Dynamic Qualities of Money.—The question concerning money which, for the purposes of the present treatise, it is most important to answer is whether general prosperity can be increased or impaired by manipulating the volume of it. Is money a dynamic agent, and can it be so regulated as to induce economic progress? These questions require careful answers.

Accepted Facts concerning Money.—We may accept without argument the conclusion that both theory and experience have reached concerning the superiority of gold and silver over other materials of which a currency can be made. They possess the universally recognized utility which makes them everywhere in demand. They have the "imperishability," the "portability," and the "divisibility" which are needed, and when made into coins, they have the "cognizability" by which they can, more readily than many other things, be identified and distinguished from cheap imitations. There remain to be settled the questions whether an expanding volume of currency is necessary for prosperity, and whether the expansion can better be secured by using two metals than it can by using one.

Effects of Free Coinage.—It is evident that when a government coins without charge all the gold and silver that are brought to it for that purpose, either metal will be worth about as much in the form of bullion as it is in the form of coin. If, for uses in the arts, an ounce of gold is worth more than the number of dollars that can be made of it, the coining of this metal will temporarily cease and some coins already made will be melted. Moreover, where both of the precious metals are used as money, neither of them can long be worth in a coin much more than is the bullion contained in the less valuable of the two. If a gold dollar will buy more silver than is needed to make a silver dollar, because of the higher value of the bullion in the former coin, silver will be bought and taken to the mint for coinage, while gold dollars will be melted. The gold will go farther in the way of paying debts when it is in this way exchanged for silver money.

The Effects of Inflation of Currency on Prices.—We are citing a further accepted fact when we say that, other things being equal, enlarging the volume of currency in use raises the prices of goods. By what particular mechanism this is brought about we do not here inquire. Not everything that is claimed under the head of a "quantity theory of money" is generally believed, but there will be little disposition anywhere to deny that, if no other dynamic movement should take place, adding fifty per cent to the volume of metallic money in circulation would make prices higher than they were before the addition.

Rising Prices and Business Profits.—If we assert, further, that permanently rising prices mean prosperity,—profits for the entrepreneur and a brisk demand for labor and capital,—we assert what, in the practical world, is too generally accepted. Sound theory and current belief are at variance on this point, and the current opinion appears at first glance to have the facts on its side. Periods of rising prices have actually been periods of prosperity. It is considered hard for either a merchant or a manufacturer "to do business on a falling market," and easy to make money on a rising one. This impression is entirely correct in so far as it concerns those fluctuations of price which occur suddenly and continue only briefly. What it is of great importance to know is whether a steady rise of prices which should continue permanently would mean permanent profits for the entrepreneur; and it can be asserted without hesitation that it would not do so if the final productivity theory of interest is sound, that is, if capital commands in the market a rate of interest which corresponds to the amount that the marginal increment of it will actually produce.

The Rate of Expansion of Currency distinguished from the Absolute Amount of Increase.—The extent to which any currency is capable of raising prices by a continued expansion depends, not on the absolute amount of that expansion, but on the percentage of enlargement that takes place within a given time. Moreover, a given percentage of increase per annum may be maintained as well by one metal as by two. If the gold and the silver money of the world were each increased by one per cent a year, prices would have the same trend under a currency made of one metal as under a currency made of both. If, on the other hand, all the currencies were based on gold only, a change to a bimetallic system would at once make a single great enlargement of the volume of money; but after this the rate of enlargement would be no greater than it was under the single standard. In the transition from a gold to a bimetallic currency, we should get rapidly rising prices; after the change had been completed, we should have a currency expanding as before at the one per cent rate. If the volume of business were to increase at the rate of two per cent a year, while other influences affecting prices were to remain unchanged, the currency would not expand as rapidly as the demand for it, and prices would not only fall, but would fall at the same rate as if only one metal had been used. Use ten metals instead of two,—make coins of tin, platinum, copper, nickel, etc.,—and if the grand composite still insures the one per cent rate of general increase of metallic money, prices will vary as they would have varied with a currency of gold alone. Wholly transitional, under such circumstances, is the rise in prices secured by the adoption of bimetallism. It is gained by adding to the stock of gold now used for ultimate payments an existing stock of silver.

Why Metallic Currency of Any Kind gains, in the Long Run, in Purchasing Power.—In the long run, almost any metallic coin of a fixed weight will gain in its purchasing power. Silver would do this as well as gold; and so would a composite coinage made of ten metals. The law of diminishing returns applies to mining as well as to agriculture. The more silver you want, the deeper you must dig for it, and the more refractory ores you must smelt. The transmuting of a raw metal into finished articles becomes a cheaper and cheaper process; but the extracting of the metal itself becomes dearer. A larger and larger fraction of the labor that is spent in making wares of silver, of gold, of copper, or of tin must be spent in getting the crude material out of the earth. There are improvements in mining, as there are in other industries, and there are large improvements in smelting; but in spite of this the continual working of more difficult mines and of more difficult ores makes the getting of the crude material, in the long run, relatively costly. Since a coin consists chiefly of raw metal, we may therefore count on having before us a rÉgime of falling prices, whatever metallic currency we adopt. The rate of the fall and the degree of steadiness in it will be greater with some metals than with others. The variations in the value of gold are, on the whole, comparatively steady. This metal fluctuates in amount and in cost, but the changes are less sudden than in the case of most others.

The Steadiness of the Change in the Purchasing Power of Money the Important Fact.—A second fact to be noted is that the best currency is one the purchasing power of which shall change, if at all, at a comparatively uniform rate. This fact is of paramount consequence, and the verification of it will repay any amount of study. It is not the rapidity with which gold gains in purchasing power, but the steadiness of the gain from year to year that determines whether it is the best money that can be had by the business world. A change in the rate of increase in the purchasing power of the coinage metal has a really disturbing effect; a steady and calculable appreciation does not. There exists in some acute minds what I venture to call a delusion about the effect on business classes of an advance in the purchasing power of gold that proceeds for a long time at a uniform rate. Conceding the prospect of a decided gain in the value of this metal, we may deny absolutely that, if it is steady, it plays into the hands of creditors, burdens the entrepreneur, blights enterprise, or has any of the effects that certain men whom we are bound to respect have claimed for it. Irregular changes of value would, indeed, produce these results. Let gold gain three per cent in value this year, one per cent next year, and four per cent in the year following, and injurious things will happen; but let it gain even as much as three per cent each year for a century, and at the test points in business life there will ensue the essential effects that would have followed if it had not gained at all.

This means that with a steadily appreciating currency the things will happen that make for prosperity. The debtor will get justice, enterprise will be safe, and wages will gain while industry gains. The entrepreneur, in whose behalf bad counsel has lately been given, will best do his strategic work, not with that currency which varies in value the least, but with that which varies most uniformly. If it appears that gold is likely to appreciate more than silver, and to appreciate more steadily, it is decidedly the better metal. It is not inflation on which the entrepreneur permanently thrives, nor is it contraction through which, in the long run, he suffers; it is changes in the rate of inflation or of contraction that produce marked and damaging effects at the critical points of business life.

Loan Interest as related to the Increase of Real Capital.—How does a slow and steady appreciation of any metallic currency affect the relations of business classes? Does it rob borrowers and enrich lenders? Does it favor the consumers by giving falling prices, and hurt producers in the same degree? Does it tax enterprise and paralyze the nerves of business? The answer is an emphatic No. Steadiness in the rate of appreciation of money is the salvation of business. Not by one iota can such a slow and steady movement, in itself alone, rob the borrowing class. This is a sweeping claim; let us examine it.

It has been shown that true interest is governed by the marginal productivity of capital. As the utility of the final increment of a commodity fixes the price that a seller can get for his whole supply, so the productive power of the final unit of capital expresses what the owner of capital can get by lending his entire supply. This earning capacity expresses itself in a percentage of the capital itself. If the final unit can create a twentieth of itself in a year, any unit can get for its owner about that amount.

In assuming that capital earns a twentieth of itself in a year, we may use a commodity standard of measurement. A grocer's capital of twenty barrels of sugar may become twenty-one barrels, and his flour and his tea increase in a like proportion. In the simplest illustration that could be given of a capital earning five per cent a year, we should assume that each kind of productive instrument in a man's possession increases in quantity, during the year, by that amount. If he be a manufacturer, his mill becomes a hundred and five feet long, instead of a hundred feet. It contains twenty-one sets of woolen machinery, instead of twenty. The flow of water that furnishes power becomes by five per cent more copious; and the stock of goods, raw, unfinished, and finished, becomes larger by the same amount.

Of course, such a symmetrical enlargement of all kinds of goods could never actually take place, for some things increase in quantity more than others. The illustration shows, however, what fixes the rate of interest: it is the self-increasing power of a miscellany of real capital. If the mill, the machinery, the stock, grow in quantity at the five per cent rate, that is the natural rate of interest on loans of real capital. The lender gives to the borrower twenty units of "commodity" and gets back twenty-one. If marginal social capital, consisting of commodity and measured in some way in units of kind, has the power to add to itself in a year one unit for every twenty, lenders will claim about that amount, and borrowers will pay it.

How the Increase of a Miscellany of Goods has to be Computed.—How does the real earning capacity of capital in concrete forms reveal itself? How does the grocer know that he can make five per cent with the final unit of capital that he borrows? Not by the fact that each lot of twenty barrels of sugar gains one barrel, that each lot of twenty pounds of tea gains one pound, and so on. If there were to be such a symmetrical all-around increase in the commodities in the man's possession, his shelves, counters, bins, tanks, would have to enlarge themselves in the same ratio. In the case of a manufacturer the mill would have to elongate itself by one foot for every twenty, as in the foregoing illustration, and the machinery and all the stock would have to grow in the same proportion. The land and the water power would have to enlarge themselves by the same constant fraction.

Of course, such a thing does not take place. The general amount of capital goods of every kind enlarges; but the enlargement is in practice computed in monetary value, and in no other way. The whole outfit becomes worth more than it was. The increase in monetary value gauges the claims of the capitalist. If the stock of goods has grown generally larger, and if prices have fallen, the claim of the capitalist will fall short of equaling the actual increase of the merchandise.

The increase in goods of different kinds is, of course, unsymmetrical. If the man is a manufacturer, his mill and his water power have probably not increased. He may have some more machinery, and he has more raw materials and more goods, finished or unfinished, than he had when he took his last inventory. If he has not more goods of these kinds, he has something that represents them; and the effect on his fortunes is as if the mill had stretched itself, and as if the machines and other capital had multiplied, all in the same ratio.

The man figures his gains in real wealth by the use of money. At the end of the year he makes a list of all his goods, attaches prices to them, and sees what the value of the stock has become by the year's business. He compares the total value in money of the goods on hand in January, 1907, with that of the stock of January, 1906. If he has bought and sold for cash only, and if during the year he has drawn for his maintenance only what he has earned by labor, the excess of value on hand at the beginning of the year 1907 informs him what his capital has earned during the preceding twelve months.

The Effect of Changes of Price on the Claims of Capitalists.—If prices have remained stable, the earnings of the capital as expressed in money will accurately correspond with the earnings as computed in commodity. It is as if the five per cent increase of the sugar and the flour of our first illustration, or of the mill and the machinery of the second, had taken place. It could then, by a sale, be converted into a five per cent increase in money. By selling the stock at its market value the merchant could realize five per cent more than the original stock cost him.

If money has gained one per cent in its purchasing power, or if prices at the end of the year are by so much lower, the inventory will show, in terms of money, only a four per cent gain. Now, the real increase of concrete capital is still five per cent, and that, by the law of interest, is what the capitalist can claim in commodities. This claim is met by an actual payment in money of four per cent. Give to the capitalist, in January, 1896, a dollar and four cents for every dollar he has loaned in January, 1895, and you enable him to command a hundred and five units of commodity for every one hundred that he commanded at the earlier date.[1] You give him by a reduced monetary payment what is equivalent to the real increase of capital.

Practical Differences between Real Interest and the Increase of Real Capital.—It is the increase of capital in kind that fixes the rate of loan interest. Care must be taken not to claim for this part of the adjustment any unerring accuracy; for the marginal productivity law does not work without friction. With real capital creating five and a half per cent, the lender might get only five. When, however, the play of forces that fixes real interest has had its way and has determined that, in commodity, capital shall secure for its owners five per cent a year, that amount is unerringly conveyed to them by the monetary payments that follow. If, by paying four per cent as interest, the merchant, in the illustrative case, makes over to the lender of capital that part of the increase of goods that by the law of interest falls to him, four per cent is the rate that the loan in money will bring. This is on the supposition that the change in the purchasing power of money is perfectly steady. If it is unsteady, effects will follow that are of much consequence.

Changes in the purchasing power of a currency produce an effect on the rate of interest on loans of "money." If, with a currency of perfectly stable value, the interest on loans is five per cent, corresponding to the earnings of real capital, then a gain in the purchasing power of the currency of one per cent a year has the effect of reducing nominal interest practically to four per cent. The debtor then really pays and the creditor really gets the same percentage as before of the actual capital loaned. The borrower, the entrepreneur in the case, finds at the end of the year that he has more commodities by five one-hundredths than he had. He must pay the equivalent of this to the lender. With money of stable purchasing power it takes five new dollars for every hundred to do it; but with money that gains in its power to buy goods at the rate of one per cent a year it takes only four. The rate of interest on loans is, in the long run, reduced by an amount that accurately corresponds with the appreciation of the monetary metal wherever the appreciation is steady. This law works with a precision that is unusual in the case of economic laws. Loan interest varies more or less from the marginal earnings of capital; but interest as paid in money accurately expresses interest as determined in kind by the play of economic forces.

Conscious Forecasts not necessary for Insuring the Adjustment of Loan Interest to Changing Prices.—It is possible that, where this subject has been considered, the impression may prevail that this reduction in the nominal rate of interest is the result of foresight on the part of borrower and lender. According to that view, both parties look forward to the time when the loan will be paid. The borrower sees that, although by means of his business he may have at the end of a year five per cent more of commodity in his possession, prices will probably have fallen so as to enable him to realize in money only four per cent. On the other hand, the creditor will see that with four per cent more in money he can, if he will, buy with his principal and interest five per cent more than he virtually loaned in commodity. He is satisfied with this increase; and, moreover, he is forced to adopt it, since the natural increase of real capital will not enable a borrower to pay more. The entrepreneur will stop borrowing if more is demanded. The whole adjustment is supposed to rest on a forecast made by the contracting parties and a speculative calculation as to the trend of prices. Now, while men do indeed consider the future, the adjustment that is actually made does not call for foresight. No conscious forward glance is necessarily involved therein. It is made by a process that works more unerringly than any joint calculation about the coming conditions could possibly do.

The interest on a loan that is to run through a period in the near future is based on the rate that capital is now producing. The evidence as to what that rate is must be furnished by the experience of the immediate past. It takes much experience, of course, accurately to determine how much the marginal unit of capital for the year 1895 has been worth to the men who have used it. This, however, has to be ascertained as best it can. It takes strategy on the part of both borrowers and lenders to make the loan rate correspond to the marginal earnings. Here there is a chance for economic friction and for variations from the theoretical standard, and the loan rate will sometimes exceed it; but in the long run the deviations will offset each other. In any case, the experience of 1906 fixes, with or without variations, the loan rate for 1907.

The earnings revealed by the experience of 1906 may be theoretically computed either in money or in commodity. Let us say they have been five per cent in real wealth, but by reason of the fall in prices they have been only four per cent in money. That, then, is the rate for a loan that is to run through 1907. If prices continue to fall at the rate now prevailing, the loan rate in money will correspond to the marginal earnings of capital for the latter year as accurately as it does for the former year. Bargain-making strategy, the "higgling of the market," may yield an imperfect result, and the lender of real or commodity capital may or may not get the exact real earnings of marginal capital of the same kind. In translating the earnings of real capital for the earlier or test year into terms of money, the appreciation of the coins has unerringly entered as an element. If the same rate of appreciation is continued through the following year, no deviation of the loan rate from the earnings of capital can result from this cause. Whatever deviation there is results from the other causes just noted.

In commercial terms a man borrows "money," and, by using it in his business, produces "money." He does this, however, by converting the currency into merchandise, and then reconverting this into currency. He gives to the lender approximately what the "marginal" part of the loan produces. If this adjustment is inexact, the lender will get less or more than the actual earnings of such capital. With money gaining in its purchasing power at a uniform rate, the adjustment is as exact as it would have been with money of stable value. The appreciation works unerringly in translating earnings measured in goods into smaller earnings measured in money. The loan rate approximates the earnings.

Effects of Changes in the Rate of Appreciation.—What happens if the rate of appreciation changes? What if gold gains two per cent in value, instead of one, during the second of the periods? The capitalist will then clearly be a gainer, and the entrepreneur will be a loser. Getting five per cent in commodity as before, the business man, by reason of falling prices, will realize only about three per cent in money. His contract, based on the experience of an earlier year, makes him pay four per cent, and he loses one. Every acceleration of the rate of increase in the purchasing power of money plays into the hands of lenders. Every retarding of that rate plays into the hands of borrowers. If in 1907 the entrepreneur gets a three per cent rate on what he borrows, as based on the experience of 1906, and if the fall in prices is reduced during that later year to one per cent, the borrower will make a clear gain of one per cent; and this will recoup him for his loss in the earlier period. Moreover, after a long period of steady prices, the beginnings of a downward trend do not instantly affect the loan rate of interest. A period must elapse sufficient to establish the fact of this downward trend, and to enable the struggles of lenders and borrowers to overcome habit in fixing a new rate that will correspond to the new earning power of monetary capital. These facts explain what at times looks like a failure of the loan market fully to take account of the fall of prices during a given interval. What that market really does is to base the interest paid in one interval on the business experience of another.

Opposite Reasons for Favoring Gold as a Basis of Currency.—What, then, is our practical conclusion? Gold has surprised the world by its increase and by the rise in prices by which this change has been attended. The interest on loans has risen as the conditions required that it should do; but the rise in interest has lagged somewhat behind the rise in prices. The enlarged output of the precious metal has been comparatively sudden, and it has been this fact which has played into the hands of entrepreneurs and, for a brief interval, entailed some loss on lenders. When the adjustment of loan interest to the rising prices shall be fully made, neither of these parties will gain at the other's expense so long as the rise shall continue at the prevalent rate; but if the rise should cease as quickly as it began, it would be entrepreneurs who would lose and lenders who would gain. Loans running at rates fixed when prices were rising would be paid by an amount of money which would buy more commodity than the business would afford. With a reduction of the output of gold there will come a demand for some measure of inflation in order that rising prices may forever continue. Adding silver to the currency would, as we have seen, accomplish this purpose only temporarily. In the long run this metal is bound to appreciate like gold. Using paper money would have a temporary effect and would be a more dangerous measure. Waiting for a short time for a new adjustment of loan interest to the trend of prices would be the only rational course. Will the further fall of prices rob the entrepreneurs? They must pay only the rate of interest that capital earns. If that is five per cent, five they must pay, so long as prices are stable. With prices falling by one per cent a year, they will have to pay only four. Will the fall check business and make men afraid to buy stocks of goods? They can carry stocks as cheaply with a four per cent rate of interest and declining prices as they can with a five per cent rate and stable prices. Will it blight enterprise by making men afraid to build mills, railroads, etc.? Here again the loan rate of interest comes to the rescue of the projectors. If they can float their bonds and notes at a lower rate, they can build with impunity.

Steadiness is the vital quality in currency. Let its purchasing power be either unchanging or steadily changing in either direction, and justice will be done and business will thrive. If a metal fluctuates greatly in its rate of increase in value, it is a poor coinage metal, even though the average rate of gain be slow; if it gains slowly and steadily, it is almost an ideally good one.

What would be the effect of any practical measure of inflation? If we use as money available for all debts the present stock of silver in the world, we make one large addition to the volume of money now available. We start an inflation that cannot continue by the use of silver alone. In the hope of perpetuating the rise in prices we may follow the silver with paper. By the action of the principle that we have stated we shall thus make the interest on loans higher, and every man who buys a farm or a house while the inflation continues will pay a high rate of interest on an enlarged purchase price. When we are forced to stop the paper issues, as in the end we must be, the price of the land, etc., will fall, and the rate of interest on new loans will fall also. The price of all produce will go down, and the purchasers of property will struggle again, as in the years following the Civil War men had to struggle, with a fixed debt, a fixed rate of interest, and falling prices. The early post bellum days will be reproduced. Entering on a policy of inflation would therefore be inviting men again to suffer what those suffered whose hard experience is so frequently depicted in Populistic literature. Conceding all that is claimed as to the evil that comes from buying or mortgaging real property while the volume of money is increasing and paying the debt so incurred while that volume is relatively contracting, one must see that a policy of inflation would end by inflicting exactly that evil on new victims, unless a method can be invented by which the inflation can continue forever. Far better will it be to endure the transient evil which a slow change in the supply of gold will bring. Retaining gold through all its minor variations will mean all the prosperity and all the justice that any monetary system can insure. If we shall ever abandon this metal, experience will make us wise enough to return to it; but we shall have paid a high price for the wisdom.

[1] There is a slight compounding here to be taken into account. If commodity has gained five per cent, while prices have lost one per cent, the capital as measured in money has increased by three and ninety-five one-hundredths per cent instead of exactly four.