Popular Science Monthly/Volume 67/July 1905/Present Monetary Problems

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THE development of thinking about money is the most interesting portion of the history of political economy. The first dawn of economic principles came with the discussion of monetary phenomena, and monetary science has not only always had a peculiar practical interest of its own, leading to its constant appearance in political campaigns in all countries, but it has also had an organic life persisting in its full vigor to the present day. In the United States, the monetary question is not at this very moment—as it has been—the football of the political parties; but there has been very recently an active upheaval in scientific discussion which is healthy and worthy of attention. In Europe, while the active discussions of bimetallism have simmered down to relative quiet, yet the interest in the fundamental monetary questions among scholars is burning with a clear flame. These present monetary problems are not only enlisting the interest of economic thinkers and reach the very center of systematic exposition, but they also happen to be those which have to do with the truth or error of convictions which are widespread among great masses of our countrymen.

It is passing strange that the vast literature of money has not been marked by a burning zeal for the statement of an organic body of principles. Discussions of money have usually been started in some local, or practical, problem; and interest has centered largely in the acquisition of historical data, without any considerable success in the formulation of the principles explaining such data. Once the problem of special interest to the public had been settled for good or for ill, the real scientific interest seemed to wane. To-day, in my judgment, the case is entirely different. The attention now being given by scholars in both Europe and America to the vital questions of monetary doctrine is nearly as intense as that given to questions of wages and interest.


II. Functions of Money.

Since the time of Ricardo there has been a magnificent confidence that the theory of money has been so well settled that there was little more to be said on the subject. The economic dogma of money, at least, was supposed to be fairly complete. And yet—in my judgment—the systematic treatment of the principles of money has remained undeveloped almost to the present day. There is scarcely any part of the field which can be regarded as thoroughly disposed of. Indeed, the very definition of money itself is to-day under the most critical examination; and with the definition goes the question as to the functions performed by money. On these points—like investigators in other sciences—we must frankly admit our lack of agreement.

First of all, it should be emphasized that the dispute about the definition and functions of money is not merely a question of words; it relates, in truth, to fundamental problems of great practical import. Every day the statesman and man of affairs are confronted by difficulties connected with the primary effect of 'money' on prices in general; but it is at once patent that the relation of the value, or quantity, of 'money' to prices can not be disposed of until we have determined what we mean by 'money.' As at present used, 'money' has no scientific precision; it is often carelessly employed in many different senses by one and the same author.

Evidently, before a rational definition of money can be found, some agreement based upon an analysis and description of the functions actually performed by money must be reached. If several dissimilar services are rendered by monetary instruments; if each of these services is associated by usage with 'money'; and if it happens that different things are employed in these different services—then, while authors may agree as to many of the functions of money, it may easily happen that they may still disagree as to which shall be regarded as essential to the definition of money. Money may have different meanings according as it is made to include, or exclude, some or any unquestioned services associated by usage with money. In such ways, an important difference might arise between that which is money in an economic, or true sense, and that which is money in a legal sense. In fact, the economic relations of money ought to be scientifically ascertained before legal functions should be assigned to it. If, for instance, the state should apply the quality of legal tender loosely to some instrument which does not completely fulfil all the functions of money, then that money is not made thereby in the economic sense true money. It thus often happens that incomplete forms of money exist, which give the public much difficulty to classify and define. The expressions 'substitutes for money,' or 'surrogates,' or 'representative money,' have arisen which depend for exactness upon the primary meaning assigned to the money on which they depend. The very functions of money need careful limitation.

Among writers as late as John Stuart Mill, there is practically no separation of these functions. The term money was applied indifferently to an instrument which served only as a medium of exchange, or only as a standard, as the case might be. Obviously, it would not be possible here to summarize all the different ways in which the functions of money have been viewed: they vary with each writer. In the main, there is a discussion upon the merits of the following separate functions:

1. A medium of exchange.
2. A standard, or measure of value.
3. A standard of deferred payments.
4. A legal means of payment.
5. A store of value.
6. A means for transferring value or capital.

The most recent German writer, the distinguished scholar, Helfferich, in an epoch-making treatise,[2] holds that there are only two primary functions of money, neither being secondary to the other: (1) Medium of exchange, (2) means of payment. He does not regard the standard function as essential to the conception of money, believing that any such service as may be included under a measure of value has been derived from the two primary functions given above. With several other writers, he finds that the medium of exchange was the thing which first developed, and then came into general use as a standard, or measure of value. He practically defines money as everything serving to facilitate exchange between economic factors. Thus, Helfferich would hold that the state, by giving legal tender power to things worthless in themselves, such as irredeemable paper, created a means of payment for debts, and therefore he would include even such instruments as these under money, because they fall under one of his primary divisions.

Whatever conclusions may be reached in regard to the functions of money, their application to the system of any one country would raise difficult questions as to the classification of money. If one of the necessary functions is lacking to any one form of money, is it, or is it not, true money? For instance, in the United States, no one would hesitate to say that gold coin is true money, and yet it is very little used as an actual medium of exchange. Therefore, we may easily call that true money which does not serve principally as a medium of exchange. Also, silver dollars, and French five-franc pieces, in the so-called 'limping gold standard,' could not be called true money in all senses, because their value is dependent on a primary form of money. Like national bank-notes and greenbacks, they are only 'surrogates' they are, perhaps, legal, but not economic, money in the fullest sense.

One may well doubt if the function of a means of payment can be distinguished from that of a medium of exchange. At least, most writers seem to agree that the medium-of-exchange function is essential to money; but if the standard function be neglected, could we possibly define that which acts only as a medium of exchange as true money? Of course not. Deposit-currency (i. e., bank checks) certainly acts as a medium of exchange, and as a means of payment; but we should, in all common sense, be obliged to place such currency in a very different class from gold coin.

Therefore, every one must agree that the critical discussion of the meaning and functions of money is fundamental to scientific progress, and to all serious treatment of the main problems of money, such as the theory of prices.


III. Credit.

In regard to another unsettled problem of money, credit, it is to be said, not only that it has been very much misunderstood, but that it has been given very little real study. There is to-day no commonly accepted definition of credit: the element of futurity in a credit-transaction is generally admitted, but 'confidence' is by some regarded as the essential element; and yet 'confidence' can play its role only because futurity exists in the credit operation.

Nor is there any received opinion as to the real nature and functions of credit. We seem, in the whole field of credit, to be on the frontier of knowledge. In any true sense, the economic end of society is the possession and use of goods which satisfy wants. Credit has been devised as one of many means to aid in accomplishing this end. In its fundamental relations it has to do with goods and their increase. To some, however, it is related only to money. The truth of this concept, to my mind, depends upon the nature of money. If it be only a means to an end, and if it does not alter the elemental principles of value, but aids and cheapens the exchange of goods, then it is easy to understand that a borrower in reality obtains the use of goods, as the purpose of a loan, and that money and credit are but the instruments devised by society for effectually carrying out that purpose. Hence the credit operation, as regards extension or contraction, is primarily based on transactions in goods; its relation to money is a secondary, and incidental, connection. Credit being a transfer of goods involving the return of an equivalent in the future, forms of credit appear only as a consequence of transactions in goods. More transactions, not more money, cause an increase of forms of credit; and, by an interesting process of evolution, forms of credit—especially the deposit-currency of banks—act as a medium of exchange, obviating recourse to money. The belief, however, that credit depends on money, and not on goods, is widespread, and much discussion is probably before us on this point.

The relation of credit to the theory of prices is not so clear: some think that all the money, plus all the credit (whatever that may be), act primarily to fix the level of prices; but any sane person will see at a glance that the forms of credit, such as bills, drafts, etc., arising from the movement of the wheat crop, have no effect on the price of that crop—the price having been made antecedent to the creation of the forms of credit which came into existence only because of the actual ales of wheat. Does a farmer wait until he sees how many wheat bills are drawn before fixing the price of his wheat? Evidently not; and the popular conception needs thorough criticism.[3]

When men speak of 'our expansion of credit,' they have a very vague and general idea in their minds. The definite and distinct forces at work are covered with darkness; and, when a revulsion of trade comes, the results are accepted as coming from some undefined and mysterious force which can only be felt, but not explained. It remains the duty of the economic thinker to outline with scientific exactness the forces uniting in the upward wave of over-trading, and to state with equal definiteness the causes of the receding movement. Principles must be sought for which will explain the differing actualities of each special crisis.


IV. Theory of Prices.

Only after the honest student has come to a satisfactory conclusion in regard to the nature of money and credit is he in a position to discuss with profit the pivotal problem of this field—the theory of prices. Perhaps I may be criticized for treating here the present monetary problems from too theoretical a point of view; and it may be urged that I should have presented the practical problems confronting each leading nation, and discussed their relations to the several monetary systems actually in use. But I must respectfully insist that the moment any practical problem in any existing monetary system is taken up, one is instantly faced by the difficulty of agreement upon the terms in use, and in fact upon the simplest monetary principles involved in the examination of each case. Every practical reformer in the field of money is in fact using some theory of prices, true or false, in all the premises laid down in his propositions. One might as well go into practical engineering without a knowledge of thermodynamics as to discuss practical monetary schemes without first settling basic monetary principles. But, unfortunately, the thinking, even among so-called economists, is to-day unsettled on so pivotal a question as the theory of prices. Practical monetary legislation, in more than one country, would he radically modified, accordingly as the so-called 'quantity-theory' of money is accepted or not. In my humble opinion, that theory is indefensible and erroneous; and yet our great politicians in the United States, in their fencing on the monetary problem, have decided that the question of the gold standard has been definitively settled, because of the large recent production of gold. The partisans of gold have thus accepted the principle on which the demands for an extension of the circulation of silver and greenbacks have been based in the past; and the position is absolutely untenable. The issues in this crucial problem are unmistakable; and they must be threshed out to a conclusion before any practical applications can be attempted. These issues may be briefly stated in the following heads:

1. Is the price of goods the quantity of some standard commodity for which they will exchange, or is it the relation between goods and a variety of several media of exchange?

2. If true money is a commodity, like gold, then what determines the exchange value between goods and that commodity? Is the problem in any way different from that of obtaining the exchange value of any two commodities?

3. What is the actual process of evaluation between goods and gold?

4. If demand and supply regulate the value of money (cost of production apart), what is the exact meaning of demand for money, and of supply of money?

5. Is the demand for a money-metal only the monetary demand? Is the demand for a commodity as money something sui generis?

6. In the theory of prices, what is meant by 'money'? Is it only gold, or gold together with everything, such as deposit-currency, which acts as a medium of exchange? In short, what constitutes the supply of money?

7. If prices are influenced by 'purchasing power' is that synonymous with the sum of the existing media of exchange, multiplied by their rapidity of circulation? Or, is purchasing power in its ultimate analysis synonymous with the offer of saleable goods?

8. Have the expenses of production, or progress in the arts, no influence on the general level of prices?

9. What is the effect of credit on general prices?

10. How do fluctuations in bank reserves actually affect general prices? Does the rate of interest, being paid for capital and not for money, have an effect on prices through its effect on loans?

11. By what economic process would a great new supply of gold influence general prices? Only by being directly offered for goods as a medium of exchange?

12. Does the Ricardian reasoning in favor of the quantity theory of prices hold in monetary systems where free coinage of the standard money exists, and where other devices are used as media of exchange? If mints are open, how can the coin differ in value from the bullion of which it is made?

It is safe to say that the thorough discussion of these points, and a satisfactory disposal of them, will aid in the solution of the central monetary problem, not only of the past, but of the present time. It is one which can not be blinked. It arises at every step in popular monetary discussions, and the economists have not given it necessary attention. On the settlement of the theory of prices, of the value of money, a host of minor questions, which have caused endless and fruitless differences of opinion, will disappear The solution of this matter of theory is of the greatest practical import; it is as important to practical monetary action as a theory of heat is to mechanics. Therefore let us not be deterred from a struggle with a fundamental matter of theory by any slighting and cheap sarcasm about the futility of theoretical and abstract discussions. As well scoff at the mathematics which lies behind physics and astronomy as theoretical.

Nor will it be wise to minimize the differences between the old and new points of view in the theory of prices. It may be said that the quantity of money would have an influence on general prices in any theory. True; but that does not touch the crucial point at issue. The quantity theorists make the process of evaluation between goods and 'money' dependent on the actual offer of the medium of exchange and goods for each other; an increase of transactions in goods is an increased demand for money, resulting, unless the quantity of money is increased, in falling prices. It is needless to say that the facts do not agree with these statements. An inductive economist, who would be unwilling to state any principle which had not been the outcome of a study of concrete data, could never, under any possible circumstances, have arrived at the quantity theory of money. In no case coming under my observation has there ever been any correspondence between the movement of general prices and the known facts as to the quantity of circulation, or the money-work to be done. If I am wrong, it lies in the power of induction to disprove my statement by the facts. In truth, the quantity-theory was the product of the metaphysicians, and not of the men of affairs; and it never has been in accord with the data of inductive study, so far as I know.

It is true that a great increase in the supply of gold would lower its value, other things remaining the same; but the effect on general prices would be a simple one, such as would be produced by any cheapening of the standard, like a change to a depreciated paper standard. But this change in the value of the standard is a radically different economic process from that by which prices are said to be influenced only by changes in the quantity of the media of exchange actually offered for goods. One or the other must be wrong.


V. Prices and the International Movement of Metallic Money.

The settlement of the theory of prices, or the principles determining the value of money (suitably defined) has an importance reaching out into the field of the international movements of specie. We can not properly formulate the methods by which the shifting of specie and goods act upon each other in international trade without having previously reached a definite conclusion upon the theory of prices. Thus the examination of and agreement upon the theory of prices will largely determine the statements made concerning the relation between the shipments of specie and the level of prices within a country.

With the Ricardian formula, derived from the experience of England in the early part of the last century, writers have attempted to solve this problem by using the quantity of money in a country as the force regulating the general level of prices; if gold is exported, prices must fall; if gold is imported, prices must rise. In brief, the originating cause of a change in the general level of prices, so far as international trade is concerned, is the shipment of specie. The movement of goods is a consequence of the change of prices brought about by the addition or subtraction of specie. That is, the quantity-theory has been relied upon to solve this highly important and practical problem of money.

The original statement of Eicardo has, of course, been added to and emended; but, in the main, it is intended to show that any one country obtains a part of the world's circulation of specie in the proportion that its trade bears to that of other countries. This quota of gold, for instance, is retained in a country by influences working automatically on the price level through changes in the quantity of gold within that nation. If gold is withdrawn, prices fall, exports of goods are increased, and in due time the gold begins to return until the country's quota of gold reaches an equilibrium adjusted to the relative demands of other countries. The movement of goods forms the variable in the process which aims at a correction of the quota of gold, whenever the equilibrium has been disturbed. The shipment of gold is the initial cause; the movement of goods is a consequence.

In support of this view—the orthodox view—it is held that gold will flow wherever its exchange value is highest. The flow of gold will make it abundant in the receiving nation, and thus, because it is cheap, will raise general gold prices there; or, vice versa, will lower prices in the countries from which gold is taken. The possession of the proper amount of gold seems to be the main consequence, while commerce is regarded as the means to the end.

This manner of treating the problem, however, reverses the true order of events. Commerce is the real objective which lies behind all other phenomena, such as the methods of payment; the movement of money is a secondary operation, dependent on the direction and extent of the shipment of goods. Moreover, to say that gold, like other goods, flows where its exchange value is highest, is a truism; the real question to be settled is, how does the flow of gold take its effect on prices? To say that because it is abundant it raises prices is to assume the whole problem at issue. How does a cheapened mass of gold adjust itself to other goods? What is the price-making process? Are goods priced only by an actual exchange of those goods against the increasing flow of gold? On this point the adherents of the orthodox teaching of Ricardo have offered no light.

The trouble with many symmetrical monetary theories is that they do not agree with the facts. For instance, it has been pointed out that the gold stock of the United States has increased three and one half times from $326,000,000 in 1880 to $1,174,000,000 in 1902; and yet that gold prices in the United States in that period have fallen. This discrepancy between fact and theory is dogmatically disposed of by assuming that the growth of our trade has outstripped the supply of gold. This position is far from tenable; there are no statistical data in existence worth a fig, which could give us the truth as to the money-work, or demand, for gold. To say that our gold has increased at all only because of our phenomenal increase in trade relatively to other countries is to make a statement without proof. Possibly our deplorable silver legislation of the past has forced us to carry more gold than we ought to have held; just as men on the frontier must invest considerable means in firearms for protection from purely local dangers. Other countries than ours have enormously increased their trade, but they have not added in the same proportion to their gold circulation. In truth, the old-fashioned theory on international price-changes needs restatement in vital parts. It will be found that forces affecting the prices of goods, such as demand and supply of those goods, are of primary influence in affecting prices, quite independent of the action of a medium of exchange—which chiefly comes into existence, in fact, as a consequence of the exchange of goods. The movement of specie is not the end of commerce, but specie moves as an instant consequence of commerce. The monetary changes follow, and do not precede the operations in merchandise and securities.


VI. Bimetallism.

Bimetallism was eagerly taken up by writers as a means of increasing what was once regarded as a deficient supply of the world's metallic circulation. The decline of prices,—which in this country began in 1866 and not in 1873—was attributed to a scarcity of 'money' throughout the world. Therefore, if silver could be added to, or retained with, the circulation of gold, the larger quantity of metallic money would, it was believed, support, or even raise, the general level of prices. The theory of prices, assumed as a matter of course in this exposition of bimetallism, was the quantity-theory.

Throughout the recent writing and speaking on monetary topics, in both Europe and America—if not also in Asia—there has been a very general subsidence of interest in bimetallism. The demand for silver has been believed to be unnecessary because of the enormous production of gold in recent years. That is, by the old quantity theory on which bimetallism was based, some authorities—and more politicians—have saved their consistency by accepting the gold standard.

The logic and character of bimetallism can not escape so easily. If the quantity-theory falls, the whole artificial structure of bimetallic argument falls; and the gold standard can not possibly be supported by intelligent minds on any such basis of theory. The facts are too ugly. In the accompanying diagram it must appear to the most casual student that if the fall of prices on or about 1873 was due to a scarcity of gold, then not only because the supply of silver has been greatly increased, but especially also because the supply of gold has been about quadrupled since 1850, we ought to have witnessed a phenomenal rise of prices in the last decade or two. The movement of prices on the diagram, however, has been generally downward, or at least not seriously rising, during all the ^years when the production of gold has been so astonishingly large. The facts oblige us to question a theory which presents such evident disparities as this; and one is obliged, in all fairmindedness, to accept the truth that many other and potent influences, besides the quantity of the media of exchange, have a powerful effect upon the price-level. When this admission is made, then the investigator is in a position to understand the remarkable influences of the great industrial revolution of the last thirty years upon the expenses of production of all articles, and hence upon their market prices. Thus, the sweep of economic forces, in the natural tide of events, is bringing us to a saner and very different point of view than that of the scientific bimetallist of past years.


VII. Stability of Exchange.

Consistency is a jewel; but it may be questioned whether it is always worth the price. The escape from the pitfalls of bimetallism and the quantity-theory has led to some new and surprising formulations. It has been the hope of the bimetallists to secure a parity of exchange between countries now using gold and silver standards. If gold could be maintained permanently at a given ratio with silver, this happy result might have been brought about. It is needless to say that bimetallism proved to be a political impossibility, even in the countries of the Latin Union. By force of business requirements, such

PSM V67 D225 gold prices and gold production.png

silver as has remained in general circulation was effectively kept at a value in gold equal to its face value by varying devices in different countries, all of which had a common principle—practically equivalent in a more or less evident form of redemption in gold. In the case of India, it is frankly accepted that the value of the rupee has been maintained at a fixed price in gold by a machinery which amounts to the establishment of the gold standard, involving a quasi-redemption of silver rupees in gold at 16d.

If, however, there are some silver-loving sensibilities to placate, such a process is not spoken of as the establishment of the gold standard through the indirect redemption of inferior silver by gold, but it has been discovered that a uniform ratio of exchange between gold and silver-using countries can be established, not by the gold standard, but by a 'gold-exchange standard.' In the recent proposals laid before Mexico and China this new form of statement has been employed. It is difficult to know what the new term means. A bill of exchange in a silver country drawn on a gold country is nothing but the amount of silver coins of the one nation which must be given to buy a stated sum of gold coins of the other nation. The silver bill varies relatively to gold coins in proportion to the changes in the value of silver bullion relatively to gold—unless the silver coins, under the laws of token-money, are kept at an artificial value, above the market value of the silver bullion in them, by some method, more or less direct, of redemption in gold. When silver bills are offered in the exchange market, they are simply offers for the sales of so much silver to be paid for in gold. If, then, the treasury of the silver-using country buys the bills, in certain emergencies of the exchange market, it is paying gold for silver; or, in other words, it is to that extent redeeming amounts of silver in gold.

Stripped of its enveloping mystery, the only way in which the new proposals for Mexico and China can establish stability of exchange is to establish the gold standard. For that purpose, if the silver coins in common use are to be rated in gold above the market value of the silver content of the coins, the only way in which parity in daily business, or in the exchanges, can be maintained is by creating a gold reserve large enough to redeem coins at par, or buy exchange at par, if no direct redemption is allowed. The whole operation, therefore, harks back to the principles regulating the value of such money as token-coins, bearing a seigniorage, or paper money, which has no value in itself. The worship of quantity as a regulator of value of money may do for those who are unwilling to test their theories by the facts; but inevitably one is obliged to admit that other forces are far more potent than quantity.


VIII. The Value of Paper Money.

I have said that the pivotal problem in the whole field of money is the theory of prices or the value of money. How true this is may be seen by the recurrence of this issue in each of the problems noted in this paper; and in the last one which I shall take up it again reappears. What regulates the value of those forms of money which circulate at a rate above their content is a question which forces itself to the front whenever we study a case of paper money. In times past, it has been sufficient to explain the value of paper money by referring its rise or fall to an increase or diminution of its quantity. This blind reliance on quantity as the main force controlling the value of money can not now, with our knowledge of the facts, be consistently held.

The amount of notes which a merchant can put out, provided he redeems them promptly, is limited only by the extent of his transactions. So it is with a nation. Given a certain set of business operations, as many notes can be kept in circulation as are needed by the community, and no more; and these notes will remain at par only if there is a recognized system—not of ultimate, but of immediate redemption. No matter what quantity of notes may be put out, if there is no system of immediate redemption, the notes will depreciate. But, if there is an effective system of immediate redemption in operation, then no matter what the amount issued, none of it can depreciate, and only that quantity which is needed by the convenience of the business public will remain outstanding. In this way it may be realized that the element of quantity is incidental to the more dominant factor of redemption.

The connection of the value of the standard money with the paper promises to pay in that standard coin is the one important consideration in determining the value of paper money. Redemption is the only sure means of ascertaining automatically what quantity of paper is needed by the public. Redemption determines both the quantity and the value of the paper.

In the case of irredeemable paper, however, it is often assumed that, in the absence of redemption, the.value of the paper is determined directly by the amount outstanding as compared with the uses to which such money can be put. There is believed to be an imperative demand for money, as a medium of exchange, which must be satisfied in some way; and in default of anything better, irredeemable paper will be required, and a value will be given to it by this imperative demand. Then, only if issued in excess of this demand, will even irredeemable paper depreciate. This is the usual explanation of the fact that irredeemable paper, worthless in itself, bears any value at all.

  1. Read at the International Congress of Arts and Science, at the Universal Exposition, St. Louis, in September, 1904.
  2. 'Das Geld,' von Karl Helfferich, Leipzig, 1903, 8vo, pp. x + 590.
  3. For a full discussion of credit, see my 'Principles of Money,' Chap. IV. (1903).