) The maid-servants now have $10 each less to spend,—the same ten dollars! That lessens prices in the lines of their expenditure. These last two changes exactly neutralize one another. The first change, in the price of domestic service, remains unneutralized. The general price-level is, then, lowered—by a cause acting from outside the equation of exchange, directly on prices. The first change comes in one price. In the final adjustment, that change remains unneutralized. How is this possible? Is the equation of exchange still valid? As a mathematical formula, yes. As expressing a causal theory, in which prices are effect, and money, trade, and velocity causes, no. The equation is kept straight by a reduction in velocity. Because the wages of maid-servants are reduced, less money goes through their hands; $10 per month per maid are short-circuited. But the cause is with the prices. The price-level, even under these absolutely rigorous assumptions, is not passive.
In general, I conclude that the price-level, under the laws governing particular prices, supply and demand, cost of production, the capitalization theory, the imputation theory, etc., can vary of its own initiative, independently of prior changes in the quantity of money, or of volume of trade, or other factors that the quantity theory stresses; and that these changes in the price-level (or in the particular prices which govern the price-level) can maintain themselves, and compel a readjustment in trade, credit, money and velocities, to correspond. This conclusion strikes at the very heart of the quantity theory, and, if valid, leaves the quantity theory disproved. More fundamentally, I should put it, prices can change because of changes in the psychological values of goods. These values are social values, and are to be explained only by a social psychology. But for the present it has seemed best to me, as a means of attracting sympathetic attention from a wider circle of economists, to make use of the less debated doctrines of the science in attacking the quantity theory. It is not necessary to rest the case on my own special theory of value. Supply and demand, cost of production, the capitalization theory, the imputation theory—the general laws of the concatenations and interrelations of prices—are quite adequate for the confutation of the quantity theory. They are laws concerned with particular prices, and the price-level is nothing but the average of particular prices. Whatever explains, really explains, the particular prices, also explains the price-level.
Fisher, as we have seen, is not of this opinion. Although he has defined the price-level as an average of particular prices[349] he none the less exalts this average into a causal entity, prior to and master of the particular prices out of which it is derived, of which it is a mere average.[350] This average, he maintains, is presupposed in the determination of all particular prices.[351] This seems to me a wholly untenable position. Ex nihilo nihil fit. There cannot be more in the average than there is in the particulars from which it is derived. In point of fact, there is necessarily vastly less. All the concrete causation is lost. The average, in itself, is nothing but a statement, a summary of results. I know nothing more metaphysical in the history of economic theory than this hypostasis of an average.[352]
I reject Fisher's notion that the average of prices is an independent entity. But I do not consider that the idea lying behind this untenable doctrine is absurd. Cost of production, supply and demand, and the other price theories do presuppose something more fundamental. They do presuppose money, and the value of money, as has been shown at length in Part I. The trouble with Fisher's notion comes in his definition of the value of money in purely relative terms as the reciprocal of the price-level, and his contention that the study of the value of money is identical with the study of price-levels.[353] Value is not a mere exchange relation.[354] Rather, every exchange relation involves two values, the values of the two objects exchanged. These two values causally determine that exchange relation. In the case of particular prices, then, we must consider not only the value of goods, but also the value of money. And the causes determining the general price-level will therefore include not alone the values of goods, but also the value of money. In the foregoing arguments by which I have shown that the price-level can vary independently of the other factors in the quantity theory scheme, I have been concerned only with changes in the values of goods, measured by a constant unit of value. If the value of money should also be varying, the concrete results on the price-level would have been different. On the face of things, there was nothing in the cases I discussed to require us to suppose that the value of money would also vary. The argument ran on the assumption of a fixed value of money. I have shown, in earlier chapters, that the assumption of a fixed value of money is fundamental to the laws of supply and demand, cost of production, and the capitalization theory. In point of fact, this assumption is rarely true—never strictly true. For causes which are in considerable degree independent of the causes governing the values of goods (as the causes governing their values are in considerable degree independent of one another), the value of money varies, now in the same direction as the values of goods in general, now in an opposite direction. Further, money itself does not escape the general laws of concatenation of values. The value of money has causes which are bound up with the values of other goods. Thus, when prices are rising and trade expanding, there is a tendency—commonly a minor tendency—for money also to rise in value, and so prices do not go quite as high as they would have gone had money remained constant. This tendency arises from the fact that there is more work for money to do in a period of active trade and rising prices. Gold also tends to rise in value in the arts, with prosperity. The reverse tendency manifests itself when prices are falling: money tends, in some measure, to fall in value with the goods,[355] and so prices do not fall as far as they would fall if money remained constant. But in general, the causes governing the values of goods, and the causes governing the value of money, are sufficiently independent to justify us in studying each separately, in abstraction, on the assumption that the other is unchanged. Hence, supply and demand, cost of production, and the other price theories, which assume a fixed value of money, are proper tools of thought for the study of the prices of goods.
CHAPTER XVI
THE QUANTITY THEORY AND INTERNATIONAL GOLD MOVEMENTS
The quantity theory explanation of international gold movements is as follows: if money comes into a country, it raises prices. If the price-level of the country is raised more rapidly than the price-levels of other countries are rising, then the country becomes a bad place in which to buy and a good place in which to sell; its exports fall off, its imports increase, and finally the inflow of money is checked, and, perhaps, money flows out again. The equilibrium of the gold supplies of different countries is thus dependent on the price-levels of the countries involved. The quantity of gold in a country determines its price-level, and no more gold can stay in a country, on this theory, than that amount which keeps its price-level in proper relation to the price-levels of other countries. It is not necessarily asserted that the price-levels of all countries must be equal—the facts too obviously contradict that. But when this precise statement is not made, the substitute statement of some "normal" relation between the price-level of one country and that of another becomes a very vague one, and the theory becomes pretty indefinite.
I am here concerned chiefly with one contention: the price-level, the average of prices, is not a cause of anything—not of gold movements or anything else. It is a mere summary of many concrete prices. Some of these concrete prices have highly important influence on international gold movements, tending, if they are low, to bring gold in, and if they are high, to repel gold. Others work in the opposite direction, tending if they are low to attract less gold than if they are high. Finally, among all the prices affecting international gold movements, the one which is most significant is commonly not included in the price-level at all: I refer to the "price of money," the short-time interest rate.
Let me elaborate each point. First, it is true that high prices of articles which enter easily into international trade tend to repel gold from the country—meaning by "high prices" prices that are higher than the prices of the same goods abroad. This relates, however, not to the general price-level, but only to a comparatively small set of prices. Most prices in a country are not prices of articles of international trade. High wages may, indeed, draw in immigrants. But high land rents, and high prices of land cannot bring in land. Nor do high land prices send away much gold to other countries for the purchase of land there. Indeed, within a single country, the differences in the relation between land yield and capital value of land are enormous. The following figures are taken from an article by J. E. Pope:[356] In Yazoo Co., Mississippi, farm lands are sold at $10 to $25 per acre. The average gross income per acre is $28. In Cass Co., Iowa, the land prices are from $100 to $125 per acre while the gross income amounts to only $11 per acre, if only crops and dairy products are taken into account, and to $20 if the sales of live stock are included. In Oglethorpe Co., Georgia, the average price is from $10 to $25 per acre, and the average income $10. In Paulding Co., Ohio, land is sold at from $75 to $100 per acre, and the average income per acre, including returns from live stock sold, is $15. Why should not landowners in Cass County, Iowa, sell their comparatively unproductive land, at a high price, and go, with their money, to Yazoo County, Mississippi? The answer is simply, that they would have to go with their money, and they prefer to stay at home! Absentee landlordism is not generally popular with men who are seeking paying investments. Land stands at one extreme. But then land is the very biggest item in an inventory of wealth, and, while not as land, actively bought and sold,[357] it is a big element in the values of many active securities. The principle holds in less degree of many other things, however. The securities of a local corporation, say a gas plant, find their best market at home, as a rule, unless the city be large. If they are held by foreign capitalists, they still find a very restricted market in the foreign country. Only those who have investigated at first hand will feel free in buying them—unless, indeed, they are guaranteed in some way by a big and well-known house. Prices of personal and professional services vary enormously in different sections of the same country, to say nothing of variations between different countries, and there is a very slow movement indeed toward bringing about higher salaries for rural preachers in Kansas because the salaries of London preachers have risen, or because of increased demand for preachers in Germany. Great numbers of commodities are too bulky to move far. Their prices vary with little relation to similar prices elsewhere. But the principle needs no more elaboration. If the reasoning be simply that men tend to buy where things are cheap, and to sell where things are dear, it is clear that that establishes a very loose relation indeed between the price-levels of different countries.
The second point is that some prices, by rising, actually bring in gold from abroad, while by falling they tend to release gold. I am not here referring to the case discussed in the chapter on "Supply and Demand," where a commodity, cotton, with an inelastic demand, is doubled, the doubled quantity selling for a less aggregate price, and so bringing in less money from abroad. That case would bear considerable generalization. I am referring here to the case where credit is built on the value of long time goods, as lands, or railroads. Concretely, let us suppose an increase in railroad rates allowed by the Public Service Commission of Missouri. This is, in itself a rise in prices. It will, further, on the capitalization theory, make the prices of stocks of the roads operating in the State rise also, and give a margin of additional security for bond-issues. This will make it possible for these roads to float foreign loans (or would have done so before the War), and so will tend to turn the exchanges in our favor. Gold will tend to come in, not to go out. Similarly if the prices of dairy products, or truck gardens, or orchards, or orange groves rise, leading to a rise in the prices of the lands involved, foreign capital will tend to come in as loans—i. e., the exchanges will turn more favorable to us, and the gold movement tend to turn our way. I suppose, by the way, that something of a point could be made against the Single Tax at this point: destroying land values would lessen the security which a community could offer outside lenders. The Single Tax would, thus, hamper the development of countries which need capital from outside. Men who wish to use their own capital, under their own management, might, as the Single Taxers claim, be tempted to come in, if they could be free from taxation on the capital they bring with them; but lenders, who wish a good margin of security, would find less inducement to lend.[358] This is a digression, but one feature of it is pertinent: though the foreigner does not care to migrate from his high-priced land to low-priced land elsewhere, he is often willing to trust a loan to the owner of high-priced land elsewhere. I will not venture the generalization that high-priced land necessarily attracts loans, and tends to turn the gold movements in favor of the country where prices are high. The point has been made that if lands are being exchanged frequently, the new buyer tends to exhaust his credit resources in paying for the land: i. e., puts so large a mortgage on it that he has little margin of security to offer for working capital.[359] I shall not here undertake to determine how far as a matter of fact, in different places, the one tendency outweighs the other. It is enough to point out that in many cases, where this factor is absent (as in the case of the railroads cited), rising prices attract, and do not repel, foreign gold, and that for none of these cases is the consequence of rising prices for the gold movements to be explained in the simple way that the quantity theory doctrine would require.
Finally, the international movements of gold[360] are enormously moved by the short-time rate of interest. The raising of the Bank Rate in England, supplemented, when necessary, by "borrowing from the market" by the Bank of England, as a means of making the Bank Rate effective, quickly turns the course of the exchanges. This is, as has been pointed out, a more effective device when used by the English money-market than when used by borrowing countries, since the borrower, by offering higher rates, is not always able to borrow more, whereas the lender, by demanding higher rates, is usually able to reduce his loans. But the difference is one of degree, and in point of fact a rise in the short time rates in New York City is commonly an effective means of bringing in gold from abroad. It is true that this is not the only factor. I have been at pains to point out how other factors work. I am as far as possible from denying the powerful influence of the "balance of trade" as treated by the older economists on international gold movements, when both visible and invisible items are included. But my point is, first, that these invisible items are numerous and flexible, and that a big factor in their determination is the short time rate of interest; and second, that the balance of physical items, even, depends, not on the price-level as a whole, but merely on the prices of those particular goods which enter into foreign trade. It is perfectly possible, and, indeed, is very common, for rising prices in a country to lead to expanding trade and expanding bank-credit, which causes bankers to wish to expand their reserves, which leads them to raise their rates on short time loans, which leads gold to come in from abroad. More simply still, the bankers may merely offer an attractive rate to the foreign bankers, and establish credits abroad, against which they draw "finance bills," which influence the gold movements in the desired manner.
CHAPTER XVII
THE QUANTITY THEORY vs. GRESHAM'S LAW
There is a pretty obvious conflict between the quantity theory and Gresham's Law. The latter is, essentially, a "quality" theory of money. For the quantity theory, dodo-bones, or anything else will do. "It is the number, and not the weight, that is essential"![361] For Gresham's Law, the weight makes all the difference in the world, if it is a question as between full weight and light weight coins, and, in general, the value of the thing of which money is made, considered in its commodity aspect, is the starting point of that doctrine.
The quantity theorist seeks, indeed, to harmonize the two. His theory is that Gresham's Law manifests itself only when there is a redundancy of the currency due to the issue of paper money, or overvalued metal. In such a case, prices rise, he holds, and then the undervalued metal, or the metallic currency, which count no more than the paper or the overvalued metal in circulation, tend to leave the country, to another country where prices are lower, or tend to leave the money use for the arts. But the quantity theorist must maintain that it is only via increased issue, with consequent rising prices, that Gresham's Law comes into operation. If there are a million dollars of gold in circulation, and a half million of irredeemable paper is added, then only half a million of the gold (or rather a little less than half) will leave. If more than that left, prices would fall, because of the scarcity of money, and then the gold would come back, because it would be worth more in concurrent circulation with the paper than it would be worth as money abroad, or in the arts. On the quantity theory, there can be no difference in the value of gold and paper, in such a case, after enough gold has left to balance the paper that has been issued. Falling prices would prevent it.
But Gresham's Law is not held by any such fetters! And the facts of monetary history, in important cases, show Gresham's Law controlling, despite the quantity theory. I will refer briefly to two such cases.
The first centres about the suspension of specie payments by the Northern banks and the Federal Treasury on January 1, 1862. This suspension was not accompanied by any increase of money. Rather, there was a decrease,[362] shortly following, in the amount of paper money. The banks in New York, and certain other States, were bound so strictly by their charters, and by the State laws, that they dared not leave their notes unredeemed. Speculators, buying notes at a discount—for virtually all bank-notes fell to a discount—were able to present them to the banks in these States and demand gold, which led to a very profitable business. The banks protected their gold by ceasing to issue notes, or by reducing the volume of note issue. Certified checks were used to a considerable extent instead. There was certainly no increase, and probably a reduction, a considerable reduction, in the volume of bank-notes in circulation. The only other paper money in circulation was the Demand Notes of the Federal Government, which were not increased after the date of the suspension, and which were in any case small in volume as compared with the total amount of money. On the quantity theory version of Gresham's Law, there was nothing to drive gold out. Gold was not pushed out by redundant currency. Rather, it left, leaving a monetary vacuum behind. Coincidently, strangely enough, prices rose. The vacuum in the money supply was so serious, that the subsequent first issue of the Greenbacks brought a welcome relief. Throughout the whole of the first year of the suspension, the volume of money was less than it had been in the preceding year. None the less, the gold stayed out of general circulation. It did not come back from abroad. And prices rose.[363]
A similar episode, the obverse of this, occurred when the Bank of England resumed specie payments in the early '20's. Then gold came back, the currency was increased, and, coincidently, prices fell.[364]
I conclude that the conflict between Gresham's Law and the quantity theory is real and fundamental, and that in cases where different qualities of money are in concurrent circulation, the undervalued money will leave, regardless of the question of quantity.
CHAPTER XVIII
THE QUANTITY THEORY AND "WORLD PRICES"
Some writers, who would call themselves quantity theorists, would repudiate many of the doctrines for which Fisher stands, and which the historical quantity theory involves. The recognition which Fisher's book has received from quantity theorists generally, justifies me in treating his book as the "official" exposition of the modern quantity theory, and, indeed, it is easy to show that Fisher is fundamentally true to the quantity theory tradition. With many writers, the disagreement with Fisher would be a mere matter of degree; they would hold that Fisher has set forth the central principle, that his qualitative reasoning is correct, but that the relations among the factors in his equation are less rigid than he maintains. As I reject even the qualitative reasoning by which Fisher defends his doctrine, and reject even the qualitative tendency which he maintains, my criticisms will apply as well to the position of this group of writers, though I should have less practical differences with them, to the extent that they admit qualifications and exceptions to Fisher's doctrine.
There is, however, a group of writers who seem to feel that the quantity theory remains sufficiently vindicated if it can be shown that an increase in gold production tends to raise prices throughout the world, while a check on gold production tends to lower prices, and who rest their case on the necessity which bankers find of keeping reserves in some sort of relation to the expansions of bank-credit.
A view of this sort is presented by J. S. Nicholson, whose statement of the application of the quantity theory to the modern world differs almost toto coelo from his original statement in the dodo-bone illustration already discussed. Nicholson[365] declares that in our modern society "the quantity of standard money, other things remaining the same, determines the general level of prices, whilst, on the other hand, the quantity of token money is determined by the general level of prices." Nicholson's reasoning is, substantially, as follows: Although the bulk of exchanging is carried on by means of credit devices, there is still a certain part of exchanging, especially in the matter of paying balances, for which standard money only can be used. He regards the whole credit system as based on standard money, and says that for any given level of prices there is a minimum amount of standard money, absolutely demanded. If the volume of standard money falls below this minimum, the price-level will fall to such a point that the volume of standard money is again adequate. He takes, moreover, a world-wide view, declaring that it is the relation between the volume of gold money throughout the world and the demand for standard money throughout the world which determines the relative values of money and commodities. "The measure of values or the general level of prices throughout the world will be so adjusted that the metals used as currency, or as the basis of substitutes for currency, will be just sufficient for the purpose. We see then, that the value of gold is determined in precisely the same manner as that of any other commodity, according to the equation between supply and demand."
In the consideration of this doctrine, let us note several points in which it differs fundamentally from the quantity theory proper, and from the situation assumed in the dodo-bone illustration. First, it is not a quantity theory of money. Money is not regarded as a homogeneous thing, each element having the same influence on prices. Rather, token money is the child of prices. This doctrine would in no way fit in with the logic of the equation of exchange, as presented by Fisher. Further, the dodo-bone idea is entirely gone. Gold, a commodity with value in non-monetary employments, is under discussion, and it is the quantity of gold that is counted significant. This recognizes, if not the need, at least the existence, of a commodity standard. Nicholson definitely avows the necessity for the redemption of representative money, even going so far as to say that "all credit rests on a gold basis,"[366] that all instruments of exchange derive their value from the volume of standard money which supports them, and that if this basis were cut away the whole structure would fall. Nicholson recognizes, further, that gold has value independent of its use as money.[367]
In evaluating Nicholson's doctrine, I wish to point out, first, the inaccuracy of the statement that all credit rests on a gold basis. It is true that credit instruments are commonly drawn in terms of standard money, which is commonly gold. International credit instruments may even specify gold, and the same thing happens at times within a country. But commonly, in this connection, gold functions, not as the value basis lying behind the credit instrument, the existence of which justifies the extension of the credit, but rather as the standard of deferred payments, by means of which the credit instrument may be made definite. The real basis of the value of a mortgage is not a particular sum of gold, but rather the value of the farm, expressed in terms of gold. The basis of a bill of exchange is not a particular sum of gold, but rather is the value of the goods which changed hands when the bill of exchange was drawn,[368] supplemented by the other possessions of drawer, drawee, and the endorsers through whose hands it has gone. Even a note unsecured by a mortgage, or not given in payment for a particular purchase, is based, in general, on the value of the general property of the man who gives it, and on the value of his anticipated income.[369] So throughout. Credit transactions, for the most part, originate in exchanges, and carry their own basis of security in the goods and securities which change hands, not in that small fraction of the world's wealth, the stock of gold, which could, Coin Harvey asserted in the middle '90's, be put in the Chicago grain-pit! And now let me extend this idea. Although coin made from the standard of value is a great convenience, there is yet no vital need, in theory, for a single dollar, pound or franc made from the standard of value. If gold should cease entirely to be used as a medium of exchange, or in bank or government reserves, if the gold dollar should become a mere formula, so many grains of gold, without there being any coins made of it, still, so long as that number of grains had a definite, ascertainable value, commensurate with the value of some other commodity which could be used as a means of paying balances and redeeming representative money, the gold dollar could still serve as a measure and standard of values. In the situation I have assumed, silver bullion, at the market ratio, could perform all the exchange and reserve functions now performed by gold, even though not so conveniently.[370] Nicholson's description of the use of gold as a reserve, while calling attention to an important fact, has led him into the error of supposing that what may be true of gold, the medium of exchange, and reserve for credit operations is necessarily true of the standard of value as such.
Nicholson is correct, however, in looking to the standard of value for part of the explanation of changes in prices. And, since it so happens that a considerable part of the value of the standard of value comes from its employment as medium of exchange and reserve, he is correct in looking to its use as money as part of the explanation of its value. His error comes, however, in failing to see that independent changes in the values of goods may also change the price-level, and that variations in the demand for gold as a commodity may also change the value of gold, and so change the price-level.
Further, in so far as Nicholson clings to the notion of prices as depending on a mechanical equilibration of physical quantities, he is subject to the criticisms given before of the general quantity theory, and in so far as he clings to the identity of the value of gold with the reciprocal of the price-level,—the relative conception of value—he is subject to the criticisms already urged.
Again, even for a single country, the connection between volume of reserves and volume of credit is very loose and shifting. A thousand factors besides volume of standard money in a country determine the expansions and contractions of credit, and the long run average of credit. For the whole world, this connection is even looser. To assume a fixed ratio between them for the whole world, one would have to assume that all the world was simultaneously, and normally, straining its possibility of credit expansion to the utmost, so that the minimum ratio—a notion which is far from precise[371]—should also be the normal maximum, and so that no country, in expanding its credit, could draw in new reserves from other countries which had more quiescent business conditions.
Nicholson's notion of the world price-level, moreover, is subject to the criticisms I have made in the chapter on "The Quantity Theory and International Gold Movements." How can the world level have a close connection with the volume of gold, if different elements in the world price-level, the price-levels of different countries, can vary so widely and divergently as compared with one another? Even granting—which I do not grant, and which I maintain I have disproved—that the price-level in one country has a close connection with its stock of gold, would it not be true that the average price-level for the world would vary greatly, with the same world stock of gold, depending on which countries had the gold?
There is nothing in Nicholson's doctrine which seems to me to justify in any degree the doctrine that prices, in a single country, or in the world at large, show any tendency to proportional variation with the quantity of money, or with the world's stock of gold.
Is it not true, then, that there is some sort of relation between gold production and world prices? It is. Gold is like other commodities. Its value tends to sink as its quantity is increased. As its value sinks, prices tend to rise. As to the elasticity in the value-curve for gold, I think it will be best to reserve discussion till a later chapter,[372] in Part III. We shall there find reason for thinking that gold has much greater elasticity in this respect than most other commodities. That its value should fall proportionately with an increase in its quantity, I should not at all conclude. Even if its value did sink proportionately with an increase, prices would rise proportionately only if the values of goods remained unchanged.
But why do we need a quantity theory of money, with all its artificial assumptions, and its law of strict proportionality, to enable us to assert the simple fact that gold, like other commodities, has a value not independent of its quantity? What theory of money would deny it? Surely not the commodity or bullionist theory. For that theory, which seeks the explanation of the value of money in the value of gold in the arts, it would go without saying that an increase in the supply of gold for the arts would lower its value there and consequently, its value as money. Surely the theory which I shall maintain in Part III of this book will not deny that increased gold production tends to lower the value of money, and consequently to raise prices. With the "quantity theorist" who is content with this conclusion, I have no quarrel—unless he claims this obvious truth as the unique possession of the quantity theory!
CHAPTER XIX
STATISTICAL DEMONSTRATIONS OF THE QUANTITY THEORY—THE REDISCOVERY OF A BURIED CITY
In the following chapter, as in most of the preceding chapters, constructive doctrine is aimed at, even though the discussion takes, in considerable part, the form of critical analysis of opposing views. We shall seek to set forth the facts, as far as may be, regarding the relations of banking transactions to trade, the relations of clearings to amounts deposited in banks, the relation of New York City clearings to country clearings, and of New York bank transactions to bank transactions in the rest of the country. We shall seek to ascertain the extent of variability in that highly elusive magnitude, "velocity of circulation," particularly "V´." We shall indicate something of the bearing of index numbers of prices on the theory of the value of money as here presented. In reaching conclusions on these and related matters, we shall build on the investigations of Dean Kinley, on the very interesting statistical studies of Kemmerer and Fisher based on Kinley's figures, on investigations more recently made by the American Bankers' Association regarding the relation of bank transactions and bank clearings, on figures from reports by the Comptroller of the Currency, as well as on other sources. One purpose of the chapter is to criticise the statistics which purport to prove the quantity theory. The bulk of the chapter is given to this. But the work of Fisher and Kemmerer thus criticised yields rich rewards for the study. The conclusions they have drawn from their figures are, in the judgment of the writer, untenable, but the figures themselves are of immense interest and importance.
The controversy over the quantity theory has been waged with many weapons. Theory, history, and statistics—to say nothing of invective!—have been freely employed. In large measure, the statistical studies have been concerned with the direct comparison of quantity of money and prices, in their variations from year to year. One of the best of these studies, that of Professor Wesley C. Mitchell, in his History of the Greenbacks (followed by his Gold, Prices and Wages under the Greenback Standard), has, to the minds of many students, including the present writer, put it beyond the pale of controversy that the fluctuations in the gold premium, and in the level of prices, in the United States during the Greenback period, both for long periods and for daily changes, were not occasioned by changes in the quantity of money,[373] but rather, primarily, by military and political events, and other things affecting the credit of the Federal Government, together with changes affecting the values of gold and of goods. Professor Mitchell's discussion is so detailed and thorough, that what controversy remains relates, not to his facts, but rather to the possibility of interpreting those facts in harmony with the quantity theory, by repudiating the notion that the direct comparison of gold premiums or of prices with quantity of money gives a valid test.[374]Recent defenders of the quantity theory have undertaken the examination of more complex statistics than those concerned with the simple concomitance of quantity of money and prices. Two of these studies, the first by Professor Kemmerer[375] and the second by Professor Fisher, are so elaborate, have commanded such general attention, and have been accepted by so many students as conclusive demonstrations, that I feel it proper to give them detailed examination. I do this especially because highly important facts for our construction argument emerge from this critical examination. Kemmerer's and Fisher's studies reach high-water mark in the effort to give statistical demonstrations of the quantity theory. If they are invalid, then I know no other attempts which many students would suppose to be possible substitutes. The theory involved in both these studies is clearly stated by Professor Kemmerer: "A study of this kind, to be of any value, must cover the monetary demand as well as the monetary supply. Any test of the validity of the quantity theory consisting merely of a comparison of the amount of money in circulation with the general price-level is as worthless as would be a test of the power of a locomotive by a simple reference to its speed without taking into account the load it was carrying or the grade it was moving over." This criticism of many previous studies is, in general, I think, valid, though I should except from this list such detailed studies as that of W. C. Mitchell, who takes account, as far as may be, of all the variables involved, and who considers day by day and week by week changes. I think the older studies of Tooke,[376] may also be excepted. In point of fact, if one wishes to know how much reliance may be placed in the quantity theory as a basis for prediction, when one knows that money is increasing, the simple comparison of money and prices is a fair test. If the "other things" which must be "equal" are so numerous and complex that the quantity theory cannot manifest itself in a direct comparison, much of its significance as a basis of prediction is gone.
It is perfectly true, however, that studies running through long periods, which give simply figures for general prices and figures for quantity of money, omitting volume of trade, are not very relevant either for proof or disproof.[377] And the conception underlying the studies of Kemmerer and Fisher, that not merely money and prices, but also volume of bank-credit, volume of trade, velocity of monetary circulation, and velocity of bank-credit, must be measured, undoubtedly represents a big advance in the conception of the statistical problem involved. The mere stating of the problem is an intellectual achievement of no mean order, and the ingenuity and scholarship involved in seeking data for concrete measurement of these highly elusive elements must command the admiration of every student of monetary problems. Volume of trade, velocity of money and velocity of bank-credit had been generally supposed, until these studies were undertaken, to be beyond the reach of the statistician. There can be no doubt at all that the efforts to measure them, or to measure variations in them, by Kemmerer and Fisher, have greatly advanced our general knowledge of the phenomena of money and credit.
With great admiration for the magnificence of the problem undertaken, and for the industry, ingenuity and scholarship which have been devoted to its solution, I have nevertheless reached the conclusion that the figures assigned by these writers to the magnitudes of their "equations of exchange" are, with the exceptions of the figures for money and deposits, widely at variance from the real facts in the case, and second, that if they were correct, they could in no sense be said to constitute proof of the quantity theory.
In the critical analysis which follows, chief attention will be devoted to Fisher's statistics. His is the later study, and it follows, in main outlines, the methods laid down by Kemmerer. He has employed Kemmerer's statistics in considerable part, amplifying them for later years, using some data not available when Kemmerer wrote, and undertaking a fuller solution of certain problems than Kemmerer did. I shall, however, from time to time make reference to Kemmerer's figures, and show points of difference between the two studies.
Let me first briefly state the second point of my criticism of these studies: namely, that even if the statistics are correct, they do not constitute proof of the quantity theory. The statistics purport to be concrete data filling out for different years the equation of exchange.[378] But the equation of exchange, as we have seen, does not prove the quantity theory. The quantity theory is a causal theory, and causation involves an order in time. The concrete figures for the equation do not prove that. Even Kemmerer's concluding chart on p. 148, showing a rough concomitance between "relative circulation" and general prices does not show that changes in relative circulation are causes of changes in general prices. The causation might be the reverse for anything his figures tell us. Fisher himself recognizes this, in considerable degree: "As previously remarked, to establish the equation of exchange is not completely to establish the quantity theory of money, for the equation does not reveal which factors are causes and which are effects."[379] Again: "But, to a candid mind, the quantity theory, in the sense in which we have taken it, ought to appear sufficiently secure without such checking. Its best proof must be a priori."[380]
The main criticism here, however, relates to the figures themselves, rather than to their meaning. The figures given by Professor Fisher are concrete magnitudes to fill out his equation of exchange, MV + M´V´ = PT[381] for the years since 1896. Thus, for 1909, the figures are: M = 1.61 billions; M´ = 6.68 billions; V = 21.1; V´ = 52.8; P = $1; T = 387 billions.[382]
Now in what follows, I shall challenge all these estimates except P for 1909, V for 1896 and 1909, and M and M´ for all years. The figures for M and M´, being the results of fairly simple computations based on Governmental statistics, need not be questioned. P for 1909 is arbitrarily placed at $1.00. V for 1896 and 1909, for reasons which will later appear, is better based than for other years, though Kemmerer and Fisher have differed greatly in their estimates for V, the former placing it at 47 and the latter at 18 or 20.[383] My criticisms with reference to V, however, will relate to the years other than 1909 and 1896.
The sources from which these absolute magnitudes are drawn are, primarily, two investigations by Dean David Kinley, one in 1896 and the other in 1909, in coÖperation with the Comptroller of the Currency.[384] The purpose of these investigations was to ascertain the proportions of checks and money in payments in the United States. Banks of all kinds, national and State banks, trust companies, private banks, etc., were requested by the Comptroller to supply data for a given day (March 16 in 1909) showing what their customers deposited on that day. They were asked to classify these deposits as cash, on the one hand, and as checks, drafts, etc. on the other. They were also asked to give a cross classification of the same deposits, as "retail deposits," "wholesale deposits," and "all other deposits." In 1909, over 12,000 banks of all kinds, out of about 25,000 banks, replied, and of these replies 11,492 were in available form. These replies showed a total of deposits of over 688 millions of dollars. Of this total, 647 millions were in checks, so that checks made up 94.1% of the whole. About 60 millions of this total were retail deposits, about 125 millions were wholesale deposits, and the rest, about 503 millions, were classed in the "all other" category. Kinley's use of these figures, for his purpose, seems to me in every way conclusive and safe. He was interested merely in the question of the proportions of checks and money in payments, retail, wholesale, and "all other." The absolute magnitudes of the elements in the equation of exchange he was not trying to measure. Professor Fisher's use of the figures presents a different problem.[385]
Let us consider, first, Professor Fisher's estimate of M´V´, taken together. M´V´ is considered to be equal to the total amount (in dollars) of checks deposited during the year.[386] To get this, for 1909, Kinley's figure, above, for checks deposited in 11,492 banks on March 16, 1909, is used. This figure is 647 millions. As half the banks had not reported, an estimate for the non-reporting banks was obtained from Professor Weston, who had aided Dean Kinley in the investigation, and who had access to the original data. Professor Weston estimated the total checks deposited during the day at 1.02 billions.[387] The question then arose as to whether this day was typical for the year. Professor Fisher found New York City bank clearings of March 17 (the day after, on which these checks would get into the clearings) to be 28% below the average for the year. He assumed the rest of the country to be half as abnormal as New York City, and increased the 1.02 billions to 1.20 billions, getting what he conceived to be the daily average of checks deposited in the United States in 1909. Multiplying this figure by 303, the number of banking days in New York City (and so, presumably, a fair average for the number of banking days in the country), he obtained 364 billions for the checks deposited in 1909. This figure he considered to be M´V´, the volume of bank deposits,[388] multiplied by its velocity of circulation. To obtain V´, therefore, his problem was simple: he divided the figure for M´V´ by the figure for M´ previously obtained from government statistics, and obtained V´.
Now I wish to call attention to three important errors involved in this calculation of M´V´ for 1909. (1) The assumption that the total check circulation is the same as the volume of checks actually used in trade is a violent one. Payments may be tax payments, loans and repayments, gifts, what not. Many checks may be used in a single transaction. Surely not all of this is properly to be counted in the M´V´ of the equation of exchange. But this topic is better discussed in connection with the estimate for T, and I reserve its fuller discussion till then. (2) The assumption that the rest of the country was abnormal in its clearings on March 17, 1909, is a pure assumption, which investigation does not verify. The rest of the country was, in fact, nearly normal! The error that comes for the year from increasing the total on this assumption amounts to at least 31 billions! The total for the year, on Professor Fisher's method of computation, with the correction to make the assumption regarding outside clearings correspond with the facts, is 333 billions, instead of 364 billions! As the figure for 1909 is a basic figure, on which figures for other years are calculated, this error is extremely significant.[389]
(3) A yet more serious error in this computation is the assumption that New York City was complete in Kinley's figures, while the rest of the country was incomplete. This error, as we shall see, largely neutralizes the error above, so far as the "finally adjusted" figure for 1909 is concerned, but it makes a vital difference in the figures for other years, as will appear, since it affects the "weighting" of New York clearings and outside clearings in the index of variation by means of which M´V´ for years other than 1909 is determined. The assumption that New York is complete, in Kinley's figures, and that all of the extra hundreds of millions added by Professor Weston in his estimate for the non-reporting banks belongs to the country outside New York, is made by Professor Fisher both on pp. 444-445, in estimating M´V´ for 1909, and on p. 446, in finding an index of variation for M´V´. The only reason given, so far as I can find, is the following: "This figure, being for New York, [Italics mine], is probably nearly complete." (Loc. cit., p. 446.) With this as a basis, Professor Fisher proceeds in his calculations to treat the figure for New York, 239 millions, as absolutely complete, and gives the rest of Professor Weston's 1.02 billions for the day, or 786 millions, to the country outside. The error above mentioned, of assuming the rest of the country to be abnormally low on March 17 in its clearings, still further increases the amount assigned to the rest of the country in the total figures for the year.[390] The conclusion finally is that New York had deposits of 93 billions in checks for the year, while the rest of the country had deposits of 271 billions in checks. As New York clearings for the year were 104 billions, while clearings for the rest of the country were only 62 billions, Professor Fisher concludes that New York clearings overcount New York check deposits, and outside clearings greatly undercount outside check deposits, so that, in the index of variation of check deposits, for years other than 1909 and 1896, New York clearings should be given a weight of only 1, while outside clearings should be weighted by 5. "That is, on the basis of 1909 figures, five times the outside clearings plus once the New York clearings should be a good barometer of check transactions." (P. 447.) All this rests on the assumption that New York figures for March 16, 1909, were complete, and the only reason assigned is, "being from New York!"
Now the figures from New York were not complete. And New York clearings do not overcount New York check deposits. Outside clearings do not undercount outside check deposits nearly to the extent that Professor Fisher assumes. For each of these three statements I shall offer what would seem to be conclusive evidence, and I shall attempt to get an estimate of the real relation between New York check transactions and check transactions for the rest of the country.
First, the figures for New York were far from complete. It may be noted that Dean Kinley, in his volume for 1909,[391] is very careful to repudiate the assumption that the cities were complete more than the country: "Moreover, it is a mere assumption that the non-reporting banks are mainly the small banks in the country districts. A great many city banks also did not report." (Italics mine.) That this is true for New York is abundantly evident from figures there given for the private banks and the trust companies, not to consider at all the State and national banks. New York shows only $1,751 in checks deposited in the "all other deposits" in private banks! This is a city which includes among its private bankers J. P. Morgan & Co., Kuhn, Loeb and Co., J. & W. Seligman & Co., and others! Figures from these banks appear nowhere in Kinley's totals, since deposits made by these banks in other banks are also excluded from Kinley's figures.[392] Of course, exact figures cannot be given to show how much New York would be increased had the private banks made full reports. We have no reports of any kind from these institutions. Every feature of their business is kept from the lime light, as far as possible—a practice which is much to be regretted, since it arouses hostility and suspicion, where a statement of the facts in the case would frequently entirely dispel them. We have, however, some information regarding the magnitude of their deposits, meaning by deposits, not what Kinley means in this investigation, namely, checks, etc., deposited on a given day, but rather, deposits in the balance sheet sense of demand obligations to depositors. In Nov. 1912, J. P. Morgan and Co. held deposits of $114,000,000, exclusive of 49 millions on deposit with their Philadelphia branch of Drexel & Co. About half of these were deposits of interstate corporations. Kuhn-Loeb held, on the average, for the six years preceding 1913 over 17 millions of deposits of interstate corporations. What their aggregate deposits were, we do not know. These figures are obtained from the report of the Pujo Committee.[393] Morgan's deposits were equalled by only three banks and two trust companies in New York (as of April 3, 1915), and Kuhn-Loeb's deposits for interstate corporations alone exceeded the total deposits of any one of the great majority of the New York Clearing House banks and trust companies. Of course, large deposits in the balance sheet sense need not mean large deposits made on a given day. Private bankers' deposits may be inactive. But we know, first, that half of these figures for Morgan, and the whole of the figures given for Kuhn-Loeb, represent the deposits of active business corporations, engaged in interstate business. They are not mere trust funds lying idle, or awaiting investment in securities. What the rest are we can only conjecture. That they are deposits of men and firms connected with the Stock Exchange in some way is highly probable. The whole drift of the statistics presented in this book, and of the argument developed in this book, would serve to show that such deposits are likely to be more than ordinarily active.[394] I refrain from assigning any figures as to the amount of checks deposited in private banks in New York on March 16, 1909. It must have run high into the millions.[395] It certainly exceeded the two thousands, or less, reported to Kinley! The figures for New York were, thus, incomplete.
But the trust companies were also incomplete. The national banks in New York reported checks totaling 186.5 millions, for all three classes of deposits; the State banks reported only 38.1 millions; the trust companies only 14.2 millions. With aggregate deposits, as shown by their balance sheets, exceeding the deposits of national banks[396] the New York City trust companies reported, as deposited on March 16, 1909, less than half as much as the State banks, less than a tenth as much as the national banks, and only 6.8% of the two combined—5.9% of the total from all three classes of institutions!
These figures are hard to reconcile with the assumption that the trust companies in New York were complete on that date.
It is, of course, possible that the trust companies, though having large deposits, have inactive deposits. This is sometimes held to be the case. But that the difference is so great in activity of deposit accounts between banks and trust companies is hardly credible. I have looked into this matter with considerable care, and have secured information and opinions from men intimately acquainted with the trust companies of New York from the inside. The only available quantitative measure of the activity of deposits would seem to be the volume of a bank's clearings. This is not perfectly accurate, by any means, but it is the best available test. Through the courtesy of a Vice President of one of the largest New York trust companies, I have obtained figures from an official of the Clearing House, which show that in New York trust company clearings run from 20 to 25% of the whole. On this basis, the trust company figures for 1909 were incomplete to the extent of from 33 millions to 46 millions, on the day in question. These clearings figures, however, are for the year, 1915, and not for the period before May, 1911, when the trust companies were admitted to the Clearing House. Prior to that time they did not deal directly with the Clearing House, but through the member banks. Do these figures, therefore, represent the situation as it existed in 1909? The possibility was entertained that entering the Clearing House had made a difference in the reserve policy of the trust companies, and so had made them change the character of their business, in such a way as to bring about greater activity of accounts. This question was put to the official of the trust company before mentioned, and his reply is that the State law regarding reserves (passed after the Panic of 1907) had already brought about this change in reserve policy, and so no difference was made upon entering the Clearing House.
The same gentleman, by the way, replying to a question regarding the deposits in private banks in New York, and the influence of such deposits on clearings, writes: "The actual figures could not be obtained from the Clearing House..., consequently can only say that deposits made with these houses add to the Clearing House totals very large sums."
There is one piece of evidence which would seem to negative these conclusions regarding the trust companies. In the Report of the New York State Superintendent of Banks, for Dec. 31, 1907, p. xxxv, is a statement that during the two years, 1903-05, the trust companies of New York cleared only 7% as much as the banks. The statement relates, however, to a period during which the trust companies not only had no Clearing House membership, which of course was true up to 1911, but also had largely withdrawn from the privilege of clearing through member banks.[397] Under these circumstances, even 7% would seem quite high. Inquiry was made of the Honorable Clark Williams, who was State Superintendent of Banks at the time the report was made, as to the source of the figures.[398] Mr. Williams, in reply, defends the figures as correct for that period, but authorizes the writer to quote him as in no way surprised at the percentages given above, 20 to 25% of the total clearings, in view of developments and changes in trust company business.
I conclude that the trust company figures for March 16, 1909, were exceedingly incomplete. The national bank figures were probably more nearly complete than any others, first because they are large, and second, because national banks would feel more obligation than other banks to reply to questions from the Comptroller. The State bank figures, 38.1 millions, as against national bank figures of 186.5 millions, were probably incomplete also, to a considerable extent, though State banks are not dominating factors in New York City. That they should exceed the figures for trust companies is surely evidence of the incompleteness of the trust company figures. The private banks are incomplete, with absolute certainty, since they are virtually not represented at all.
Further evidence that the New York figures were incomplete, however, will appear in the data regarding our second thesis, namely, that New York clearings do not overcount New York check deposits. The aggregate check deposits reported from New York, on the date in question, is 239 millions. Clearings for that day were 268 millions,[399] substantially exceeding the reported check deposits. Now do clearings exceed check deposits in New York City?
Evidence with reference to outside clearings, in connection with bank transactions, we now have in very definite and abundant form, and it will be convenient to approach the question of New York clearings, first, indirectly, via country clearings. We shall, therefore, take up first the thesis that clearings outside New York do not undercount bank deposits outside New York nearly as much as Professor Fisher thinks. According to his estimate, checks deposited during the year in banks outside New York (exclusive of checks deposited by one bank in another) were 271 billions. (Loc. cit., 446.) Outside clearings were only 62 billions, and his conclusion is that the ratio of deposits to clearings is 4.4 to 1, or, in other words, that outside clearings amount to less than 22.8% of outside check deposits.
Now an extensive investigation, covering the period from June, 1913, to Oct. 1914, inclusive, has been made by the American Bankers' Association, through Mr. O. Howard Wolfe, Secretary of the Clearing House Section. This investigation covered cities of various sizes, in various parts of the country. Its results are immensely more trustworthy than any results based on a single day, as Professor Fisher's results are, could be, even had Professor Fisher's method been otherwise correct. An account of this investigation is to be found in the Annalist of Dec. 7, 1914.[400] This investigation involves, for the period in question, a comparison of "total bank transactions" in each city with the clearings of that city, together with a summary covering all the cities. "Total bank transactions" consist of all debits against deposit liabilities of each member of the Clearing House, whether they come through the Clearing House or over the counter. They include payrolls, for example, which, of course, never get into clearings. They include drafts on deposits of one bank in another. In a letter to the Editor of the Annalist, Mr. Wolfe states that "total bank transactions include all debits against deposit liabilities, whether by check, draft or charge ticket. The only exceptions are certified checks and certain cashier's checks, both of which to an extent represent a duplication." For the period in question, clearings amounted, on the average, for all cities, to 40% of "total transactions." The cities did not include New York City, as stated.
Now we cannot apply this 40% at once to the question in hand. Professor Fisher's 22.8% relates to the relation between clearings and checks and drafts deposited, excluding items deposited by banks, and excluding, of course, cash deposited. What is the relation between Kinley's "deposits" and Wolfe's "total transactions"?
It is clear that "total transactions" must, in a period of time, exceed Kinley's "deposits" very considerably. In a general way, what goes out of a bank, and what comes into a bank, must approximately equal one another in a period of time. In a general way, a depositor finds his income and his outgo balancing. Of course, some accumulate, paying in more than they withdrew, but in general such accounts are made with savings banks. The business man borrows from his bank, getting a "deposit credit" (without "depositing" in Kinley's sense), then checks against his "deposit," then receives checks in payments to himself, "deposits" them, building up his deposit balance again, and then checks against his deposit balance, in favor of the bank, to pay off his loan. What comes in and what goes out—abstracting from the growth of a rapidly expanding bank—balance. But notice, in the case cited above, that "total transactions" include more items than Kinley's "deposits" show. When the bank makes a loan, and gives a deposit credit, this does not, usually, show in Kinley's deposits. When, however, the loan is paid off by a check to the bank, it does show in "total transactions." Moreover, when a man deposits cash in the bank, it does not show in Kinley's figures for checks deposited. When, however, he withdraws cash from the bank, or his check to another is "cashed," it does appear in "total transactions." Further, checks deposited to the credit of one bank in another do not appear in Kinley's figures. Checks drawn, however, by one bank on another do appear in total transactions. How great the difference is between "total transactions" and "deposits" in the banks outside New York we cannot say precisely. The cash items alone, on the basis of Kinley's figures, would make a difference of about 9%.[401] To allow 11% excess to "total transactions" over "deposits" for the other reasons listed, is surely not to make an exaggerated allowance. We thus count "deposits" in Kinley's sense, for the banks outside New York City, as 80% of "total transactions." Since, then, clearings are 40% of "total transactions," they will be 50% of "deposits." This figure is more than twice as great as Professor Fisher's figure of 22.8%. Even if we counted deposits as equalling total transactions, Professor Fisher's estimate would be clearly very much too low.
How, then, do we stand? On Professor Fisher's showing, the overwhelming bulk of checks deposited were in the country outside New York—271 billions for the year, outside, as against 93 billions in New York City. If the ratio (50%) for outside clearings to deposits was the same for 1909 that it was in 1913-14 for the outside banks, we shall have to revise this radically. We have 62 billions of country clearings in 1909; we would have, then, 124 billions[402] of country check deposits! If Fisher's total figure for the country is correct, 353 billions as "finally adjusted," the balance, or 229 billions, would belong to New York! New York clearings, 104 billions, would thus be less than half of New York deposits! If we count outside clearings for 1909 as only 40% of outside check deposits, outside deposits would be, for 1909, only 155 billions, as against Professor Fisher's 271 billions, a difference of 116 billions! I am sure that his error in estimating outside check deposits is at least as great as that, and that we cannot assign to New York City less than a major part of the total check deposits of the whole country.
This result fits in with the figures actually reported to Dean Kinley, corrected to fit the known facts about March 17 clearings, better than Professor Fisher's estimate, by a good margin. According to Professor Fisher's estimate, New York City checks deposited are only 25.5% of the total. Kinley's actual figures give 239 millions to New York City, and 408 millions to the country outside. But New York clearings were 28% below normal on March 17, while country clearings were only 2.45% below normal. Adding 28% to the figure for New York checks, we get 306 millions. Adding 2.45% to the outside checks, we get 418 millions. Of the total, 724 millions, New York checks would be, then, 42.3%. We have shown reasons for considering New York deposits to be very incomplete for March 16, particularly as regards the private banks and trust companies. Comparison of the New York figures with the results indicated by the ratio of country clearings to country deposits would thus indicate that New York was much less complete than the country as a whole. Even so, I need to add but 7.3% of the total to Kinley's actual figures for New York, corrected in the light of next day clearings, to give New York half of the check deposits. Professor Fisher must subtract 16.8% of the total from the actual figures for New York, as corrected in the light of next day's clearings, in order to get his figure of 25.5%. To vary as widely from the actually reported figures as Professor Fisher does, I should have to assign 59.1% of total check deposits to New York City. I refrain from making an exact estimate. I am content with the conclusion that something more than half of the checks deposited in 1909 were in New York. This seems to be too clear for serious controversy.
The indirect approach to the relation between New York clearings and New York deposits, via the study of outside clearings in 1913 and 1914, taken in conjunction with the figures for check deposits in 1909, would seem to make it quite clear that New York clearings do not exceed New York deposits, or, indeed, constitute a substantially higher percentage of them than is the case with country clearings and deposits.[403] Logically, assuming the correctness of the estimate for checks deposited, the case is complete: we have a simple problem in arithmetic: given country clearings for 1909, 62 billions; given the ratio of country clearings to country deposits (and a minimum for this ratio is clearly given, in the 40% which country clearings are of "total transactions"), we can fix a maximum for country deposits, which is 155 billions. Then, given our estimate of 353 billions for total check deposits, we subtract the maximum possible for country deposits from it, and get a minimum possible for New York City of 198 billions of check deposits. Comparing this with the known clearings of 104 billions in New York, we find that New York clearings constitute, as a maximum possible, 52.5% of New York check deposits. If the reasons given for holding check deposits in the country to be less than total transactions are accepted, the ratio of clearings to deposits in New York City is lower.
Indirect calculations, however, even when logically complete, ought to be checked up by other methods, when possible. We have some further data, drawn from an earlier period, 1890-91-92, which suggest the same conclusion.
The reason commonly offered for holding that New York clearings exaggerate local New York transactions, as compared with country clearings and country transactions, is that New York is the clearing house for the country. Country banks send their idle cash there; country banks pay other banks by drafts on their New York balances; country banks send out of town checks to New York for collection; business men in St. Louis pay business men in Chicago with New York exchange, etc. These items are supposed greatly to swell New York clearings.
Now several of these reasons are not at all valid. Cash shipped back and forth between New York and the interior does not get into clearings. Secondly, New York, because of the charges made for collecting out of town checks, has tended to lose much of the collection business. Chicago probably does a great deal more of it than New York does.[404] However, even if checks on out of town banks were sent largely to New York for collection, they would not get into the clearings. New York banks send checks on country banks directly to country correspondents. Checks on out of town banks sent in for collection do swell clearings in Boston and Kansas City, where arrangements have been made, to the advantage of all concerned, to have the clearing houses handle this business. But New York has not made provision for it.[405] The only checks that get into New York clearings will be checks drawn on New York banks.[406]These checks will be of two kinds: (1) checks drawn by individuals and firms on New York banks. These checks will commonly be drawn by people in New York, and, in so far as they come from out of town, will represent business between New York and other places, hence, New York business. (2) Drafts by banks on their New York balances. These will be of three kinds: (a) drafts sold, especially by country banks, to their customers who need to make payments in other cities. Many of these will represent payments to New Yorkers for transactions between New York and the country, hence New York business, and will appear in the check deposits of individuals, firms, and corporations in New York, (b) There will also be drafts from one country bank, on New York, to another country bank, in which New York is truly being used as a clearing house, New York exchange taking the place of an intercity shipment of cash.[407] (c) Drafts by New York banks on New York banks, to avoid deficits at the Clearing House, or—especially in the case of private bankers, between whom and brokers the line is hard to draw,—for general purposes.
Now, fortunately, we have some data, trustworthy, even though old, for the volume of bank-drafts on New York, and, more important, for the proportion of drafts on New York to drafts on banks in other cities. These figures are, as stated, from the three years, 1890, 1891, and 1892. For the purpose in hand, however, they are relevant, since then, as now, New York clearings were nearly twice as great, on the whole, as country clearings, and if this excess of New York clearings is due to that cause, it should have manifested itself in these figures. If the proportion of these drafts on New York to the total of bank-drafts was greater than the proportion of New York clearings of total clearings, we might find reason for supposing that New York clearings were unduly swelled by this fact. But in fact, drafts on New York are not out of proportion. The figures are virtually complete for drafts drawn by all the national banks on national and other banks for the years in question. They will be found in the Comptroller's Reports for the three years, under the caption, "Domestic Exchanges." For 1890 the figures are:
The Comptroller (Report of 1890, p. 19) gives an estimate for drafts drawn by State and private banks of an additional 6,089 millions. He does not try to apportion these among New York and the other cities. There is no reason to suppose that the percentage for these banks of drafts drawn on New York would be higher than for national banks, and there is some reason for supposing that they would be lower: namely, that these institutions would lack the incentive supplied by the National Bank Act for depositing reserves in a Central Reserve City. The Comptroller's figures probably do not include the great private banks in New York, which deposit in New York commercial banks, and draw huge checks against their deposits. These checks, probably, however, chiefly represent stock exchange collateral loans to brokers, and so appear in brokers' deposits as well as in New York clearings—represent New York deposits. I do not use this estimate in my computations. If I did, the results, so far as proportions are concerned, would be the same, since I could do nothing but assign the same proportions to them. It will be seen that my argument rests on the proportions, chiefly.
Now what difference would be made if we wiped out all these draft transactions, and reduced clearings to correspond? New York clearings in 1890 were 37,660 millions; country clearings were 21,184 millions. Let us subtract the drafts on New York from New York clearings, and the drafts on other places from the country clearings. The result is: New York clearings, 30,376 millions; country clearings, 16,918 millions. New York clearings still retain their former status! New York clearings are still nearly twice as great as country clearings! It is not the bank drafts used in making New York the "clearing house" for the country that swell New York clearings as compared with the rest of the country! It is something else! The main explanation, as we have in part seen, and shall further see, is a mass of speculative transactions, chiefly Stock Exchange transactions, and loan transactions connected therewith! New York clearings grow out of New York business, primarily.
The figures for the other two years vary little from those of 1890. What variation there is shows a growth of drafts on interior cities, and a decline of drafts on New York. New York showed 63.07% of these drafts in 1890, 61% in 1891, and 60.77% in 1892.[408]
As we have seen, the only checks or drafts that get into New York clearings are those drawn on New York banks. The checks on New York banks probably almost all represent business in which one party is a New York individual, firm, or corporation. The drafts by out-of-town banks will contain all the items, virtually, that represent "clearings" through New York. Not all of these, by any means, will represent such clearings. A very substantial part of them will represent exchange sold to customers to make payments in New York. We exaggerate the "clearing through New York" when we subtract all these drafts from New York clearings. Since, however, we treat country clearings in the same way, no error results, so far as the proportions between them are concerned.
The two sets of data converge. Both from the figures of 1913-14, in conjunction with estimated check circulation in 1909, and from the figures of 1890-92, can we conclude that New York clearings do not overcount New York transactions. The conclusion would seem to be inevitable that New York is really as important in our volume of banking transactions as its clearings would indicate. This may be qualified by a recognition of the possibility that New York clearings are more efficient in handling check deposits than are clearings in other cities. Some scattering data from national banks for single days at a time indicate that a higher percentage of checks is cleared in New York than elsewhere in the country,[409] and one observation for five national banks for a ten-day period shows 67% of checks deposited cleared.[410] These checks include deposits made by other banks, as do the figures of Kemmerer's observations. But there are no direct observations covering New York for a long enough period, or for enough institutions, to warrant any definite conclusions.[411]The error of assuming clearings of March 17 in the country outside New York to be abnormally low, swelled Professor Fisher's total figure for check circulation by 31 billions, as we have seen. On the other hand, the error of assuming New York City to be complete in Kinley's figures tended to make the total smaller than it would have been, since New York City was 28% below normal, and an increase of 28% applied to half of Professor Weston's figure of 1.02 billions, gives about 70 millions more for the day, or 21 billions more for the year, than when the 28% increase is applied to only a quarter of Professor Weston's figure. These two errors roughly neutralize one another, and we may accept Professor Fisher's "finally adjusted" estimate of 353 billions[412] for the year as roughly approximating the amount of checks deposited.[413] How "rough" an estimate one gets by taking a single day as the basis for a year need not be here discussed. I should be disposed to think that an indirect calculation, via clearings, in view of our more extensive knowledge of the relation of clearings to "total transactions," might well be worth more, so far as deposits outside New York are concerned. Since, however, we lack any extended figures for the relation of transactions and clearings in New York, and since even for the country we are obliged to make guesses as to the relation of "checks deposited" to "total transactions," I refrain from trying to improve further on Professor Fisher's estimate for checks deposited in 1909—even though questioning that "check deposits" and M´V´ are identical.
What, however, shall we say of M´V´ for other years? In the calculation of this, Professor Fisher relies on the absolute figures for 1909 (and 1896, similarly calculated), together with an "index" based on New York and country clearings. In this index he weights country clearings by 5,[414] and New York clearings by 1. The result is, of course, that country clearings dominate the index. But New York clearings are much more variable than country clearings. The range of variation in New York clearings for the years 1897 to 1908, inclusive, is from 33.4 billions in 1897, to 104.7 billions, in 1906; the latter figure being more than three times as great as the former. The range in country clearings is from 23.8 billions, in 1897, to 57.8 billions, in 1907, the latter figure being 210/23 as great as the former. But more significant is the degree of year by year variability. The country clearings, with the exception of 1908, always rise,—a steady, if not quite symmetrical, increase. New York clearings, however, go up and down, 42 billions in 1898, 60.8 billions in 1899, 52.6 billions in 1900, 79.4 billions in 1901, 66.0 billions in 1903, 104.7 billions in 1906, 87.2 billions in 1907, 79.3 billions in 1908. New York clearings are highly variable in both directions, while country clearings vary almost wholly in one direction, with a maximum difference of 6.4 billions between any two consecutive years, and with an average yearly variation of only 3.5 billions.[415] When country clearings are weighted by 5, almost all of the high degree of variability of New York clearings is covered up, and volume of checks deposited for years other than 1909 and 1896 is thrown hopelessly away from the facts. It is too large by far in most years. In 1905, 1906 and probably 1901 it is too small. It does not vary nearly enough. As V´ for years other than 1909 and 1896 is determined, for Professor Fisher's equation, by dividing the M´V´ thus estimated by the M´ for the year, it is clear that V´ as estimated by Professor Fisher is very much less variable than it is in fact. It is pretty variable even in his figures, but his figures do not nearly show how variable it is.[416]
Again, this undue weighting of country clearings, swallowing up New York, vitiates Professor Fisher's estimates for V, the velocity of money, for years other than 1909 and 1896. One of the elements in the calculation of V is the estimated V´.[417] Since V´ is wrong, V will also be wrong. V is probably much more variable than Professor Fisher's figures would indicate. With great admiration for the ingenuity of Professor Fisher's speculations regarding V, I find too many elements of conjecture, and too many arbitrary assumptions, to give me confidence in the figure for any year. I refrain from going into any general criticism of his method of calculating V, however, contenting myself with the one clear point that, to the extent that the values of V for years other than 1909 and 1896 depend on the estimated M´V´ for those years, they are less variable than they ought to be.[418]
The same conclusion regarding Professor Fisher's estimates for V´ have been reached, by a different method, by Professor Wesley C. Mitchell. He, too, concludes that V´ is, in fact, more variable than Professor Fisher would indicate.[419]
I conclude, therefore, that neither V´ nor V has been correctly calculated, for years other than 1909 and 1896. I pass now to a consideration of T, the volume of trade, after which I shall consider P, the price-level, in the equation of exchange.
Let us first recall the point made in the chapter on "The Equation of Exchange," that P and T, the price-level and the volume of trade, are not independent even in idea. If one is given an independent definition, the other cannot be given an independent definition. If the equation is to be true, then P must be weighted by the numbers of each item (as hats) exchanged. P is not a mere average, but is a weighted average, and T is always the denominator in the formula for P. In developing statistics for P and T, therefore, this fact must be kept in mind, and the elements entering into each must coincide, and vary together year by year.
In our chapter on "The Volume of Money and the Volume of Trade," we showed that the great bulk of trade is speculation. We showed that the indicia of variation which Fisher[420] and Kemmerer have constructed for trade, dominated by inflexible physical items of consumption and production, give wholly misleading results for every year except the base year. They give a steadily growing, inflexible figure, with little variation from its steady path. Trade, if chiefly speculation, is highly flexible, varies enormously from year to year, waxes and wanes. This point need not be further developed. At best Fisher's figure for trade can be accepted only for one year, 1909.
Is, however, the figure for 1909, 387 billions, an acceptable figure? Is it not decidedly too large? It is made up, it will be recalled, by taking the figures for MV and M´V´, adding them together to get one side of the equation, and declaring them equal to PT. P is then declared to be $1, by the arbitrary device of taking as the unit of T one dollar's worth of every sort of good at the prices of 1909. T is, then, 387 billions, since MV plus M´V´ equals 387 billions. The theory underlying this is that deposits made in banks correctly represent trade.[421] Our criticisms as to the absolute magnitude assigned to T (and hence to MV plus M´V´) will rest in large measure in challenging this assumption. It is our contention[422] that deposits made in banks very greatly overcount trade.
Deposits made in banks include taxes and other public revenues; they include loans and repayments, and interest-payments; they include gifts and benevolences, money sent by parents to children away from home, pensions, payments of insurance losses, annuities, dividends on stocks, payments to and from savings and loan associations, fines, contributions to churches, and other non-commercial organizations, etc., etc. None of this represents trade.
But further, whether payments are in trade or not, many times indeed does it happen that several checks are drawn in connection with the same transaction. Professor Kemmerer, entertaining this possibility, thought it might be neutralized by cases where the same check passes through several hands, making payments in several different transactions. He calls this, however, a "gratuitous assumption of unverifiable accuracy,"[423] and makes no claim to have given the matter careful study.
In general, I think it safe to hold that the case where a single check passes through several hands is not important.[424] It will happen chiefly with small checks in small places, or with small checks paid to laborers. It is the pecuniary magnitude of checks, rather than their number, that counts here. I am informed by several bankers that large checks are almost universally deposited at once. This is for several reasons: (1) The recipient of the check wishes to make sure that it is good. (2) It is unlikely that the check is of the right size for another transaction, unless the recipient is a mere agent for a third party, in which case he should (but commonly does not) pass it on to his principal, if double counting is to be avoided. (3) Every person who handles sums of any size wishes a record of the transaction, and his own canceled check is a receipt which he would not have if he passed on the check of another.
This last point will go far toward explaining why bank transactions may multiply without a corresponding multiplication of trade. The banks do the bookkeeping for modern business in increasing degree. Checks are records, of high legal value. A colleague recently told me that he, in his own capacity, had just drawn a check to himself, as trustee, transferring a sum from one account to another. Another colleague, with eight different bank accounts, estimates that over 50% of the deposits in three of them represent transfers from other accounts. This kind of duplication, where trust relations are involved, is enormous. Intercorporate relations and separate bank accounts within a corporation complicate it still further.
A check is drawn by a subsidiary corporation to its dividend account, and deposited; a check on this dividend account[425] is then deposited in the general account of the parent corporation; a third deposit, of the same funds, is then made in the dividend account of the parent corporation; a fourth deposit of the same funds is made in a trust fund which holds stock in the parent corporation; a fifth deposit in the personal account of the beneficiary of the trust fund; a sixth deposit may be made of a check on this fund in the personal account of the beneficiary's wife. The first three of these deposits, at least, will be made of the total dividend of the subsidiary corporation. Not one of these six deposits represents trade. Payments of wages and rents should count as trade, but payments of interest and dividends stand on a separate footing. When a man has bought a stock or a bond, he has already bought all the income which is to come from them, and to count the interest and dividends as separate items is double counting. They are payments, but not trade. Even if the dividend payment be counted as trade, however, it is counted six times.
There is enormous overcounting as a consequence of the combinations of corporations, each of which retains its own numerous bank accounts. The Interstate Commerce Commission calls attention to great duplications from this cause in connection with railway income accounts.[426] Even within single corporations the duplications[427] are very great. Thus, the local agent of a railroad deposits his receipts in a local bank. His check, or, more usually, the draft of the bank, is subsequently deposited in a bank at headquarters. Subsequent disbursements, in places away from headquarters, particularly of wages, will frequently be preceded by deposits in other local banks. This duplication will be true of telegraph, telephone, insurance and other companies which have scattered agencies, including the wholesale trade. Advertising agencies will illustrate it. All checks between agent and principal, customer and broker, etc., will illustrate it. There is a great deal of double counting in stock transactions from this source. Thus, a Boston broker takes orders, with a check for margin, for execution in New York. The order is executed by a New York broker, who deals with another New York broker, who represents a Louisville broker, who represents a Louisville client. Now to the extent that any checks at all pass between the Boston broker and his client, the Boston broker and the New York broker, the other New York broker and the Louisville broker, or the Louisville broker and his client, we have overcounting. Only the check between the two New York brokers is properly counted. It is, of course, well known that a small percentage of the dealings of a customer of a brokerage house is represented by checks between broker and customer. Professor Fisher states this to be about 5%.[428] It is, however, 5% of overcounting! Moreover, through keeping "open accounts," with irregular settlements of "margins" only, the Boston broker and the New York broker reduce markedly the checks passing between them. There is a back and forth flow of items which in large degree cancel one another, since the Boston broker sells in New York as well as buys there, and the New York broker, to a less degree, both buys and sells Boston securities, through his Boston correspondent. But not all by any means is canceled, and all the checks that pass in this way represent double counting. The total is large.
Public funds are included in the deposits reported to Kinley. Taxes are not trade. Double, triple and multiple counting comes as revenues are received by local authorities, transferred to State accounts, subsequently redistributed to local accounts, or to the treasurers of State institutions, transferred from one bank to another, etc. The State of Massachusetts scatters its deposits in banks all over the State, and makes transfers from one account to another. The City of Boston has many bank accounts. The Federal Treasury deals largely with banks over the country.
Whenever a retail store has branches, duplications are likely to occur. "Chain stores" make great overcounting. "Kiting" swells bank deposits.
Replying to these contentions, Professor Fisher has urged that there is large undercounting, also, and that the undercounting balances the overcounting. I have myself called attention to a good deal of undercounting in the chapter on "Barter." A substantial amount of ordinary trade is carried on by means of partially offsetting book-credit, time bills of exchange, simple barter, etc. The amount might even run high, as compared with ordinary trade, when the clearing arrangements in the stock and produce exchanges are taken into account. But it is impossible to figure out anything at all in this line which is to be compared with the great gap between the 141 billions of trade we were able to find,[429] and the 387 billions Professor Fisher assigns to trade. The gap of over 245 billions is much too great. Besides, in our 141 billions, we have counted barter items, book-credit items, time-bill of exchange items, etc., already.
The main item of undercounting must be in connection with the clearing arrangements in the speculative exchanges. This would seem to be Professor Fisher's view, as well.[430] Data are at hand for the two great exchanges of the country which enable us to measure, with some precision, the amount of the undercounting—i. e., to tell the extent to which checks are dispensed with in the trading of these two great exchanges. The two exchanges are the Chicago Board of Trade and the New York Stock Exchange.
For the New York Stock Exchange, figures are taken from Pratt's Work of Wall Street, 1912 ed., pp. 166-167, 180, 273. The figures are for the big year, 1901, when 266 million shares were sold, more than in 1909 by 51 millions of shares, and when the Stock Exchange Clearing House should have done better, in the magnitude of the undercounting, than it did in 1909. Figures since 1901 are, Pratt states,[431] not available. Pratt also gives figures for 1893, but does not give data as to the percentage of stocks handled by the Clearing House, so that comparison with the 1901 figures cannot be made.
In 1901, 265,944,659 shares were sold. Of these, 15% were "X-Clearing House," i. e., not on the list of stocks handled through the Stock Exchange Clearing House. This 15% was paid for in full by check. The bond sales are not cleared, and so another billion dollars of checks is required for this item.[432] If we assume (on the basis of the estimates given to the writer by DeCoppet & Doremus, and Mr. Byron W. Holt, for recent years) that 25% of the 100 share sales would be added if "odd lots" were counted, we have another large item that does not go to the Clearing House. "Private clearings" reduce the number of checks in connection with odd lots, but not so effectively as is the case with hundred share sales put through the Clearing House. So far the Clearing House has done nothing. What did it do with the 85% of the stocks in hundred share lots offered for clearing?
The figures are perfectly definite. The 85% of the 266 million shares sold was 226 million shares. The "share balance" remaining after the Clearing House had done its best was 134 million shares.[433] The number of shares sold, then, for which checks did not have to pass as a result of the clearing process was 93 millions. In terms of dollars, we may put the same figures. The estimated money-value of the 266 million shares sold was 20.5 billions;[434] 85% of this is 17,425 millions. The certifications required to pay for the 134 million share balance was 10,930 millions. The saving in checks was, thus, 6,495 millions of dollars. This is the full extent to which the Stock Exchange Clearing House undercounts recorded share sales. This is less than 1.7% of Professor Fisher's 387 billions! To offset this, however, we have overcounting in the 5% of checks for all dealings on the Exchange which pass between brokers and customers, as shown, and all the checks between brokers and out-of-town brokers. We shall also find items of overcounting which vastly more than offset this undercounting, in loan transactions between brokers, and between banks and brokers, to which we shall shortly give attention.
This six and a half billions in checks saved on account of sales of stocks is no small matter, absolutely. But this, though measuring the extent of undercounted sales, by no means measures the services of the Clearing House to the Stock Exchange. Not merely stocks sold have to be cleared. Stocks borrowed are also cleared. Borrowing of stocks is not trade, but borrowing of stocks requires the passage of money and checks. When stocks are borrowed, money is loaned. A bear sells short. He has to deliver next day. He accomplishes this by having his broker "borrow" the stock he needs from a broker representing a bull, who is long on the stocks, and who needs money to "carry" them. The bull, who lends the stock, receives dividends from the bear, as they accrue, and pays the bear interest on the money lent. An enormous lot of this takes place. Moreover, to some extent, these transactions are increased artificially, in order that the broker may make his "clearing sheet" misleading, and avoid revealing his position with reference to the market.[435] Loans of stock and sales of stock appear alike in the transactions of the Clearing House. Moreover, apart from the necessities of the bears for stocks to deliver, we have the necessities of the bulls for money to carry their stocks. If a broker who has borrowed largely from the banks finds his customers turning to the bear side of the market, he has an excess of funds. He may repay his loans, but they may be, in part, time loans, and in any case, he may find it just as well, if he can make a small fraction of 1% in interest, to lend to another broker, among whose customers the bulls are increasing. A vast deal of money is thus transferred, on collateral security, by means of "loaning stocks." Brokers prefer to borrow money from one another in this manner, since no margins are required, in general, whereas banks would require margins. These various reasons make a vast deal of "borrowing and carrying" transactions, and a regular place is set aside for them on the Floor—Post 4, commonly called the "Money Post." At this post, also, the banks, through brokers, lend on call, and the published call rates are established there. Of this, however, we shall have more to say later.
The extent to which this loaning of stocks takes place at the "Money Post," as compared with the loaning done privately, varies. It makes no difference, however, from the standpoint of the volume of these transactions that go to the Clearing House whether they are put through at the "Money Post" or outside. The loans made by the banks at the "Money Post" do not affect the Stock Exchange Clearing House totals.[436] Formerly the "Money Post" was a place where the position of the bears could be gauged in a given stock. If the demand for a stock was great, the bulls could take heart, and increase the pressure. To avoid giving away this information, however, borrowing is done on a large scale privately, at present.[437] Of course, if the pressure gets too strong, it will manifest itself at the money post anyhow, since bears borrowing particular stocks will forego all or part of the interest, or even pay a premium for the stock.[438]
Now it is possible, from the figures given for the total clearings of the Stock Exchange Clearing House, in conjunction with the figures of recorded sales, and the percentage of "X-Clearing House" sales, to get a fairly accurate idea of the magnitude of these stock borrowing operations between brokers. The total number of shares offered for clearing by "both sides" in 1901 was 926,347,300! This is double the actual amount, since both buyer and seller report the same transaction to the Clearing House, the former with a "receive from" sheet, and the latter with a "deliver to" sheet. Half this amount, or 463,173,650 shares, represents the actual number of shares to be handled. As we have seen, 226 millions of this (85% of the recorded sales of 266 millions) represents sales. The rest, or 237,173,650, represents borrowing of stocks.[439] Borrowing exceeds actual sales, if the figures for 1901—a year of enormous sales—are representative. We have, now, an explanation of the prevailing opinion among brokers that the Stock Exchange Clearing House dispenses with the major part of the checks that would otherwise be required. For their purposes, it does make a vast difference. Pratt's figures[440] show that, without the Clearing House, certifications of $27,995,896,400 would have been required; that certifications of $17,065,042,800 were obviated[441] by the Clearing House, leaving the balance of $10,930,853,600 of certifications which had to be used. This balance, as we have seen, is the major portion of what would have had to be paid anyhow for the stocks actually sold and offered for clearing. The saving on the actual sales is only 6.5 billions. But the saving to the brokers was, of course, much greater. Even six and a half billions is no slight matter for any purpose except the explanation of our 245 surplus billions! Pratt gives an estimate at another place of the certifications required by the Stock Exchange sales, reaching virtually the same conclusion that we have reached by a somewhat different combination of his figures. He indicates that 14 billions of certifications were required, counting in the bonds, in 1901.[442] This compares with the 20.5 billions estimated value of stocks sold, and approximately one billion of bonds. This leaves 7.5 billions of certifications obviated on sales. This takes no account of the "odd lots." If they run to an additional 25%, we have five billions more which are not put through the Clearing House. My information is, however, that "private clearings" reduce the checks in connection with these, though not so efficiently as is the case with the big Clearing House.
Do the figures that get into the "all other" deposits from those connected with the Stock Exchange undercount sales made there? Not yet have we taken account of an item which swamps all that we have considered. I refer to loan transactions by the banks, particularly call loans. The volume of these is enormous. At the "Money Post" alone, the figures average between 20 millions and 25 millions a day.[443] The range is from 10 to 50 millions. The major part of these loans are not made on the Floor of the Exchange, however, but privately, between banks and brokers. Even on the Floor, no records of the loans are kept, and only estimates are available. For the loans made privately, no figures are attainable at all. The total must be enormous. One authority writes, in a letter, "The total amount of money loaned at the post varies considerably, depending upon the rate. For instance, when money is under 3%, loans are largely made directly between the banks and the brokers, but when it gets over 3% and gets strong, more loans are made at the post. Some national banks make all their loans there right along, so I understand." My information from an officer of the National City Bank is that it lends the major part of its demand money on the floor of the Exchange. The other chief lenders, according to the Pujo Report,[444] are the National Bank of Commerce, The Chase National, the Hanover National, J. P. Morgan and Co., and Kuhn-Loeb. The same report states that the bulk of such loans are made directly between banks and brokers, and not at the "Money Post."
How do these transactions affect Kinley's figures for deposits, and so Fisher's total of 387 billions? The small dealer deals, usually, with one bank. When he borrows, he gets a "credit" on his deposit account, but makes no "deposit" that would get into Kinley's figures. But stockbrokers deal with many banks. They have one bank which "certifies" for them, and with which they regularly keep a "balance." But for their loans, they deal with whatever bank gives them the best rate, or has the funds to spare. In time of tight money, they shift their loans with great frequency. They borrow also from one another. "Money" is "worth money" in New York, and idle funds will be lent by whomever has them for whatever the market will pay, on collateral security on call. When a broker deposits money in his bank borrowed from another bank or another broker, he gets a deposit credit which does get into Kinley's figures—he deposits a certified check, or a bank draft. The following has been described as a typical transaction by the bond expert of a Boston banking house, and has been amplified by several Wall Street men with whom I have discussed it. A, whose home bank is Bank W, has borrowed, on call, $500,000 from Bank X. Bank X calls the loan. A finds Bank Y willing to lend him enough to pay it off. Before he can get the new loan from Bank Y, however, he must get his collateral released by Bank X. Before he can do that, he must pay off the loan at Bank X. His recourse, then, is to Bank W, his regular bank, which certifies for him, and with which he keeps his balance. Bank W gives him a certified check (either an overcertification, or a "morning loan" transaction), for $500,000, with which he pays off the loan at Bank X. He then takes the collateral from Bank X to Bank Y, and makes a new loan. He gets a draft from Bank Y, which he deposits with Bank W, and then draws another check against his deposit with Bank W to pay off the "morning loan," in case the transaction took that form. Here are three checks for this loan transaction, two of which get into clearings, and one of which gets into "all other deposits." But the checks may be multiplied. A, instead of getting a new loan at Bank Y, may call a loan from broker B, who may then call a loan from broker C, who may go to Bank Y to get the funds he needs to pay B. Here are two new checks in the series, both of which get into the "all other" deposits. Checks fly about recklessly in Wall Street, and men will turn over money many times, if an eighth of 1%, or less, can stick by the way, on a good sum, for a few days! This is strikingly illustrated by a fact which caught my attention in the monthly bank statement of a brokerage house which I was allowed to examine. The deposits made during the month, and the checks drawn during the month, balanced to within five hundred and fifty dollars out of several millions. The broker said of this: "It would be true even for a single day, and it would be true for a year. The bank requires us to keep a minimum balance; it is to our interest not to keep more than that. If we have more at the end of the day, we lend it out; if we have less, we borrow to make up the deficiency. We try to have just that balance, and no more, to our credit at the bank at the end of every day." The handling of funds by a brokerage house is a fine art, involving both technical skill and a philosophic grasp of the factors of the "money market." Are rates going up? Then it is well to reduce call loans, and borrow more on time. If lower rates are anticipated, more call money will be employed—with the possibility of a "squeeze" if too much is taken that way. Hidden dangers must be foreseen. The sums borrowed are enormous, and brokers' profits depend in very substantial degree on their skill in borrowing as cheaply as possible, and in utilizing their funds to the utmost.
It is here, I think, in loan transactions between banks and brokers and between brokers, that we have a major part of the explanation of the huge deposit figures for New York City, and for the tremendous influence of stock sales on clearings, which Mr. Silberling's[445] figures show. This is the opinion of Professor O. M. W. Sprague, who first called my attention to the volume of call loans, and rapid shifting of call loans, in New York, and it is the opinion of every Wall Street man with whom I have discussed the matter. The actual pecuniary magnitude of the share sales and bond sales is not enough to do it. The mass of connected loan transactions, however, substantially greater in volume than the actual sales of securities, is, with the security sales, enough to do it.
When the call rate is high, which will particularly happen when bank reserves are low, the shifting in loans will be much increased. One bank will have money to lend one day, but the next day will have to call it, to meet heavy demands at the Clearing House, while some other bank will have the surplus funds to lend. The brokers, by bidding up the rate, will tempt the temporary lending even of small surpluses, if their necessities are great. The volume of "all other deposits" and of bank clearings will be swelled by this much beyond ordinary. That this should not be revealed to ordinary statistical tests is due to the fact that speculation tends to fall off at such a time, so that the other factors in the stock exchange operations tend to reduce daily deposits and bank clearings. Mr. Silberling has applied to this problem the technique of a refinement of the correlation method, the method of partial correlation, with the result of confirming this view.[446]
I conclude, therefore, that stock exchange transactions, instead of being undercounted in bank deposits, are very greatly overcounted.[447] The big item that does it is loan transactions between brokers and brokers and between brokers and banks.
The evidence from the Chicago Board of Trade, with reference to the extent of clearings within the exchange there, comes in a letter from the Secretary of the Board of Trade to Professor Taussig. The only clearing house transactions are in connection with "futures." All "spot" transactions are paid in full by check. All futures other than those offset by clearing are paid in full by check. The total amount put through the Clearing House in 1915 was 118 millions, of which the balances paid were 41 millions (saving checks to the extent of 77 millions). This 77 millions is a trifle indeed as compared with the gap of 245 billions we are trying to fill! It is a trifle also as compared with the business done on the Board of Trade. The Secretary estimates that commodities to the value of $375,000,000 actually arrived on the exchange in 1915. On the average, the figure would be $350,000,000. For the Stock Yards "it is approximately the same—last year was $375,000,000. Of fruits, vegetables, poultry, butter, eggs, etc., sold in South Water Street, it is claimed by their statisticians, the value is $350,000,000, or a total of about eleven hundred millions arriving [Italics mine] yearly at this great market place, all of which is paid for by checks, and when the ownership changes, the change of ownership is always paid by check." How many times the goods change hands, cannot be stated on the basis of records of the Board of Trade. The Secretary contents himself with saying that they are "sold and resold many times." We have discussed this, on the basis of reputed figures of the Federal tax on grain futures in 1915, in our chapter on "Volume of Money and Volume of Trade." In any case, it is clear that the 77 millions of checks economized, though absolutely great, is relatively a bagatelle. It is, moreover, more than compensated for by loan transactions. The Secretary estimates that for a sixty-day period, when grain is coming in, from two to four millions will be lent by the banks daily on arriving grain. How great the loan transactions on subsequent sales will be we can only conjecture.
While able to find, then, important cases of trade and speculation which dispense with the use of checks, I cannot find anything of magnitude sufficient to aid Professor Fisher's case, and I find, on the other hand, enormous overcounting in every field where business and banks meet, as well as in the relations of banks to non-commercial depositors.
I conclude, therefore, with reference to the figures of Fisher and Kemmerer[448] for volume of trade, that they are much exaggerated for the base year, and that for every other year they are wholly wrong, both because of their excessive magnitude, and because the index of variation has been wrongly chosen.
The discussion of P, the price-level, in the statistics of Kemmerer and Fisher need not be extended. P, for the equation of exchange, and for the quantity theory, is a weighted average, each price that goes into it being weighted by the number of exchanges involving the commodity of which it is the price. The weighting of P should correspond to the elements in T, the volume of trade, and should vary from year to year, as the elements in T change.[449] Now Kemmerer's P is weighted as follows: wages, 3, security prices, 8, wholesale prices, 89.[450] If our conclusions with reference to the composition of the volume of trade, as developed in the chapter on "Volume of Money and Volume of Trade," are valid, this weighting gives us a P which has no relevance to the equation of exchange. The wholesale items should have a weight of not more than one-sixth of the total for 1909. Certain commodities, as wheat and cotton, in which there is heavy speculation, should be given great weight, and securities should have, probably, the greatest weight of all. If "trade" is to be extended to cover transactions in bills of exchange and loan transactions (as it is by Kemmerer),[451] then P should contain these things, weighted more than all else put together, particularly if call loans are included. The weights should be radically altered from year to year. We should then get a P which would fit the "equation of exchange"—though what else it would be good for is hard to say! The same criticism applies to Fisher's P. It is dominated by wholesale prices.[452] It therefore has no relevance to an equation of exchange in which only one-sixth at the very most of the items are wholesale items. Neither Fisher nor Kemmerer alter their weights in P at all, to correspond to yearly alterations in the composition of T.
As indicia of changes in the absolute value of money, Kemmerer's and Fisher's index numbers, or other index numbers of numerous wholesale prices, with a substantial weighting of wages, are probably better than an index dominated by stocks. Stocks fluctuate more widely than wholesale prices and wages, their values are more affected by variations in business confidence, and by variations in the rate of interest. For measuring the value of money, the index numbers here criticised are very good. But for the purpose for which they are chosen, namely, to fill the equation of exchange, and to measure variations in a price-level of the sort the quantity theory and the equation of exchange are concerned with, they are simply irrelevant. If it were really true that such an index number varied with the quantity of money, then the quantity theory would be effectively disproved!
Now, in general summary of our criticisms of the figures of Kemmerer and Fisher: they have systematically buried New York City, and systematically covered up speculation. All the errors converge in this direction. The indicia of trade cover up speculation and the other things that go on in New York, and other financial centers. The indicia of prices do likewise. Fisher weights New York clearings only 1, while weighting country clearings 5, in his index of variation of check transactions. He also counts New York returns for March 16, 1909, as complete, and gives all of his estimate for non-reporting banks to the country. Kemmerer does not do this, but he does exaggerate the importance of money, as compared with checks, and does not allow the velocity of money to vary at all in his figures, thus getting a much greater constancy in the figure for total circulation of money and checks than is proper, and covering up the flexibility and variability which New York gives to our system.[453] In general, our task in this chapter has been an archÆological excavation—we have rediscovered a buried city.
