Full text of Why is the Dollar Shrinking? A Study in the High Cost of Living

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

WHY

THE

DOLLAR
IS
SHRINKINO

IRVING FISHER

Econ5135 .5
Harvard College Library
I
NO N
SVIX

AC ACAD
UMTTRISTO
R
CH

A
AN
DI

WWECCLESIONES

AE HARD

TII

S

FROM

THE QUARTERLY JOURNAL
OF ECONOMICS

WHY

-

WHY IS THE DOLLAR SHRINKING ?

THE MACMILLAN COMPANY
NEW YORK • BOSTON · CHICAGO · DALLAS
ATLANTA • SAN FRANCISCO

MACMILLAN
& CO ., LIMITED
LONDON • BOMBAY • CALCUTTA
MELBOURNE

THE MACMILLAN CO . OF CANADA, LTD.
TORONTO

WHY IS THE DOLLAR
SHRINKING ?
A STUDY IN THE HIGH COST
OF LIVING

BY

IRVING FISHER
PROFESSOR OF POLITICAL ECONOMY IN YALE UNIVERSITY
AUTHOR OF " THE PURCHASING POWER OF, MONEY "

" THE NATURE OF CAPITAĚ AND INCOME, " ETC,

*

་

ར

ད

New York
THE MACMILLAN COMPANY
1914

All rights reserved

Econ 5136 . 5 .. .

:

From the
Quarterly Journal
of Economics .

COPYRIGHT, 1914,

BY THE MACMILLAN COMPANY.

.Set up,and elegrotyped . Published September, 1914.

O "

Norwood Press

J. 8. Cushing Co. - Berwick & Smith Co.
Norwood , Mass., U .8 .A .

To
SIR DAVID BARBOUR
VETERAN ADVOCATE OF THE PRINCIPLES
FOR WHICH THIS BOOK STANDS

PREFACE
PRESENT-DAY discussion on the high cost of

living showssomebewilderment in the mind of the
general public as to the mechanism by which the
scale of money prices is determined . Few people
realize that the principles determining the general
scale of prices are quite distinct from the principles
determining the individual prices themselves. Few

realize, for instance, that the money price of any
commodity has to do not only with that commod

ity but also with money , and that, therefore, a
monetary element enters into every price.

The object of this book is to state, as simply as
possible, the general principles which fix the scale
of prices, and to show the manner in which these
principles apply to the present “ high cost of
living. "

These principles are not new .

They are the

same as the well-known principles of Ricardo, and

of most subsequent writers on economics. They
have been more elaborately stated in my “ The
Purchasing Power of Money.”
If these principles are correct, the purchasing
power of a dollar — or its reciprocal, the level
of prices — depends exclusively on five definite
vii

PREFACE

factors : (1) the volume of money in circulation ;
(2 ) its velocity of circulation ; ( 3 ) the volume of
bank deposits subject to check ; ( 4 ) its velocity ;
and (5 ) the volume of trade . Of course, each
one of these five influences itself depends on
other more remote influences, and these others on

others still more remote , and so on ad infinitum .
But no cause can affect the scale of prices except
as it acts through one of the five above enumerated .

In my opinion the branch of economics which

treats of these five regulators of purchasing power
deserves to be recognized as an exact science, ca
pable of precise formulation , demonstration , and

statistical verification .
For a hundred years the world has been suffer
ing from periodic changes in the scale of prices,

affecting the interests of hundreds of millions of

human beings and producing alternate expansions
and depressions of trade. It is not too much to
say that the evils of a variable monetary standard
are among the most serious economic evils with

which civilization has to deal.
In the United States we are about to witness

some extremely interesting applications of the
principles here stated, owing to the two great acts
passed by Congress toward the close of 1913, i.e.,

the tariff act and the currency act. For instance,
the tariff reduction, by inviting imports of com

modities,will tend for a time to encourage the ex
port of gold , until the drain limits itself by the
fall of our prices or the rise of foreign prices . The
viii

PREFACE

tobably ttend
end
nd, will
merits aact
if soprobably
Acurrency

to increase bank
deposits and, if so, to restrain the fall of the
American scale of prices and so to prolong the ex
port of gold . If these results ensue, there may

well be much surpriseexpressed and some criticism .
It will then be important that the public shall
correctly understand what is going on ; otherwise
many senseless proposals may be made and even

adopted .

I hope soon , in another book , to set forth a
remedy for changes in the scale of prices by

- “ standardizing the dollar.”
I am indebted to the North American Review for
permission to use unaltered certain passages from
my article “ Is the High Cost of Living Going
Higher ? ” published in December, 1912.

I am also under obligations to several of my
students, especially Mr. Paul M . Atkins, for aid
in assembling the statistics from which the dia
grams are constructed .
IRVING FISHER .

YALE UNIVERSITY,
April, 1914.

POSTSCRIPT
(AUGUST 25, 1914)

This book was already printed, but not issued, when
the great European war broke out. So colossal an
event will, naturally, have important effects on prices.

At this writing, when the war is merely beginning, it
is, of course, quite impossible to predict with accuracy
what all these effects will be. In general, however,

wemay feel confident that the net and ultimate effect
will be to aggravate the upward tendency which , as we

already had reason to believe, was impending. In
Europe, especially , the cost of living will probably rise

above anything previously known . The rise is likely
to be greater after the war than during the war.
The rise during the war will probably be less rapid in

England than in the other warring countries, but after
the war, more rapid . There is even possible, the
anomaly, that, during the war, the general level of
prices in England will actually fall. The rise during
the war, in small countries, like Belgium , will probably

be greater than that in large countries, like France,

which are morenearly self-supporting. The rise in any
country which resorts to irredeemable . paper money

will be further aggravated in proportion to the degree
of inflation .

POSTSCRIPT

Such are the chief probable effects on price levels.
But what is more important, this rise will be an es

pecial hardship to the peoples at war because of the
great impoverishment which the war will surely bring.
That is to say, high money prices will be accompanied

by low money earnings. The cost of the war, accord
ing to the best estimates, will equal or exceed half of
the total income of the inhabitants of the warring
nations. It is true that much of this burden can be

shifted to future years ; but, even then, it will severely
tax resources already crippled by the previous destruc
tion and disorganization of capital.
Fortunately for us in the United States, unless we
are drawn into the conflict, the rise of prices will be less

than in Europe, and we shall have our earning power
substantially unimpaired .
We are speaking, of course, only of general price
movements, not of individual prices. Wemay be sure
that, though many goods will rise in price , some will
fall, and some will oscillate up and down. In fact, the
first and most striking effect of the war on prices will
be to disperse or scatter them . Foods will especially
rise and bonds will especially fall.
In the four pages to which this postscript must be

restricted, it is only possible to mention a few of the
chief reasons which have led to these conclusions.

This book was written largely to show that the price
level is, in general, the resultant of a race between
the circulation of money and credit on the one hand
and the volume of trade on the other, - a race as to

which will grow the faster.
During the war both racers will rest awhile . Prob

POSTSCRIPT

ably both will recede materially, but trade faster than
circulation ; this will cause prices to rise. After the
war both will again expand, but credit will rebound

faster than trade ; this will cause prices to rise still
further .

If we examine the diagrams of this book during and
after the great wars ofmodern times, the Crimean War
(1854 - 1856 ), the American Civil War (1861– 1865 ),
the Franco -Prussian War (1870- 1871), the Spanish

American War (1898 ), the Boer War (1899 –1902),
and the Russo -Japanese War (1904– 1905), we shall
notice that the price level usually rises at the begin
ning of a war and again after the war is finished . In

the American Civil War, the existence of the Green
backs obscured these facts. But the price level, ex
pressed in gold , increased faster after , than it did dur

ing, the Civil War.

Edward E . Gellender, who has made a detailed
study of prices in relation to wars, shows in the publi

cations of the (British ) Institute of Bankers, Novem

ber, 1901, that after wars trade generally booms and
prices rise until a crisis appears (e.g. that of 1857 after

the Crimean War, that of 1866 after the Civil War,
that of 1873 after the Franco-Prussian War).
We have ventured the opinion that the English
price level will rise less during and more after the war
than Continental price levels. This is because it is

believed that the effect on prices due to changes of
trade in England will be less, and the effect on prices
due to changes of her money and credit circulation,

more than on the Continent, both during and after
the war. During the war, England will withdraw

POSTSCRIPT

fewer reservists from

industry than the other

nations ; and there is less chance in England of the
stoppage, by physical destruction , of her internal com
merce . Even her foreign trade is being safeguarded
from interference far more thoroughly than is that of
any other warring nations ; and, in any event, this for
eign trade, vast as it is, only amounts to perhaps a

tithe of the internal commerce. On the other hand ,
since England is much more fully on a credit basis than
the Continent, where the use of checks is not yet wide

spread, the reduction, through hoarding and stoppages
of loans, in the circulation of cash and credit in Eng
land, will havemore effect toward depressing the price

level than on the Continent. After thewar the rebound
of credit will likewise be more effective in England than
on the Continent.

4

TI

TABLE OF CONTENTS
CHAPTER I

UNDERLYING IDEAS
1. WEALTH . .
. . .

.

.

1

2. PROPERTY

.

8

SEOTION

.

.

.

.

PAGE

.

.

.

.

.

.

CHAPTER II
MONEY

1. MONEY FALLACIES .

.

.

. 15

2. PRICES IN GENERAL AND IN PARTICULAR .

.

3. TAE NATURE OF MONEY

. 25

.

.

.

.

CHAPTER III
THE EQUATION OF EXCHANGE
USTRATION
ARITHMETICAL ILLUSTRATION
1. ARITHMETICA

.

.

.

. 34

2. MECHANICAL ILLUSTRATION .
3 . ALGEBRAIC ILLUSTRATION .

.
.

.
.

.

.

.

. 46

4. THE “ QUANTITY THEORY OF MONEY”

44

CHAPTER IV
BANK DEPOSITS SUBJECT TO CHECK
1. THE MYSTERY OF CIRCULATING CREDIT . . 52
2 . THE BASIS OF CIRCULATING CREDIT .
xi

.

.

59

TABLE OF CONTENTS
PAGE

SECTION

3. BANKING LIMITATIONS .

.

.

.

.

. 63

4. THE TOTAL CURRENCY AND ITS CIRCULATION :

69

5. DEPOSIT CURRENCY NORMALLY PROPORTIONAL
TO MONEY
6. SUMMARY .

.

.

.

.

.

.

.

.

.

.

.

71

.

.

.

74

CHAPTER V
TRANSITION PERIODS - CRISES AND

DEPRESSIONS

1. RISING PRICES

2. How A RISE OF PRICES CULMINATES IN A CRISIS
3. COMPLETION OF THE CREDIT CYCLE . . .
4. THE SAFEGUARD OF High INTEREST . . .

CHAPTER VI
REMOTE INFLUENCES ON PRICES
1. INFLUENCE WHICH CONDITIONS OF PRODUCTION
AND CONSUMPTION EXERT ON TRADE AND

THEREFORE ON PRICES .

.

.

. 88

2 . INFLUENCE OF INDIVIDUAL HABITS ON VELOCITY
OF CIRCULATION AND THEREFORE ON PRICES

93

3. INFLUENCES ON THE VOLUME OF DEPOSIT CUR
. 101
.
RENCY AND THEREFORE ON PRICES

CHAPTER VII

REMOTE INFLUENCES ON PRICES (Continued )
1. INFLUENCE OF THE “ BALANCE OF TRADE ” ON
THE QUANTITY OF MONEY AND THEREFORE
ON PRICES .

.

.

xii

.

.

.

.

. 104

TABLE OF CONTENTS
SECTION

PAGB

2. INFLUENCE OF MELTING AND MINTING ON THE
QUANTITY OF MONEY AND THEREFORE ON
PRICES

.

.

.

.

.

.

. 111

3. INFLUENCE OF PRODUCTION AND CONSUMPTION
OF MONEY METALS ON QUANTITY OF MONEY
AND THEREFORE ON PRICES .

.

.

. 114

CHAPTER VIII

OPERATION OF MONETARY SYSTEMS
.

.

.

2. BIMETALLISM .

.

.

.

.

3. THE “ LIMPING STANDARD ” .

.

.

.

1. GRESHAM 's LAW

.

.

. 121

.

.

124

.

.

130

CHAPTER IX

CONCLUDING DISCUSSION OF PRINCIPLES
1 . CAN “ OTHER THINGS REMAIN EQUAL ” ? .

. 136

2 . AN INCREASE OF MONEY DOES NOT DECREASE

.

.

.

. 141

3. AN INDEX NUMBER OF PRICES .

ITS VELOCITY .

.

.

.

.

. 148

.

. 156

. .
. .
. .

. 159
. 180
. 186

CHAPTER X

HISTORY OF PRICE LEVELS
1. EARLY RECORDS

.

.

.

.

2. THE NINETEENTH CENTURY . .
3. THE PRESENT PRICE MOVEMENT .
APPENDIX TO CHAPTER X . . .
xiii

.

TABLE OF CONTENTS
CHAPTER XI
CONFUSIONS CONCERNING PRESENT
PRICE MOVEMENT
PAGE

SECTION

1. FALLACIES UNDERLYING POPULAR EXPLANATIONS
OF THE High Cost OF LIVING . . . 189
2. POPULAR EXPLANATIONS OF THE High Cost OF
LIVING

.

.

.

. 191

3. EFFECT OF FALLACIOUS BELIEFS .

.

.

. 204

.

.

. 207

.

.

.

.

CHAPTER XII
THE FUTURE
1. As to MONEY .

.

.

.

.

2. As to CREDIT AND VOLUME OF TRADE . . 215
3. CONCLUSIONS . . . . . . . . . 219

xiv

WHY IS THE DOLLAR SHRINKING ?

WHY IS THE DOLLAR
SHRINKING ?
A STUDY IN THE HIGH COST OF LIVING
CHAPTER I
UNDERLYING

IDEAS

§ 1 . Wealth

THE purpose of this little book is to explain as
clearly and briefly as possible the reasons why a
dollar will not go as far as it did ten or fifteen years
ago and why in general its purchasing power should
fluctuate from time to time. This problem is only
a part of the great problem of the high cost of living.

The problem of the cost of living in its completeness
is a problem of the purchasing power of incomes ,
and the purchasing power of any income is de
pendent on two factors of which the purchasing
power of the dollar is only one ; the other is the
number of dollars in that income. In the present
book we shall not take up the latter factor except
incidentally , but shall confine ourselves to the
former, — the purchasing power of the dollar.

WHY IS THE DOLLAR SHRINKING ?

[CH. I.

But this narrower problem is really the important
problem at the present time, for we are not suffer

ing to -day — at least the average man is not —
from a high cost of living in the sense that our in
come as a whole will notbuy as much as fifteen years
ago. Though it is quite true that an individual
dollar will not buy as much to -day as fifteen years

ago, yet the average man to -day has so many more
dollars of income than did the average man fifteen
years ago that incomes as a whole will buy more .

If we are to understand this problem of the high
cost of living, we must, at the outset, recognize the

fact that the cost of living is " high " in terms of
money.

The problem then is not only concerned

with “ living " — i.e., food, clothing, shelter, etc. —
for which we pay our money, but also with this
money which we pay. In short the problem of the
purchasing power of the dollar has to do with the

dollar as well as with the things the dollar will buy .

It is simply a question of the relation between money
and goods.

There are few things in life more familiar than
“ money ” and few less understood. To avoid
errors at the outset, we should acquaint ourselves
with certain underlying ideas.

One very common mistake is to confuse money
with wealth . Wealth 1 includes all material objects
1 For fuller discussion , see the writer 's The Nature of
Capital and Income, New York (Macmillan ), 1906 . Re
printed 1912 .

$ 1.)

UNDERLYING IDEAS

owned by human beings. Thus lands and buildings,
raw materials and finished products are wealth .

Gold is a kind of wealth, which, though insignificant x

in amount, is important because from it the chief
money of the world is made, and in terms of it
all other wealth is expressed .

Because we usually express wealth in dollars
and cents we are therefore apt to forget that pri
marily each kind of wealth is measured, not in
money, but in its own physical units. There are
several ways of measuring wealth in physical units .

Most articles of commerce are measured by weight.
Coal is measured in tons ; cotton in pounds ; gold

in ounces. Even when gold is measured in " dol
lars” we must not forget that the gold dollar is

merely a certain unit of weight — about the nine
teenth of an ounce (i.e., 25 .8 grains of standard gold ,
nine-tenths fine or pure) .
Some commodities are measured in spacial units

- units of length , area, or volume. Thread is
measured by the yard ; carpets by the square
yard ; land by the acre ; gas by the cubic foot ;

wheat by the bushel ; milk by the quart ; wood
by the cord.

Sometimes there are definite units in which articles
are already formed . Thus eggs , while they may be
measured in pounds, are usually simply counted , the

egg itself being the unit. Chairs, books, desks, bi
cycles, locomotives, and hundreds of other articles
might be cited which exist in definite units.

WHY IS THE DOLLAR SHRINKING ?

(Ch . I.

We can usually translate from one unit into
another. Thus tomatoes may be measured and
sold by the bushel, which is a spacial unit, or by the
pound, which is a weight unit, or they may be

counted and sold by the dozen .
Wealth must not be confused with the mere

qualities of wealth ; thus the fertility of the soil is
not wealth though fertile soil is wealth . Nor should
wealth be confused with the use or benefits of
wealth , nor with the rights to those benefits (“ prop

erty rights” ), nor with the evidence or written
certificates of those rights.

Different kinds of wealth are constantly being
exchanged . An exchange of two articles of wealth

between two different persons is the mutual and
voluntary transfer of their ownership, each transfer
being made in consideration of the other .
While it is true that any two kinds of wealth

may be exchanged , some kinds of wealth are more

acceptable in exchange than others. Money pri
marily means wealth which is generally acceptable in
exchange. This definition is based on the most
important characteristic of money — its exchange

ability or capacity to serve as a medium of exchange.
When one of the two objects exchanged is money ,
the exchange is called a purchase (to the one who

parts with the money) or sale (to the one who
receives the money ) . When neither of the two
objects exchanged is money the exchange is called
barter.

§ 1.1

UNDERLYING IDEAS

The price of wealth of any kind is the amount
of wealth of any other kind given in exchange for a
unit of that wealth , i.e., it is the “ ratio of exchange "

found by dividing one of the quantities of wealth
exchanged by the other. The denominator of this
ratio is the quantity of the article the price of which
is to be expressed. The numerator is the quantity
of the other article .
Theoretically, we can always express the price of
either of the two articles in terms of the other . But
usually money is one of the two things exchanged
and is the numerator.
Having defined price, we next define value. The
value of any given amount of wealth is simply its

price multiplied by its quantity . Thus if the price
of steel rails is $ 28 per ton ,the value of a thousand
tons is $ 28 per ton multiplied by 1000 tons, or

$ 28,000.

As soon as we set a price on various kinds

of wealth we can measure their value if we know their
quantity .

The measurement of various items of wealth in
" value” has a great advantage over its measure
ment in “ quantity.” It enables us to translate
many different kinds of wealth into one kind and
thus to add them all together. Pairs of shoes,
pounds of beef, houses, and bushels of wheat are

unlike quantities and cannot be added together.
But their values, being expressed in a single common
unit (as the dollar),may be added together, despite

the diversity of the various articles thus valued .

WHY IS THE DOLLAR SHRINKING ?

[Ch. I.

Since prices and values are usually expressed in
terms of money, — the most exchangeable kind of
wealth, — money may be said to bring uniformity

of measurement out of diversity . In other words,
it is not only a medium of exchange, but it can be
used also as a measure of value.

It serves as a means of comparing values of differ
ent things by expressing them both in a common
denominator. It would be far more trouble to
compare each article directly with every other

article, for there would be very many more com
parisons.
Although this reduction to a common money
measure is a great practical convenience, we must
not imagine that it gives what could in any fair
sense be called “ the only true measure” of wealth.
In fact, to measure the amount of wealth by its

money value is often misleading. The money value
of car wheels exported from the United States in
one month was $ 12,000 and in a later month $ 15 ,
000 , from which fact wemight infer that the quantity
of these exports had increased . But the number
of car wheels exported in the first of those two

months was 2200, and in the second only 2100 ,
showing a decrease. The price had increased faster
than the number had decreased . sLikewise
, the
en fa ainn ithese
ho
ncrea eperiods
eriods sshow
figures for imports offallcoffee
a decline in dollars, despite an increase in pounds.
Here the price had fallen faster than the number
of pounds had risen . It is conceivable that the

$ 1.)

UNDERLYING IDEAS

quantity of every article might decrease , and yet
the price simultaneously increase so much that
there would be an apparent increase of wealth when

there really was nothing of the kind . This is apt
to be the case in times of inflation and depreciation

of the currency , such as the present. For this
reason a very large part of the alleged recent increase
of wealth and trade in the United States is fictitious.
Even when we are confessedly trying to measure
the value of wealth and not its quantity, it is diffi

cult or impossible to find a one " right" way. Im
ports into the United States from Mexico in one

year were worth 28 millions of American gold dol
lars , and ten years later their value was 40 millions
- an increase in value of 42 per cent; but these

very same imports measured in Mexican silver
dollars were 41 millions in the first year and 90

millions in the second — an increase in value of
nearly 120 per cent. These two rates of increase ,
42 per cent and 120 per cent, although they repre
sent exactly the same facts, do not agree with each
other ; yet the American merchant reckons the

values one way, and the Mexican merchant the
other .

In a sense both are right ; that is to say ,

both are true statements of the comparative value of
thearticles imported ,one of the value in gold and the
other of the value in silver.

If the value were to be

measured in iron , copper, coal, cotton , orany other ar
ticle,we should haveas many other different" values,”
and no two of them would necessarily agree.

WHY IS THE DOLLAR SHRINKING ? (CH. I.
“ The value of wealth ,” therefore, is an incomplete

phrase ; to be definite , we should say, “ the value of
wealth in terms of gold ,” or in terms of some other
particular kind of wealth. Hence we cannot employ
such values for comparing different groups of wealth ,

except under certain conditions, and to a limited

degree. To compare the wealth values of distant
places or times — as America and China, Ancient
Rome and Modern Italy — will inevitably give
conflicting and unsatisfactory results.

§ 2 . Property
To own wealth is to have a right to its benefits.
Thus to own a loaf of bread means nothing more
nor less than to have the right to benefit by it, i.e .,
to eat it, sell it, or otherwise employ it to satisfy one's
desires. To own a suit of clothes is to have the
right to wear it . To own a carriage is to have the

right to drive in it or otherwise utilize it as long as
it lasts. To own a plot of land means to have the
right to use it forever . The ultimate objects for
which wealth exists are the benefits which it confers.
If some one should give you a house on condition
that you should never use it , sell it, rent it, or give

it away, you might be justified in refusing it as
worthless.

Many articles confer benefits on their owners

by yielding them money. The benefit to the land
lord from the land or building which he lets is the
receipt by him of rent . The benefit to the owners

§ 2.)

UNDERLYING IDEAS

of a railway from the railway is the receipt by them
of their dividends. But not all benefits , of course ,
are simply the receipt of money, and even the receipt
of money is not an ultimate benefit, but only a

means to enjoyments.
Benefits may also be rendered by human beings .
Such benefits are usually called services or work
done. When rendered by things rather than
persons, benefits are commonly called uses.

Sometimes benefits consist of positive advantages
and sometimes of the prevention of disadvantages .
To be more exact, benefits mean either desirable
events obtained or undesirable events averted by means

of wealth or human beings. For example , when
a loom changes yarn into cloth , the transformation
is a desirable change due to the loom ; it is a
benefit conferred or performed by the loom . The
benefit from a plough is the turning up of the soil.

The benefits or services performed by a bricklayer
consist in the laying of bricks. The benefits or
uses conferred by a fence around a farm

consist

in preventing the cattle from roaming away. The

dikes in Holland confer the benefit of keeping out
the ocean. The benefits conferred by a diamond
necklace consist in its pleasing glitter .
Benefits may bemeasured just as wealth may be
measured, although the units of measurement are
not, of course, the same. The measurement of ser
vices or benefits is usually rougher than that of
wealth, because it is more difficult to establish units

WHY IS THE DOLLAR SHRINKING ?
of measure.

[Ch. I.

The shelter of a house and the use or

" wear" of a suit of clothes are difficult to measure
accurately . To save trouble, benefits are usually
measured by time, although , as soon as it becomes
profitable to do so , the tendency is to establish a

more satisfactory measure “ by the piece.”
Opposed to the benefits of wealth are its costs.
Costs may be called negative benefits. The pur
pose of wealth is to benefit its owner ; that is, to

cause to happen what he desires to happen, and to

prevent from happening what he desires not to
happen. But often wealth can work no benefit with
out entailing some cost, i.e., preventing what is

desirable or occasioning what is undesirable . For
instance, one cannot enjoy the benefits of a dwelling
without incurring the costs of taking care of it.
Costs may, of course, be measured , just as benefits
are measured — by number, by time, or by other

appropriate units ; and costs, when thus measured
may, by price and value, be translated into terms
of money precisely like the opposite items — bene
fits.

Wemustbeware of assuming that cost is always in
the form of an expenditure of money. Such money
cost has received exaggerated importance in the
eyes of business men and has tended to hide themore

important and fundamental kind of cost, namely ,
labour. Even labour appears to the employer
in the guise of a money cost — the expenditure of

wages. This expenditure , however, is not itself
10

$ 2.)

labour.

UNDERLYING IDEAS

Those who feel a real labour cost are the

labourers themselves. It is by their physical and
mental exertions that the work of the world is chiefly
done.
In the last analysis payments of money from one

member of society to another are neither income nor
outgo to society as a whole. Yet when people talk
of the cost of production, they usually think of
money payments. The items called costs of pro
duction are mostly payments from person to person ,
at various stages of production . Each such item
is two-faced and, in the final total, wipes itself off

the slate . The only ultimate item of cost is labour
cost or efforts ; that is, all the experiences of an un

desirable nature which are undergone in order
that experiences of a desirable nature may be se

cured. In the last analysis income consists of satis
factions and outgo of efforts to secure satisfactions.
Between efforts and satisfactions may intervene

innumerable payments and operations, but they
all must cancel out in the end . They are merely
the machinery connecting the efforts and satis

factions. This is evident in the case of an isolated
individual like Robinson Crusoe, who handles no

money ; but it is equally true of the most highly
organized society. It is only obscured by the fact
that each member of such a society talks and thinks
in terms ofmoney.
Our real income is the receipt, not of money , but

of what money is spent for, i.e.,what is often called

WHY IS THE DOLLAR SHRINKING ? (CH. I.
our “ living.” That is, money income is converted
into or spent for real income in the form of food and

clothing, or rather the use of food and clothing, and
in the form of shelter , amusements, etc., i.e ., the
use of dwelling-houses and of the other goods con

tributing direct benefits to human beings. These
uses include the necessaries, comforts, and luxuries

of life. The more money incomeit costs to acquire
a given amount of real income, the higher the “ cost

of living,” of which we hear so much to -day. The
money which the workman is paid in wages is not
his real wages, but only his nominal wages. The
real wages are the workman's living for which that
money is spent.

If a man has the right to all the prospective bene

fits which may come in the future from a particular
article of wealth , he is said to have its complete
ownership , or its ownership without encumbrance.

If he has a right to only some of the benefits from a
particular article of wealth , he is said to own that
wealth partially , or to “ have an interest ” in it .
When two brothers own a farm equally in partner
ship , each is a part owner ; each has a half interest

in the farm ; that is, each has a right to half of the
benefits to be had from the farm . What is divided
between the two brothers is not the farm , but the
benefits of the farm .

To emphasize this fact, the

law describes each brother's share as an “ undivided

half interest.” Partnership rights are usually em
ployed only when the number of coöwners is small.
12

$ 2.]

UNDERLYING IDEAS

When the number is large, the ownership is usually
subdivided into shares of stock ; but the principle is
the same — each individual owns a right to a certain
fraction of the benefits which come to the owners.

After the quantities of property of different kinds
are measured, we may apply the same concepts of

transfer, exchange , price, and value which have
already been applied to wealth and benefits, each
particular kind being measured in its own partic

ular unit. Consider, for example , the property
called stock in the Pennsylvania Railway Company.

This is measured by the “ number of shares," the
share here being the unit of measurement.
If wealth were always owned in fee simple, i.e.,
if there were no division of ownership , — no partner
ship rights , no shares and no stock companies, –

there would be little practical need to distinguish

property from wealth ; and as a matter of fact,
in the rough popular usage, any article of wealth ,
and especially real estate , is often inaccurately
called a " piece of property .” But the ownership
of wealth is frequently divided ; and this fact neces
sitates a careful distinction between the thing owned

and the rights of the owners. Thus, a railroad is
wealth . Its shares and bonded debt are rights to

this wealth . Each owner of shares or bonds has
the right to a fractional part of the benefits from the
railway. The total of these and the other rights

comprises the complete ownership of, or property
in , the railway.

WHY IS THE DOLLAR SHRINKING ? (CH. I.
Besides the distinction between wealth and prop
erty rights, another distinction should here be noted.
This is the distinction between property rights

and certificates of those rights. The former are
the rights to use wealth , the latter are merely the
written evidence of those rights.

Thus, the right

to receive dividends from a railroad is property,
but the written paper evidencing that right is a

stock certificate. The right to a railway trip is a
property right, the ticket evidencing that right is a

certificate of property. The promise of a bank is
a property right; the bank note on which that
promise is engraved is a certificate of property.

The three really important and fundamental
concepts which have been defined are wealth , bene

fits, and property. As each of them appears ex
plicitly in exchange for money , it is convenient to
employ some one collective term to embrace them

all. The term we shall use for this purpose is
" goods."

CHAPTER II
MONEY

§ 1 . Money Fallacies
ONE purpose of the last chapter was to afford a
general picture of the various kinds of goods —

wealth , property, services — with which we meet
in commerce . In this chapter and the next we shall
give our attention to that particular group of
goods — money and its substitutes — for which all

other goods are commonly exchanged .
The subject of the present chapter ,money, is be
set with misunderstandings and fallacies. We may
as well pause at the outset to mention , although
we will not attempt to fully explain or expose, a few
of the most common and persistent money fallacies
and confusions. When the reader has finished the
book , he will be able to refute their fallacious reason

ing for himself.
First of all we must not make the mistake of
confusing money with wealth . We have seen that

wealth is different from and bigger than money.

Yet it is astonishing how easy it is to forget this
simple fact. One reason for forgetting it is because

of the careless use of words, as when we say of a
rich man " he has a great deal of money.”

Few

persons, to be sure, are so naïve as to imagine that
15

WHY IS THE DOLLAR SHRINKING ? (CH. II.

a millionnaire is one who has a million dollars of
actualmoney stored away ; but they vaguely assume
that somewhere or somehow " he has the money.”

Among money fallacies is the idea that if
oneman “ makes” money, someone else must “ lose ” .
it, since there is only a fixed stock of money in the
world , and it seems clear that “ whatever money
the money -maker gets must come out of some one

else's pocket.” The flaw in this reasoning is the
assumption that gains in trade are simply gains
in actual money, so that in every business transac

tion only one party can be the gainer. If this were
true, we might as well substitute gambling for busi
ness and for manufacturing ; for in gambling the
number of dollars won is equal to the number of

dollars lost. As a matter of fact, however , it is not

in order to obtain money that people engage in
trade, but in order to obtain what money will buy ,
and that is precisely what both parties to a normal
transaction eventually do obtain .

Again , some persons have tried to prove that the
people of the earth can never pay off their debts

because these debts amount to more than the
existing supply of money . “ If we owe money,"
it is argued, “ we can't pay more money than there
is.” This assertion sounds plausible ,but a moment's

thought will show that the same money can be, and
in fact is, paid over and over again in discharge of
several different debts ; not to mention that some

debts are paid without the use of money at all.
16

§ 1.]

MONEY

A few years ago at a meeting of the American
Economic Association a Western banker expressed
the opinion that the total amount of money in the
world ought to be equivalent to the total wealth of
the world ; else, he suggested , people would never
be able to pay their debts. He explained that in
the United States there were then twenty dollars
of wealth for every dollar of money ; and he inferred
that therefore there was but one chance in twenty

of a debtor's paying his debts. “ I will give five
dollars,” he said, “ to any onewho can disprove that

statement.” When no one accepted the challenge,
a wag suggested that it was because there was but
one chance in twenty of getting the promised five
dollars ! The attempt to equalize money and wealth
by increasing money twenty-fold would , as we shall
see later, prove absolutely futile. The moment

we increased the amount of money, the money value
of all other forms of wealth would rise , and there

would , therefore, still be a discrepancy between the
amount of money and the money value of wealth .

A very persistentmoney fallacy is the notion that
sometimes there is not enough money to do the
world 's business, and that unless at such times the

quantity of money is increased , the wheels of busi
ness will either stop or slacken their pace. The
fact is, however, that any quantity of money,
whether large or small, will do the world 's business
as soon as the level of prices is properly adjusted
to that quantity. In an article on this subject
17

WHY IS THE DOLLAR SHRINKING ? (CH. II.
a few years ago an editor of a popular magazine
put this fallacy into the very title : " There is not
enough money in the world to do the world 's work .”
He said , “ Themoney is not coming out of the ground

fast enough to meet the new conditions of life.”
In reality, money is coming out of the ground faster
than the“ new conditions" require at the present level
of prices, with the consequentresult of raising prices.
A more subtle form of money fallacy is that which

admits that money is not identical with wealth ,
but contends that money is an indispensable means
of getting wealth . A very intelligent gentleman
recently asserted that the railways of this country

could never have been built in the early fifties had
it not been for the lucky discovery of gold in Cali
fornia in 1849, which provided the “ means by which
we could pay for the construction of the railways."
He overlooked the fact that the world does not get

its wealth by buying it. One person may buy from
another ; but the world as a whole does not buy
wealth , for the simple reason that there would be

no one to buy it from . The world gets its railways,

not by buying them , but by building them . What
provides our railways is not the gold mines, but the

iron mines. Even though there were not a single
cent of money in the world , it would still be possible

to have railways. The gold of California enriched
those who discovered it because it enabled them
to buy wealth of others; but it did not provide the
world with railways any more than Robinson
18

§ 1.)

MONEY

Crusoe's discovery of money in the ship provided

him with food.
If money could make the world rich , we should
not need to wait for gold discoveries. We could

make paper money . This, in fact , has often been
tried . The French people once thought they were
going to get rich by having the government print

unlimited quantities of paper money. Austria ,
Italy , Argentina, Japan , as well as many other
countries, including the American colonies, and the

United States , have tried the same experiment with

the same results — no real increase in wealth , but
simply an increase in the amount of money to be
exchanged for wealth .
A similar and very common fallacy is that to pro
mote the circulation ofmoney is to promote theacqui
sition of wealth . Frederick the Great tried to justify

his wars on this ground. In a letter he said : “ My
numerous armies promote the circulation of money,
and disburse impartially among the provinces the

taxes paid by the people of the state.” The idea back
of such statements is that some gain is secured by
artificially forcing money to change hands. Of course

the circulation of money is not, of itself, of any im

portance unless,with it, occurs an increase of wealth .
The idea that money is the essence of wealth was
one of the ideas which gave rise to a set of doctrines
and practices, called Colbertism or Mercantilism ,
constituting the earliest so -called “ school" of polit
ical economy. Colbert was a distinguished minister
19

WHY IS THE DOLLAR SHRINKING ? (CH. II.
under Louis XIV of France in the seventeenth
century, and a firm believer in the theory that, in
order to be wealthy , a nation must have an abun
dance of money. His theory becameknown as Mer
cantilism because it regarded trade between nations
in the same light in which merchants look upon

their business — each measuring his prosperity by
the difference between the amount of money he ex
pends and the amount he takes in . To keep money
within the country , Colbert and the Mercantilists
advocated the policy now known as “ protection .”
To -day it is generally understood that, in trade
between nations, as in that between individuals,
both parties may gain in an exchange transaction ;
but the mercantilistic fallacy that a nation may get
rich by selling more than it purchases, and collecting

the “ favourable balance of trade” in money, still
forms one of the popular bases of protectionism in

the United States. The more intelligent protec
tionists give quite different reasons for a protective
tariff, but the old fallacious reason still appeals to
the multitude. They continue to think that by
putting up a high tariff so that people are prevented
from spending money abroad and are compelled
to keep it at home, the country will in someway be

made richer. One reason for the persistence of this
fallacy is the continued use of the misleading phrase

“ favourable balance of trade” to indicate an excess
of exports over imports, and " unfavourable balance
of trade ” to indicate the opposite condition .
20

§ 1.)

MONEY

There is a common money fallacy concerning the
rate of interest. The rate of interest may be defined

as the ratio of an annual payment of money to the
lump sum of money which that annual payment
will buy . So the rate of interest is often called the

" price of money," and it is inferred that the rate

of interest depends upon the quantity of money on
the market. The trade journals tell us that “ money
is easy ” in Wall Street, meaning that interest is
low , or that it is easy to borrow money . Or we are
told that " the money market is tight,” meaning
that it is hard to borrow money . Weoften hear the

argument that the present high cost of living cannot
be due to any plentifulness of money, because if

money were really plentiful, it would be “ cheap,"
i.e., the rate of interest would be low . Probably
the great majority of unthinking business men be

lieve that interest is low when money is plentiful,
and high when money is scarce. But this view is
fallacious and does not agree with the facts.
We must remember that interest is not only the

price ofmoney,but also theprice in money. Thus the
rate of interest is found by dividing, say , the $ 5 paid
per yearby the $ 100 cash for which it is paid . Both

the numerator and the denominator of this fraction
are expressed in termsofmoney .

Inflation ofmoney

ultimately works equally on both sides.
We should beware of the phrase " the price of

money,” for it has two meanings. It may mean the
rate of interest, which is a ratio of exchange between
21

WHY IS THE DOLLAR SHRINKING ? [CH. II.
two moneys — the price of money capital in terms

of money income; or it may mean the purchasing
power of money over other goods — the amount

of other goods for which a given amount of money
can be exchanged . The abundance of money will,
as we shall see , reduce its price in the latter sense
of purchasing power over goods, but it need not on

that account reduce its price in the former sense of
the rate of interest.

We shall find that the real importance of the
quantity of money lies, not in the so-called money
market — the loan market — but in the general

level of prices. Curiously enough , in the popular
mind the exact opposite is commonly supposed .
It is believed that money greatly affects the money
market, but has little or nothing to do with the high
cost of living.

Money fallacies of the kinds we have described
must be carefully avoided . We should be on our

guard against every proposition concerning money.
“ Making " money , for instance , is a catch phrase ,
used without any definition. Properly speaking,
1 One reason for this idea is that a banker usually looks
upon money in relation to his reserves.

If the bank re

serve is low , he raises the rate of interest to " protect "
his reserve, while if the reserve is abundant, he reduces

the rate of interest in order to reduce the reserve.

The

banker is constantly watching his reserve, and has to
adjust the rate of interest with respect thereto . But he
should not judge the amount of money in circulation by
the amount of money inside his vaults.
22

MONEY

§ 2.)

nobody can " make " money except the man in the
mint. The rest of us may gain wealth , but, unless

we are counterfeiters, we cannot literally " make"
money .

We live in a complicated civilization in which
we talk in termsofmoney. Money has come to be
a sort of veil which hides the other and more impor
tant wealth of the world .

$ 2 . Prices in General and in particular
The chief purpose of this book is to study the pur
chasing power of a monetary unit — let us say ,
the dollar. But the purchasing power of the dollar

is simply the reciprocal of the general level of prices.
To say that prices have doubled is the same thing
as to say that the purchasing power of the dollar

has been cut in two. Our problem is therefore
simply to study the general principles which deter
mine the rise or fall of prices , a subject which to -day

is receiving world -wide attention under the head
of the “ high cost of living.”
Unfortunately few of those people who talk so
glibly about the high cost of living realize the mone

tary side of the problem . Not only do they fix
attention on the goods side, but they make the mis
take of thinking that a general rise of prices is ex

plainable on the same principles of supply and de
mand as apply to the rise of a particular price .
They think that they can explain the general rise
of prices by explaining the rise of each individual
23

WHY IS THE DOLLAR SHRINKING ? (CH. II.

price . One might as well try to explain the rise
of the tides by observing the causes which raise up

individualwaves.
The truth is that so far from the general level of
prices depending on individual prices , each individual
price depends in part on the general level of prices.
Thus the price of sugar is a ratio between sugar
and money. Any one who buys sugar balances

in his mind the importance of the sugar to him as
against the importance of the money which he has
to pay for it.

In making this comparison , the

money stands in his mind for the other things which
it might buy if not spent for sugar. If this general
purchasing power of the dollar is great, money will
seem precious in his mind, and he will bemore loath
to part with a given amount of it for sugar than if

its purchasing power over other things is small ;
that is, the greater the power of money to purchase
things in general, the less of it will be offered for
sugar in particular, and the lower the price of sugar
will therefore become. In other words, the lower

the general price level, the lower will be the price
of sugar. In still other words, the price of sugar

must sympathize with prices in general. If they are
high , it will tend to be high, and if they are low , it
will tend to be low . Before the purchaser of sugar
can decide how much money he is willing to exchange

for it, hemust have some idea of what else he could
buy for his money.

This explains why a traveller feels at first so help
24

§ 3.]

MONEY

less in a foreign country when he is told the prices
of goods in terms of unfamiliar units.

If the trav

eller has never heard before of kronen , gulden ,
rubles, or milreis, any prices expressed in these units

will mean nothing to him . He cannot say how many
of any one of these units he is willing to pay for any
given article until he knows how the purchasing

power of that unit compares with the unit to which
he is accustomed. There must always be in the
minds of those who use money some idea of its

purchasing power. This needs emphasis because
it is so often overlooked . Although the purchasing

power of money is assumed,weare usually as uncon
scious of it as we are of the background of a picture

against which we see and unconsciously measure
the figures in the foreground.
Let us, then , once for all, give up any thought of
studying the prices in the price level singly , and
instead , consider them in the mass . We shall see

that it is a question of the flow of money and its
substitutes, and the flow of goods in return for them .

It is just as possible to study the general level of
prices independently of particular prices as it is
to study the general tides of the ocean independently
of its particular waves. To do this , however, will
require a study of money .

83. The Nature of Money
It is a very curious fact that money, though a
most convenient device in practice , is always a stum
25

WHY IS THE DOLLAR SHRINKING ? [CH. II.

bling-block in theory. At the beginning of this

chapter we pointed out some of the imagined
functions of money that do not belong to it.
We are now ready to ask : What are the real

functions of money ?

We have defined money primarily as wealth
generally acceptable in exchange. But when this
definition was framed we had not yet defined prop

erty rights as a form of goods distinguishable from
concrete wealth ; and these rights, especially in the
form of bank -notes, are also generally acceptable
in exchange. We therefore now extend our defini

tion of money to include all goods generally accept
able in exchange for other goods. The term money
is also used loosely to refer to the certificate of such

property right. Thus we generally think of the
paper bank -note itself as money rather than the
right which it certifies.

The facility with which money may be exchanged
or its general acceptability is the chief characteristic
of money. This general acceptability may be re
enforced by law , the money thus becoming “ legal
tender.” 1 But such reënforcement is not essential.

All that is necessary in order that any good may be
money is that general acceptability shall attach to

it. On the frontier, without any legal sanction ,
money is sometimes gold dust or gold nuggets.
1 Legal-tender money is money which may be legally
tendered or offered by a debtor to his creditor in discharge
of any debts expressed in terms of money .
26

$ 3.)

MONEY

In the colony of Virginia it was tobacco . Among
the Indians in New England it was wampum .

How does it happen that any particular commod
ity comes into use as money ? Not originally be
cause a government so decreed, but because the
commodity was readily salable on account of its utility
for direct commodity uses quite other than monetary .

It is not likely that the monetary use was at
first even thought of.

It simply grew gradually .

Thus gold was readily sold and resold . Many
wanted it for jewellery, and many others could

easily be induced to accept it in exchange, even if
they had no personal use for it themselves ; for they
knew they could resell it at any time to some one
who had such a use for it. Gradually it became

customary to accept it with no thought of any other
use than to resell it or pass it on indefinitely . Gold
has finally survived as the most important form of
money . It is easily transportable and is durable .
Practically all metallic money to -day in civilized
countries is “ coined,” but uncoined gold nuggets or
bars are just as truly money if they are generally
acceptable in exchange. At bottom , coining is merely
putting on a certification of weight and fineness.
“ Coining " puts the finishing touch on money as
distinct from other exchangeable goods. As long

as money is still, let us say, gold nuggets or gold
dust, there is nothing definitely to distinguish it
as money from other goods of high exchange
ability except its higher exchangeability, or, to put
27

WHY IS THE DOLLAR SHRINKING ? [CH. II.
it in another way, there is little reason why other
articles almost as exchangeable as the gold nuggets

and gold dust should not be called money.
In the pre-coinage stage the world was in a tran
sition period between a system of barter and a
system of purchase -and -sale. Gradually barter
became obsolete because of its inconveniences and
annoyances; thus under the preëxisting system of
out and out barter in which every article is exchanged

directly against every other , there were between ten
articles 45 price ratios as against 10 if money were
used ; between one hundred articles there were

4950 such ratios instead of 100. Alfred Russell
Wallace ,when travelling in the Malay Archipelago,
where only barter existed , had to keep on hand a

supply of knives, cloth , sago, and numerous other
commodities in order to be able to do any trad
ing .

Barter is also inconvenient because some of the

various goods which have to be used — for example ,
knives — are not easily subdivided .
Nevertheless, barter is not yet entirely extinct

and probably never will be. Farm labour is partly
paid in farm products, and country clergymen are
sometimes paid by their parishioners in the produce
of their farms. In factory towns the employees
are sometimes paid in " truck ” at “ the company

store.” In fact, even in the most highly organized
and modern markets with every monetary and credit
facility , barter is still practised in certain cases.
28

§ 3.]

MONEY

Servants receive part of their pay in board and lodg

ing. Other occasional sporadic cases of barter are
of daily occurrence. Yet these cases are insignifi
cant in comparison with the colossal exchanges
effected by money and checks.

There are variousdegrees of exchangeability which
must be transcended before we arrive at real money.
Of all kinds of goods, one of the least exchangeable

is real estate. It is often difficult to find a person
who wants to buy a particular piece of real estate.
A mortgage on real estate is one degree more ex

changeable . Yet even a mortgage is less exchange
able than a well-known and safe corporation security
or a government bond. One degree more exchange
able than a government bond is a time bill of ex
change ; one degree more exchangeable than a time
bill of exchange is a sight draft ; while a check is
almost as exchangeable as money itself. Yet no
one of these is really money ; for none of them is
“ generally acceptable.”

If we confine our attention to present and normal
conditions, and to those means of exchange which
either are money or most nearly approximate it,
we shall find that money itself belongs to a general
class of goodswhich we may call “ circulatingmedia .”
Circulating media may be any kind of goods which ,
whether generally acceptable or not, do actually ,
for their chief purpose and use, serve as a means
of exchange.
Circulating media consist of two chief classes :
29

WHY IS THE DOLLAR SHRINKING ? (Ch. II.
( 1) money ; ( 2 ) bank deposits. By means of checks,
bank deposits serve as a means of payment in ex

change for other goods. A check is the evidence
of the transfer of bank deposits. It is acceptable

to the payee only by his consent. It would not
be generally accepted by strangers . Yet by checks,

bank deposits, even more than money, do actually
serve as a medium of exchange.

In this country,

bank deposits subject to check, or, as they are some
times called , “ deposit currency," perform over
90 per cent of all exchange transactions.
But although a bank deposit transferable by check

is included in circulating media , it is not money.
A bank note, on the other hand, is both circulating

medium and money . Between these two lies the
final line of distinction separating what is money

and what is not. The line is delicately drawn,
especially in the case of such checks as cashier's
checks or certified checks ; for the latter are ex
tremely similar, in respect to acceptability , to bank

notes. Each is a demand liability on a bank , and
each confers on the holder the right to draw money .

Yet while a bank-note is generally acceptable in
exchange, a check is acceptable only by special
consent of the payee . Real money is what a payee

accepts without question, because he is induced
to do so either by “ legal tender” laws or by a well
established custom or both.

Of real money there are two kinds: primary
and fiduciary. Money is called primary if it is a
30

$ 3.)

MONEY

commodity, any given unit of which has just as
much value in some other use as it has in monetary

use ; that is, primary money is a commodity which
has its full value even if it is not used as money or
even if it is changed to a form in which it will not
circulate as money. For instance , gold coins in
the United States are primary money, since their
value will be undiminished even if they are melted

into gold bullion. In the same way, the tobacco
money of Virginia in colonial days was primary,
having as much value as tobacco as it had as money.
Fiduciary money, on the other hand , is money
the value of which depends partly or wholly on the

owner's confidence that he can exchange it for
primary money, or at any rate for other goods, e.g.,

for primary money at a bank or government office
or for discharge of debts or purchase of goods of
merchants. For instance, a silver dollar in the

United States is fiduciary money, since it is worth
a dollar only because of the public confidence that

the government will take it in taxes and the people
in discharge of debts and for other purposes on equal
terms with a dollar of gold . If a silver dollar be
melted into bullion , it will, unlike the gold dollar,
1 Some economists have proposed that what is here
called “ fiduciary " money should not be called money at
all ; that is, that the term “ money " should be restricted
to primary money. It seems preferable , however, here as
elsewhere, to follow ordinary usage.

There are instances

where countries have for a time had no primary money,

but only fiduciary money .
31

WHY IS THE DOLLAR SHRINKING ? (CH. II.
II

.

lose a large part of its value. That is, the bullion

in a silver dollar is not worth a dollar ; it is only
worth about forty cents . Our other silver coins
are worth as bullion even less in proportion to their

value as money, and our nickel and bronze coins
are worth still less in proportion . Bank -notes,

government notes, and other forms of paper money
are still more striking examples of fiduciary money,

being practically
worthless as

paper, but hav

DEPOSITS SUBJECT
TO CHECK

ing a high value
as money , owing
to theconfidence

that they can be

8

FIDUCIARY
MONEY

PRIMARY
MONEYİF
2 /3

exchanged

for

gold at thebanks

| BILLIONS

or the govern

ment treasury .
The larger part

BILLION Z

of the money in

Fig . 1

use in the United

States is fiduciary money , the chief examples being
silver dollars, fractional silver, minor coins, silver
certificates, gold certificates, governmentnotes (nick
named “ green -backs” ) , and bank -notes . The exact
nature of these various kinds of money constitutes

a subject outside the purpose of this book. The
reader can, however, learn much as to their nature
for himself,by reading the inscriptions on the various
32

§ 3.]

MONEY

forms of money, which , from time to time, pass
through his hands.
The qualities of primary money which make for
exchangeability are numerous. The most important

are portability, durability, and divisibility. The
chief quality of fiduciary money, which makes it
exchangeable, is its redeemability in primary money,
or else its imposed character of “ legal tender.”
Figure 1 indicates the classification of all cir
culating media in the United States. It shows
that the total amount of circulating media is slightly
over ten billions, of which eight and one-half billions
are bank deposits subject to check, and one and two
thirds billions, money ; and that of this one and

two-thirds billions of money one billion is fidu
ciary money and only two-thirds of a billion primary
money .

33

CHAPTER III
THE EQUATION OF EXCHANGE
§ 1. Arithmetical Illustration

In the present chapter we shall study the pur

chasing power of money in a preliminary way, ex
cluding the consideration of bank deposit - or

check — circulation and confining our attention to
the circulation of money, primary and fiduciary.
In the United States our only primary money

is gold coin. The fiduciary money includes token
coins and paper money.
Checks aside,we may classify exchanges into three

groups : the exchange of money against money ; or

“ changing money ” ; the exchange of goods against
goods, or “ barter” ; the exchange of money against
goods, or purchase and sale. Only the last-named

species of exchange involves what we call the circu
lation ofmoney.

The circulation ofmoney signifies,

therefore, the aggregate amount of its transfers
against goods. All money held for circulation, i.e.,
for use in payment for goods purchased , is called

money in circulation . This includes the money in
the pockets and purses of the people and in the tills
and safes of merchants. In the United States this
includes all money except what is in the vaults of

the banks and of the United States government.
34

§ 1.]

THE EQUATION OF EXCHANGE

If for the present we overlook the influence of
checks, we may say that the price level depends on
only three sets of causes : (1) the quantity of money

in circulation ; (2) its “ efficiency ” or velocity of
circulation (or the average number of times a year
a dollar is exchanged for goods) ; and (3 ) the volume

of trade (or amount of goods per year bought by
money) . The so-called " quantity theory ” (i.e.,

the theory that prices vary proportionally to money)
has often been incorrectly formulated, but it is at
least correct in the sense that the level of prices

varies directly with the quantity of money in cir

culation, provided the velocity of circulation of
that money and the volume of trade effected by
means of it are not changed . This theory will be
made clearer by the “ equation of exchange," which
is now to be explained .
The equation of exchange is a statement, in
mathematical form , of the total transactions effected

in a certain period in a given community. It is

obtained simply by adding together the equations
of exchange for all individual transactions. Sup
pose, for instance, that a person buys 10 pounds

of sugar at 7 cents per pound .

This is an exchange

transaction , in which 10 pounds of sugar have been

regarded as equivalent 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
· 35

WHY IS THE DOLLAR SHRINKING ? [CH. III.

of exchange for a certain period in a given community .
That is, the left side of this equation represents all
the money spent and the right represents the value

of all goods bought within the given period. Dur
ing this period, however, the samemoney may serve,
and usually does serve, for several transactions.

For that reason , the left, or money, side of the equa
tion is , of course, several times the total amount of

money in circulation . The money side may evi
dently be considered as the product of the quantity
of money multiplied by the rapidity of its circula
tion , i.e., the number of times it is exchanged for
goods.

The important magnitude called the velocity of
circulation or rapidity of turnover means simply
the quotient obtained by dividing the total money
payments for goods in the course of a year by the
average amount in circulation in an entire com

munity and is a sort of average of the rates of turn
over of different persons. Each person has his own

rate of turnover ,which he can readily calculate by
dividing the amount of money he expends per year
by the average amount he carries. The goods side

of the equation is made up ofthe quantities of goods
multiplied by their respective prices.
Let us begin with the money side of the equation
of exchange. If the number of dollars of money in
a country is 5 ,000,000 , and the average velocity of

circulation of these five million dollars is twenty

times per year , then the total amount of money
36

$ 1.)

THE EQUATION OF EXCHANGE

expended (for goods) during any year is $ 5,000 ,000
X 20 , or $ 100,000,000 . This is the money side of the
equation of exchange.
Since the money side of the equation is $ 100 ,000 ,

000, the goods side must be the same. For if $ 100 ,

000,000 has been spent for goods in the course of
the year, then $ 100 ,000 ,000 worth of goods must

have been sold in that year. In order to avoid the
necessity of writing out the quantities and prices

of the innumerable varieties of goods which are
actually exchanged , let us assume for the present

that there are only three kinds of goods — bread ,
coal, and cloth ; and that the sales are :
200 ,000 ,000 loaves of bread at $.10 a loaf,
10 ,000,000 tons of coal at $5.00 a ton , and
30 ,000,000 yards of cloth at $ 1.00 a yard .

The total value of these transactions is evidently

$ 100, 000,000, i.e., $ 20,000,000 worth of bread plus
$ 50 ,000,000 worth of coal plus $ 30 ,000 ,000 worth
of cloth .

The equation of exchange, therefore, is

as follows:
$ 5,000,000 X 20 = 200,000,000 loaves X $ . 10 a loaf
+ 10 ,000,000 tons

X $ 5 .00 a ton

+ 30 ,000,000 yards x $ 1.00 a yard .

This equation contains, then , on the money side

two magnitudes : (1) the quantity of money, and
(2) the number of times it circulates or is “ turned
over ” in a year; and on the goods side two groups
of magnitudes in two columns : (1) the quantities
37

WHY IS THE DOLLAR SHRINKING ? [CH. III.
of goods exchanged in a year (loaves, tons, yards),
and (2 ) the prices of these goods ($ . 10 per loaf,
$ 5 .00 per ton , and $ 1 .00 per yard ).

The equation

shows that these four sets of magnitudes are mu
tually related. Because this equation must be

fulfilled, the prices must bear a relation to the three
other sets of magnitudes — quantity of money,

rapidity of circulation, and quantities of goods ex
changed. Consequently, these prices must , as a

whole, vary proportionally with the quantity of
money and with its velocity of circulation , and in

versely with the quantities of goods exchanged .
Suppose, for instance, that the quantity of money
were doubled, while its velocity of circulation and
the quantity of goods exchanged remained the same.

Then, since the equation of exchange must con
tinue to hold true, it would be quite impossible for
prices to remain unchanged . Themoney side would
now be $ 10 ,000,000 X 20 times a year, or $200,

000,000 ; whereas, if prices should not change,
the goods would remain $ 100 ,000 ,000 and the

equation would be violated. Since exchanges,
individually and collectively, always involve an
equivalent quid pro quo, the two sides must be

equal. Therefore, under the given conditions,
prices must change in such a way as to raise the
goods side from $ 100,000,000 to $ 200,000,000.

This

doubling may be accomplished by an even or by an
uneven rise of prices, but some sort of a rise of prices
there must be. If the prices rise evenly , they will
38

§ 1.)

THE EQUATION OF EXCHANGE

evidently all be exactly doubled , so that the equa
tion will read :
$ 10 ,000,000 X 20 = 200 ,000,000 loaves X $ 20 per loaf
+ 10 ,000,000 tons X $ 10.00 per ton

+ 30,000,000 yards * $ 2.00 per yard .
If the prices rise unevenly , the doubling must evi
dently be brought about by compensation ; if some

prices rise by less than double, others must rise
by enough more than double to exactly compensate.

But whether all prices increase uniformly , each
being exactly double, or some prices increase more
and some less (so as still to double the total money
value of the goods purchased ), the prices are doubled
on the average. This proposition is usually expressed

by saying that the “ general level of prices” is raised
twofold . From the mere fact, therefore, that the

money spent for goods must equal the quantities
of those goodsmultiplied by their prices , it follows
that the level of prices must rise or fall according
to changes in the quantity of money, unless there
are changes in its velocity of circulation or in the

quantities of goods exchanged .
Just as changes in the quantity of money affect
prices, so will changes in the other factors — quan

tities of goods and velocity of circulation - affect
prices.

In the case of a change in the velocity

of circulation, the change is very similar to that
seen in the case of a change in the quantity of money.
Thus a doubling in the velocity of circulation of
39

WHY IS THE DOLLAR SHRINKING ? (CH. III.
money will double the level of prices, provided the
quantity of money in circulation and the quantities

of goods exchanged for money remain as before.
The equation will change (from its original form )

to the following : $ 5 ,000,000 X 40 = 200,000,000 loaves X $
+

10,000,000 tons

20 a loaf

X $ 10.00 a ton

+ 30,000,000 yards X $ 2 .00 a yard ;
or else the equation will assume a form in which
some of the prices will more than double , and others

less than double by enough to preserve the sametotal
value of the sales .
Again , a doubling in the quantities of goods ex
changed will cut in two the height of the price level,
provided the quantity of money and its velocity
of circulation remain the same. Under these cir

cumstances the equation will change (from its orig
inal form ) to :
$ 5 ,000,000 X 20 = 400,000,000 loaves X $ .05 a loaf
+

20 ,000 ,000 tons

X

+ 60,000,000 yards X

2 .50 a ton

.50 a yard ;

or else it will assume a form in which some of the

prices are more than halved , and others less than
halved, so as to preserve the equation .
Finally, if there is a simultaneous change in two
or all of the three influences , i.e., quantity of money,

velocity of circulation, and quantities of goods ex
changed, the price level will be a compound or re
sultant of these various influences. If, for example,
40

§ 2.)

THE EQUATION OF EXCHANGE

the quantity of money is doubled , and its velocity
of circulation is halved, while the quantity of goods
exchanged remains constant, the price level will be
undisturbed. Likewise , it will be undisturbed if
the quantity of money is doubled and the quantity
of goods is doubled, while the velocity of circulation
remains the same. To double the quantity of money,
therefore, does not always double prices. We must
distinctly recognize that the quantity of money is
only one of three factors , all equally important in

determining the price level.
§ 2. Mechanical Illustration

The equation of exchange has now been expressed
by an arithmetical illustration . It may be repre
sented visually by a mechanical illustration. This
is embodied in Figure 2,which represents a mechani

cal balance in equilibrium , the two sides of which
symbolize respectively themoney side and the goods
TITO
- T "
OO

R1901

Fig . 2

side of the equation of exchange. The weight at
the left, symbolized by a purse, represents the
money in circulation ; the leverage or distance from

the fulcrum atwhich the purse is hung represents the
41

WHY IS THE DOLLAR SHRINKING ? [CH . III.

efficiency ofthis money,or its velocity of circulation .
The product of the weight by its leverage is exactly
balanced by or equal to corresponding products on
the opposite side. On the right side are three

weights, representing bread , coal, and cloth , and
symbolized respectively by a loaf, a coal scuttle ,

and a roll of cloth . The leverage, or distance of
each from the fulcrum , represents its price . In
order that the leverages at the right may not be
inordinately long, we have found it convenient

to reduce the unit of measure of coal from tons to
hundredweights , and that of cloth from yards to
feet, and consequently to enlarge correspondingly
the number of units (the measure of coal changing

from

10,000,000 tons to 200,000,000 hundred

weights, and that of the cloth from 30 ,000, 000 yards

to 90 ,000,000 feet ). In these new units the price of
coal becomes 25 cents per hundredweight (in place

of $ 5 . 00 per ton) and that of cloth becomes 33 }
cents per foot (in place of $ 1.00 per yard ).
If the purse at the left becomes heavier, it is

evident that, in order to maintain the balance ,
some of the weights at the right must be heavier

also or must be moved toward the right, or else the
purse itself must be moved toward the right. If,
now , we assume that the last and first of these three
changes do not occur, the middle one must occur.
In other words, if the position of the purse remains

unaltered (i.e., if the velocity of circulation of
money does not change), and if the weights at the
42

$ 2.)

THE EQUATION OF EXCHANGE

right remain unaltered (i.e., if the volume of trade
does not change ), then some or all of these weights
must move to the right (i.e., the prices of goods
must increase ). If these prices increase uniformly,
they will increase in the same ratio as the increase
in money ; if they do not increase uniformly, some
will increase more and some less than this ratio ,

maintaining an average. Likewise , it is evident

that if the velocity of circulation ofmoney increases ,
i.e., if the leverage at the left lengthens, and if the
money in circulation (the purse) and the trade (the
various weights at the right) remain the same,
there must be an increase in prices (lengthening of
the leverages at the right). Again , if there is an
increase in trade (represented by an increase in

weights at the right), and if the velocity of money
(left leverage) and the quantity of money (left
weight) remain the same, there must be a decrease

in prices (right leverages).
In general, any change in one of these four sets

of magnitudes must be accompanied by such a
change or changes in one or more of the other three

as shall maintain equilibrium .
As we are interested in the average change in

prices rather than in the prices individually , we
may simplify this mechanical representation by
hanging all the right-hand weights at one average
point, so that the leverage shall represent the average
of prices. This average, of 10 cents per loaf, 25
cents per hundredweight, and 33 } cents per foot,
43

WHY IS THE DOLLAR SHRINKING ? [CH. III.
is found by dividing the total value (10 cents times
200 million loaves, plus 25 cents times 200 million

hundredweight, plus 33 } cents times 90 million
feet, or $ 100,000,000) by the total number of units

5 -MILLIONS

20000
200

·

Fig . 3

leta

(200 million plus 200 million plus 90 million, or
490 million ), which is $ 100,000,000 = 490,000,000,
or 20 .4 cents per unit. This leverage is a so
called “ weighted average ” of the three original
leverages, the " weights ” being literally the weights

hanging at the right.
This averaging of prices is represented in Figure

3, which visualizes the fact that the average price
of goods (right leverage) varies directly with the
quantity of money (left weight), directly with its
velocity of circulation (left leverage), and inversely

with the volume of trade (right weight).
§ 3. Algebraic Illustration
To put these relations in general terms, let
M stand for money in circulation ,
V , its velocity of circulation ,

P, p', p'', etc., the prices of various goods,

Q , Q ', Q " , etc., the quantities of those goods sold .
44

§ 3.]

THE EQUATION OF EXCHANGE

Then wemay write the formula as follows:
MV = pq
+ p'Q
+ p '' Q''
+ etc.
MV evidently represents the amount of money ex

pended for goods during the year. On the other side
of the equation , pQ , p ' Q', and so on , represent the
values of the various goodsbought. If in this equation
M is doubled (and V and the Q ’s remain unchanged ),
then the p's will, on the average, be doubled ; if V is
doubled (and M and the Q 's are unchanged), the p 's

will be doubled also ; while if the Q 's are doubled (and

M and V are unchanged ), the p’s will be halved.
The right side of this equation is the sum of terms
of the form pQ , a price multiplied by a quantity
bought. It is customary in mathematics to abbreviate
a sum of terms (all of which are of the same form ) by

using “ I!” as a prefix to pl . The Greek letter “ 2,"
called " sigma,” is the equivalent of the English letter
“ S ," the initial letter of “ sum ,” and is employed as a
symbol of summation.

This symbol does not signify

a magnitude as do the symbols M , V , P , Q , etc. It
signifies merely the operation of addition, and should
be read “ the sum of terms of the following type.”

The equation of exchange may therefore be written :
MV = EpQ .
Wemay, if we wish , further simplify the right side
by writing it in the form PT, where P is an average of

all the p’s, and T is the sum of all the Q ’s.

T then

represents in one magnitude the volume of trade of the
45

WHY IS THE DOLLAR SHRINKING ? (CH. III.

community. The equation thus simplified (MV = PT)
is the algebraic interpretation of themechanical illus

tration given in Figure 3, where all the goods, instead
of being hung separately, as in Figure 2 , are combined
and hung at an average point representing their aver
age price.

$ 4. The “ Quantity Theory of Money ”
To recapitulate, we find then that, under the
conditions assumed, the price level varies : (1) di
rectly as the quantity of money in circulation ( M ) ;

(2 ) directly as the velocity of its circulation (V ) ;
(3 ) inversely as the volume of trade done by it ( T).
The first of these three relations needs special em
phasis. It constitutes the “ quantity theory of
money .”
So important is this principle, and so bitterly
contested has it been , that we shall illustrate it

further. By “ the quantity of money ” is meant the
number of dollars (or other given monetary units)
in circulation . This number may be changed in
several ways, of which the four named below are

most important. A statement of these four will
serve to picture to our mind the meaning of the
conclusions we have reached and to reveal the fun

damental peculiarity of money on which they rest.
I. As a first illustration, let us suppose the govern
ment to double the denominations of all money ; that

is, let us suppose that what has been hitherto a half
dollar is henceforth called a dollar, and that what has
46

§ 4.

THE EQUATION OF EXCHANGE

been hitherto a dollar is henceforth called two dol
lars. Evidently the number of “ dollars” in cir

culation will then be doubled ; and the price level,
measured in terms of the new “ dollars," will be
double what it would otherwise be. Every one will
pay out the same coins as if no such law were passed .

But he will, in each case, be paying twice as many
“ dollars.” For example, if $3 formerly had to
be paid for a pair of shoes, the price of this same

pair of shoes will now become $6 . The number of
dollars in circulation ( M ) having been doubled (its
velocity of circulation (V ) and the volume of trade
( T ) remaining the same), the average of the prices
( P) must be doubled .
II. For a second illustration , suppose the govern
ment cuts each dollar in two, coining the halves

into new “ dollars ” ; and , recalling all paper notes , ·
replaces them with double the original number —
two new notes for each old one of the same denomina

tion. In short, suppose money not only to be re
named , as in the first illustration, but also reissued .
Prices in the debased coinage will again be doubled

just as in the first illustration . Wherever a dollar
had been paid before debasement, two dollars —
i.e ., two of the old halves coined into two of the new
dollars — will now be paid instead .

In the first illustration, the increase in quantity

was simply nominal, being brought about by re
naming coins. In the second illustration , besides

renaming, the further fact of recoining is introduced .

WHY IS THE DOLLAR SHRINKING ? [CH . III.

In the first case, the number of actual pieces of

money of each kind was unchanged , but their de
nominations were doubled. In the second case ,
the number of pieces is also doubled by splitting

each coin and reminting it into two coins, each of
the same nominal denomination as the original
whole of which it is the half, and by similarly doub

ling the paper money.
III. For a third illustration, suppose that, in
stead of doubling the number of dollars by splitting

them in two and recoining the halves, the govern
ment duplicates each piece of money in existence
and presents the duplicate to the possessor of the

original. (We must in this case suppose, further ,
that there is some effectual bar to prevent the melt

ing or exporting of money. Otherwise the quantity
of money in circulation will not be doubled ; much
of the increase will escape.) If the quantity of

money is thus doubled , prices will also be doubled
just as truly as in the second illustration , in which
there were exactly the same number of coins as
now under consideration as well as the same de
nominations. The only difference between the

second and the third illustrations will be in the size
and weight of the coins. The weights of the indi
vidual coins, instead of being reduced, will remain

unchanged ; but their number willbedoubled . This
doubling of coins must have the same effect as the

50 per cent debasement ; that is, it must have the
effect of doubling prices .
48

§ 4.]

THE EQUATION OF EXCHANGE

IV . The force of the third illustration becomes
even more evident, if (in accordance with the pres

entation of Ricardo) we pass back by means of a
seigniorage from the third illustration to the second .

That is, after duplicating all money , let the govern
ment subtract half of each coin , thereby reducing
the weight to that of the debased coinage in the
second illustration, and removing the only point
of distinction between the two. This " seigniorage "
or charge for coinage made by the sovereign will not
affect the money value of the coins, so long as their
number remains unchanged. Prices will remain
at exactly the same level as before the abstraction

of seigniorage.
Thus to double the quantity of money will double
prices in whatever way the doubling may be brought
about, — unless there should occur at the same
time some change in the velocity of circulation of
money or in the volume of trade.
The reader may ask whether some change in the

velocity of circulation of money or in the volume
of trade will not necessarily occur as a direct conse
quence of the increased quantity of money . The
answer to this question is in the negative , but this
answer will be better understood after we have seen
on what causes velocity of circulation and volume

of trade depend . In the present chapter we are
concerned merely to show that an increase in money

willnecessitate a rise in prices provided the velocity of
circulation and volume of trade do remain the same.
49

WHY IS THE DOLLAR SHRINKING ? (CH. III.

There are many historical instances of raising
prices by inflating the currency. At present, Ar
gentina has an inflated paper currency, and prices
in paper pesos are a little more than double the
prices in the original gold pesos.

The quantity theory, then , asserts that (pro
vided velocity of circulation and volume of trade

are unchanged) if we increase the number of dollars,
whether by renaming coins, by cutting them in
two, by duplicating them , or by any other means,
prices will be increased in the same proportion . It

is the number, and not the weight, that is essential.
As long as the number of dollars remains the same

each dollar will have the same purchasing power or

value, no matter what the weight may be.

This

fact needs great emphasis. It is a fact which differ

entiates money from all other goods and explains
the peculiar manner in which its purchasing power

is related to other goods.
In the case of sugar or any other ordinary com

modity it is the actual weight and not the number
of units in which that weight is expressed which is
the important thing. Thus if the quantity of sugar

in a community is changed from

1,000,000 hun

dredweight to 1,000 ,000 pounds, it does not fol
low that a pound will have the value in exchange

previously possessed by a hundredweight. But if

the money in circulation is changed from 1,000,000
units of one weight to 1,000,000 units of a lighter
weight, the value of the new and lighter coins will
50

§ 4.]

THE EQUATION OF EXCHANGE

be just as great as was the value of the old and
heavy ones, for we have seen from the equation of

exchange that their purchasing power will be un
changed .
The quantity theory of money thus rests, ulti
mately , upon the fundamental peculiarity which

money alone of all goods possesses — the fact that
it has no definite relation to the satisfaction of human
wants, but only the power to purchase things which

do have such satisfying power .

CHAPTER IV
BANK DEPOSITS SUBJECT TO CHECK
§ 1 . The Mystery of Circulating Credit

We are now ready to explain the nature of bank
deposit currency, or circulating credit. Credit,
in the sense here employed , is the promise of one
party (called the debtor) to pay money to another
party (called the creditor) . Bank deposits subject

to check are the claimsagainst the bank of a special
class of creditors known as depositors, by virtue

of which they may, on demand, draw by check
specified sums of money from the bank. Since no
other kind of bank deposits will be considered by us,

we shall usually refer to bank deposits subject to
check simply as “ bank deposits.” They are also
called “ circulating credit.”
It is to be observed that not the checks them

selves are the ultimate currency ; but the bank de
posits or credit balances on the books of the banks
against which the checks are drawn. As has been
noted , these deposits subject to check are not
actually money, since they are not generally accept
able ; they always require the special consent of the

payee . But they are circulating media because such
is their chief purpose and use.
52

$ 1.) BANK DEPOSITS SUBJECT TO CHECK

It is in connection with the transfer of bank de
posits that there arises the so -called “ mystery of
banking .”

Many persons have imagined that cir

culating credit is a special form of wealth which may
be created by the bank — out of whole cloth , as it
were. Others have maintained that credit has no

foundation in actual wealth at all,but is a kind of un
real and inflated bubble with a precarious , if not
wholly illegitimate , existence. As a matter of fact,

bank deposits areas easy to understand asbank -notes,
and what is said , in this chapter, of bank deposits
may in substance be taken as true also of bank -notes .
The chief difference is a formal one, the notes cir

culating freely from hand to hand , while the deposit
currency circulates only by means of specially in
dorsed orders called “ checks.”

To understand the real nature of bank deposits,
let us imagine a hypothetical institution - a kind
of primitive bank existing mainly for the sake of

deposits and the safe-keeping of actual money .
The original bank of Amsterdam was somewhat
like the bank we are now imagining. In such a
bank a number of people deposit $ 100,000 in gold ,

each accepting a receipt for the amount of his
deposit. If this bank should draw up a “ capital
account” or statement, it would show $ 100,000 in
its vaults and $ 100, 000 owed to depositers, as

follows :
ASSETS

LIABILITIES

Gold . . . . $ 100,000

Due depositors . . $ 100,000
53

WHY IS THE DOLLAR SHRINKING ? [CH. IV .

The right-hand side of the statement is, of course,
made up of smaller amounts owed to individual

depositers. Assuming that there is owed to A
$ 10,000, to B $ 10 ,000 , and to all others $ 80,000, we
may write the bank statement as follows :
ASSETS
LIABILITIES
Gold . . . . $100 ,000 Due depositor A . $ 10 ,000
Due depositor B .
Due other depositors

$ 100,000

10,000
80,000

$ 100,000

Now assume that A wishes to pay B $ 1000.
A could go to the bank with B , present certificates
or checks for $ 1000, obtain the gold , and hand it

over to B , who might then redeposit it in the same

bank, merely handing it back through the cashier's
window and taking a new certificate in his own
name. Instead , however, of both A and B visiting

the bank and handling the money, A might simply
give B a check for $ 1000. B would then send the
check to thebank and thebank would simply reduce
A 's credit on its books by $ 1000 and increase B 's

by the same amount. The transfer in either case

would mean that A 's holding in the bank was re
duced from $ 10,000 to $ 9000 , and that B 's was

increased from $ 10 ,000 to $ 11,000. The statement
would then read :

ASSETS

LIABILITIES

Gold . . . . $ 100,000 Due depositor A
Due depositor B

. $ 9 ,000
.

11,000

Due other depositors

80,000
$ 100,000

$ 100 ,000

54

$ 1.) BANK DEPOSITS SUBJECT TO CHECK

Thus the certificates, or checks, would circulate
in place of money among the various depositors in
the bank. What really changes ownership , or “ cir

culates," in such cases is the “ deposits," i.e., the right
to draw money . The check is merely a certain
evidence of this right and ofthe transfer of this right
from one person to another.

The man who receives

the check uses it as evidence of a right to draw at
the bank against the account of the man who drew
the check .

In the case under consideration , the bank would

be conducted at a loss. It would be giving the time
and labour of its clericalforce for the accommodation
of its depositors , without getting anything in return .
But such a hypothetical bank would soon find much as did the bank of Amsterdam — that it
could make profits by lending at interest some of

the gold on deposit. This could not offend the
depositors , for they do not expect or desire to get
back the identical gold they deposited. What
they want is simply to be able at any time to obtain
the same amountof gold . Since , then , their arrange
ment with the bank calls for the payment not of
any particular gold , butmerely of a definite amount,
and that but occasionally , the bank finds itself free
to lend out part of the gold that otherwise would
lie idle in its vaults.

To keep it idle would be a

great and needless waste of opportunity .
Let us suppose , then , that the bank decides to
loan out half the money which it has in its vaults.
55

WHY IS THE DOLLAR SHRINKING ? (CH . IV .

In this country such loaning is usually done in ex
change for " promissory notes ” of the borrowers.
Now the loan is really an exchange of the money

for the promissory note. Let us suppose that the
borrowers actually draw out $ 50,000 of gold . The
bank thereby exchanges this money for promissory
notes, and its books will read :
LIABILITIES
ASSETS
$ 9 ,000
Gold . . . . $ 50,000 Due depositor A
11,000
Promissory notes 50,000 Due depositor B
Due other depositors
80 ,000
$ 100,000
$ 100,000
It will be noted that now the gold in thebank is only

$ 50,000, while the total deposits are still $ 100,000 .
In other words, the depositors now have more
“ money on deposit ” than the bank has in its vaults !
But, as will be shown , this form of expression in

volves a popular fallacy, in the misuse of the word
“ money.” Something of equivalent value is be

hind each loan, but not necessarily money.
Next, suppose the borrowers become, in a sense ,
lenders also, by redepositing the $50 ,000 of money

which they borrowed, in return for the right to draw
out the same sum on demand , preferring to use the

same in making payments by check rather than by
money. In other words, suppose thatafter borrowing
$ 50,000 from thebank they lend it back to the bank.

The bank 's assets will thus be enlarged by $ 50,000

and its obligations (or credit extended )willbe equally
enlarged ; and the balance- sheet will become :
56

$ 1.) BANK DEPOSITS SUBJECT TO CHECK
ASSETS

LIABILITIES

Gold . . . . $ 100,000 Due depositor A
Promissory notes

. $ 9,000

50,000 Due depositor B
.
Due other depositors

11,000
80,000

Due new depositors,

i.e., the borrowers

50,000
$ 150,000

$ 150,000

In this case gold was borrowed in exchange for
a promissory note and then handed back in exchange
for a right to draw . Thus the gold really did not
budge ; but the bank received a promissory note
and the depositor a right to draw . Evidently ,
therefore , the same result would have followed if
each borrower had merely handed in his promissory

note and received in exchange a right to draw . As
this operation is most frequently puzzling to the

uninitiated , we repeat the tables representing the
conditions before and after these “ loans,” i.e., these

exchanges of promissory notes for rights to draw .
BEFORE THE LOANS
LIABILITIES

ASSETS

Gold . . . . $ 100,000 Due depositors . . $100,000

AFTER THE LOANS
ASSETS

BILITIES

Gold . . . . $100 ,000 Due depositors . . $ 150,000
Promissory notes 50,000

Clearly, therefore, the intermediation of the
money in this case is needless complication, though
it may help to a theoretical understanding of the
57

WHY IS THE DOLLAR SHRINKING ? [CH. IV.
resultant shifting of rights and liabilities . Thus

the bank may receive deposits of gold or deposits
of promises to pay. In exchange for these promises
it may give, or lend, either a right to draw or gold .

Even when the borrower has “ deposited ” only a

promise to pay money, by fiction he is still held to
have deposited money ; and , like the original de
positor of actual money, he is given the right to

make out checks to draw out money. The total
value of rights to draw , in whichever way arising ,
is termed “ deposits." Banks more often lend rights
to draw than actual money, partly because of the

greater convenience to borrowers and partly be
cause the banks wish to keep their actual money

on hand , or “ cash reserves,” large, in order to meet
large and unexpected demands. It is true that if a

bank loans money, part of the money so loaned
will be redeposited by the persons to whom the
borrowers pay it in the course of business; but it
will not necessarily be redeposited in the samebank.
Hence the average banker prefers that the borrower
should not withdraw actual money.

Besides lendingdeposit rights,banks may also lend
their own notes , called “ bank -notes.” And the prin
ciple governing bank -notes is the sameas the principle
governing deposit rights. The holder simply gets

a pocketful of bank -notes instead of a credit on his

bank account. The bank must always be ready to
pay, on demand, either the note holders — i.e ., to
“ redeem its notes” — or the depositors, and in
58

§ 2.) BANK DEPOSITS SUBJECT TO CHECK
either case the bank exchanges a promise for a
promise . In the case of the note, the bank has

exchanged its bank-note for a customer's promissory
note . The bank -note carries no interest, is payable
on demand , and is issued by an institution well

known and trusted. The customer's note bears
interest, is usually payable at a definite date, and
issued simply by an individual.
Assuming that the bank issues $50,000 of bank
notes, the balance-sheet will now become:
ASSETS

ILITIES

Gold . . . . $ 100,000 Due depositors . . $ 150,000
Loans (promissory
Due bank -note holders 50,000
notes ) . . . 100,000
$ 200,000
$ 200 ,000

$ 2. The Basis of Circulating Credit
We repeat that by means of credit the deposits
and notes of a bank may exceed its cash . There
would be nothing mysterious or obscure about this
fact if people could be induced not to think of bank

ing operations as money operations. To so repre

sent them is metaphorical and misleading. They
are no more money operations than they are real
estate transactions. A bank depositor, A , has not

ordinarily “ deposited money ” ; and whether he
has or not, he certainly cannot properly say that he

“ has money in the bank.” What he does have is
the bank's promise to pay money on demand . The
bank owes him money. When a private person
59

WHY IS THE DOLLAR SHRINKING ? [CH. IV.
owes money, the creditor never thinks of saying

that he has it on deposit in the debtor's pocket.
The same principles of property which apply
to bank deposits also apply to bank -notes. There
is wealth somewhere behind the mutual promises ,
though in different degrees of accessibility. The
note holder's promise (his promissory note) is se
cured by his assets ; and the bank's promise (the
bank -note) is secured by the bank 's assets. The
note holder has “ swapped ” less-known credit for

better-known credit.
If this fact is borne in mind , the reader will be

able to conquer the doubt which may already have
arisen in his mind — the doubt as to the legitimacy
of the bank 's procedure in “ lending some of its
depositor's money.” It cannot be too strongly
emphasized that, in any balance-sheet , the value
of the liabilities rests on that of the assets .

The

deposits of a bank are no exceptions. Wemust not

be misled by the fact that the cash assets may be
less than the deposits. When the uninitiated first
learn that the number of dollars which note holders

and depositors have the right to draw out of a bank
exceeds the number of dollars in the bank, they are
apt to jump to the conclusion that there is nothing

behind the notes or deposit liabilities. Yet behind
these obligations there is always, in the case of

a solvent bank, full value — if not actual dollars, at
any rate, dollars' worth of property. By no jug
glery can the liabilities exceed the assets except in
60

$ 2.) BANK DEPOSITS SUBJECT TO CHECK

insolvency, and even in that case only nominally ,

for it still holds that the true value of the liabilities
will be only what can be paid on them — perhaps

only 25 cents on the dollar. This true value of the
liabilities will rest upon and be equal to the true
value of the assets behind them by means of which
they will be paid , so far as may be . Debts which

cannot or will not be paid in full are often called
“ bad debts ” ; and the value of “ bad debts ” is not

their face value,but their actual value to the creditor.
These assets, as already indicated , are, and ought
to be, largely the notes of merchants , although so
far as the principles here discussed are concerned ,

they might be any property whatever. If they
consisted in the ownership of real estate or wealth

unencumbered , so that the tangible wealth which
property always represents were clearly evident, all

mystery would disappear. But the effect would
not be different.

Instead of taking grain , machines,

or steel ingots on deposit, in exchange for the sums

lent, banks prefer to take interest-bearing notes of
corporations and individuals who own , directly or
indirectly, grain , machines, and steel ingots ; and

by the banking laws the banks are even compelled

to take the notes instead of the ingots. The bank
finds itself with liabilities which exceed its cash
assets; but this excess of liabilities is balanced by the
possession of other assets than cash. These other
assets of the bank are the liabilities of business men .
These liabilities are in turn supported by the assets
61

WHY IS THE DOLLAR SHRINKING ? (CH. IV.
of the business men . If we continue to follow up
the chain of liabilities and assets, we shall find the
ultimate basis of the bank 's liabilities in the concrete
tangible wealth of the world .
This ultimate basis of the entire credit structure
is kept out of sight, but the basis exists. Indeed , we
may say that banking, in a sense, causes this concrete ,
tangible wealth to circulate. Even though the acres
of a landowner or the iron stoves of a stove dealer

cannot circulate in literally the same way that gold
dollars circulate , yet the landowner or stove dealer

may give to the bank a note on which the banker
may base bank-notes or deposits ; and these bank

notes and deposits will circulate like gold dollars.
Through banking, he who possesses wealth difficult

to exchange can create a circulating medium based
upon that wealth . He has only to give his note, for

which , of course, his property is liable, get in return
the right to draw , and lo ! his comparatively unex
changeable wealth becomes liquid currency. To put
it crudely , deposit banking is a device for coining
into dollars, land, stoves, and other wealth not other
wise generally exchangeable .

We began by regarding a bank as substantially a

coöperative enterprise, operated for the convenience
and at the expense of its depositors. But as soon
as the bank reaches the point of lending money to
X , Y , and Z on time, while itself owing money on

demand, it assumes toward X , Y , and Z risks which
the depositors would be unwilling to assume. To
62

$ 3.) BANK DEPOSITS SUBJECT TO CHECK

meet this situation , the responsibility and expense
of running the bank are taken by a third class of
people — stockholders — who are willing to assume

the risk for the sake of the chance of profit. Stock
holders, in order to guarantee the depositors against
loss, put in some cash of their own.

The object is

to make good any loss to depositors, while reserving
the right to keep the profits earned by loaning at
interest . Let us suppose that the stockholders
put in $50,000, viz. $40,000 in gold and $ 10 ,000 in

the purchase of a bank building. The accounts
now stand :
LIABILITIES

ASSETS

Gold . . . . $ 140,000 Due depositors . . $ 150,000
Loans . . . .
Building . . .

100,000 Due note holders

.

Due stockholders

.

10,000

50,000
50 ,000

$ 250,000

$ 250,000

The accounts as they now stand include the chief
features of an ordinary modern bank — a so -called
“ bank of deposit, issue, and discount.”
$ 3. Banking Limitations
We have seen that there are assets to meet the

liabilities. Wenow should note that the form of the
assets must be such as will insure meeting the lia

bilities promptly. Since the business of a bank is
to furnish easily exchangeable property (cash or
credit) in place of the “ slower ” property of its
depositors, it fails of its purpose when it is caught

with insufficient cash , by which is meant money.
63

WHY IS THE DOLLAR SHRINKING ? [CH. IV.

Yet it makes profits partly by tying up its quick
property, i.e., lending it out in quarters where it is
less accessible . Its problem in policy is to tie up

enough to increase its earning, but not to tie up so
much as to get tied up itself. So far as anything
has yet been said to the contrary, a bank might
increase indefinitely its loans in relation to its cash

or in relation to its capital. If this were so , deposit
currency could be indefinitely inflated .
There are , however , limits to such expansion of
loans imposed by prudence and sound economic
policy . Insolvency and insufficiency of cash must

both be avoided . Insolvency is that condition
which threatens when liabilities are extended with
insufficient capital. Insufficiency of cash is that

condition which threatens when liabilities are ex
tended unduly relatively to cash .

Insolvency is

reached when the assets no longer cover the liabili

ties (to others than stockholders ), so that the
bank is unable to pay its debts. Insufficiency of

cash is reached when , although the bank's total
assets may be fully equal to its liabilities, the actual
cash on hand is insufficient to meet the needs of
the instant, and the bank is unable to pay its debts

on demand.

The risk of insolvency is the greater, the less the
ratio of the stockholders' interest to all liabilities
to others . The risk of insufficiency of cash is the
greater, the less the ratio of the cash to the demand

liabilities. In other words, the leading safeguard
64

$ 3.) BANK DEPOSITS SUBJECT TO CHECK
against insolvency lies in a large capital and surplus,
but the leading safeguard against insufficiency of

cash lies in a large cash reserve. Insolvency proper
may befall any business enterprise . Insufficiency

of cash relates especially to banks in their function
of redeeming notes and deposits.
Let us illustrate insufficiency of cash . In our

bank 's accounts as we left them there appeared
cash to the extent of $ 140,000 and $ 200,000 of de
mand liabilities (deposits and notes). Themanagers
of the bank may think this fund of $ 140,000 un

necessarily large or the loans unnecessarily small.

They may then increase their loans (extended to
customers partly in the form of cash and partly

in the form of deposit accounts) until the cash held
by the bank is reduced , say to $ 40 ,000 , and the
liabilities due depositors and note holders increased

to $ 300, 000. If, under these circumstances, some

depositor or note holder demands $50,000 cash ,
immediate payment will be impossible.

It is true

that the assets still equal the liabilities. There is
full value behind the $ 50,000 demanded ; but the
understanding was that depositors and note holders

should be paid in money on demand. Were this not
a stipulation of the deposit contract, the bank might
pay the claims thus made upon it by transferring
to its creditors the promissory notes due it from its

debtors ; or it might ask the customers to wait until
it could turn these securities into cash .

Since a bank cannot follow either of these plans,
65

WHY IS THE DOLLAR SHRINKING ? (CH. IV .
it tries,where insufficiency of cash impends, to fore
stall this condition by “ calling in " some of its loans,

or if none can be called in , by selling some of its
securities or other property for cash . But it happens,
unfortunately , that there is a limit to the amount
of cash which a bank can suddenly realize. No bank

could escape failure if a large percentage of its note
holders and depositors should simultaneously de
mand cash payment. The paradox of a run on a
bank is well expressed by the case of the man who
inquired of his bank whether it had cash available
for paying the amount of his deposit, saying, “ If
you can give me the money, I don 't want it ; but

if you can't, I do.” Such was the situation in 1907
in Wall Street . All the depositors at one time
wanted to be sure their money “ was there.”

Yet

it never is there all at one time.
Since , then, insufficiency of cash is so troublesome
a condition - so difficult to escape when it has
arrived , and so difficult to forestall when it begins
to approach — a bank must so regulate its loans

and note issues as to keep on hand a sufficient cash
reserve, and thus prevent insufficiency of cash from
even threatening . It can regulate the reserve in

various ways. For instance, it can increase its
reserve relatively to its liabilities by " discounting "
less freely - by raising the rate of discount and thus

discouraging would -be borrowers, by outright re
fusal to lend or even renew old loans, or by “ call
ing in ” loans subject to call. Reversely , it can
66

§ 3.1 BANK DEPOSITS SUBJECT TO CHECK
decrease its reserve relatively to its liabilities by
discounting more freely -- by lowering the rate of
discount and thus attracting borrowers . The more
the loans in proportion to the cash on hand , the
greater the profits, but the greater the danger also .

In the long run a bank maintains its necessary re
serve by means of adjusting the interest rate charged
for loans. If it has few loans, and a reserve large
enough to support loans of much greater volume, it
will endeavour to extend its loans by lowering the

rate of interest. If its loans are large, and it fears
too great demands on the reserve, it will restrict

the loans by a high interest charge. Thus by al
ternately raising and lowering the rate of interest,

a bank keeps its loans within the sum which the re
serve can support ,but endeavours to keep them (for
the sake of profit ) as high as the reserve will support.

If the sums owed to individual depositors are large ,

relatively to the total liabilities, the reserve should
be proportionately large, since the action of a small
number of depositors can deplete it rapidly . The
reserve in a large city of great banking activity
needs to be greater in proportion to its demand

liabilities than in a small town with infrequent
banking transactions. No absolute numerical rule
can be given , though arbitrary rules are often im
posed by law . Banks in the United States, are
required to keep a ratio of reserve to deposits, vary
ing from 127 per cent to 25 per cent, according as
they are state or national banks, and according
67

WHY IS THE DOLLAR SHRINKING ? (CH. IV .
to their location . The proposed National Reserve

banks,which are to be purely bankers' banks, are
to keep a still higher ratio .

For the whole

country the reserves in banks are about one-fifth
of the deposits. These reserves are all in de
fence of deposits. In defence of bank -notes,which
are issued only by national banks, the method of
protection is different. True, the same economic

principles apply to both bank-notes and deposits ,
but the law treats them differently. The gov
ernment itself chooses to undertake to redeem the

national bank -notes on demand , imposing on the
banks certain obligations to deposit with itself
a redemption fund and government bonds.

The

same principle is to be extended to the new reserve
notes.

As previously stated ,the cash reserves of banks,

though money, are not, properly speaking, money
in circulation. The reason is that they are not held
for the purchase of goods, but the redemption of
another kind of currency — deposits. Thus the

money in any society is divided into two chief parts :
money in circulation and money in banks. In
the United States these two are approximately equal,
both being about one and a half billion dollars.1
1 In the United States there is a third , though smaller,

stock of money, the hoard in the United States Treasury,
amounting at present to about a third of a billion of dollars .
In other countries the government money is usually almost

all deposited in banks.

68

$ 4.) BANK DEPOSITS SUBJECT TO CHECK
§ 4 . The Total Currency and its Circulation

The study of banking operations, then, discloses
two species of bank currency : one, bank -notes , be
longing to the category of money ; and the other ,

deposits, belonging outside of that category but
constituting an excellentsubstitute. Referring these

to the larger category “ goods,” we have a threefold
classification of goods : first, actual money ; second ,
rights to draw money (deposits) ; and, third, all
other goods. Among these , then , there are six
possible types of exchange :
(1) Money against money .
(2) Deposits against deposits.

(3) Goods against goods.
(4 ) Money against deposits.
(5 ) Money against goods.
(6 ) Deposits against goods.

For our purpose,only the last two types of exchange
are important, for these constitute the circulation
of circulating media . As regards the other four, the
first and third are “ money changing " and " barter,"

respectively . The second and fourth are banking
transactions, the second being such operations as
the selling of drafts for checks or the mutual can
cellation of bank clearings, and the fourth being
such operations as the depositing or withdrawal

ofmoney , by depositing cash or cashing checks.
The analysis of the balance -sheets has prepared
us for the inclusion of bank deposits or circulating
69

WHY IS THE DOLLAR SHRINKING ? [CH. IV.
credit in the equation of exchange. We shall
still use M to express the quantity of actual money
and V to express the velocity of its circulation .
Similarly , we shall now use M ' to express the total

deposits subject to transfer by check , and V ' to

express the average velocity of their circulation.

The total value of purchases in a year is no longer
to be measured by MV, but by MV + M 'V '. The
equation of exchange, therefore, becomes :

MV + M 'V' = EpQ = PT.
Let us again represent the equation of exchange
by means of a mechanical picture. In Figure 4 ,
trade, as before , is represented on the right by the
weight of a miscellaneous assortment of goods ;
Imm
OLLON

O
DO
on

Fig . 4

and their average price by the distance to the right

from the fulcrum or the leverage atwhich this weight
hangs. Again, at the left,money (M ) is represented
by a weight in the form of a purse, and its velocity
of circulation (V ) by its leverage ; but now we have
a new weight at the left, in the form of a bank-book,
to represent the bank deposits (M '). The velocity
of circulation (V ') of these bank deposits is repre

sented by its distance from the fulcrum or the lever
age atwhich thebook hangs.
70

$ 5.) BANK DEPOSITS SUBJECT TO CHECK
Thismechanism makes clear the fact that the aver
age price (right leverage) increases with the increase

ofmoney or bank deposits and with the velocities of
their circulation , and decreases with the increase in
the volume of trade.

Recurring to the left side of the equation of ex
change, or MV + M ' V ', we see that in a community
without bank deposits the left side of the equation
reduces simply to MV , the formula of the preceding
chapter , for in such a community the term M ' V '
vanishes . The introduction of M ' tends to raise

prices ; that is, the hanging of the bank-book on the
left requires a lengthening of the leverage at the right.
$ 5 . Deposit Currency Normally Proportional to
Money

With the extension of the equation of monetary
circulation to include deposit circulation, the influ

ence exerted by the quantity of money on general
prices becomes less direct ; and the process of trac
ing this influence becomes more difficult and compli
cated . It has even been argued that this interposi

tion of circulating credit breaks whatever connection

there might be between prices and the quantity of
money . This would be true if circulating credit
were independent of money. But the fact is that
the quantity of circulating credit, M ', tends to hold

a definite relation to M , the quantity of money in
circulation ; that is, deposits are normally a more or

less definite multiple of money.
71

WHY IS THE DOLLAR SHRINKING ? (CH. IV .
Two facts normally give deposits a more or less

definite ratio to money. The first has been already
explained, viz., that bank reserves are kept in a more

or less definite ratio to bank deposits. The second
is that individuals, firms, and corporations preserve
more or less definite ratios between their cash trans
actions and their check transactions, and also be
tween their money and deposit balances. These
ratios are determined by motives of individual
convenience and habit.

In general, business firms

use money for wage payments, and for small mis
cellaneous transactions included under the term

" petty cash ” ; while for settlements with each
other they usually prefer checks. These prefer
ences are so strong that we could not imagine them

overriden except temporarily , and to a small degree .
A business firm would hardly pay car fares with
checks and liquidate its large liabilities with cash .
Each person strikes an equilibrium between his use
of the two methods of payment and does not greatly

disturb it except for short periods of time. He keeps
his stock of money or his bank balance in constant

adjustment to the payments he makes in money
or by check . Whenever his stock ofmoney becomes
relatively small and his bank balance relatively
large, he cashes a check. In the opposite event, he
deposits cash.

In this way he is constantly con

verting one of the two media of exchange into the
other. A private individual usually feeds his purse
from his bank account ; a retail commercial firm
72

§ 5.) BANK DEPOSITS SUBJECT TO CHECK
usually feeds its bank account from its till.
bank acts as intermediary for both .

The

Another reason why money and checks each have
separate spheres, tending at any given time to
maintain a fairly definite relation to each other ,
is that cash and checks are , generally speaking,
used by different classes. Wage-earners for the
most part use only money, while the professional
and propertied classes and “ fictitious persons”
(i.e., corporations, partnerships, etc.) use mostly
checks. At present probably over half of the fami

lies in the United States use no checks.
For any one individual the adjustment of cash
in -pocket to deposits-in -bank will be extremely

rough ; for sometimes the one or the other will be
much too large or too small. But, in the community

as a whole, the adjustment of the cash to deposits
used will be very delicate ; for the temporary aberra
tions ofmany thousands of individuals will ordinarily

almost completely neutralize each other.

In a given community the quantitative relation of
deposit currency to money is determined by several

considerations of convenience . In the first place , the
more highly developed the business of a community,

the more prevalent the use of checks. Where busi
ness is conducted on a large scale merchants habit
ually transact their larger operations with each other
by means of checks,and their smaller ones by means

of cash . Again , the more concentrated the popula
tion , the more prevalent the use of checks. In cities
73

WHY IS THE DOLLAR SHRINKING ? (CH. IV .
it is more convenientboth for the payer and thepayee

to make large payments by check ; whereas in the
country, trips to a bank are too expensive in timeand
effort to be convenient, and therefore more money is
used in proportion to the amount of business done.
There is, then, a relation of convenience and cus

tom between checks and cash circulation, and a
more or less stable ratio between the usual deposit
balance of the average man or corporation and the
usual fund of money kept in pocket or till. This
fact, as applied to the country as a whole, means

that by convenience a fairly definite ratio is fixed
between M and M '. If that ratio is disturbed tem
porarily, there will come into play a tendency to
restore it. Individuals will deposit surplus cash
or they will cash surplus deposits .

Hence ,both money in circulation (as shown above )
and money in reserve (as shown previously ) tend
to keep in a fixed ratio to deposits. It follows that
the two must be in a more or less definite, though
elastic , ratio to each other.

$ 6 . Summary
The contents of this chapter may be formulated

in a few simple propositions.
(1 ) Banks supply two kinds of currency , viz.,

bank-notes – which are money ; and bank deposits
(rights to draw ) - which are not money .

(2 ) A bank check is merely presumptive evidence
of a right to draw .
74

$ 6 .) BANK DEPOSITS SUBJECT TO CHECK

(3) Behind the claims of depositors and note
holders stand , not simply the cash reserve, but all
the assets of the bank .

(4 ) Deposit banking is a device by which wealth ,
incapable of direct circulation , may be made the
basis of the circulation of rights to draw .
(5 ) The basis of such circulating rights to draw

or deposits must consist in part of actual money ,
and it should consist in part also of quick assets
readily exchangeable for money.
(6 ) Six sorts of exchange exist among the three

classes of goods, money , deposits , and other goods.

Of these six sorts of exchange, the most important
for our present purposes are the exchanges of money
and deposits against other goods.
( 7) The equation of exchange, extended so as to

make it include bank deposits, reads thus :
MV + M 'V ' = { pQ = PT.
(8 ) Bank deposits ( M ') tend to keep a normal ratio

to bank reserves and to the quantity ofmoney ( M );
because , in the first place, cash reserves are neces
sary to support bank deposits, and these must

bear somemore or less constant ratio to the amount
of such deposits ; and because, in the second place ,
business convenience dictates that the circulating
medium or currency shall be apportioned between

deposits and money in a certain more or less definite,
even though elastic , ratio .
75

CHAPTER

V

TRANSITION PERIODS — CRISES AND DEPRESSIONS
§ 1 . Rising Prices
We are now ready to study temporary or transi

tional changes in the magnitudes in the equation
of exchange. Let us begin by assuming a slight
initial disturbance, such as that produced , for in

stance, by an increase in the quantity of money.
This, through the equation of exchange, will cause

a rise in prices. As prices rise, profits of business
men measured in money will rise also . This will
be true even if the costs of business rise in the

same proportion.

Thus, if a man, who formerly

sold goods for $ 10,000 which cost $6000, clearing
$ 4000, could now get double prices at double cost,
his profitwould double also ,being $ 20 ,000 - $ 12,000 ,
or $8000. Of course , such a rise of profits would
be purely nominal, as it would merely keep pace
with the rise in price level. The business man would
gain no advantage ; for his large money profits now
would buy no more than his small money profits
bought before.

But, as a matter of fact,the business man 's prof
its will usually rise much more than this, because
many of his expenses will tend to remain the same.

In particular his payments to his creditors for in

$ 1.)

TRANSITION PERIODS

terest on past loans, to his landlord for rent, and to
his employees for salaries and wages will for a time
remain unaffected or little affected by the general

rise in prices. Consequently , he will find himself
making greater profits than usual,and be encouraged
to expand his business by increasing his borrow
ings. These borrowings are mostly in the form of

short-time loans from banks; and, as we have seen ,
such loans engender deposits. Therefore, deposit
currency ( M ') will increase. But this extension of
deposit currency tends further to raise the general

level of prices, just as the increase of gold raised
it in the first place. This further rise of prices
enables borrowers who are now receiving greater
profits to receive still greater profits. Borrowing,
already stimulated , is stimulated still further .

More loans are demanded , and , with the resulting
expansion of bank loans, deposit currency ( M '),

already expanded , expands still more. Hence prices
rise still further .
This sequence of events may be briefly stated as
follows :

( 1) Prices rise (whatever the first cause may be ;
we have chosen for illustration an increase in the
amount of money in circulation ).
(2 ) “ Enterprisers ” – persons who undertake

business enterprises of various kinds — get much
higher prices than before , without having much
greater expenses (for interest, rent, salaries, etc.) ,

and therefore make much greater profits.

WHY IS THE DOLLAR SHRINKING ? (CH. V.

(3) Enterpriser-borrowers, encouraged by large
profits , increase their borrowings.

(4 ) Deposit currency ( M ') expands relatively to
money ( M ).

(5 ) Because of this expansion of deposit currency
(M ') prices continue to rise ; that is, phenomenon
No. 1 is repeated . Then No. 2 is repeated ,and so on .

In other words, a slight initial rise of prices sets
in motion a train of events which tends to repeat
itself. Rise of prices generates rise of prices and
continues to do so as long as the enterprisers' profits
continue abnormally high .

$ 2 . How a Rise of Prices culminates in a Crisis
The expansion in deposit currency indicated in
this cumulative movement abnormally increases
the ratio of deposits ( M ') to money ( M ) . This,
however , is not the only disturbance caused by the
increase in M . There are disturbances to some ex
tent in T , in V , and in V '.

In particular, trade

( T) will be stimulated by the stimulation of
loans. New constructions of buildings, machinery,
etc., are entered upon .

These effects are always

observed during rising prices, and people note ap
provingly that " business is good ” and “ times are
booming.” Such statements represent the point
of view of the ordinary business man who is an

" enterpriser -borrower.”

They do not represent

the sentiments of the creditor, the salaried man , or

the labourer,most of whom are silentbut long-suffer
78

§ 2.)

TRANSITION PERIODS

ing, paying higher prices, but not getting propor
tionally higher incomes.

Such one-sided expansion cannot proceed forever.
It must ultimately spend itself. The unadjusted
elements ultimately adjust themselves with a jump.

The landlord raises his rent at the first opportunity.

The employee demands more pay, often striking
to get it. The creditor raises the rate of interest.
The whole situation is changed. The banks are
forced in self -defence to refuse loans (or at any rate

to discourage loansbymakingharder terms for them )
because they cannot permit so abnormal an expan

sion of loans relatively to reserves. To allow such
expansion to continue would mean breaking the
law and might mean breaking the bank . Then
borrowers can no longer hope to make great profits,
and loans cease to expand.
Now an enterprise, which is started by borrowing,

is expected to be continued by renewed borrowing.
But with loans hard to get, those persons who have
counted on renewing their loans on the former

terms and for the former amounts are unable to do
so . It follows that those of them who cannot con

tract new debts and , without contracting such new

debts, cannot pay old ones, are destined to become
insolvent and fail. The failure (or prospect of
failure) of firms that have borrowed heavily from

banks induces fear on the part of many depositors

that the banks will not be able to realize on these
loans. Hence the banks themselves may fall under
79

WHY IS THE DOLLAR SHRINKING ? (CH . V .

suspicion and their depositors demand cash . Then
occur those “ runs on the banks ” which deplete the
bank reserves at the very moment they are most

needed to pay the demands of the depositors. Being
short of reserves, the banks have to curtail their

loans. Any renewed borrowing becomes difficult
or impossible, and even the original loans may be

“ called ” by the banks. Those enterprisers who
are caught must have money or credit to liquidate
their obligations or else become insolvent. Some
of them are destined to become bankrupt, and ,
with their failure, the demand for loans is corre
spondingly reduced.
This culmination of an upward price movement is
what is called a crisis — a condition characterized

by failures due to lack of cash when and where it is
most needed.
These bankruptcies tend to spread ; for when a

man cannot pay his creditors, the latter in turn find
difficulty in paying theirs. In this way the fall of

one firm is communicated successively to many
others , as one brick in a row may knock down the
whole row .

§ 3 . Completion of the Credit Cycle
After the crisis , a reaction sets in . Bank loans

tend to be small, and consequently deposits (M ')
are reduced . The contraction of deposit currency
makes prices fall still more . Those who have bor
rowed for the purpose of buying stocks of goods, now
80

& 31.

TRANSITION

TRANSITION DIDIO
PERIODS

find they cannot sell them for enough even to pay
back what they have borrowed . The sequence of
events is now the opposite of what it was before : ( 1) Prices fall.
( 2) Enterprisers getmuch lower prices than be

fore without having much lower expenses (for in
terest, rent, salaries, etc .), and therefore makemuch
lower profits.
( 3) Enterpriser -borrowers, discouraged by small
profits , contract their borrowings.

(4 ) Deposit currency ( M ') contracts relatively
to money ( M ).

(5) Because of this contraction of deposit cur
rency (M ') prices continue to fall ; that is, phenom

enon No. 1 is repeated . Then No. 2 is repeated,
and so on .

Thus a fall of prices generates a further fall of
prices. The cycle evidently repeats itself as long as

the enterprisers 'profits remain abnormally low . The
man who losesmost is the businessman in debt. Heis
the typicalbusiness man , and he now complains that
" business is bad.” There is a “ depression of trade.”
The contraction becomes self-limiting as soon as

loans are easier to get. Banks are led to make
loans easy in order to get rid of their accumulated

reserves. After a time, normal conditions begin
to return . The weakest producers have been forced
out, or have at least been prevented from expand

ing their business by increased loans. The strongest
firms are left to build up a new credit structure.
81

WHY IS THE DOLLAR SHRINKING ? [CH. V .

Borrowers again becomewilling to take ventures ; fail
ures decrease in number; bank loans cease to de
crease ; prices cease to fall ; borrowing and carrying

on business becomes profitable ; loans are again de
manded ; prices again begin to rise , and there occurs a
repetition of theupward movement already described .

The upward and downward movements taken

together constitute a complete credit cycle, which
resembles the forward and backward movements of
a pendulum .

Many historical examples could be cited . The
discovery of gold in California in the middle of the
last century was followed by an inflation of the
world's currencies, first through the new gold and
later through expansion of deposit currency as well.

Prices rose rapidly ; businessmen made high profits ;
times were good until 1857, when a crisis oc
curred both in the United States and Europe.

This

was followed by a sharp fall in prices, a depression
in trade, a recovery , and another period of inflation
culminating in a second crisis in 1866 . Again the

pendulum swung back only to return again in the
crisis of 1873. A more recent example is found in
the gold inflation beginning in 1896 in consequence of
the enormous gold production in the Transvaal, in
Cripple Creek , and in the Klondike. The money

in circulation in the United States doubled in eleven
years (1896 – 1907), bank deposits subject to check

nearly trebled , and prices rose one-half. " Pros
perity ” (that is, profitable business from the point
82

$ 4 .)

TRANSITION PERIODS

of view of the enterpriser) at first seemed boundless.
In 1907 the wave broke in the crisis of that year,

followed by a contraction of deposits and a fall of
prices in the next year with a gradual recovery in
the years immediately following. Then the cycle

began again and we have just apparently passed the
crest again , although nothing acute enough to be
called a severe crisis has occurred.

The jolt to

credit in 1913 was much milder than in 1907, and
we are apparently soon to enter on another period of
expansion .
We have considered the rise, culmination , fall,

and recovery of prices. In most cases the time
occupied by the swing of the commercial pendulum

to and fro is about ten years. While the pendulum
is continually seeking a stable position , practically
there is almost always some occurrence to prevent
perfect equilibrium . Oscillations are set up which ,
though tending to be self-corrective, are continually
perpetuated by fresh disturbances.

The oscilla

tions are like those of a ship in a rough sea . While
in a calm sea a ship will " pitch ” only a few times
before coming to rest, in a high sea the pitching
never ceases; though continually seeking equilibrium ,
the ship continually encounters causes which accen

tuate the oscillations.
§ 4. The Safeguard of High Interest

The foregoing sketch of prices gives, of course,
S

only the elementary features of price cycles. In any
83

WHY IS THE DOLLAR SHRINKING ? CH. V.
actual case numerous special factors enter . It

would divert us too far from the main purpose of
this book to go into further details on this subject .

For such details the reader is referred to Prof.
Wesley C . Mitchell's great monograph , “ Business
Cycles.” 1
Before leaving this subject, however , I shall
take the opportunity to enlarge a little on what has
been said about the rate of interest ; for this plays
a central rôle in credit cycles and one which is not

generally appreciated. Most people want the rate
of interest always to be low and when in crises it is
high they blame the banks for raising it. But the
truth is that the banks are usually to blame for not
raising it early enough to prevent the crisis.
The rate of interest tends to be and ought to be

high when the prices are rising ; and , reversely , tends
to be and ought to be low while prices are falling.
Suppose, for instance, that prices are rising at the

rate of 1 per cent per annum . Then $ 100 lent
to-day is equivalent in purchasing power, not to
$ 100 repayable next year, but to $ 101 repayable
next year. Thus the lender, when he gets back his
principal of only $ 100 , does not get back as much

purchasing power as he lent, and the borrower does
not pay back as much purchasing power as he bor
rowed. In other words, the fact that prices have
risen during the year has made things easier for the
borrower and harder for the lender. During the
1 Berkeley (University of California Press) , 1913.
84

§ 4 .]

TRANSITION PERIODS

Civil War, after the United States government had

inflated the currency with " greenbacks,” the first
result was a rise of prices, and the next result
was that men who had mortgaged their farms
in the West found it easy to pay back their loans.
As they said , the mortgages on their farms " dis

appeared like smoke.”

Five thousand dollars paid

back in 1864 for $ 5000 loaned in 1860 really repre
sented only half as much purchasing power over
goods; for prices had doubled . That is, the inflation
of the currency freed the borrowers from half their

debts. We see, then, that when prices are rising,
the principal of a debt becomes less and less valuable.

If prices are rising 1 per cent per annum , that is,
if the principal of the debt, in terms of goods, is

falling about 1 per cent, then the interest on the
debt ought to be increased about 1 per cent in
order that there should be the same burden on the

borrower as there would have been if prices had

not risen . If the prices are rising 2 per cent per
annum , 2 per cent would have to be added to the
rate of interest in order to compensate for the rise ;
and so on for other rates of rise in prices. On the
other hand, if prices are falling, the rate of interest
ought to be reduced in order to offset the apprecia
tion of the principal.

This ideal compensation in the interest rate might
occur if man 's foresightwere perfect, and as a matter
of fact an approximation at such adjustment does
actually occur. A statistical study of the periods
85

WHY IS THE DOLLAR SHRINKING ? (CH. V .
of rising and falling prices in the United States,

England,Germany, France, China,Japan,and India
shows that, in general, when prices are rising, the

rate of interest is high, and when prices are falling
it is low . Although partially adjusted during transi
tion period , it is not sufficiently adjusted . The

essential fact remains that during falling prices
the burden of debts grows greater, and during ris
ing prices, less. Were the rate of interest properly
and promptly adjusted , crises would be fewer and
they would be less severe.

How , then , can we get a better adjustment of
the rate of interest ? One way is to prevent these
changes in price levels as much as possible — to

“ standardize” the dollar. This may be a long time
in happening. A second way is for business men
to become more alive to the future and more quick
to predict what is going to happen to prices. Edu
cation in this line will go on and is going on through

the trade journals .

A third way is through the removal of the exist
ing prejudice against raising the rate of interest.
Westill inherit the old idea that interest is “ usury ”

or robbery. If we could once get rid of the preju
dice against allowing the rate of interest to rise high
as well as to fall low , that is, could regard the rate

of interest as properly subject to fluctuation and as
being a market price changing day by day, like any
other price , a long step would be taken toward pre

venting crises .
86

§ 4 .]

TRANSITION PERIODS

A fourth way is to make credit more elastic.
This is to be accomplished by the new currency
act. Hitherto in the United States, the banks after

allowing loans at too low a rate and so expanding
them unduly , have suddenly ceased loaning when ,
aş at a crisis, the legal limit of reserves was reached .
Instead of this sudden rigid limit to loans the new
act will place an elastic limit ; for the banker can
secure loanable funds by " rediscounting " some of

his loans with the federal reserve bank. In this
way he can always extend accommodation to cus
tomers , although at higher rates. A sound business
man has the right to expect his bank to give him

necessary loans at all times, provided he can and will
meet the termswhich themarket requires. Hitherto

he could never be sure at certain times of securing
loans on any terms at all. The new provisions
should greatly reduce the danger and severity of
crises.

CHAPTER VI
REMOTE INFLUENCES ON PRICES

§ 1. Influence which Conditions of Production and
Consumption Exert on Trade and therefore on

Prices
Thus far we have considered the level of prices
as affected by the volume of trade, by the velocity
of circulation of money and deposits, and by the
quantity of money and of deposits. These are the
only influences which can directly affect the level of

prices. Any other influences on prices must act
through these five .

There are myriads of such in

fluences (outside of the equation of exchange) that
affect prices through the medium of these five.

At the close of the last chapter we noted the effect
during transition periods of a change or the lack of
change in the rate of interest. It is our purpose in

this chapter to note some of the outside influences

which at all times affect the factors of the equation
of exchange.
We shall first consider the outside influences that

affect the volume of trade and , through it, the
price level. The most important may be classified
as follows :
88

$ 1.)

REMOTE INFLUENCES ON PRICES

1. Conditions affecting producers.
(a )Geographical differences in natural resources.
(b ) The division of labour.

(c) Knowledge of the technique of production .
(d ) The accumulation of capital.

2 . Conditions affecting consumers.
(a) The extent and variety of human wants.
3. Conditions connecting producers and consumers .
(a) Facilities for transportation .
(6) Relative freedom of trade.
(c) Character ofmonetary and banking systems.
( d ) Business confidence.

That many of these conditions promote trade

is so obvious and well known as to require no ex
planation . The fact that some parts of the earth
produce wheat, others spices , others furs, etc., evi

dently tends to cause trade to flow between these
parts, while the fact that some groups of persons
devote themselves to farming , others to cloth mak

ing, others to building, etc., evidently implies trade

between these groups. It is clear also that the
state of knowledge of the means and methods of

production will stimulate trade.

For instance ,

mines of Africa and Australia were left unworked

for centuries by ignorant natives, but were opened
by white men possessing a knowledge of metal
lurgy. Again , it is clear that knowledge to be of use
must be applied ; and that its application usually
requires the aid of capital. The greater and the
89

WHY IS THE DOLLAR SHRINKING ? (CH. VI.
more productive the stock of capital in any com
munity , the more goods it can put into currents of

trade. A mill will make a town a centre of trade.
Docks, elevators, warehouses, and railway ter

minals help to transform a harbour into a port of
commerce.
Since increase in trade tends to decrease the gen

eral level of prices, it is obvious that anything which
tends to increase trade likewise tends to decrease
the general level of prices . We conclude, there

fore, that among the various causes which tend to

decrease prices are greater geographical or personal
specialization, improved productive technique, and

the accumulation of capital.
Almost equally obvious is the relation of the extent
and variety of human wants to the volume of trade.
Wants are, as it were, the mainsprings of economic
activity and, in the last analysis, keep the economic
world in motion . The desire to have clothes as fine
as the clothes of others, or finer, or different, leads

to the multiplicity of silks, satins, laces, etc., and
the same principle applies to furniture , amuse
ments, books, works of art, and every other means of

gratification. .
The increase of wants in so far as it leads to an

increase in trade tends to lower the price level.
The next group of influences mentioned in our
list are those influences which conditions connecting

producers and consumers exert on trade and there
fore on prices .
90

$ 1.)

REMOTE INFLUENCES ON PRICES

As Macaulay said , with the exception of the alpha
bet and the printing-press, no set of inventions has

tended to alter civilization so much as those which
abridge distance — such as the railway, the steamship ,

the telephone, the telegraph , and that conveyer of
information and advertisements, the newspaper .

These all tend , therefore, to decrease prices.
But trade barriers are not only physical, but
legal. A tariff between countries has the same in
fluence in decreasing trade as a chain of mountains.
The freer the trade, the more of it there will be.

In France many communities have a local tariff
(octroi) which tends to interfere with local trade.

In the United States trade is free within the coun
try itself, but between the United States and other
countries there is a tariff wall.

The very fact of

increasing facilities for transportation by lowering or
removing physical barriers, has stimulated nations
and communities to erect legal barriers in their

place. Tariffs not only tend to decrease the fre
quency of exchanges, but to the extent that they

prevent international or interlocal division of labour

and make countries more alike as well as less pro
ductive, they also tend to decrease the amounts
of goods which can be exchanged. The ultimate
effect is thus to raise prices. This is the effect on

the general level of prices. Besides this general
effect are the particular effects on those articles on
which duties are laid , butwith these particular effects

we have here nothing to do.
91

WHY IS THE DOLLAR SHRINKING ? (CH. VI.
Another sort of restriction on
straint of trade" of monopolies
These , of course, like any other
amounts of goods sold , tend to

trade is the " re
or combinations.
reduction in the
raise the general

level of prices.

The development of efficient monetary and

banking systems tends, among other effects, to in - ,
crease trade. There have been times in the his

tory of the world when money was in so uncer
tain a state that people hesitated to make many
trade contracts because of the lack of knowledge of

what would be required of them when the contract
should be fulfilled. In the same way, when people
cannot depend on the good faith or stability of
banks, they will hesitate to embark in extensive
trading .

Confidence not only in banks in particular,

but in business dealings in general, is truly said to
be “ the soul of trade.” In South America there
are many places waiting to be developed simply
because capitalists do not feel any security in con
tracts there. They are fearful that by hook or by
crook the fruit of any development they may under
take will be taken from them .

We see, then, that prices will tend to fall through
an increase in trade, which may in turn be brought
about by improved transportation , by increased
freedom of trade, by improved monetary and bank

ing systems, and by business confidence.
92

$ 2.)

REMOTE INFLUENCES ON PRICES

§ 2 . Influence of Individual Habits on Velocities of

Circulation and therefore on Prices

Having examined those causes outside the equa
tion which affect the volume of trade, our next task
is to consider those outside causes which affect the
velocities of circulation of money and of deposits.

For the most part, the causes affecting one of these
velocities affect the other also . These causes may
be classified as follows:

1. Habits of the individual.
(a ) As to hoarding.
(6 ) As to book credit and loans.

(c) As to the use of checks.
2 . Systems of payments in the community .
(a ) As to frequency of receipts and of disburse
ments .

(6 ) As to regularity of receipts and of disburse
ments.

(c) As to correspondence between receipts and
disbursements.

3 . General causes.
(a ) Density of population.
(6 ) Rapidity of transportation.
Taking these up in order, we may first consider
what influence hoarding has on the velocity of cir
culation . Velocity of circulation of money is the
same thing as its rate of turnover. It is to be found

by dividing the total payments effected by money
93

WHY IS THE DOLLAR SHRINKING ? (CH. VI.
in a year by the average amount of money in cir
culation in that year. It is an average of the
rates of turnover of the individuals who compose

society. This velocity of circulation or rapidity of
turnover of money is the greater for each individual,
the more money he expends with a given average
amount of cash on hand , or the less average cash he

keeps for a given yearly expenditure. One man
keeps an average of $ 10 in his pocket and expends
$ 500 a year ; he therefore turns over the average

contents of his pocket fifty times a year. Another,
while expending the same sum ($ 500), keeps the
more prudent average of $20 ; he, therefore , turns
over his stock of cash only twenty -five times a year.
Some people are , by habit, always impecunious

or short of ready money and tend to have a high
rate of turnover ; others carry a full purse and have
a slow rate of turnover. When , as used to be the

custom in France , people put money away in stock

ings and kept it there for months, the circulation
must have been extremely slow . The same prin
ciple applies to deposits.
Hoarded money is sometimes said to be withdrawn
from circulation, but this is only another way of
saying that hoarding tends to decrease the velocity
of circulation . The only real distinction between
“ hoarding " money in a stocking or safe and “ carry
ing " money in a purse is one of degree . Themoney
remains in the stocking or safe longer than in the
purse.

In either case it may be said to be in cir
94

§ 2.)

REMOTE INFLUENCES ON PRICES

culation, but when “ hoarded,” it circulates much
more slowly. The discontinuance of hoarding evi
dently tends to increase the price level by increasing
the velocity of circulating money.

This must be

the tendency in future generations when the great
buried hoards of the Orient are put into active
circulation. This will surely happen ultimately
when Occidental habits shall have been generally

adopted .
The habit of “ charging,” i.e., using book credit ,
tends to increase the velocity of circulation of money,
because the man who gets things “ charged ” does
not need to keep on hand as much money as he would
if hemade all payments in cash. A man who daily
pays cash needs to keep cash for daily contingencies.

The system of cash payments, unlike the system of
book credit , requires that money shall be kept on

hand in advance of purchases. Evidently if money

must be provided in advance, it must be provided
in larger quantities than when merely required to
liquidate past debts. In the system of cash pay
ments a man must keep money idle in advance,
lest he be caught in the embarrassing position of

lacking it when he most needs it. With book credit
he knows that even if he should be caught without
a penny in his pocket, he can still get supplies on
credit. These he can pay for when money comes
to hand . As soon as this money is received there is
a use awaiting it to pay debts accumulated . For
instance ,a labourer receiving and spending $ 7 a week ,
95

WHY IS THE DOLLAR SHRINKING ? [CH. VI.
if he cannot “ charge,” must make his week 's wages
last through the week. If he spends $ 1 a day, his
weekly cycle must show on hand on successive days
at least $ 7 , $ 6 , $ 5 , $ 4 , $ 3 , $ 2 , and $ 1, at which time

another $ 7 comes in . This makes the average

balance $4 . The rate of turnover (ratio of expendi
ture to cash carried ) would then be $7 divided by 4,
or about twice a week . But if he can charge every
thing,and then wait until pay-day to meet the result
ing obligations, he need keep nothing through the
week , paying out his $ 7 when it comes in . His
weekly cycle need show no higher balances than
$ 7 , $ 0 , $ 0 , $ 0 , $ 0 , $ 0 , $ 0 , averaging only $ 1 ; the
turnover would then be $ 7 divided by 1 or seven

times a week .
Analogous to the use of book credit is the use of
loans of any kind. In a highly organized center of

trade, like the New York stock or produce exchanges ,
credit is extended to an extreme degree in order to
facilitate the transactions of a large volume of busi
ness without the necessity of keeping on hand a
large cash balance of money or deposits subject to

check . Credit is extended by loans, by allowing
purchases on small payments called " margins,”
and in other ways. All these extensions of loan
credits tend to increase the velocity of circulation
of money and deposits.
Through book credit and loans, therefore, the
average amount of money or bank deposits which
each person must keep on hand to meet a given ex
96

$ 2.)

REMOTE INFLUENCES ON PRICES

penditure is made less.

This means that the rate

of turnover is increased ; for if people spend the
same amounts as before , but keep smaller amounts
on hand , the quotient of the amount spent divided
by the amount on hand must increase .
The habit of using checks rather than money will

also affect the velocity of circulation of money, be
cause a depositor's surplus money instead of being
hoarded will probably be put in the bank in return

for a right to draw by check.
Banks thus offer an outlet for any surplus pocket
money or surplus till money, and tend to prevent

the existence of idle hoards. On the other hand ,

surplus deposits may be converted into cash —
that is, exchanged for cash — as desired.

The net

result is that those who make use of both cash and

deposits have the opportunity, by adjusting the
two, to prevent either from being idle.
We see, then , that these three habits — the
habit of carrying small supplies of cash instead

of “ hoarding,” the habit of charging, and the habit
of using checks — all tend to raise the level of prices
through their effects on the velocity of circulation
of money, or of deposits.

We comenext to the influence of systems of pay
ments on velocities of circulation and therefore on
prices.

The more frequently money or checks are re

ceived and disbursed , the shorter is the average
interval between the receipt and the expenditure
97

WHY IS THE DOLLAR SHRINKING ? (CH. VI.
of money or checks, and the more rapid is the veloc
ity of circulation .

Thismay best beseen from an example. A change

from monthly to weekly wage payments tends to
increase the velocity of circulation of money.

If a

labourer is paid weekly $ 7, and reduces this evenly
each day, ending each week empty -handed , his
average cash , as we have seen, would be little over
half of $ 7 , or about $ 4 . This makes his turnover
nearly twice a week. Under monthly payments,

the labourer who receives and spends an average of
$ 1 a day will have to spread the $ 30, more or less

evenly , over the following thirty days. If, at the
next pay-day, he comes out empty -handed , his
average money during the month has been about
$ 15. This makes his turnover about twice a month.

Thus the rate of turnover ismore rapid under weekly
than under monthly payments, provided , of course ,

the introduction of weekly payments does not dis
turb some other factor influencing velocity . If it
leads to cash payments in place of book credit, the

rate of turnover may really decrease instead of in
creasing .
Again , when the workman can be fairly certain

of both his receipts and expenditures , he can , by
close calculation, adjust them so precisely as safely

to end each payment cycle with an empty pocket.
This habit is extremely common among certain
classes of city labourers. On the other hand , if the

receipts and expenditures are irregular, either in
98

§ 2.)

REMOTE INFLUENCES ON PRICES

amount or in time, prudence requires the worker
to keep a larger sum on hand to insure against mis
haps. Even when foreknown with certainty, irregu

lar receipts require a larger average sum to be kept
on hand. We may, therefore, conclude that regu
larity, both of receipts and of payments, tends to

increase velocity of circulation.
We next consider the correspondence between
receipts and disbursements, i.e.,making the payments

come at nearly the same times as the times when the
receipts are obtained . It is manifestly a great
convenience to the spender of money, or of deposits,
if dealers to whom he is in debt will allow him

to

postpone payment until he has received his money
or his check. This arrangement obviates the neces

sity of keeping much money or deposits on hand,
and therefore increases their velocity of circulation .

Where the payments which a man is to make for
rent, interest, insurance, and taxes occur at periods

irrespective of the times when he receives money , it
will be necessary for him to accumulate money on
deposits in advance, thus increasing the average
on hand, withdrawing money from use for a time,
and decreasing the velocity of circulation .

We conclude, then, that correspondence and regu
larity of payments, no less than frequency of pay
ments, tend to increase prices by increasing velocity
of circulation .

We come now to the influences of general causes
on velocities of circulation and therefore on prices.
99

WHY IS THE DOLLAR SHRINKING ? [CH. VI.
The more densely populated a locality, the more

rapid will be the velocity of circulation because there
will be readier access to people from whom money is
received or to whom

it is paid . Although there

are no statistics on this subject, the velocity of
circulation must be slower in the country than in
the city . A lady who has a city house and a country
house states that in the country she keeps money

in her purse " for weeks,” whereas in the city she
keeps it but a " few days.” Pierre des Essars has
worked out the velocity of circulation of bank de
posits in many European cities. Examination of
his figures reveals the fact that, in almost all cases,

the larger the town in which the bank is situated,
the more active the deposits. The Bank of Greece
has a turnover whose rate of rapidity is only four
times a year, while that of the Bank of France is over

one hundred times a year.
Again , the more extensive and the speedier the
transportation in general, the more rapid the cir

culation of money. Anything which makes it
easier to pass money from one person to another
will tend to increase the velocity of circulation .

Railways have this effect. The telegraph has in
creased the velocity of circulation of deposits , since

these can now be transferred thousands of miles

in a few minutes. Mail and express, by facilitating
the transmission of bank deposits and money, have

likewise tended to increase their velocity of circula
tion .

100

$ 3.) REMOTE INFLUENCES ON PRICES

We conclude, then, that density of population
and rapidity of communication tend to increase

prices by increasing velocities of circulation .
§ 3 . Influences on the Volume of Deposit Currency

and therefore on Prices
We have to consider lastly the specific outside
influences on the volume of deposits subject to
check .

These are chiefly :

(1) The system of banking and the habits of the
people in utilizing that system .
(2) The habit of charging.

It goes without saying that a banking system must
be devised and developed before deposits can affect
prices or even exist. The invention of banking
has undoubtedly led to a great increase in deposits
and a consequent rise of prices. This has been true
in spite of the fact that the development of efficient
monetary and banking systems tends to increase
the volume of trade and to that extent to lower the
price level. Here, as in many other instances ,
the effects of improving monetary and banking facili

ties are complex , affecting more than one factor in
the equation of exchange. The price- raising effect
is far more important than the price -depressing

effect. In the future one of the chief causes tending
to raise prices will doubtless be the expansion of

deposits subject to check.
We have already seen that “ charging” increases
101

WHY IS THE DOLLAR SHRINKING ? [CH. VI.

the velocity of circulation of money. It is also a
means of increasing the volume of deposits subject
to check ; that is, “ charging ” is often a preliminary

to payment by check rather than by cash — if a cus
tomer did not have his obligations " charged ,”

he would pay by money and not by check. The
ultimate effect of the practice of charging, there
fore, is to increase the ratio of check payments to
cash payments and the ratio of deposits to money
carried ( M ' to M ) and therefore to increase the
amount of credit currency which a given quantity
ofmoney can sustain .

This effect, the substitution of checks for cash

payments, is probably by far the most important
effect of “ charging,” and exerts a powerful influence
toward raising prices.

Anything which tends to increase bank deposits
tends to that extent to raise prices. Thus the
creation of “ trusts” has resulted in the issue of a
great mass of stocks and bonds which are more
readily accepted by bankers as “ collateral” for loans

than the stocks and bonds of the smaller and less
known companies from which the “ trusts” are
formed . The consequence is : more bank loans,
greater deposits, and a higher level of prices. Be

sides these and the other effects of “ trusts,” which
have been mentioned elsewhere , on the general level

of prices, there are more obvious and direct effects
on the particular prices of the goods dealt in by the
“ trusts." But we have here nothing to do with
102

§ 3.) REMOTE INFLUENCES ON PRICES
particular prices . Wemay observe, however , that
when trusts raise particular prices. it does not follow
that thereby they raise the general level of prices .
Unless they disturb the five factors, M , M ', V , V ',
or T , they cannot effect the general level of prices ;

for in that case, the general level of prices, as the
equation or exchange shows, could not be disturbed
either, and the raising of prices of particular trust
made articles would have to result indirectly in

lowering the prices of some other goods enough to
compensate.

103

CHAPTER VII

REMOTE INFLUENCES ON PRICES (Continued )
§ 1. Influence of the “ Balance of Trade ” on the
Quantity ofMoney and therefore on Prices
We have now considered those influences outside

the equation of exchange which affect the volume of
trade ( T ), the velocity of circulation of money and

deposits (V and V ') , and the amount of deposits
( M '). We have left the outside influences which
affect the quantity of money (M ) .
The chief of these may be classified as follows:
(1) Influences operating through the exportation and
importation of money.
(2 ) Influences operating through the melting and
minting of money.

(3) Influences operating through the production and
consumption ofmoney metals.
(4 ) Influences of monetary and banking systems.

The first to be considered is the influence of for
eign trade on the quantity of money in a country
and therefore on its price level. Hitherto we have

confined our studies of price levels to an isolated
community , having no trade relations with other
communities. In the modern world , however, no
104

§ 1.)

REMOTE INFLUENCES (Continued)

such community exists, and it is important to observe
that international trade gives present-day problems
of money and of price level an international char
acter.

If all countries had their own irredeemable paper
money and no money that was acceptable elsewhere,

price levels in different countries would have no
intimate connection . Indeed , the connection is
actually slight as between countries which have
different metallic standards ; for example , between a

gold -basis and a silver -basis country . But where
two or more nations trading with each other use

the same standard , there is a tendency for the price
level of each to influence profoundly the price
level of the other.

The price level in a small country like Switzer
land depends largely upon the price levels in other
countries ; for if the price levels in these countries
is higher or lower than in Switzerland , the difference
will set up trade currents which will increase or de
crease the quantity of money in Switzerland and
therefore raise or lower its level of prices to corre

spond to the levels outside. Gold , which is the
primary or full-weight money in most civilized
nations, is in this way constantly sent from one
country or community to another. When a single

small country is under consideration, while it is
quite correct to say that the quantity of money in
that country determines the price level, we must

not fail to note that the quantity of money within
105

WHY IS THE DOLLAR SHRINKING ? (CH. VII.

its borders is in turn dependent upon the level of
prices outside. An individual country bears the

same relation to the world that a lagoon bears to
the ocean . The level of the lagoon depends, of
course, upon the quantity of water in it. But the
quantity of water in it depends upon the level of
the ocean. As the tide in the outside ocean rises
and falls, the quantity of water in the lagoon will
adjust itself accordingly.

To simplify the problem of the distribution of
money among different communities , we shall, for

the time being, ignore the fact that money consists
ordinarily of material capable of monetary uses.
We shall therefore omit consideration of the disap
pearance of money through melting ; likewise , for
the present, we shall omit consideration of the pro
duction of money through minting.
Let us, then , consider the causes that determine
the quantity of money in a state like Connecticut.

If the level of prices in Connecticut temporarily
falls below that of the surrounding states, Rhode
Island, Massachusetts, and New York, the effect is
to cause an export of money from these states to

Connecticut, because people will buy goods wherever
they are cheapest and sell them wherever they are
dearest. With its low prices, Connecticut becomes

a good place to buy from , and a poor place to sell
in . But if outsiders buy of Connecticut, they will
have to bring money to buy with . There will,
therefore, be a tendency for money to flow to Con
106

$ 1.)

REMOTE INFLUENCES (Continued )

necticut until the level of prices there rises to a
level which will arrest the influx. If, on the other
hand , prices in Connecticut are higher than in sur

rounding states, it becomes a good place to sell in
and a poor one to buy from . But if outsiders sell
in Connecticut, they will receivemoney in exchange.
There is, then, a tendency for money to flow out of
Connecticut until the level of prices in Connecticut

is lower. In general,money flows away from places

where the level of prices is high, and toward places
where it is low . Men sell goods where they can

get most money, and buy goods where they will
have to give the least money. We say “ money ,”

for in the long run we do not need to consider the
interflow of bank deposits ; as we have seen , in the

long run deposit currency in each country willmain
tain a definite ratio to money.

In the long run

an increase or decrease of money in a country will
increase or decrease its deposits.

But it must not be inferred that the prices of
various articles or even the general level of prices
willbecome precisely the same in different countries.
Distance , ignorance as to where the best markets
are to be found , tariffs, and costs of transportation

help to maintain price differences. The native
products of each region tend to be cheaper in that
region . They are exported as long as the excess of
prices abroad is enough to more than cover the
cost of transportation . Ordinarily a commodity will
not be exported at a price which will not at least be
107

WHY IS THE DOLLAR SHRINKING ? (CH . VII.

equal to the price in the country of origin plus the

freight. Many commodities are shipped only one
way. Thus, wheat is shipped from the United
States to England , but not from England to the

United States. It tends to be cheaper in the United
States. Large exportations raise its price in America
toward the price in England , but the American
price will usually remain below the English price
by the cost of transportation . A few commodities
may be sent in either direction , according to market
conditions.

But although international or interlocal trade will
never bring about exact uniformity of price levels,
it will, to the extent that it exists, produce an adjust
ment of these levels toward uniformity by regulating,
in the manner already described , the distribution of

money. If one commodity enters , to any consider
able extent, into international trade, it alone will
suffice, though slowly , to act as a regulator of money
distribution ; for, in return for that commodity ,

money may flow , and , as the price level rises or
falls, the quantity of that commodity sold is cor
respondingly adjusted. In ordinary intercourse
between nations, even when a deliberate attempt is
made to interfere with it by protective tariffs, there
will always be a large number of commodities thus

acting as outlets and inlets .
And since the quantity of money itself affects prices
for all sorts of commodities, the regulative effect of

international trade applies, not simply to the com
108

§ 1.)

REMOTE INFLUENCES (Continued)

modities which enter into that trade, but to all
others as well. It follows that nowadays inter

national or interlocal trade is constantly regulating
price levels throughout the world .
Wemust not leave this subject without emphasiz
ing the effects of a tariff on the purchasing power of
money . When a country adopts a duty on im
ports, the tendency is for the level of prices in that
country to rise. A tariff obviously raises the prices
of the “ protected ” goods. But the tariff does more
than that — it tends also to raise the prices of un

protected goods.

Thus, a new tariff first causes a

decrease in imports but no change in exports.

The

foreigner will, for a time, continue to buy from the

protected country almost as much as before. This
unchecked buying of goods means unchecked export

of goods, while the imports have suddenly been
checked. There will result, therefore, a temporary
excess of the protected country's exports over its
imports or a so- called “ favourable ” balance of trade,

that is, a net inflow of money. This inflow will
eventually raise the prices, not alone of protected
goods, but of unprotected goods as well. The rise

will continue till it reaches a point high enough to
put a stop to the " favourable " balance of trade, —
that is, until the raised prices check the purchase

by foreigners of the export goods.

Although the " favourable balance ” of trade
created by a tariff is temporary, it leaves behind a
permanent increase of money and of prices. This
109

WHY IS THE DOLLAR SHRINKING ? (CH. VII.

is perhaps the chief reason why a protective tariff
seems, to many, a cause of prosperity. It furnishes
a temporary stimulus not only to protected indus
tries, but to trade in general, which is, in reality,
simply the stimulus of money inflation .

The per

manent effect is to keep prices in general, including

money wages, at a higher level in the protected
country than in free-trade countries.

This is doubt

less one reason why American wages and prices are
higher than English .
The reduction of the tariff by the Underwood act
should tend to lower prices by stimulating imports

and causing an outflow of gold .

Among the many fallacies connected with " the
balance of trade," is the idea that unless the trade
between any two countries balances, one of them
must be losing to the other. But it is only nec

essary that the trade between any one country and
all the rest of the world should balance. For
instance, trade is often triangular or indirect. The
United States may send a surplus of exports to
Canada , Canada send a surplus of exports to Ger
many, while Germany sends a surplus of exports to

the United States.

Another common oversightin dealingwith the“ bal
ance of trade ” is the failure to take into account invis

ible items of trade, such as freights, insurance, bank

ing commissions, tourists, travelling expenses, and
last, butnot least,payments for investment securities.

The export of securities are very important items
110

$ 2.1

REMOTE INFLUENCES (Continued)

in international trade. Even the interest coupons
on past indebtedness form , in the case ofmany coun

tries, including the United States , very large items.

Finally , though all these invisible items be accu
rately measured, there would still be a slight dif
ference between exports and imports, owing to the

fact that there is not always a quid pro quo, but that
some international trade represents gifts. This is
particularly true in the case of the United States in
which many of the immigrants send remittances to
their relatives in “ the old country.”

§ 2 . Influence of Melting and Minting on the Quan
tity of Money and therefore on Prices
Wehave seen how M in the equation of exchange
is affected by the importation or exportation of
money . Considered with reference to the M

in

any one of the countries concerned , the M 's in all
the others are “ outside influences.”

Proceeding now one step farther, we must con
sider those influences on M that are not only out
side of the equation of exchange for any particular
country , but also outside that for the whole world .

Besides the monetary inflow and outflow through
importation and exportation there is an inflow and
outflow through minting and melting. In other
words, not only do the stocks of money in the world
connect with each other like interconnecting bodies
of water, but they connect in the same way with
the outside stock of bullion . In the modern world
111

WHY IS THE DOLLAR SHRINKING ? [CH. VII.

one of the precious metals, such as gold , usually
plays the part of primary money, and this metal
has two uses — a monetary use and a commodity

use. That is to say, gold is not only a money ma
terial, but a commodity as well. In their character
of commodities, the preciousmetals are raw materials

for jewelry, works of art , and other products into
which they may be wrought.

It is in this unmanu

factured or raw state that they are called bullion .
Gold money may be changed into gold bullion ,
and vice versa . In fact, both changes are going on
constantly , for if the value of gold , as compared with

other commodities, is greater in the one use than in
the other, gold will immediately flow toward which
ever use is more profitable , and the market price of
gold bullion , in terms of gold money, will determine

the direction of the flow . Since 100 ounces of gold
% fine can be transformed into 1860 gold dollars ,

the market value of so much gold bullion, % fine,
must tend to be $ 1860. If it costs nothing to have

bullion coined into money, and nothing to melt
money into bullion , there will be an automatic flux

and reflux from money to bullion and from bullion

to money that will prevent the price of bullion from
varying greatly . If the price of gold bullion is
greater than the money which could be minted from
it, for instance , if 100 ounces of gold sell for $ 1861,
the users of gold who require bullion — notably
jewelers — will save the $ 1 difference by melting
$ 1860 of gold coin into 100 ounces of bullion . Con
112

$ 2.)

REMOTE INFLUENCES (Continued )

trariwise , if the price of bullion is less than the value
of gold coin , say $ 1859, the owners of bullion will
save the $ 1 difference by taking 100 ounces of
bullion to the mint and having it coined into 1860

gold dollars. The effect of melting coin , on the one
hand , is to decrease the amount of gold money and
increase the amount of gold bullion, thereby lower
ing the value of gold as bullion and raising the value

of gold as money ; and thereby also lowering the
price level and restoring the equality between

bullion and money. The effect of minting bullion
into coin is, by the opposite process, to bring the
value of gold as coin and the value of gold as bullion

into equilibrium .
When a charge called “ seigniorage ” is made for
changing bullion into coin , or where the process in
volves expense or delay , the flow of bullion into

currency will be to that extent impeded . But under
a modern system of free coinage and with modern
methods of reducing coin to bullion , both melting
and minting may be performed so inexpensively and

so quickly that there is practically no cost or delay
involved. In fact, there are few instances of more
exact price adjustment than the adjustmentbetween

gold bullion and gold coin . It follows that the
quantity of money and, therefore, its purchasing
power , is directly dependent on that of gold bullion.
This stability of the price of gold bullion ex

pressed in gold coin causes confusion in the minds
of people, giving them the erroneous impression
113

WHY IS THE DOLLAR SHRINKING ? (CH. VII.

that there is no change in the value of money .
Indeed, this stability has often been cited to show
that gold is a stable standard of value. Dealers in

objects made of gold seem to misunderstand the
significance of the fact that an ounce of gold (
fine) always costs $ 18 .60 in the United States, or an
ounce of gold (i fine) always costs £3: 178. 10 d.
in England. This means nothing more than the

fact that gold in one form and measured in one way
will always bear a constant ratio to gold in another
form and measured in another way. An ounce of
gold bullion is worth a fixed number of gold dollars

for the same reason that a pound sterling of gold is
worth a fixed number of gold dollars, or that a ton

of large steel ingots is worth a fixed number of
pounds of small steel ingots.

Except, then , for extremely slight and temporary
fluctuations, gold bullion and gold money must
always have the same value. Therefore, in the

following discussion respecting the more consider
able fluctuations affecting both , we shall speak of
these values interchangeably as “ the value of gold .”
$ 3. Influence of the Production and Consumption

of Money Metals on the Quantity of Money
and therefore on Prices

The stock of bullion is not the ultimate outside
influence on the quantity of money. As the stock
of bullion and the stock of money influence each
other , so the total stock of both is itself influenced
114

$ 3.)

REMOTE INFLUENCES (Continued)

by production and consumption. The production
of gold consists in the output of the mines, which
constantly tends to add to the existing stocks both
of bullion and coin . The consumption of gold con

sists in the use ofbullion in the arts by being wrought
into jewelery, gilding, etc ., and in losses of coin by
abrasion, shipwreck , etc. If we consider the amount
of gold coin and bullion as a sort of reservoir , pro
duction would be the inflow from the mines, and
consumption the outflow to the arts and by destruc
tion and loss. To the inflow from the mines should
be added the re-inflow from forms of art into which
gold had previously been wrought, but which have
since become obsolete.

This is illustrated by the

business of producing gold bullion by burning gold
picture -frames.
We shall consider, first, the inflow or production ,
and afterward the outflow or consumption . The
regulator of the inflow (which practically means the

production of gold from the mines) is its estimated
cost of production . Wherever the estimated cost

of producing a dollar of gold is less than the existing

value of a dollar in gold , the gold will (normally ) be
produced . Wherever the cost of production ex
ceeds the existing value of a dollar, the gold will
(normally ) not be produced. In the former case
the production of gold is profitable ; in the latter

it is unprofitable.
This holds true in whatever way cost of produc
tion is measured , whether in terms of gold itself, or
115

WHY IS

THE DOLLAR SHRINKING ? (CH. VII.

in terms of some other commodity such as wheat,
or of commodities in general. In gold -standard

countries the gold -miner does actually reckon the

cost of producing gold in terms of gold . From his
standpoint it is a needless complication to translate

the cost of production and the value of the product
into someother standard than gold . He is interested

in the relation between the two, and this relation
will be the same whichever standard is employed.
To illustrate how the producer of gold measures
everything in terms of gold , suppose that the price
level rises. He will then have to pay more dollars
for wages, machinery, fuel, etc., while the prices

obtained for his product (expressed in those same

dollars) will, as always, remain unchanged . Con
versely , a fall in the price level will lower his cost of
production (measured in dollars) , while the price of

his product will still, as always, remain the same.

Thus we have a variable number expressing the cost
of production and a constant number expressing the
price of gold product.
If we express the same phenomena, not in terms
of gold , but in terms of wheat, or rather, let us say,
in terms of goods in general, we shall have the oppo

site conditions. Then a fall in the price level can
not be said to affect his cost ofproduction (measured
in goods), while the " price,” or purchasing power,
of his product over goods will rise. A constantnum
ber expresses the cost of gold and a variable number ,

its price (purchasing power).
116

$ 3.)

REMOTE INFLUENCES (Continued )

Thus the comparison between price and cost of

production is the same,whether we use gold or other
commodities as our criterion . In the one view –

i.e.,when prices of labour and commodities aremeas
ured in gold — a rise of these prices appears as a
rise in the gold -miner 's cost of production — the

money cost to him of labour and materials — while
the price of his product, gold , appears constant;
in the other view — i.e., when labour and commodi
ties are measured in other goods — the same phe

nomenon is expressed as a fall in the purchasing

power of his product, gold ,while the cost of labour
and materials in terms of themselves is the constant

quantity. In the one view his costs rise relatively
to his product; in the other his product falls rela
tively to his costs. In either view he will be dis
couraged . He will look at his troubles in the former

light, i.e., as a rise in the cost of production ; but
we shall find it more useful to look at them in the

latter, i.e., as a fall in the purchasing power of the
product. In either case the comparison is between
the cost of the production of gold and the purchas
ing power of gold .

If this purchasing power is

above the cost of production in any particular mine,

it will pay to work that mine. If the purchasing
power of gold is lower than the cost of production
in any particular mine, it will not pay to work that
mine.
So much for the inflow of gold and the conditions
regulating it. We turn next to outflow or consump
117

WHY IS THE DOLLAR SHRINKING ? (CH. VII.
tion of gold .

This has two forms, viz. : consump

tion in the arts and consumption for monetary
purposes.

First,we shall consider its consumption in the arts.
If objects made of gold are cheap, — that is, if the
prices of other objects are relatively high , — then
the relative cheapness of the gold objects will lead

to increase in their use and consumption . Express
ing the matter in termsof money prices, when prices
of everything else are higher and people 's incomes
are likewise higher, while gold-leaf and gold orna
ments remain at their old prices, people will use
and consumemore gold -leaf and ornaments .

These are instances of the consumption of gold
in the form of commodities.

The consumption and

loss of gold as coin is a matter of “ abrasion ” ( gradual

waste by wearing or rubbing against other coins or
the hands, pocket, or purse ), of loss by shipwreck
and other accidents. They change with the changes
in theamount of gold in use and in its rapidity of
exchange.

A fall, therefore, in purchasing power of the value
of gold affects both consumption and production . It
stimulates consumption (that is, the turning of bul

lion into articles of commerce) ; and it discourages
production. An increase of purchasing power, of
course, acts in the opposite way. Conversely ,
consumption and production affect purchasing

power. Consumption, or the withdrawal of bullion
into commerce, raises the purchasing power of
118

$ 3.)

REMOTE INFLUENCES (Continued )

what is left, while production from the mines lowers
the purchasing power .
The purchasing power of money, being thus

played upon by opposing forces of production and
consumption , is driven up or down as the case may
be.

We have now discussed all but one of the
important outside influences upon the equation of
exchange. That one is the character of themonetary
and banking system which affects the quantity of

money and deposits. This we reserve for special
discussion in the following chapter .
Meanwhile, we may note that almost all of the

influences which at the present time actually affect
either the quantity or the velocities of circulation
have been and are predominantly in the direction
of higher prices. Almost the only opposing in
fluence is the increased volume of trade. We may
also point out that some of those influences dis

cussed in this and the preceding chapter operate
in more than one way. Consider, for instance,

technical knowledge and invention, which affect
the equation of exchange by increasing trade. So
far as these increase trade, the tendency is to

decrease prices ; but so far as they develop metal
lurgy and the other arts which increase the

production and transportation of the precious
metals, they tend to increase prices . So far as
they make the transportation and circulation of
money and deposits quicker, they also tend to
119

WHY IS THE DOLLAR SHRINKING ? (CH. VII.
increase prices.

So far as they lead to the

development of the art of banking, they likewise
tend to increase prices both by increasing deposit
currency (M ') and by increasing the velocity of
circulation of both money and deposits. So far as
they lead to the concentration of population in
cities , they tend to increase prices by accelerating
circulation .

120

CHAPTER

VIII

OPERATION OF MONETARY SYSTEMS

$ 1. Gresham 's Law
Thus far we have considered the influences which

determine the purchasing power of money when the
money in circulation is all of one kind. We have
now to consider the monetary systems in which two

or more kinds of money are used .
One of the first difficulties in the early history of
money was that of keeping two or more metals in

circulation at the same time. The monetary unit
in one of the two would become cheaper than in the

other, and the cheaper would drive out the dearer.
To this tendency has been given the name of
“ Gresham 's Law ” in honour (rather undeservedly )

of Sir Thomas Gresham , a financial adviser of
Queen Elizabeth. He called attention

to the

tendency in the middle of the sixteenth century ,
although it is now known that many others had
anticipated him . In fact, the Law seems to have

been recognized among the ancient Greeks. It is
mentioned in the “ Frogs" of Aristophanes :
“ For your old and standard pieces, valued and ap
proved and tried,

Here among the Grecian nations and in all the world
beside,
121

WHY IS THE DOLLAR SHRINKING ? (CH. VIII.

Recognized in every realm for trusty stampand pure
essay,

Are rejected and abandoned for the trash of yester
day ;

For a vile, adulterate issue, drossy , counterfeit, and
base

Which the traffic of the city passes current in their
place !”

Gresham 's Law is ordinarily stated in the form ,
" bad money drives out good money ,” for it has
usually been observed that the badly worn, defaced,
light-weight, “ clipped ," " sweated ,” and otherwise

deteriorated money tends to drive out full-weight,
freshly minted coins. This formulation , however ,

is not accurate. “ Bad ” coins, e.g., worn , bent,
defaced,or even " clipped ” coins,willdrive out other
money only so far as they are less valuable. Some

times bright freshly minted coins drive out old , dull,
defaced coins, as, for instance, when new gold drove

out silver from the United States after 1837, thenew
gold dollar being cheaper than the old silver dollar.
Accurately stated , the Law is simply : The cheaper

money tends to drive out the dearer.
A good example of Gresham 's Law as applied to

gold and silver is found in the history of Japan .
When the treaty of 1858 between Great Britain and

Japan was adopted, an ounce of gold was worth in
Japan only 41 ounces of silver, whereas in Europe
it was worth 151 ounces , or 3 times as much .
The result was that the first merchants who entered
122

§ 1.] OPERATION OF MONETARY SYSTEMS

Japan from Europe could make a large profit by
trading in gold and silver. By taking,say, 41 ounces
of silver to Japan they could buy an ounce of gold ,

and taking this ounce of gold back to Europe they
could obtain 152 ounces of silver for it, or more than
three times as much as they started with. So
silver flowed into Japan and gold flowed out.
The reason why the cheaper of two moneys
always prevails is that the choice of the use of
money rests chiefly with the man who gives it in

exchange, not with theman who receives it. When
any one has the choice of paying his debts in either
of two moneys, motives of economy will evidently

prompt him to use the cheaper. If the initiative
and choice lay principally with the person who
receives instead of the person who pays the money,
the opposite would hold true. The dearer or “ good ”
money would then drive out the cheaper or “ bad ”

money. It is because the payer of money exercises
the choice that the cheaper money tends to be passed
on and the dearer money to be withdrawn.
Any individual into whose hands the two moneys
may chance to fall may exercise this choice and
withdraw the newly minted coins. But there are

two classes especially interested and most instru
mental in withdrawing the “ good ” money from
circulation ; namely , those who wish it either for

export or for melting, — the bankers and the gold
smiths.

What,then ,becomes of the dearer money ? Itmay
123

WHY IS THE DOLLAR SHRINKING ? CH. VIII.

be hoarded or go into the melting-pot or go abroad –
hoarded and melted from motives of economy, and
sent abroad because ,where foreign trade is involved ,
it is the foreigner receiving the money, rather than
ourselves giving it,who dictates what kind of money
shall be accepted. He will take only the best,
because our legal tender laws do not bind him .

Until “ milling " 1 the edges of coins was invented ,
and a " limit of tolerance ” 2 of the mintwas adopted ,
much embarrassment was felt in commerce from the
fact that the “ clipping ” and debasing of coins was a
common practice. Nowadays, however , any coin
which has been so “ sweated ” or “ clipped ” as to

reduce its weight appreciably ceases to be legal
tender, and being commonly rejected by those to
whom it is offered , ceases to be money. Within the
customary or legal limits of tolerance, however, —
that is, as long as the cheaper money continues to be
money, - it will tend to drive out the dearer.

§ 2. Bimetallism
The obvious effect of Gresham 's Law is to de
crease the purchasing power of money at every
opportunity .

The history of the world 's currencies

is largely a record of money debasements , often at
1 Making the edges finely corrugated so that they can
not be filed or otherwise rubbed off without detection .

2 The allowable deviation from the statutory weight.
If the deviation exceeds this, the coin is rendered un

acceptable in law as legal tender.
124

$ 2.) OPERATION OF MONETARY SYSTEMS

thebehest of the sovereign. Our chief purpose now ,
in considering Gresham 's Law , is to formulate more
fully the causes determining the purchasing power of

money under monetary systems subject to the
operation of Gresham 's Law . One application
is to " bimetallism .” Under bimetallism , govern
ments open their mints to the free coinage of two
metals (usually gold and silver) at a fixed coinage

ratio , and make both sorts of coin unlimited legal
tender at that ratio . Under this system the debtor
has the option , unless otherwise bound by contract,
ofmaking the payment either in gold or silver money .

These, in fact, are the two requisites of complete
bimetallism , viz .:

(1) The free and unlimited coinage of both metals at
a fixed ratio .
(2) The unlimited legal tender of each metal at that
ratio .

The object of bimetallism is to render the pur
chasing power of money more stable. It has been
denied that bimetallism ever did or can make gold

and silver dollars circulate side by side at equal
values.

This denial is based on Gresham ' s Law , by

which the cheaper metal will drive out the dearer.
Our first task is to show , quite irrespective of its
1 By the " coinage ratio " ismeant the ratio of the weight
of the silver dollar to that of the gold dollar.

This is at

present 16 to 1 ; for a silver dollar weighs 4123 grains,

which is almost exactly sixteen times the weight of a gold

dollar of 25.8 grains.
125

WHY IS THE DOLLAR SHRINKING ? (CH. VIII.
desirability, that bimetallism can “ work ” and has
worked under certain circumstances, but not under

others.
Suppose that, at first, gold alone is freely coined
(and is unlimited legal tender ) and then (as proposed
in the United States by the “ free silver " party in

1896 and 1900) silver is put on exactly the samebasis,
the mints being opened to its free coinage also.
The results of thus opening themints to silver at
a ratio of 16 to 1 with gold will be different, according
to the relative market value of gold and silver before

the mints are opened . If 4123 grains of silver were

dearer than 25 .8 grains of gold , there would be no
silver coined at all, for no one will take 4121 grains
of silver to be coined and used as a dollar of money

when he can get more than a gold dollar for it by
selling it as silver bullion .
But if (as happens to be the case to -day) 4121
grains of silver are cheaper than 25.8 grains of gold ,
every owner of silver bullion will make a profit by

taking it to the mint. In this way he can get a
silver dollar for every 4121 grains of silver bullion,

while in the silver bullion market he can get only ,
let us say, fifty cents. The result will be a wild
scramble among all owners of silver bullion to get it
coined , in order to transform each 4121 grains of it

into a full- fledged dollar instead of fifty cents,which
previously was all they could get for it. It is
true that the new silver dollar may not be worth as
much in purchasing power as a gold dollar ; but being
126

$ 2.) OPERATION OF MONETARY SYSTEMS
legal tender, it will have just as great debt-paying
power.

There can be no doubt, then , that silver, being
cheaper than gold , will be taken to the mint as soon

as the bimetallic law takes effect. The question
now is, What will be the result ?

To this question

the answer is briefly as follows:
I. The first effect (as has been emphasized by
" monometallists ” ) will be the operation of Gresham 's

Law , by which the cheap silver dollars will tend to

expel the dear gold dollars from circulation .
II. But (as emphasized by “ bimetallists ” ) this
very operation of Gresham 's Law is self-limiting ;
for it tends to reduce the original disparity between

the values of the gold and silver dollars. Owing

to the eagerness of debtors to use silver instead of
gold in paying their debts , the value of silver is in
creased and that of gold decreased .

This mutual

approach of the values of gold and silver dollars may
result in making them equal and if they become
equal before gold is entirely expelled from circula

tion, we shall have both metals in concurrent cir
culation at par .
III. But (as pointed out by the “ monometal
lists ” ) the next result will be a great stimulus to the
minting of silver and a great discouragement to the

mining of gold . Consequently, silver will gradually
becomemore plentiful, and therefore cheaper again ,
and gold scarcer, and therefore dearer again . Con
sequently, silver will again tend to expel gold .
127

WHY IS THE DOLLAR SHRINKING ? [CH. VIII.

IV . But (as insisted by “ bimetallists” ) this
increase of the stock of silver (coin and bullion )

and decrease of the stock of gold are also self
limiting ; for the increased production of silver will

be checked by increased cost of production, and con
sumption will tend to overtake production, while
the opposite adjustments apply to gold . The result
may be the concurrent circulation of both metals
or it may be the expulsion of one of them from cir

culation. All depends on the quantities produced .
If one of the metals is produced in superabundance
beyond a certain limit, it will completely displace
the other. Bimetallism is thus possible only within
limits, and there is always a chance , amounting
in the long run to a certainty, that the system will
break down .
We may now illustrate , by historical examples ,
the principles just explained . The first and most
important case is that of France. The ratio of
151 to 1 was adopted by France in 1785 , and con
tinued by the law of 1803. The history of France
and the Latin Union during the period from 1785 ,

and especially from 1803, to 1873 is instructive.
It affords a practical illustration of the theory that
when conditions are favourable , gold and silver can be

kept tied together for a considerable period by means
of bimetallism . During this period the public was

ordinarily unconscious of any disparity of value,
and only observed the changes from the relative pre

dominance of gold to the relative predominance of
128

$ 2.) OPERATION OF MONETARY SYSTEMS
silver in the currency and vice versa . In the whole
sale bullion market, it is true, there were slight
variations from the ratio of 151 to 1. But such varia
tions simply supplied the force to restore equilibrium .
From 1803 until about 1850 the tendency was

for silver to displace gold . In this period there was
a net export of gold .
By 1850 the process had practically reached its
limit.

Bimetallism would have broken down and

resulted in silver monometallism , then and there,
except for the fact that, as though to save the day ,
gold had just been discovered in California . The
consequence of the new and increased gold produc
tion was a reverse movement, an inflow of gold into

the French currency , and an outflow of silver.
From 1848 to 1870, inclusive, the net importation
of gold amounted to 5, 153,000,000 francs, or over

224 ,000,000 francs a year, while the net exportation
of silver from 1852 to 1864, inclusive, amounted to
1, 726 ,000,000 francs , or nearly 133,000,000 francs

a year. Gold was displacing silver and filling the
currency.

It seemed probable that France would be

entirely drained of silver currency and come to a

gold basis. But the gold mines were gradually
exhausted , while silver production increased , with
the consequence that there was again a reversal of

the movement. Silver gradually pushed gold out
of circulation and, had not France and the other
countries of the Latin Union successively suspended
the free coinage of silver in 1873 - 1878 , they would
129

WHY IS THE DOLLAR SHRINKING ? [CH. VIII.

have found themselves on a silver, instead of a gold ,
basis.

It has been claimed by bimetallists that this

action in demonetizing silver was itself the cause
of the breakdown. The truth is,that thebreakdown
was the cause of demonetization , although de
monetization, by keeping back silver from circula

tion and keeping gold in circulation, did operate
to widen the breach already made.
The Latin Union might conceivably have main
tained bimetallism longer if other countries had

joined with them . But it had to absorb , not only
much of the silver provided by the mines, but also

a considerable amount which had previously formed
part of themonetary stock of Germany, and which ,
at theadoption of the gold standard by that country
following the Franco -Prussian War, was thrown on
the market .

That is, not only the silver mines, but

countries demonetizing silver, dumped silver on the

Latin Union . Add to this the movement toward
the gold standard in Scandinavia and the United

States, and it becomes evident that the obstacles
were many, for a union comprising so few , and mostly
unimportant states.
$ 3. The “ Limping ” Standard
Bimetallism is to-day a subject of historical

interest only. It is no longer practised ; but its
former prevalence has left behind it in many coun

tries, including France and the United States, a

monetary system which is sometimes called the
130

$ 3.) OPERATION OF MONETARY SYSTEMS
“ limping” or “ one-legged ” standard . Such a
system comes about when , in a system of bimetal
lism , before either metal can wholly expel the other ,

the mint is closed to the cheaper of them , but the
coinage that has been accomplished up to date is
not recalled . Suppose silver to be the metal thus
excluded — as in France and the United States.
Any money of that metal already coined and in

circulation is kept in circulation at par with gold .

This parity may continue, even if limited additional
amounts of silver be coined from time to time.

There will then result a difference in value between
bullion and silver coin , the silver coin being over

valued. In short,we thus have a gold standard with
silver token money.

In the case just discussed , the value of the coined
silver will be equal to the value of gold at the legal
ratio . Precisely the sameprinciple applies in the case
of any money the value of which as money is greater
than the value of its constituent material. Take

the case , for instance,of paper money. So long as it
has the distinctive character 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 . If its quantity

increases indefinitely , it will gradually push out the
gold until there is no gold left. Likewise, credit
money and credit in the form of bank deposits would

have this effect. To the extent that they are used,
they lessen the need for gold in circulation .
131

WHY IS THE DOLLAR SHRINKING ? (CH. VIII.
So long as the quantity of silver or other token

money, e.g., paper money , is too small to displace
gold completely, gold will continue in circulation .
The value of other money in this case cannot fall

below that of gold . For if it should , it would ,

by Gresham 's Law , displace gold ; we are assuming
that it is not of sufficient quantity to produce this
effect.

The parity between silver coin and gold coin ,
under this “ limping ” standard is, therefore , not
necessarily dependent on any redeemability in gold ,
butmay result merely from limitation on the amount
of silver coin. Such limitation is usually sufficient
to maintain parity, despite irredeemability . This
is not always true, however; for if for any reason

(such as its novelty and strangeness , or rumours of
further inflation) the people should not have con
fidence in some form of irredeemable paper or token
money , even though it were not overissued, it would
depreciate and be nearly as cheap in money form as
it is in the raw state. It might even be so com
pletely rejected that it would cease to circulate and
cease to bemoney . A man is willing to accept money
at its face value so long as he has confidence that

every one else is ready to do the same. But it is
possible, for instance, for a mere fear of overissue to
destroy this confidence. The payee, who under
ordinary circumstances submits patiently to what
ever money is a customary or legal tender, may then

take a hand and insist on “ contracting out” of the
132

$ 3.) OPERATION OF MONETARY SYSTEMS
offending standard. That is, he may insist on mak

ing all his future contracts in terms of the better
metal — gold, for instance — and thus contribute to

the further downfall in value of the depreciated
paper , or he may resort to barter or even cease to

engage in commercial contracts altogether .
Irredeemable paper money , then , like our irre
deemable silver dollars, may circulate at par with
other money if limited in quantity and not too un
popular. If it is gradually increased in amount, such
irredeemable money may expel all metallic money
and be left in undisputed possession of the field .
Jevons said : “ There is plenty of evidence to
prove that an inconvertible paper money , if care
fully limited in quantity, can retain its full value.
Such was the case with the Bank of England notes
for several years after the suspension of specie
payments in 1797, and such is the case with the

present [1875] notes of the Bank of France .” But
Jevons observes that all irredeemable paper money
started as redeemable . He adds that habit may
do much to keep money in circulation when it is once

started, “ but it is doubtful whether the most power
ful government could oblige its subjects to accept

and circulate as money a worthless substance

which they had no other motive for receiving."
Irredeemable money has always had a fascination
for many people. But it has never proved desirable.
It is a constant temptation toward abuse , causes
business distrust, discourages long-time contracts ,
133

WHY IS THE DOLLAR SHRINKING ? (CH. VIII.

and has almost invariably proved a veritable curse
to the country employing it. While, therefore ,
redeemability is not absolutely essential to produce
parity of value with the primary money, it is practi

cally a wise precaution .
The lack of redeemability of silver dollars in the

United States is one of the chief defects in our
unsatisfactory monetary system Our paper silver
certificates are redeemable in silver dollars , but these

silver dollars are not redeemable in gold . The
absurdity of the situation consists in the fiction that
somehow the redemption of the silver certificates in

silver dollars keeps them both at par with gold .
The truth is that the paper would keep its parity
with gold just as well if there were no redemption in
silver . A silver dollar as silver is worth less than a

gold dollar just as truly as a paper dollar as paper
is worth less than a gold dollar.

The fact that the

silver is worth half a dollar, while the paper is worth
only a fraction of a cent, will not avail in the least
to make either the silver or the paper worth a whole

dollar. A pillar reaching halfway to the ceiling
cannot hold the ceiling up any more than a pillar
an inch high. The silver certificates and dollars
keep at par with gold merely because they are not
sufficient in quantity to displace gold . If their quan
tity should ever be made great enough, they would
displace gold and depreciate ; and the redeemability
of oneof them in the other could not avail to prevent
such depreciation .

134

$ 3.) OPERATION OF MONETARY SYSTEMS

Very much the same thing is true of the United
States notes or “ greenbacks.”

These are only

nominally redeemable ; for as soon as redeemed they
must be reissued . The essence and virtue of re
demption is retirement, and without retirement
redemption is a mockery. The requirement that the

greenback must never be retired permits no contrac
tion . The result is that when contraction becomes
necessary , it occursby the export of gold . In 1893,
when a forced expansion of silver certificates and
" treasury notes ” was in progress, the greenbacks
acted, as President Cleveland said , as an " endless
chain .” Their redemption drew gold out of the
treasury for export, and their reissue led to a repe
tition of this operation until enough gold overflowed

to make room for the new silver certificates and
treasury notes . The process was only ended by
repealing the law requiring silver inflation .

135

CHAPTER IX
CONCLUDING DISCUSSION OF PRINCIPLES

§ 1. Can “ Other Things Remain Equal " ?
The chief purpose of the preceding eight chapters

is to set forth the causes determining the purchasing
power of money.

This purchasing power has been

studied as the effect of five and only five causes.
These fall naturally into three groups.

These

three groups are (1) circulating media , (2 ) their
velocity, and (3 ) the volume of trade for which they
are circulated . These and their effect, i.e., the price
level, are, we saw , connected by an equation of ex
change, MV + M 'V ' = PT. The three causes, in
turn , we found to be themselves effects of antecedent
causes lying entirely outside of the equation of ex

change. To be specific,wesaw that (1) the volume of
trade will be increased , and therefore the price level

correspondingly decreased, by the differentiation of
human wants, by diversification of industry , and by

facilitation of communication ; (2) the velocities of
circulation will be increased, and therefore the price
level increased, by improvident habits, diminution
of hoarding by the use of book credit, and by rapid
transportation ; (3 ) the quantity of money will be

increased , and therefore the price level increased ,
136

$ 1.)

DISCUSSION OF PRINCIPLES

by the import and minting of money, and, antece
dently , by the mining of the money metal, by the

introduction of another and initially cheaper money
metal through bimetallism , and by the issue of
bank -notes and other paper money ; (4 ) the quantity
of deposits will be increased, and therefore the price
level increased, by extension of the banking system
and by the use of book credit .

The reverse causes

produce, of course , reverse effects.
Thus, behind the three sets of causes which alone
affect the purchasing power of money, we find over
a dozen antecedent causes.

If we chose to pursue

the inquiry to still remoter stages, the number of
causes would be found to increase at each stage in

much the same way as the number of one's ancestors
increases with each generation into the past.

In the

last analysis myriads of factors play upon the pur

chasing power of money ; but it would be neither
feasible nor profitable to catalogue them . The
value of our analysis consists rather in simplifying

the problem by setting forth clearly the three proxi
mate causes through which all others whatsoever

must operate . At the close of our study, as at the
beginning, stands forth the equation of exchange
as the great determinant of the purchasing power
of money. With its aid we see that normally the
quantity of deposit currency varies directly with the

quantity of money, and that therefore the introduc
tion of deposits does not disturb the relations found
to hold true before. That is, it is still true that ( 1)
137

WHY IS THE DOLLAR SHRINKING ? [CH. IX .
prices vary directly as the quantity of money, pro

vided the volume of trade and the velocities of
circulation remain unchanged ; (2) that prices vary
directly as the velocities of circulation of money

and deposits (if these two velocities vary together),
provided the quantity of money (and therefore ac

cording to our assumption, deposits) and the volume
of trade remain unchanged ; and (3) that prices
vary inversely as the volume of trade, provided
the quantity of money and therefore deposits)
as well as the velocities of circulation remain un

changed.
But the question now arises — can the factors

supposed to “ remain unchanged ” in these three
cases actually remain unchanged ?

To this question

the answer is, “ Yes, with one exception.”

A change

in the volume of trade per capita probably affects ,
besides prices , the velocities of circulation , so that
these velocities cannot " remain unchanged .” At a

given price level, the greater the per capita trade,
the more rapid is the individual turnover .
Practical evidence and illustration of this is found

by examining the cash accounts of 113 Yale students ,

who kept each for one month a careful record of the
average cash in the pocket and the daily expendi
tures . It was found that those who expended less
than $ 600 a year kept, on the average, in the
pocket $8 .60, and spent at the rate of $ 367 per
07

annum , thus having a turnover of 3.60 or 43 times

a year, while those who expended over $600 a
138

$ 1.]

DISCUSSION OF PRINCIPLES

year carried an average cash balance of $ 12.70, and

spent at the rate of $ 1175 a year, making a turn
over of 12.56 or 93 times a year.

This shows that

the latter class averages three times as great an
expenditure as the former , but carried only 50 per
centmore cash in the pocket, and, in consequence,
had a velocity of circulation of money more than
twice as great. In fact, classifying the students
more minutely into five groups, namely : ( 1) those
expending less than $ 300 a year ; (2 ) those over $ 300

and under $600 ; ( 3) those over $600 and under
$ 900 ; (4 ) those over $ 900 and under $ 1200 ;
(5 ) those over $ 1200, we find that the velocities of
circulation were, respectively , 17 , 59, 61, 96 , 137.

These figures certainly suggest, if they do not prove,
that for a given price level, the greater the expendi
ture, the higher the rate of turnover . In other words,
the turnover varies with the volume of trade of the
individual. If this conclusion is sound, then the
larger the per capita trade of a community,the more

rapid the turnover of money , and presumably of
deposits , which is simply what we should expect on
general principles ; for it merely means that the

larger the scale of any business operation, the greater
the economy of the use of cash . Small stores have
to keep a larger stock of cash relatively to their busi

ness than large stores , just as small banks need a
larger reserve in proportion to business transacted.
From this conclusion the surprising result follows:

that though an increase of the world 's volume of
139

WHY IS THE DOLLAR SHRINKING ? (CH. IX .
trade tends directly to reduce the general level of
prices, nevertheless , if that increase is greater than
the increase in the population so that there is an
actual per capita increase in the volume of trade,
then this exerts, as an indirect effect, a counter

tendency to raise prices by increasing the velocity
of circulation of money and credit.

The meagre

statistics of the students referred to may , it is true,
notbe typical ; but taking them as we find them , they

indicate that a trebling in the per capita trade causes
a doubling in the velocities of circulation of money
and credit.

This strongly suggests the conclusion

that any effect on the price level from an increase
in the volume of trade, so far as it is an increase per

capita , is more than half counteracted by the indirect
effect on the velocities of circulation .
But, with this exception and apart from transition

periods, the three groups of magnitudes which de
termine the price level — (1) money and deposits,
(2 ) their velocities, (3 ) volume of trade — are

practically independent of each other. That is to
say, a change in the quantity ofmoney (and therefore

of deposits), though it may temporarily affect
velocities and trade, will not do so in the long run .

Instead, it will exert all its effects on prices, which
will therefore change in the same proportions.

Similarly, a change in velocities, though it may
temporarily affect money and deposits as well as
trade, will not do so in the long run , but will also

exert all its effects on prices.
140

§ 2.)

DISCUSSION OF PRINCIPLES

These conclusions rest on the fact that careful
study and investigation fail to show any other rela

tions among the factors in the equation of exchange
than those which have been mentioned .

§ 2 . An Increase of Money does not Decrease its

Velocity
As no one denies the truth of the equation of ex

change, any one who could disprove the quantity
theory of money in the sense maintained in this

book ) must do so by showing that an increase in
the quantity of money , instead of tending to increase

the level of prices, tends rather to affect one ormore
ofthe other four elementsin the equation of exchange,
viz., either (1 ) to decrease the velocity of circulation
of money , or (2 ) to decrease the deposits subject

to check, or (3 ) to decrease their velocity , or (4 ) to
increase the volume of trade. None of these prop
ositions hasany evidence in its support.

It cannot be shown, for instance, that (except
during transition periods) there is any tendency for
an increase in the quantity of money to decrease its
velocity of circulation . Some persons who have
never investigated the subject imagine that ifmoney
were suddenly doubled in quantity, prices need not

rise but that the public would , for some unaccount
able reason , carry double the former quantity of

money while expending precisely the same amounts ;
in other words, that the velocity of circulation of
money would decrease .

But this would be incon
141

WHY IS THE DOLLAR SHRINKING ? [CH . IX .

venient and we have seen that the velocity of circula
tion ofmoney is determined by the convenience of the
people .

They find for themselves what is the most

convenient amount to carry in order that it shall be

best adapted to meet their particular expenditures.
If,then,money and expenditure are mutually adjusted
to suit the convenience of the people , this implies that
any increase in the amounts carried would (for a given
price level) be inconveniently large.

To make the picture definite , let us suppose that
the average per capita amount of money in actual
circulation in the United States, outside of the United

States Treasury and the banks, is about $ 15, and

that somemysterious Santa Claus suddenly doubles
the amount in the possession of each individual.
Thismeans that the average individualwill have $ 30 ,
where before he had $ 15 . Now , statistics show that
the average per capita amount in circulation changes

only a few cents from month to month. While the
amount of money carried by an individual will
necessarily fluctuate because of his expenditures and
receipts, in a large group of people theaverage amount
carried by the several individuals composing the

group will fluctuate but little. If, then , so large an
addition to the total circulation is suddenly made as

to put fifteen extra dollars per capita in the hands of
the public, the first thought of most people will be
how to get rid of this inconvenient addition to the
money which they are carrying. If they should
be inclined to hoard it in stockings or safes,or to bury
142

§ 2.1

DISCUSSION OF PRINCIPLES

it in the earth, or to drop it into the sea , it would have
no tendency to raise prices . Instead , however, they

will seek to make some use of it either by expending
it for goods or by depositing it in banks. Thus a few
days after the supposed visit of Santa Claus, the
surprised recipients of the extra money will, in most
cases, have disposed of it in one of these two ways.
To the extent that they dispose of it in the first
way, — in the purchase of goods, - it is evident that
there will be a tendency to raise prices , for thesudden

expenditure of $ 15 per capita , even by a small
fraction of the people of the United States , will mean
a phenomenal rush upon the shops.
The average individual does not expend in actual

money more than $15 in two weeks. This is about
a dollar a day, or about $ 100,000,000 a day for the
entire country. If within , let us say, five days from

his windfall of $ 15 the average man should try to
spend an extra sum of $ 15 , the result would be $ 3 per

day per capita, or $300,000,000 a day for the nation.
This, in addition to the usual $ 100,000,000 a day,

would make $400,000,000 a day, or four times the
ordinary rate of expenditure . Such a sudden brisk
ness in trade would astonish the shopkeepers and

lead them promptly to raise their prices; otherwise,
in many cases their stocks would be entirely depleted .
At first sight, it might seem that it would only
require a few days for each one to get rid of his extra
money so that the flurry in prices would , therefore,

be only temporary ; but such reasoning would be
143

WHY IS THE DOLLAR SHRINKING ? (CH. IX .

fallacious; for wemust not forget that the only way
in which the individualcan get rid of his money is by
handing it over to somebody else. Society is not rid
of it. If the shopkeepers, who under our Santa Claus

hypothesis have already had their till money doubled
mysteriously , receive in addition the surplus cash
of their customers, they will now be the ones em
barrassed with a surplus of cash and will, in their
turn , endeavour to get rid of it, by purchasing goods
for their business or by depositing it in banks.
Since , then, the effort to get rid of money by trans
ferring it merely results in somebody else having a
surplus, the surplus in the community remains
unchanged. Therefore, the effort to get rid of it and

the consequent effect on prices will continue until
prices have reached a sufficiently high level.

This conclusion cannot be avoided by supposing
that most of the money is not spent in trade, but
deposited in banks. The bankers whose deposits
are thus suddenly swollen will now be the ones who

will strive to get rid of the surplus cash. No banker
wishes to have idle reserves, and each will make the
increase in reserves the basis for an increase of busi
ness , including an increase of deposits. We have

seen that this tendency results ultimately in preserv
ing the relative amounts of the three magnitudes :

money in circulation , money in bank reserves, and
deposits based on these reserves. In the end, then ,
the doubling of society's money will mean a doubling

(1) of the money in circulation , (2) of the money
144

$ 2.]

DISCUSSION OF PRINCIPLES

in banks,and (3) of thedeposits based on this money .
In a short time it will also mean a doubling of prices,
for as long as prices fail to be double what they were,
there will be the same phenomenon of inconvenient
surpluses . Individuals, tradesmen , bankers , etc.,
will be trying to get rid of these surpluses, and their
efforts to get rid of them must tend to raise prices .
When, however, prices have reached double their
original level, there willbe no longer any effort to
get rid of surplus cash ; for there will be no surplus

cash . The $30 per capita which has thus been
created will no longer seem excessive, in view of the

fact that prices are double what they formerly were
and that the persons carrying this money will, on

the average, find their wages or incomes doubled
likewise. Thus, if formerly the average individual
was accustomed to spend $ 300 and to carry an aver
age balance of $ 15, he will now spend $600 and carry

an average balance of $ 30 . The adjustment of the
$ 30 relatively to $600 has exactly the same signifi
cance as the former $ 15 relatively to $ 300. In

either case the relation is one to twenty, which
means that the individual turns his money over,
on the average, twenty times a year. Thus, in the
end, a doubling of the quantity of money does not
exert its effect in disturbing the velocity of circula

tion , but in raising the generallevel of prices.

It is worth noting that the imaginary example we
have given represents, except in its details, exactly

what actually happenswhen new gold is discovered .
145

WHY IS THE DOLLAR SHRINKING ? [CH. IX .

Gold miners convert their product into money, some
times using it as such in the form of nuggets or gold
dust and sometimes taking it to the mint and con

verting it into coin . They find themselves in posses
sion of bags full of money far beyond what they

need as themost convenient amount of pocketmoney.
If, for instance , one of these men has just received
from themint a thousand dollars in gold, he is almost
sure to get rid of at least $ 950 of it as speedily as

possible, either by spending it or by depositing it in

the bank. In either case, he and the hundreds of
others who are doing the same thing tend to raise

prices in the community where they are spending
their money or checks on the banks in which they
deposit their money .

It was thus that prices rose in the mining camps
of California a half dozen decades ago and in Colo

rado and the Klondike one or two decades ago.
This local rise of prices then communicated itself to
other places ; for, as we have seen , the price level
cannot in one locality greatly exceed that in a neigh
bouring locality without causing an export ofmoney
to the cheaper locality.
Thus, new money gradually finds its way into
circulation throughout the world , raising prices as
it flows from place to place. The process of raising

prices consists in all cases of the effort to get rid of an
inconvenient surplus of cash or deposits, a surplus
which cannot be permanently got rid of by transfer

ring it from hand to hand ,but only by a rise of prices.
146

§ 2.

DISCUSSION OF PRINCIPLES

In this way it could be shown that an increase in

the quantity of money will not affect the velocity
of circulation of bank deposits (V ') nor the volume
of trade ( T ) . It will merely increase the vol
ume of deposits ( M ') and the level of prices ( P ) .
But, of course, a change of money (M ) does not
prevent other causes from acting at the same time;
these other causes may and do affect the five factors

M , M ', V , V ', and T, and often aggravate or neu
tralize the effect of money ( M ) on the level of prices

( P ). The effects of these other causes, however,
are not the effects of money. So far as money by
itself is concerned, its effect is only on deposits (M ')
and the price level ( P ) and is proportional to
its quantity . The importance and reality of this
proposition is not diminished in the least by the fact
that the “ other causes” seldom or never, as a matter
of fact, remain quiescent and allow the effect on
prices of an increase in money to be seen separately
from effects of other causes . The effects of changes

in money are always blended with the effects of
changes in the other factors in the equation of ex
change, just as the effects of gravity upon a falling

body are blended with the effects of the resistance
of the atmosphere.

Our main conclusion , then , is that, after careful

study, we find nothing to interfere with the truth
of the quantity theory , that variations in money
(M ) produce normally proportional changes in
prices.
147

WHY IS THE DOLLAR SHRINKING ? (CH. IX .

§ 3. An Index Number of Prices

We have been studying the causes determining
the purchasing power of money, or its reciprocal,
the general level or scale of prices . Hitherto we

have not examined very carefully exactly what a
" general level” of prices may mean, although in
Chapter III, § 1, a simple imaginary case was

considered in which the average price of bread,
cloth , and coal was worked out . There was no
need of defining a general level of prices so long as
we assumed , as we have done hitherto , that all

prices move in perfect unison.

But, practically ,

prices never do move in perfect unison .

If some

prices (p 's) do not rise enough to preserve our
equation , others must rise more. If some rise too
much , others must rise less . The case is further

complicated by the fact that some prices cannot
adjust themselves at all and some can adjust them

selves but tardily . A price fixed by contract can

not be affected by any change coming into operation
between the date of the contract and the date of
its fulfilment. The existence of such contracts
constitutes one of the chief arguments for a system

of currency such that the uncertainties of its pur
chasing power are the least possible. Contracts are

a useful device ; and an uncertain monetary stand
ard disarranges them and discourages their forma

tion . Even in the absence of explicit contracts ,
prices may be kept from adjustment by implied
148

$ 3.1

DISCUSSION OF PRINCIPLES

understandings and by the mere inertia of habit .
And besides these restrictions on free movement of
prices there are often legal restrictions ; as, for ex

ample, when railroads are prohibited from charging
over two cents per passenger per mile , or when street
railways are limited to five-cent or three-cent fares.

Whatever the causes of non-adjustment, the result

is that the prices which do change will have to
change in a greater ratio than they would were
there no prices which do not change. Just as an
obstruction put across one-half of a stream causes
an increase of current in the other half, so any

deficiency in the movement of some prices must
cause an excess in the movement of others .
Another class of goods, the price of which cannot

fluctuate greatly with other prices, are those special

commodities which consist largely of the money
metal.

Thus, in a country employing a gold stand

ard , the prices of gold for dentistry , of gold rings
and ornaments, gold watches, gold -rimmed spec
tacles , gilded picture -frames , etc ., instead of vary
ing in proportion to other prices, always vary in a
smaller proportion. The range of variation is the
narrower , the more predominantly the price of the

article depends upon the gold as one of its raw
materials .

From the fact that gold -made articles are thus
more or less securely tied in value to the gold
standard , it follows also that the prices of substitutes
for such articles will tend to vary less than prices
149

WHY IS THE DOLLAR SHRINKING ? (CA. IX .
in general. These substitute articles will include
silver watches, ornaments of silver, and various

other forms of jewelry, whether containing gold
or not.

A further dispersion of prices is produced by the
fact that the special forces of supply and demand
are constantly playing on each individual price, and
causing relative variations among them , and al

though these variations cannot affect the general
price level, they can affect the number and extent
of individual divergencies above and below that

general level.
It is evident, therefore , that prices must con

stantly change relatively to each other, whatever
happens to their general level. It would be as idle
to expect a uniform movement in prices as a uni
form movement for all bees in a swarm . On the

other hand, it would be as idle to deny the existence
of a general movement of prices because they do not
all move alike as to deny a general movement of a
swarm of bees because the individual bees have
different movements. The general movement of

prices is expressed by an " index number” which
gives the average level of prices at any time as
compared with some other time used for comparison .

Besides the changes in individual prices, there
will be corresponding changes in the quantities of the

commodities which are exchanged at these prices
respectively . In other words, as each p changes,
the Q connected with it will change also , because
150

$ 3.]

DISCUSSION OF PRINCIPLES

usually any influence affecting the price of a com
modity will also affect the consumption of it.
We see, therefore, that it is well nigh useless to
speak of uniform changes in prices (p's) or of uni
form changes in quantities exchanged (Q's). There
fore, instead of supposing such uniform changes, we
must now proceed to the problem of developing some
convenient method of indicating by an average the
general trend of the changes in prices or in quantities .
Wemust formulate two composite or average mag

nitudes: the price level ( P ) or index number or
“ scale " of prices on the one hand and the volume

of trade ( T ) on the other.
As we have seen in Chapter III, P is an average of
all the p 's and T is the sum of all the Q 's. P is
the “ index number ” of the general level of prices .

In order, in practice , to calculate P and T , suit
able units ofmeasure for the various articles must be
selected .

The ordinary units in which the various

Q 's are measured will not be the most suitable.
Coal is sold by the ton , sugar by the pound, wheat
by the bushel, etc. If we should merely add
together these tons, pounds, bushels, etc., and call
their grand total so many “ units ” of commodities,
we should have a very arbitrary summation. It

will make a difference in the result whether we
measure coal by tons or hundredweights.

The

system becomes less arbitrary and more useful for

the purpose of comparing price levels in different
years if we use, as the unit for measuring any com
151

WHY IS THE DOLLAR SHRINKING ? (CH. IX .

modity , 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. Then

every price in the base year becomes exactly one
dollar, and the average of all prices in that year also

becomes exactly one dollar. In any other year, the

average price (i.e., the average of the prices of the
arbitrarily chosen units which in the base year were
worth a dollar) willbe the index number representing
the price level, while the number of such units will
be the volume of trade. Thus, let us suppose, for

simplicity, that there are only three commodities
(bread , coal, and cloth), and let us use the accom

panying table for facts to start with .
PRICES (IN DOLLARS)
YEAR

Bread
(per

Loaf)

1909

.

1914 .

Coal | Cloth
( per
Ton )

(per

5.00
6 .00

1.00
1. 10

QUANTITIES EXCHANGED
Bread

Coal

Cloth

(Millions (Millions (Millions

of Tons) of Yards)

200
210

We wish to compare the average price or price
level in the year 1914 with that in 1909 as the base
year, and also to reckon the total volume of trade
in 1914 in comparison with that in 1909. If we

were not desirous of taking great pains to secure the
best results , we could use the above figures just

as they stand — averaging the prices and add
152

$ 3.]

DISCUSSION OF PRINCIPLES

ing together the quantities. By this rough-and

ready method the average price per unit for 1909
would be 0.10 + 5.00 + 1.00) = 3, or $ 2.03 ; and
for 1914 (. 15 + 6 .00 + 1.10) = 3, or $ 2.42; the

total trade for 1909 would be 200 + 10 + 30 , or 240

million units; and for 1914, 210 + 11 + 35, or 256 .
That is, the price level would show a rise between
1909 and 1914 from $ 2.03 to $ 2.42, or a rise of 19.2

per cent, while the volume of trade would show a
rise from 240 to 256 , or 6.6 per cent.
But the simple method just used gives too much
weight in the price comparison to coal, the price of
which happens to be expressed by a large number,
simply because it is measured by a large unit. One
way to remedy this disproportionate weighting is to
measure all articles by one unit, as the pound ; but

a better way is that already described above, viz.,
to use as our unit " the dollar's worth in 1909.”
The dollar's worth of bread in 1909 was evidently
ten loaves, the dollar's worth of coal, the fifth of a
ton, and that of cloth, the yard . Taking these
units, we now have :
PRICES (IN DOLLARS)
YEAR

1909 . .
1914 . .

Bread
(per Ten
Loaves)

1.00
1.50

Coal
(per

Ton )

Cloth
(per

Yard )

1.00
1.00
1.20 | 1.10

153

QUANTITIES
Bread

Coal

Cloth

(Millions (Millions (Millions

of Ten lof 1 Tons ) of Yards)

Loaves)

20

50

30

21

55

35

WHY IS THE DOLLAR SHRINKING ? [CH. IX .
The average price in 1909, on the basis of these
new units, is simply $ 1, since this is the price of
each individual article ; while the average price in

1914 is, ifwe take the simple arithmetical average,
($ 1 .50 + $ 1. 20 + $ 1. 10 ) = 3 , or $ 1.27. The total
volume of trade in 1909 is (in millions of units)

20 + 50 + 30, or 100 ; and in 1914, 21 + 55 + 35 ,
or 111. Thus, according to this reckoning, the price
levelhas risen from $ 1.00 to $ 1 .27, or, as it is usually
expressed , from a base of 100 per cent to a height
of 127 per cent — a rise of 27 per cent ; while trade

has increased from 100 million units to 111 million
units, an increase of 11 per cent.
We may slightly improve the above method by
taking for 1914 a " weighted ” average of prices in

stead of a simple average. It is found by dividing
the total value of all the goods by their total quan
tity .

This is a better method because , in the result,

it gives less weight to the commodities less dealt

in , such as bread. The average for 1909 will still
be $ 1.00 , for that is the price for each individual com

modity ; but the average for 1914 will be slightly
different. The total value is (in millions of dollars )
1.50 X 21 + 1 .20 x 55 + 1.10 X 35 , or 136 million
dollars , and the total quantity is, as we have already

seen , 21 + 55 + 35, or 111 million units ; conse
quently , the average price is 136 • 111, or $ 1.23.
According to this last and best method, then , the

price level has risen from $ 1.00 (or 100 per cent) to
$ 1.23 (or 123 per cent). That is, the index numbers
154

§ 3.)

DISCUSSION OF PRINCIPLES

are 100 per cent for 1909, and 123 per cent for 1914 .

This indicates a rise of 23 per cent.
The results of the three methods of reckoning the
average rise of prices differ slightly , showing re

spectively a rise of 19, 27, and 23 per cent. Other
methods 1 of which many are possible, would also
differ slightly . No method gives an absolutely
perfect index of changes in price levels, but the last
one worked out above is as good as any . The

main point in any system of averages is to give

great weight to the great staples of trade, and little
weight to the insignificant articles. Radium has
fallen in price enormously in the last few years,
but radium is so unimportant as an article of com

merce that its great fall ought not to be allowed in
our reckoning to have much effect on the index

number for the general price level.
Fortunately , it is found , in practice , that most
methods of computing index numbers show sub

stantially the same general changes in price levels.
1 The reader who is interested in a study of the
comparative merits of some two score methods of com

puting index numbers is

referred to the writer' s The

Purchasing Power of Money , New York (Macmillan ), 1913,
Chapter X , and appendix to Chapter X .

155

CHAPTER X

THE HISTORY OF PRICE LEVELS
§ 1. Early Records

It is impossible to have absolutely accurate index
numbers, but those constructed for recent years by
the United States Bureau of Labour are accurate
enough for all practical purposes. For the remote

past we have only very rough index numbers, be
cause the records of prices in past times are so
defective. These rough index numbers are suffi

cient, however, to show that the general trend of
prices during the last ten centuries1 has usually been
1 The authorities to whom we owe comparisons with re
mote centuries are D 'Avenel, Hanauer, and Leber . Com

parisons with still more remote times have been made

while this book was going through the press by Prof. J. F .
Ferguson of Bryn Mawrwho writes me that by using data
from the “ edict of Diocletian ” 301 A . D. the prices of eleven

kindsof foods are found to average50 to 60 % of their prices
in the United States in 1912 A . D . Incidentally wemaymen

tion the fact that Prof. Ferguson also works out the relative
wages for ten occupations, showing that the Roman wages
in 301 A . D . were only 8 to 20 % of present American wages.

Thus the Roman workman received less than one tenth of
themoney wages prevailing at present and paid more than

half asmuch for food ; so it would appear that he enjoyed
less than one- fifth as much real income as a present-day
American labourer.

156

$ 1.)

THE HISTORY OF PRICE LEVELS

upward . Judging from some records for the eighth
and ninth centuries, we may conclude that prices
are now five to ten times as high as then — 1100

years ago — and from four to six times as high as
in the period between 1200 and 1500 A.D . Since
the last date , that is, practically , since the discovery

of America , prices have almost steadily risen .
Figure 5 shows the estimates — which , of course ,
are only very rough — of D ’Avenel for France.
loo

120

1400

1500

1600 -

1700

1800

1900

FIG . 5. - France

They cover continuously the period between 1200

and 1790 and include comparisons with 850 and
1890.
A recent book, The Literary Profession in the
Elizabethan Age,by Phoebe Sheavyn , brings out the

resemblance between the conditions in the sixteenth
century and those of to-day.
“ Meanwhile, prices were rising rapidly , owing

partly to increased consumption, partly to the influx
of silver from the West. In the latter half of the
sixteenth century, corn cost from three to ten times

the average price of the previous three centuries.

Sugar rose from fourpence to half a crown. Stowe
tells us that not only corn, “but all things else,
whatever sustenance for man , was likewise raised

without all conscience or reason. Rents increased
157

WHY IS THE DOLLAR SHRINKING ? (CH . X .

exorbitantly during the same period . A farm which

in the earlier part of the century let for ten shillings,
would fetch in 1583 as much as ten pounds."
Bishop Fleetwood in 1707 published some statistics

which led him to believe that “ £5 two hundred and
sixty years ago was equivalent to £28 or £30 now
( 1707].”

The successive opening of gold and silver mines
has been largely responsible for the repeated upward
movements of prices.

For the first half century

after the discovery of America the annual average
production of gold was less than five million dol
lars. ( To -day it is a hundred times as great and
that of silver about the same.) A century later ,
after the opening of the rich Potosimines of Bolivia ,

the production of silver was four times as great,
averaging 18 millions of dollars a year. The New
World mines began to pour theirproduct into Europe ;

first into Spain , the chief owner of the mines,then,
by trade, into the Netherlands and other parts of
Europe. Accordingly , as the economist, Cliffe Leslie,

showed , prices rose first in Spain , then in the Nether
lands, and then in other regions. The rise of prices
in the sixteenth century was so rapid as to consti
tute a veritable price revolution .
The following table 1 shows the estimates which
have been made of the stock of the precious metals

in Europe at the different century years and the
1 For details , see Irving Fisher, The Purchasing Power
of Money, pp. 234 - 237 .
158

§ 2.)

THE HISTORY OF PRICE LEVELS

price levels roughly computed by various economic
historians.
STOCK OF PRECIOUS RELATIVE PRICE LEVEL
METALS IN EUROPE IN (As % OF PRICE LEVEL

DATE

BILLIONS OF DOLLARS

1500
1600
1700
1800

.
.
.
.

.
.
.
.

.
.
.
.

. .
.
.
.

1900 . .

170
550
1450

1850
5890

OF 1800 )

35
75
90
100

125 (?)

§ 2. The Nineteenth Century
Beginning with the close of the eighteenth cen
tury we have more exact statistics of price move

ments . Figure 6, which is formed by joining

together the statistics of Jevons and Sauerbeck ,
shows with considerable accuracy the changes
in the general price level in England from year to

year from 1782 to 1913 inclusive.2
The light line of Figure 7 reproduces the curve of
English prices in Figure 6 from 1840 to 1913.3 Figures
1 It will be seen from this table that the increase in
prices did not keep up with the increase in the stock of

metals. This was presumably due to the increase in the
volume of trade.

2 The prices between 1801 and 1820 , during which Eng

land was on a basis ofdepreciated paper money, are reduced
to the gold standard .

3 This curve is made from the calculations of G . H .
Knibbs, of Melbourne, statistician of Australia , being
formed by combining the figures of Sauerbeck, the Econo

omist, and the British Board of Trade.
159

WHY IS THE DOLLAR SHRINKING ? (Ch. X .
8 to 22 inclusive present in their light lines the price

curves, respectively, of the United States, Canada,2
Germany,France,Belgium , Holland, Denmark, Italy,
180 )

1401

1760 90

1800

10

20

30

40

50

60

70

80

90 1000 10

Fig . 6 . — England

Austria , Spain , Australia, New Zealand, New South

Wales, Japan and India.

The dark line in each

1 The figures for the United States are those of the Ald
rich Senate Report on Wages and Prices, supplemented since

1890 by the statistics of the Bureau of Labor,and all reduced

by Knibbs so that the price level of 1911may be 100 per cent.
2 These Canadian figures are those of Mr. R . H . Coats,

labour statistician of Canada, and are here reduced in ac
cordance with Knibbs' calculations to make the index num

ber for 1911 appear as 100 per cent.
3 The above-named curves are, for the most part, formed

from the figures of Knibbs, which , in turn , are taken from

various available sources . The figures for Holland, Spain ,
160

20

30

§ 2.) THE HISTORY OF PRICE LEVELS

14

100h

80

1990

90

1900

Fig . 7. — England

diagram represents the average price movement of
the countries of the world. It will be seen that
Japan , and India are not from Knibbs,but from the Bul
letin de l'Institut Internationale de la Statistique and other
statistical publications.
1 This curve is also from Knibbs' calculations, and

includes, beginning with 1840, England and the United
M

161

WHY IS THE DOLLAR SHRINKING ? (Ch. X .

the price movements of England, the United States
and Canada are closely similar to those of the
world in general. In the curve for the United States,
however, a discrepancy in the similarity appears
about 1865, as our Civil War and the “ greenbacks ”
then issued caused American prices to soar far above
those of other lands. These inconvertible notes, i.e.,
the “ greenbacks,” depreciated so greatly that the
price level in the United States actually doubled

between 1861 and 1865.1

The statistics of the three countries just men
tioned , namely, England , the United States and
Canada, are the best price statistics which we have,

and show a remarkable family likeness, since, in gen
eral, each agrees so closely with the average for the
world .

The statistics upon which the diagrams for the
remaining countries are based , are not so good ,

as usually they do not include so many commodi

ties. This probably explains why in some of these
countries we do not find so perfect an agreement as

we probably would find if we had more perfect sta
tistics. However, even with the imperfect data from

which these curves are constructed , there is, in

general, a striking similarity between the average
States; from 1847, France ; from 1851, Germany ; from
1861, New Zealand and Australia ; from

1890 , Belgium ,

Italy , and Canada. All the statistics are reduced so that
the price level of 1911 shall appear as 100 per cent.
1 The “ greenback ” standard existed in the United States

between 1862 and 1878 inclusive.
162

$ 2.) THE HISTORY OF PRICE LEVELS
200

180

1840

Fig. 8. — United States

163

WHY IS THE DOLLAR SHRINKING ? (CH. X .
world prices (as shown by the dark curve in each
case) and the prices of the particular country
mentioned (as shown by the

light curve in each case).
The most striking fact,

therefore, in regard to the
price movements in various
countries is their similarity.
This, of itself,is a very good
reason for suspecting some
common world -wide cause

to be at work, such as the
gold supply, instead of the
coincidence of local causes

in different countries, such
as droughts , tariffs, trusts ,
etc .

It will be noted , how
ever, that the curves for

India and Japan prior to
the middle of the ' 90 's, dis

1890

1900

1910

Fig . 9. - Canada

agree with the world curve.
The reason for this discrep
ancy will be made clear a
little later in the present
section .

The main periods of price movements, then , since
1789, in all gold standard countries for which we have
statistics may be stated approximately as given below

in the first column. It is impossible to secure very
164

$ 2.]

THE HISTORY OF PRICE LEVELS

exact statistics of the volumeofmoney in circulation ,
much less of credit currency and the volume of trade
and still less of the velocities of circulation of money
and deposits. The following table, therefore,merely
notes in the last column any increase in the stock
of money metals.
STOCK OF MONEY
DATE

PRICES

METALS IN EUROPE

1789– 1809

rose

increasing

1809 - 1849

fell

stationary

rose

increasing

fell

increasing slightly
increasing

1849– 1873

.

1873 – 1896
. .
1896 - present . .

rose

The question now is — do the facts of the fore
going table coincide with our theory of price levels ?
Their agreement is, in fact, somewhat remarkable
in view of the complete lack, not only of exact
statistics on the volume of trade and of all statistics

whatever on velocity of circulation, but also of
statistics on the volume of bank -notes, government
notes, and deposit currency .

We know , however, that modern banking, which

had scarcely developed at all before the French
Revolution , developed rapidly throughout the nine
teenth century. It is also known that banking and
deposit currency developed more rapidly during the
third period in the table (1849– 1873) than during
1 History of Precious Metals, Alexander DelMar, p. 449.
165

WHY IS THE DOLLAR SHRINKING ? (Ch. X.
the fourth (1873– 1896 ), which fact contributes
somewhat to explain the contrast between the price
movements of these two periods.
10

100 .

1840

50

70

80

1800

FIG. 10 . — Germany

Sometimes the circulating media shot ahead of

trade and then prices rose. This was undoubtedly

the case in the periods 1789–1809, 1849–1873, and
1896 to the present time, for in all three of these
166

82.)

THE HISTORY OF PRICE LEVELS

periods it is known that circulating media increased

with unusual rapidity, while there is no reason to

100

1840

80

90

1900

Fig . 11. — France

believe that trade increased especially fast. In fact,
in the last-named period, in which we are now liv
ing, there is strong evidence that trade is lagging
167

WHY IS THE DOLLAR SHRINKING ? (CH. X .

behind media of exchange and by about the right
amount to explain the rise of prices .
On the other hand, we may reasonably infer that

circulating media lagged behind trade in the periods
140

120

120

100

100

1890

1900

1310

1890

Fig . 12. — Belgium

1900

1910

Fig . 13. — Holland

1809–1849 and 1873–1896, for in the former case
the stock of circulating media did not increase at all
and in the latter case it increased but slightly,
168

§ 2.)

THE HISTORY OF PRICE LEVELS

whereas there is evidence that the volume of trade
increased in both periods.
Wemay, therefore, summarize the course of price

movements during the nineteenth century by the
following general state
ments :

1 . Between 1789 and
1809 pricesrose rapidly .
The index numbers of

Jevons for England
which give us the first

accurate picture of price
movements increased

from 85 to 157.

That

is, prices practically
doubled in twenty

years. This rise was
doubtless due to the

increased stock of gold
and silver, which in
turn was due to their
large production dur
1880

90

1900

10

Fig . 14 . - Denmark

ing this period as com -

pared with the periods
before and after . The production of silver was es

pecially great. The Napoleonic wars, with their de

struction of wealth and interference with trade, prob
ably exercised some influence in the same direction .

2. Between 1809 and 1849 prices fell. The fall in
England was measured by Jevons as a fall from 157
169

WHY IS THE DOLLAR SHRINKING ? (CH. X .

to 64. That is, in forty years prices were reduced
to less than half. This fall was presumably due to

the lull in the production of the precious metals,
which prevented the aggre
gate stock from keeping
pace with the volume of

business . Indeed, the ag

gregate stock remained sta
120

tionary , while the volume
of business must have in

creased greatly . Even the
development of bank cur
rency was insufficient to off

set the continued increase
in the volume of business.

It is interesting to observe
that this period of falling
prices was interrupted by
a temporary rise after 1833,

which Jevons was at a loss
to account for, but which
may perhaps be explained
by the inflow of Russian
gold after the discoveries
1890

1900

1910

of gold in Siberia in 1830 .

3. Between 1849 and 1873
(although with two nota
ble interruptions) prices rose. They rose , ac
FIG . 15. - Italy

cording to Jevons' figures supplemented by Sauer
beck 's, from 64 to 86 , and according to Sauerbeck 's
170

$ 2.)

THE HISTORY OF PRICE LEVELS

alone, from 74 to 111. That is, in 24 years prices
increased , according to one calculation , by one

third ; according to another, by one-half. A sim

-

1865

70

1900

80

Fig . 16 . — Austria

ilar rise occurred in the other countries for which
there are statistics covering this period , namely,
Germany, France, and the United States. This
171

WHY IS THE DOLLAR SHRINKING ? (CA. X.
rise was presumably in consequence of the gold

inflation following the famous California gold dis
coveries in 1849 and Australian discoveries in 1851
and 1852.

The simulta

neous rapid development of
banking contributed to the
same result.

140

4 . Between 1873 and 1896
prices fell in all countries

using the gold standard , as
the diagrams show . This

100

fall was presumably due to
the slackening in the pro

duction of gold ; to the
adoption of the gold stand
ard by nations previously

on a silver basis, and the
consequent withdrawal of

gold by these new users
from the old ; to the arrest
of the expansion of silver

money consequent on the

1890

1900

1910

Fig . 17 . - Spain

closure of mints to silver ;
to the slackening in the
growth of banking ; and to
the ever present growth of
trade.

During the long fall of prices from 1873 to 1896 ,
country after country adopted the gold standard .
Germany adopted the gold standard in 1871 -1873,
172

§ 2.) THE HISTORY OF PRICE LEVELS
200

140

100

1860

70

80

90

FIG . 18. — Australia

173

1900

WHY IS THE DOLLAR SHRINKING ? (CA. X .

thus helping to render impossible the maintenance
of bimetallism by the Latin Union (France, Bel

gium , Switzerland, Italy, and Greece). The Scan
dinavian monetary union adopted the gold standard
in 1873. Between that date and 1878 the countries

of the Latin Union suspended the free coinage of
silver and came practically to a gold basis. In the
United States the demonetization of silver in 1873 ,

the so -called “ crime of '73,” signified that with
resumption (which took place in 1879), the country
would come to a gold basis. The Netherlands

virtually adopted the gold standard in 1875 –1876 ,
Egypt in 1885, Austria in 1892 , India in 1893, Chili
in 1895 , Venezuela and Costa Rica in 1896 , Russia ,
Japan, and Peru in 1897, Ecuador in 1899, Mexico
in 1905. In fact,most countries of importance have
now definitely adopted the gold standard .
The figures given in the preceding table apply

only to gold countries. But about 1873 gold and
silver parted company ; bimetallism ceased to hold
them together. It is interesting, therefore, to ask
whether the movement of prices in silver countries

continued like that in gold countries. We find it
did not, as already pointed out on the diagrams of
India and Japan , and as was to be expected by those
who realize that price movements have a monetary

side. Prices rose in India , as shown by the relative
index numbers, from 107 in 1873 to 140 in 1896 ; in

Japan from 104 in 1873 to 133 in 1896 ; and in
China from 100 in 1874 to 109 in 1893. These
174

$ 2.) THE HISTORY OF PRICE LEVELS
200
180

-

1880

70

80

90

Fig. 19. New Zealand

175

1900

WHY IS, THE DOLLAR SHRINKING ? (CH. X .

figures , although not as reliable and representative

as the figures for gold countries, agree with each
other in indicating a rise of prices in silver countries.

The amount of rise is differently indicated, ranging
roughly from 10 per cent to 35 per cent. The fol

lowing table shows the general contrast between
prices in gold and silver countries as between 1873–
1876 and 1890 – 1893, the last year being that of the
closure of the Indian mint to silver.
Gold COUNTRIES SILVER COUNTRIES

1873 - 1876

.

.

.

.

.

100

100

78

117

1890 – 1893 . . . .

We see that prices in the gold countries fell a little
more than 20 per cent, while prices in silver countries
rose a little less than 20 per cent. If some way had
been contrived by which gold and silver could have

been kept together (say by world -wide bimetallism ),
prices would not have fallen so much in gold coun

tries, or risen so much (if at all) in silver countries .

After Japan joined , and India, in effect, rejoined
the gold nations, in the '90's, the price movements
of these two countries have corresponded with those

of other gold -standard countries. As to statistics
earlier than 1873 there seem

to be none avail

able for the Orient except those of Robertson for

India which begin with 1861. These show some
similarity between the price movements of the
176

$ 2.) THE HISTORY OF PRICE LEVELS
period 1861 -1873 in India to the price movements
in the western world at that period . It would be

120!

100

70

1860

80

90 -

1900

Fig. 20. — New South Wales
interesting if some student of Japan would work out

index numbers earlier than 1873. We could thus
N

177

WHY IS THE DOLLAR SHRINKING ? (CH. X.
tell whether in that early period , when , because of
French bimetallism , the Orient and the Occident en

joyed a stable par of exchange, the Oriental and

100

1870

80

SO

1900

FIG . 21. — Japan

Occidental price movements corresponded or not.

But so far as we have data to tell us, we find that
the Oriental and Occidental prices moved apart
178

8 2.

THE HISTORY OF PRICE LEVELS

when their monetary standards moved apart, but
moved together when their monetary standards were

the same. Nothing could better illustrate the para

1870

80

90
1000
Fig . 22. — India

1 0

mount influence of the monetary standard on price
movements.

5. From 1896 to the present, prices have been
rising. The causes which have produced this rise
and which are still at work will be discussed in the
next section .
179

WHY IS THE DOLLAR SHRINKING ? (CH. X .
§ 3. The Present Price Movement
We come now to the upward movement of prices,

beginning with 1896 or 1897,which has given rise
to the present world -wide complaint over the “ high

cost of living.”

This upward movement is in sharp

contrast with the downward movement occurring in
the period between 1873and 1896 . During the last
eighteen years in every country for which we have
statistics — all gold -standard countries — prices have
risen rapidly. This is shown by the diagrams al
ready given . As these diagrams indicate , the rise
of prices between 1896 and 1913 has been ap

proximately 65 per cent for Germany, 50 per cent
for the United States, 45 per cent for Canada and
France, and 35 per cent for England .
As is evident, statistics do not all agree as to
the extent of this movement, but they do all agree
as to its direction .

Their agreement in this regard would probably be
even closer than it is, if the same system of sta

tistics were used in all countries. That this is true
may be reasonably inferred from the fact that two
different statistical methods applied to the same
country often show as great a difference as the dif
ferences found among different countries. For in

stance, the statistics of price movements in Canada
and the United States are not as dissimilar as are
those of Sauerbeck and the Board of Trade for Eng
land or of the " Hooker ” and the “ Hamburg ” sta
tistics for Germany .
180

$ 3.)

THE HISTORY OF PRICE LEVELS

Of course , some prices have not risen but have
actually fallen . Others have risen much more than
the average. This is particularly true of agricul
tural and forest products. Their prices have nearly

doubled. The prices of securities have also moved ,
some up and some down. Bonds, both public and
private , have fallen . Good stocks, in general, have
risen. Wemust not make the mistake of looking

at the prices of particular commodities when our
question is one of the general price level.
Neither must we confuse the issue by cheap apho
rismssuch as that which would make usbelieve there

is no high cost of living, but only a “ cost of high
living.” While there can be no question that stand
ards of living have advanced , there can be no reason

able doubt that prices have risen ; in other words,
that the actual cost of buying a given quantity of
staple commodities is greater to -day than it was
eighteen years ago ; or in still other words that the

purchasing power of the dollar has fallen .
Again it may be true, and probably is , that the
purchasing power of our incomes taken as a whole,
has increased, so that we actually have more goods
than formerly .

But if so, this is not because prices

are any lower, i.e ., because the purchasing power of
the dollar has increased , but because the number of
dollars in our incomehas, on the average, increased."

The broad fact, then , is that prices are rising all
1 For facts concerning the wage-earner , however , see
Appendix to this Chapter.

181

WHY IS THE DOLLAR SHRINKING ? (CH. X .

over the world . And anything that is happening
all over the world it would seem must have a world
ue cause.
cause .
wide

The only cause which fits in with the principles
governing price levels as well as with all previous
human experience is inflation — inflation of money
and of credit currency. In fact, the rise of prices
in the United States for which we have the fullest
statistics is almost exactly what we should expect
and could calculate from the known changes in

money, deposits, their velocities, and trade.1
For the last eighteen years we are able to construct

for the United States fairly accurate estimates of all
the factors, M , M ', V , V ', P , T , in the equation of

exchange. The statistics of the magnitudes for the
eighteen yearsmentioned are all represented in Figure
23. In this diagram the equation of exchange for

each year is represented by the mechanical balance

described in a previous chapter.
We note that in the years considered every factor

has greatly increased. The quantity of money in
circulation (M ), represented by the purse, has about
doubled ; bank deposits subject to check (M ') , rep
resented by the bank -book , have about trebled ; the

volume of trade (T ), represented by the weight at
the right, has increased about two and a half fold ;
1 For full discussion see Irving Fisher , The Purchasing
Power of Money, Chapter XII and Appendix to Chap
ter XII ; also articles on “ The Equation of Exchange " in

The American Economic Review , for June, 1911, 1912, 1913,
and 1914 .

182

RO

70

"Zo

1.8 5

.
BANK

.
LIONS

TTT
30

DEPOSITS

30

75. 7BILLIONS

40

DEPOSITS

50

BILLS

.18 7

BANK

TONS

DEPOSITS

5'0
7060

60

513BETONS
.

BANK

178BILLION

171BILLION

1.04BILION

1.36 BILLION

1.39BILLION

.Fig23

1913

10

1912 10

1904

1903
20 30

40
30
20

40
30
20 50 6'o

E.

SALLIOMPASS
GILLION
UND
50

TENTS

90 100 110 120
80

310BILLION
MO

80 90 100 110 120

455IZBER
UNIT
BILLION

50 80 90 100 110 TITI120
60
70

70

M70

, BILLION
310
MIT

.
.M

w
': s

9.

$ 3.]

THE HISTORY OF PRICE LEVELS

the velocity of circulation of money (V ), repre
sented by the leverage of the purse , or its distance

from the fulcrum , has increased slightly ; and the
velocity of circulation of bank deposits (V ') , repre
sented by the leverage of the bank -book , has in

creased about fifty per cent.

cre

As the net result of these changes, the index
number of prices (P ) , or the leverage of the weight

at the right, has increased about two-thirds. The
price level of 1909 is taken as 100 per cent. On
this scale the price level of 1896 is 60 per cent, and
that of the other years as indicated.1
Let us express the matter in terms of cause and

effect. The diagram affords a picture of the fact
that increases in money and deposits and in their

velocities (represented , respectively, by the in
1 The total increase from 1896 to the present is about 75
per cent, which is more than the increase of wholesale

prices,owing principally to the fact that the present statistics
include,besides wholesale prices, the prices of shares. The
volume of trade for any year is represented as the number
of “ dollars' worth ” on the basis of the prices in 1909.
Thus theactualvalue of trade in 1909 was $ 387 ,000 ,000 ,000,

i.e., 387 billion units of goods of various kinds, the units
being such as to be each worth one dollar in 1909. The
trade in 1912 was 450 ,000 ,000 ,000 of these same units (i .e .,

such as were worth $ 1 each in 1909). Similarly , the trade
in 1896 was 191,000,000 ,000 of these units . As the index

number of prices shows that the price level of 1896 was
only about 60 per cent of the price level of 1909, the actual
value of the trade in 1896 was only $ 114 ,600 ,000,000 .

This is PT for 1896 , i.e., 191 billion units (each worth $ 1
in 1909) at 60 cents each , the price of a unit in 1896 .

183

WHY IS THE DOLLAR SHRINKING ? (CH. X .

creased weights of purse and bank -book , and their
increased distances from the fulcrum ) have necessi

tated an increase in average prices (represented by.
the increased distance of the tray from the fulcrum )

in spite of the increased volume of business which
has been transacted (represented by the increased

weight of the tray).
For other countries than the United States, we
have no corresponding exact statistics for the five
factors in the equation of exchange. We do know ,
however, in a general way that the money ( M ) in

the civilized world has been increasing rapidly. We
have a few statistics as to money, both metallic and

paper . Edmond Théry in a recent article, the
English translation of which is published in The
Market World and Chronicle for April 18, 1914,
shows that the gold money in the world in

creased 54 % between 1902 and 1912. He also
points out that the bank notes of European banks
of issue increased from $ 3,130,000 ,000 to $ 4 ,860,

000,000 between 1902 and 1912, an increase of 55 % .
A study by the writeri indicates that the total
money in circulation in the gold standard world
has in recent years been increasing at the average
rate of 22 % per annum .

We know also that deposits subject to check

(M ') have greatly expanded . In thewriter's article
just referred to, statistics have been given to show
1 American Economic Review , September, 1912, “ Will the
Present Upward Trend of World Prices Continue ? ”
184

$ 3.]

THE HISTORY OF PRICE LEVELS

that deposits subject to check have in recent years
been increasing in the gold standard world at the
rate of 8 % per annum .

Théry estimates that com

mercial bills held by the banks of Europe increased
between 1902 and 1912 from about nine billions of

dollars to about fifteen billions of dollars, an increase
of 69 per cent or an average increase of nearly 6

per cent per annum . These figures are rough
estimates, but are regarded by M . Théry as sub
stantially correct. While they are estimates of
commercial bills or bank loans and not of deposits
subject to check , it is altogether likely that the in

crease in the latter is at least as great.
The writer's article also showsthat there is reason
to believe that the velocities of circulation of money

and deposits have increased, though it is impossible
to statey at what exact rates.
l slsame
ated tarticle,
olume ooff ttrade
o has
o have the
ine vvolume
sideInrabthe

been estimated to have increased , but at a con
siderably slower rate than the expansion of money
and deposits .
We see then that the more exact our data the
more exactly do they corroborate our theory that

prices have risen because of gold and credit inflation.

185

:

APPENDIX

TO CHAPTER

X

The main object of this book is to study
the purchasing power of the dollar and not the
number of dollars in incomes , but for the informa
tion of the reader, Figure 24 is given , which shows

for the United States , according to the best data
we have, the course of wholesale prices, retail prices,
and money wages . The dark line showsthe course
of money wages from 1840 to 1907, the last date
for which our Bureau of Labour has published

general wage statistics. Comparing this curve with
the curve for wholesale prices,we derive the follow
ing facts:
( 1) Between 1840 and the outbreak of the Civil
War, wages increased , while prices decreased, so
that the wage-earner gained in real wages .
(2 ) During the Civil War, prices shot up far
faster than wages, so that the workman lost. After

ward , prices fell more rapidly than wages, so that
the workman gained .
( 3) Between 1879 and 1896 , money wages rose,
while prices fell, so that the workman again gained .
(4 ) Since 1896 , prices have increased faster than
wages, so that the workman has lost. This is espe

cially true of retail prices , the figures for which in
186

200

180

ho
rool wwholesale prices

s

y price

WAS

1900

. /840

prices
Wholesale
Retail prices
Fig . 24. — United States Wag
| es

187

WHY IS THE DOLLAR SHRINKING ? (CH. X .
addition to those for wholesale prices are available

since 1890 , and are shown by the dotted curve.
It will be seen that in general prices move more
rapidly than wages, whether the movement is up

ward or downward . This tendency of wages to
lag behind prices puts the wage-earner into the

gaining class during a period of falling prices, and
into the losing class during a period of rising prices

such as the present.
We have no statistics for the incomes of any
class other than wage-earners , but statistics as to

production and consumption of goodswould indicate

that the average income of all classes has increased.

188

CHAPTER XI
CONFUSIONS CONCERNING PRESENT PRICE MOVEMENT
§ 1. Fallacies Underlying Popular Explanations of
the High Cost of Living

If the analysis we have given is correct, the
shrinkage in the dollar, amounting to more than one
third in the last eighteen years, is due to the in
flation ofmoney and credit, or, in other words,to the
fact that the means for conducting trade have

outrun the volume of trade to be conducted thereby .
This conclusion not only fits our analysis in the

abstract , but fits the facts as we find them . These
show that the use of money and checks has in

creased in the United States at an average rate of

9 per cent per annum , while trade has only in
creased at the rate of 52 per cent per annum , thus

accounting for the actual increase of prices of 31
per cent per annum .
But we cannot satisfy objectors to this conclusion
unless we meet their objections on their own ground.

Most people argue the problem of the high cost of
living on entirely wrong principles. They try to
explain the rise in general prices by the same sort

of reasoning as they are accustomed to use in trying
to explain the rise of price of some particular ar
189

WHY IS THE DOLLAR SHRINKING ? [CH. XI.
ticle . They do not realize one of the truths which

this book has aimed to make clear, that it is as
futile to explain a general rise of prices by appeal
ing to the particular forces affecting particular prices ,
as it would be to explain a rise in the ocean tides by

appealing to the forces which make the waves. To
change the simile, the people who look to a micro
scopic study of each individual commodity in order

to understand the general movement of all com
modities “ cannot see the woods for the trees.”

To

again change the simile , we cannot assume that the

rise of a particular price pulls up the general level
of prices with it any more than we can assume that
a man who walks upstairs pulls the earth up with
him . The man really pushes the earth down an
infinitesimal distance and the centre of gravity of

himself and the earth together remains unaffected .
If it were worth while, we could show that in some
cases (not all) a rise in a particular price tends to

push down the general level of other prices. For
instance , scarcity of food, while it tends to raise
food prices , tends to lower the prices of other things,
for it causes more income to be spent for food , and
so leaves less income for other things, which in turn
causes a less effective demand for these other things.
Another summary way of disposing of the problem

is to say that “ supply and demand explain every
thing,” meaning that each individual price is thus

determined and that these together form the general
price level. But those who appeal to supply and
190

$ 2.)

PRESENT PRICE MOVEMENT

demand to avoid the need of appealing to monetary
factors leave out of account a very important in
stance of supply and demand , i.e ., the supply and

demand of gold . They forget that the supply and
demand of gold cannot, under our present system ,
affect the price of gold itself, for the price of gold is

fixed by the weight of our gold dollar (25.8 gr.) at
the number of times this weight is contained in an
ounce of gold (i.e., an ounce (or 480 gr.) ; a dollar
(or 25.8 gr.) = $ 18.60) so that the price of standard
gold ( fine) must always be $ 18 .60 per ounce .

This arbitrary fixation of the price of gold prevents
absolutely thenatural effect from an increased supply
of gold . If the supply of silver is increased, it tends
to lower the price of silver, but an increase in the
supply of gold cannot lower the price of gold .
Since the increased supply of gold cannot lower the
price of gold , it takes its revenge, as it were, by
raising the prices of other things expressed in gold .

§ 2 . Popular Explanations of the High Cost of Living

In order to leave no argument unanswered , let us,
for a moment, look at the other reasons ordinarily

given for the high cost of living : the tariff, the trusts,

the labour unions, shortened hours of labour, the
middleman, cold storage, longer hauls on railroads,
marketing by telephone, the free delivery system ,
the individual package, the enforcement of sanitary

laws, the tuberculin testing of cattle and the destruc
tion of tainted meat, sanitary milk , advertising, un
191

WHY IS THE DOLLAR SHRINKING ? (CH. XI.

scientific management, the elimination of renovated
butter , and of “ rots ” and “ spots " in eggs, food
adulteration, wars, armaments, extravagance , con
centration of population in cities, impoverishment
of the soil, the displacement of the neighbourhood

farmer, the fact that farmers' wives no longer com
pete in butter making or poultry raising, droughts,
and the high cost of land .
We shall take up briefly these alleged causes in
the order above named .
As to the tariff, it is quite true that the imposition

of a tariff tends to “ dam up " themoney in a coun
try and so to raise the level of prices, as has been

explained in previous chapters. But needless to say ,

this way in which the tariff affects the price level is
quite foreign to the thought of those who would fix
the responsibility on the tariff.

They believe that

the tariff, quite irrespective of any effect on the

quantity of money, tends to keep individual prices
high (as indeed it does in some cases) and therefore

(they imagine) to raise the general price level. As
we have seen in the last section , this reasoning from
individual to general prices is fallacious. Moreover
the American tariff cannot be held responsible for
the world rise of prices with which we have to
deal. Prices have risen in countries both with
high tariffs and with low tariffs.
Similarly, the trusts cannot be held responsible
for the rise of prices throughout the world . Prices
have risen in countries with and in countries with
192

82.]

PRESENT PRICE MOVEMENT

out trusts. Moreover, trust-made goods have, ap
parently , risen in price rather less than goods in
general. It is true, however , that trusts have, in the

United States, greatly increased the supply of
negotiable securities which have been utilized as

collateral securities for bank loans and become the
basis for deposits , thus aiding in credit inflation.
But this manner in which trusts have tended to
raise prices is again quite foreign to the thought
of those who would fix the responsibility on trusts .

They assert that trusts raise prices arbitrarily and
that what they can do toward raising individual

prices tends to raise the general price level.
Nor can labour unions and their attempts to re
strict output be held responsible for so gigantic an
effect as that with which we have to deal. For, in
the first place, labour unions are not a phenomenon

of the last decade and a half,but existed in the pre
viousperiod of falling prices ; and secondly ,any effect
due to labour unions in the last eighteen years would
be confined to the United States, England, and a few
other places where they have grown in activity in

that period and could not be held responsible , for
instance, for the rise of prices in India .
The reduction in the hours of labour might con
ceivably, by reducing fatigue and so increasing the
productivity of labour, increase the volumeof trade

and so tend to reduce rather than raise prices. But
trade unions are making the mistake of using short

ened hours as a means of limiting the output. It
193

WHY IS THE DOLLAR SHRINKING ? (CH. XI.

is a part of their self-injuring “ go easy ” policy.
This, of course, has a tendency to reduce the volume
of trade and to raise prices in accordance with the

equation of exchange.

Yet we cannot explain the

rise in the cost of living by a reduction in the vol
ume of trade, for , as a matter of fact, the volume
of trade has not been reduced .
The middleman has come in formuch blame in the

last few years. Whether as a whole the middleman's
profits are greater than formerly is a fair question .
Granted , for the sake of argument, that in the last

eighteen years the middleman's profits have greatly
increased, not only absolutely , but relatively to the
rise of prices , the effect would simply be that of a

wedge driven between retail and wholesale prices.
But here again , whatever the theoretical tendency,
the facts do not show any considerable wedging apart
of wholesale and retail prices. Wholesale prices have

certainly not fallen , but risen , and they seem to have
risen in general almost as fast as retail prices.

Cold storage has been blamed simply because at
certain seasons of the year the indignant customer

has been told by the retailer that he cannot lower
prices so long as the cold - storage people are with

holding great quantities of goods. As a matter of

fact, however, taking the year round , the effect of
cold storage is not to raise prices , but simply to even
prices , raising them in certain seasons when they

would otherwise be low and lowering them in other
seasons when they would otherwise be high .
194

$ 2.)

PRESENT PRICE MOVEMENT

Longer hauls on railroads, the telephone, free de
livery service, the individual package, the enforce
ment of sanitary laws, tuberculin testing of cattle

and the destruction of tainted meat, sanitary milk ,
advertising, unscientific management, the elimina

tion of renovated butter ,and of“ rots ” and “ spots ”
in eggs, are all alleged reasons for an increase in the
cost of production . Wemay, for brevity , overlook

the fact that many of these changes improve the
quality and so give the consumer a quid pro quo.
But we cannot overlook the fact that these alleged

increases in the cost of production must either be
very small of themselves, or must be more than
offset by economies elsewhere in production , for the
simple reason that the actual cost of producing
goods to-day, in terms of labour, is undoubtedly less
than it was eighteen years ago . We must not
measure the cost of production in money simply ,
without taking into account the loss in the purchas

ing power of the dollar. Otherwise we shall be

reasoning in a circle, and merely trying to explain
the rise of prices of goods by means of the rise of

prices of labour, or vice versa .
Of all the alleged explanations of the high cost
of living, none are more shallow than those which
explain it in terms of high money costs of produc
tion. Such an explanation merely explains one price

in relation to another price. It is, of course , true
that many prices are related to each other.

The

price of bread and the price of wheat are related to
195

WHY IS THE DOLLAR SHRINKING ?

CH. XI.

each other and must always move in sympathy.
One of these prices cannot go up very much with
out the other going up also , but when the baker
tell us that bread has risen in price, because of the

rise in the price of wheat, he has not explained the
rise of either bread or wheat. He has merely

shoved the explanation on to something outside of
his own business. It is, of course, a part of a busi
ness man's duty to look at the immediate causes
affecting the prices with which he deals, but if we
want an explanation of price movements, we must

look beyond these immediate causes to remoter ones.
In other words, if the baker would really explain
the rise in the price of bread , he must explain also

the rise in the price of wheat, and he cannot do
this by again shoving off the explanation to another
commodity . Such a method of explanation never

strikes the root of the matter . It continually shifts
the explanation .

It is like the explanations of the

old philosophers who said the earth was held up by

a giant. When asked to explain what held the giant
up, they alleged a turtle on which he stood . We
still need to know what holds the turtle up , and no
matter how many stages back we go , so long as we

have to assume another supporting agent, we really
get no fundamental explanation . What we wish to
explain is the rise in prices of things in general. It

does not help us much when our grocer tells us
he is charging higher prices because he is charged

higher prices by some one else. Naturally the re
196

$ 2.]

PRESENT PRICE MOVEMENT

tailer likes to excuse himself by putting it off on the
wholesaler, and the wholesaler in turn excuses him

self by explaining that his costs of production , that
is, the prices he is charged by the jobber, have gone
up . The jobber in turn accuses the producer and
the producer points to his increased wage bill ; but

even this does not give us any final result. The
wage-earner tells us that he has to get higher wages
because of the higher retail prices which he has to

pay. So this effort to explain the high cost of living
merely comes around again to the high cost of living
itself.

Such reasoning reminds one of a cartoon published

a few years ago in which a number of men were
standing in a circle each labelled and each pointing

an accusing finger at his neighbour around the circle
from retailer to wholesaler , jobber , producer, wage

earner , and retailer again .
Food adulteration is practically the opposite of
some of the above-named processes which aim to

improve and not deteriorate the quality of food.
If improving foods raises their price, adulterating
foodswith cheap ingredients should lower their price
as well as quality. Exactly by what reasoning food
adulteration can be shown to raise the cost of living
has never been explained . Such talk illustrates the

easy way in which people point to any current
event as a supposed cause of the high cost of living.
Wars and armament represent a waste , but a
waste which has been going on far longer than has
197

WHY IS THE DOLLAR SHRINKING ? (CH. XI.

the rise of prices. Undoubtedly these causes tend
to lower the volume of trade, but their effect is
greatly exaggerated . This is evident, not only
from the fact that the volume of trade has greatly

increased in spite of the increased expenditures in
times of peace for war armament, but also by the

fact that any increase in these expenditures, colossal
as they seem , are extremely small compared with
the volume of trade. The increase in war arma
ment during the last decade and a half may amount
to a few hundreds of millions a year, but the volume

of trade amounts, in the United States alone, to
nearly five hundred billions.

Instead of wars being the cause of the high cost
of living, the high cost of living is sometimes a part
cause of wars. The world -wide discontent pro
duced by the high cost of living has been known
specifically to have caused violence in bread and

meat riots, has helped overturn political parties,
and probably has had some share in the rebellions
and wars of Europe. The Chinese Revolution is
also said to be largely due to the rise in the price of
rice, for China has apparently been having an in
flation of her own .
Extravagance or luxury is another cause which

is not confined to the last eighteen years, yet prices
fell in former times while luxury existed , just as
truly as prices have risen in recent years.
The increase in extravagance and luxury dur
ing the last twenty or thirty years — so far
198

$ 2.

PRESENT PRICE MOVEMENT

as such an increase has actually occurred — is

due partly to the fact that in actual wealth the
world is more able to enjoy luxury to -day
than formerly , and partly to the fact that the

rise of prices itself has shifted wealth into the
hands of an easy spending class. Expanding the

first of these two statements we may say that one
reason why people spend more to-day on automo
biles, electric lights, bath -tubs, etc., is that these
modern conveniences have only recently been
perfected and been made generally available.

Twenty years ago people did not spend money on
automobiles because the automobile did not exist.

The prevalence of automobiles to -day means inven
tion and wealth , rather than an increase in the spirit

of extravagance.

.

Turning to the second reason for increased ex
travagance, we may say that, so far as there has
been any real increase in this general direction , it

is a symptom or effect of the high cost of living,
rather than a cause . When prices are rising, wages,
interest, and rent tend to lag behind ; consequently
the " enterpriser ” in business, for a time, gains,
because these expenses do not increase as fast as
the prices of his products increase. The enterpriser,
the speculator, the plunger , who gain for a time by
rising prices, constitute a class especially prone to

display and luxury. In short, those who would
ascribe the high cost of living to a cost of high
living are reversing cause and effect.
199

WHY IS THE DOLLAR SHRINKING ? (CH. XI.

The concentration of population in cities is sup

posed,by reducing the number of producers and in
creasing the number of consumers, to have increased
the cost of living. It is true that this migration to

the city tends to reduce farm products, but the fact
is,farm products have increased nevertheless. More
over the city dwellers arenot mere idle consumers,but
active producers of manufactured and other goods,

which , however, have risen in price as truly , even if
not as much, as farm products.
As to the alleged impoverishment of the soil, the
displacement of the neighbourhood farmer and the
fact that farmers' wives no longer compete in
butter making or poultry raising, it is a great
mistake to believe that the farm (including the
farmer and his family as productive agents) has,

as yet, lost in its power to feed the world . The
facts do 'not bear out the conclusion that there

is any falling off in the products of the farm . On
the contrary, the figures of the International In
stitute of Agriculture at Rome, as well as of our
own Department of Agriculture in America, lead to

exactly the opposite conclusion . It is true that the
census figures for 1910 showed a decrease per capita
in farm products as compared with 1900. But
the particular contrast between these two census
years is not typical, as Mr. Nathaniel C . Murray, of
the Department of Agriculture, has shown . Sir

George Paish , an eminent English economist, has
given statistics for England ,showing that the produc
200

§ 2.

PRESENT PRICE MOVEMENT

tion of grains taken altogether has increased 54 per
cent during the last eighteen years. This represents
an increase of 23 per cent per annum while the in

crease in population has only been about 1 per cent
per annum . Taking the last few years and com

paring them with the late 90's,we find, both in this
country and other countries, no evidence of falling
off in agriculture, but every evidence of progress,
not only absolutely but relatively to population .
The droughts which have been cited as causes
of high prices are too local and temporary to bear
examination as a cause of a world -wide and eighteen

year-long rise of prices.
A recent writer emphasizes the high cost of land,
especially in cities, the figures for which he claimed

“ proved absolutely ” that thehigh cost of living was
due to this cause , but he quite forgot the fact that at
the early periods with which he compared the mod
ern price of real estate, the cost of living was actually
higher than it is to-day ! In so far as the cost of

real estate has really gone up in the last eighteen

years, we must remember that when all else rises,
the price of land will necessarily rise also . This is
merely one more example of the very common pit
fall into which so many unconsciously fall, of ex
plaining the rise of one price by the rise of another.
It is as though a Massachusetts fisherman should
explain the rise of tides there by the rise of tides on
the Maine coast and pass this off as an explanation
of the rise of tides in general Of course it is true,
201

WHY IS THE DOLLAR SHRINKING ? (CH. XI.

that if the tides rise on the Maine coast they must
rise on the Massachusetts coast also. But the op

posite is equally true and neither explains the rise
of both . It is idle to explain the general rise from
the simple fact that some particular price has risen .
What we must seek is the fundamental cause raising

all prices.
That cause, we have seen, is inflation, both of
money and of credit.

This is well recognized by

most students of the subject, but is not yet recog

nized by the general public, partly because they
are misled by the fallacies and careless statements
which we have just been discussing, and still more
because they do not understand either the princi
ples which affect the purchasing power of the dol
lar or the facts of human history .
It has been the aim of this book to set forth , as

simply as possible, these principles and facts. In
brief, the aim has been to show that :
(1) The general price level ( P) is determined by the
other factors in the equation of exchange (money, de

posits, their velocities, and trade, or M , M ', V , V !
and T).

(2) So far as we have evidence, the facts of history
agree with this conclusion . In particular, prices have
risen after new gold discoveries or banking expansion ;

have fallen after monetary or credit contraction ; have
moved alike among countries having the same mone
tary standard ; have moved differently among coun

tries having differentmonetary standards (gold , silver,
202

§ 2.

PRESENT PRICE MOVEMENT

paper) ; and , where we have statistics for all the causes
affecting price levels (viz . M , M ' V , V ', and T), have
changed from year to year by almost exactly the right
amounts to fulfil the theory .

(3) The rival theories to explain the high cost of
living are none of them in agreement with the facts .
It is altogether natural and inevitable that the
true reason for the high cost of living should not
be generally understood , for the simple reason that
few people have studied monetary science and his

tory enough to master them . The samemisunder

standings have invariably appeared at all periods
in the past when price revolutions were in progress.
Phoebe Sheavyn , in her book from which I have

quoted earlier in this volume, in referring to the
Elizabethan Age, when prices were rising in much

the same way as to -day, and for much the same
reasons, says :

“ This 'dearth ' (i.e., dearness) of the necessaries
of life is a frequent topic with Elizabethan writers on
social questions. They are puzzled to account for it

in the face of the evident prosperity of the nation."
A study of the literature of two generations ago ,
when the mining of gold in California and Aus

tralia was inflating the world 's currencies, reveals
popular confusions precisely similar to those now
prevalent. And many of us will remember the
numerous fanciful causes to which a generation ago
the prolonged fall of prices then in progress was mis
takenly ascribed .
203

WHY IS THE DOLLAR SHRINKING ? (Ch. XI.
§ 3. Effect of Fallacious Beliefs

But although the world is entirely misled and con
fused as to the causes of the high cost of living, the
very fact that they are misled and confused is itself
a fact of portentous significance and is leading to
important events, political, social, economic . Just

as themisunderstandings as to falling prices in the
'80's and ' 90's led to the free silver campaign of

1896 and stimulated the Irish Land Agitation and
Home Rule movement, so the misunderstandings as
to theriseof prices now going on are leading to various
proposals in various places. They have stimulated
the demand for lower tariffs, which has already
become effective in America , and which is being in
sistently pressed in other countries, notably Germany,

France, and Japan. On the other hand, in England
the high cost of living has been cited as a reason why
England should encourage its own productions by

putting on a tariff. Everywhere the effect of the
unrest is to propose a change from the present con

dition of things to something alleged to be better.
Probably there is no bigger force in the world to
day working for socialism than the rising cost of liv

ing. Theworkingmen are told that this rise is due to
" capitalism ” and are urged to fight capitalism . A
socialist recently said to me : “ I realize perfectly
that the high cost of living is primarily due to
the increase in gold production and the inflation of

the world 's currencies, but it is an ill wind that does
204

$ 3.)

PRESENT PRICE MOVEMENT

notblow someone some good and I am not altogether
sorry to see the high cost of living used in Germany
and elsewhere as a lever to arouse the workingman

to become a revolutionary socialist.”

The dissatisfaction and unrest among wage
earners is certainly profound and widespread . As

already noted , it has led to bread and meat riots in
Germany , Austria , France, and Japan . Byron W .

Holt predicted , in a remarkable article written seven
years ago, “ a prolonged period of rapidly rising
prices, is reasonably certain to become a period of

unrest, discontent, agitation, strikes , riots, and wars."
But discontent is not confined to the labouring

man . Salaried men of all kinds, ~ i.e ., clerks,

teachers, officials, etc., - chafe under the same in
justices.

The beneficiaries of trust funds invested

in bonds, such as widowsand orphans, and endowed
institutions, such as colleges and hospitals, suffer
because their interest remains the same while prices
rise. Bonds and mortgages have grown unpopular
and have fallen greatly in price . One great life in

surance company has lost some fifty millions of dol
lars through such depreciation . Even the railroads
are finding difficulty doing business under their pres
ent rates because their prices are fixed by law ,while

their costs go up with the rise in the general price
level. This is the fundamental reason why rail
roads are asking permission to raise their rates.
For these reasons, because of the actual injustices
produced by rising prices through interference with
205

WHY IS THE DOLLAR SHRINKING ? (Ch. XI.

distribution and the subtle transfer of wealth from
those having fixed money incomes to other mem
bers of society , it becomes of the utmost importance

to know whether rising prices may be expected to
continue in the future.

studied in the next chapter.

206

This problem

will be

CHAPTER XII
THE FUTURE

§ 1. As to Money
WHETHER prices will continue to rise is a question

difficult to answer fully and with statistical precision,
owing to lack of data sufficiently complete. And
yet there are a thousand statistical straws in Europe
and America which show clearly which way the wind

is blowing.
This evidence takes account of all the chief factors

which can influence the general price level. Predic
tions based on one factor only are most worthless.

Thus, although gold is an important factor in the

case, those predictions which are based only on fore
casts of future gold production are of little value.
In order to forecast the future we need to examine

the prospects for each of the five factors in the
equation of exchange which affect the price level
( P ). These are money ( M ), its velocity ( V ) ,

deposits subject to check (M '), their velocity ( V '),
and the volume of trade ( T ).

Our study leads to the general conclusion that in

flation is destined to continue in the future, that is,

that the facilities for exchanging goods are likely to
increase much faster than the requirements of busi
207

WHY IS THE DOLLAR SHRINKING ? (CA. XII.
ness. Taking the world as a whole, money and
credit substitutes for money, that is, checks, will,
according to these calculations, outstrip the growth

of business by probably as much as 2 per cent per
annum , causing, therefore, an annual rise in prices

of about 2 per cent per annum , possibly less, but
probably more . For the United States in particu
lar the rise in the price level for the next few years

is likely to be arrested by the tariff reductions of
1913, causing an export of gold and a contraction
of our currency , although the new currency act will

tend to expand the deposit currency of the country
and so prolong the period of adjustment by means of
the export of gold . After a new equilibrium is es
tablished , the upward movement is likely to be re

newed again .
We can best justify these conclusions by a brief

review of the evidence.
First, then , let us consider the future world supply
of money. This will be affected by gold mining and
by changes in monetary systems. There is some

reason to believe that gold production has reached
its maximum

and may, in the future, gradually

decline, but it would be a great mistake to
jump to the conclusion that prices must there
fore fall. At the present writing the reports
for the world 's gold production in 1913 are ex

citing comment, and many are rejoicing or com
plaining because an actual reduction has apparently
occurred . But such a view overlooks the fact that it
208

§ 1.)

THE FUTURE

is not the annual output of gold , or even the annual
absorption of gold into the currencies of the world ,
which really affects prices, but the total stock of gold

money. The world 's stock of gold money may con
tinue to increase long after gold production has begun
to fall off, just as a lake may continue to rise long after
the mountain torrent which is filling it has begun to

subside. The lake continues to fill up so long as the
inflowing stream , subsiding though it may be, still

continues to pour in faster than evaporation and
other drains draw the water out. The great lakes of
the world 's gold coin will fill up so long as the mines,

even while being exhausted , nevertheless continue
to pour in gold faster than the consumption and loss
of gold drain it out.
The most careful review of present gold -mining

conditions shows that we may expect a continuance

of gold inflation for a generation or more. In 1908
de Launay, in The World 's Gold , wrote : “ for at
least thirty years we may count on an output of gold
higher than, or at least comparable to, that of
the last few years." This gold will come from the
United States, Alaska, Mexico , the Transvaal, and
other parts of Africa and Australia , and later from
Colombia , Bolivia, Chili, the Ural Province, Siberia ,

and Korea. Professor Edgeworth David , ofSydney

University , the Australian geologist who accom
panied Shackleton on his Antarctic expedition, an
ticipates that gold reefs will be found in this region
as rich and workable as those of Alaska .
209

WHY IS THE DOLLAR SHRINKING ? (CH. XII.

All this takes no account of possible improvements
in metallurgy. But if we let imagination run a little
ahead of our times, we may expect such improve
ments in the future, just as in the past. Still lower
grades may be worked or possibly the sea compelled
to give up its gold . Like the surface of the conti
nents, the waters of the sea contain many thousand
times as much gold as all the gold thus far extracted

in the whole history of the world . It is hoped that
the knowledge of how to get this hidden treasure
may not be secured. To whatever extent inventors
and gold miners might be enriched thereby , scarcely

a worse economic calamity can be imagined than the
resulting depreciation. It may be, however, that
only by such a calamity can the nations of the world
be aroused to the necessity of getting rid of so elusive
a standard of value as the present gold standard .
Besides the actualincrease of gold there is a virtual
increase through the release of Orientalhoards. We

may, I believe, expect such a release of Oriental

hoards in the future. The astonishing lengths to
which hoarding is now carried in Egypt and India
are emphasized by Director Roberts of the United

States Mint. He says :
“ The Egyptian situation is somewhat like that of
India — but there is some mystery about the way
the gold disappears from view . It does not enter
into bank stocks, and it is difficult to understand how
a country of its size and population and in which

the masses of the people are so poor can absorb so
210

§ 1.)

much gold . . . .

THE FUTURE

Some light is shed upon the

situation by the following statement in an address
by Lord Cromer,made in London in 1907 :
“ A little while ago I heard of an Egyptian gentle
man who died leaving a fortune of £80,000, the whole
of which was in gold coin in his cellars. Then again ,

I heard of a substantial yeoman who bought a prop
erty for £25,000 . Half an hour after the contract

was signed he appeared with a train of donkeys
bearing on their backs the money , which had been
buried in his garden . I hear that on the occasion
of a fire in a provincial town no less than £5 ,000 was

found in earthen pots. I could multiply instances of
this sort. There can be no doubt that the practice

of hoarding is carried on to an excessive degree.' —
(The Statist).”
In the minutes to the Report of the Indian Cur
rency Committee which appeared in 1892, or over

twenty years ago , the presiding Chairman, Lord
Farrer Herschell, gave the following evidence :
" It is remarkable how soon coined money dis
appears in India . I was there at the time of the

American war, when large sums of money came into
the country and momentarily there was an immense

advance in the price of everything in Bombay ; but
in a short time the great flood of silver that came in

disappeared among the great population of India
as water would in sand .”

The amount of such hoards has been emphasized

by Director Roberts, in the passages quoted as
211

WHY IS THE DOLLAR SHRINKING ?

(CH. XII.

evidence that they provide a future sink for gold

and thus tend to absorb gold , and perhaps arrest
the rise of prices . There can be no doubt that the
Oriental hoarding will continue for years to afford

an outlet for redundant gold and so tend to mitigate

the resultant rise of prices. But it is erroneous to
conclude that it will be sufficient to arrest this rise.

The weakness of such an argument lies in the tacit
assumption that the influence of hoarding will be

more powerful in the future than in the past, whereas
the opposite is more likely to be the case ; and even

in the past it has not been sufficient to prevent a

rapid rise of prices.
In the future we must reckon with a lessening

tendency to hoard . Just as with the introduction
of banking, hoarding long ago went out of vogue in
England , and more recently in France, so it must

surely , if slowly , go out of vogue in India and Egypt.
The transformation will take place as these countries
gradually introduce Occidental banking. Already
there is a rapid growth of banking in these countries .
The same principle applies to Oriental hoards in
the form of ornaments. Centuries ago Englishmen

used to put part of their hoards into “ plate,” which
could be reconverted into coin if emergency required .
With the advent of banking devices such a custom
has long since disappeared . It is to be expected that

little by little the same process will turn part of
the Oriental hoards of ornaments into monetary use.

Thus, as a consequence of the introduction of
212

§ 1.)

THE FUTURE

Western civilization into the Orient, we have the
prospect of further additions to the effective use
of the world 's gold , a further virtual inflation of the
currency. In other words, Oriental hoardingmerely
gives temporary relief. Part of the gold dug out of
the ground in Africa is put back into the ground in

Asia. But some day it is sure to be dug up again
and put into circulation .
Director Roberts says :

“ There is an undoubted tendency in all countries
to use banks more than formerly , and it is probable

that the stock of gold in banks has been recruited
not only from new production , but to some extent
from gold heretofore held in private hoards and out

of use. In every country the younger generation
to whom these hoards descend is likely to put them
to some use .”
Not only individual hoards but also gov
ernment hoards and even bank hoards seem likely
in the future to decline or at any rate to cease
being accumulated . A decade and more ago gold
was so scarce as compared with the demandsmade
upon it that a large part of the early additions
to the world 's stock were absorbed to strengthen
weak reserves and government hoardsand to replace
silver and paper . About a billion of gold has been

accumulated by the United States in the last ten
years and about half a billion by Russia and France .
Moreover, Japan , Argentina, and Brazil have ab
sorbed much gold . India , Mexico, the Philippines ,
213

WHY IS THE DOLLAR SHRINKING ? (CH. XII.

Panama, and the Straits Settlements have made
demands on gold to sustain their " gold exchange

standard.” An economist of note writes :
“ The effect in raising prices, I think , would have
been vastly greater than it has been had not the
United States, Russia , and Egypt been hoarding
gold and thus employing it uneconomically .”
These demands on gold have now been so far
satisfied that in the future any addition to the world 's
stock will be freer to enter actual circulation and
so to act on prices.

As has been previously explained , hoarded money
is simply money which circulates slowly or not at
all. Consequently the discontinuance of hoarding
will mean an increase in the velocity of circulation
of money, and this will tend to raise prices. It

will furthermore mean the placing of money in
banks, and this money will be the reserve on the
basis of which five or ten times as much “ deposits
subject to check ” will develop. These deposits
will notonly be five to ten times as large an amount
as the money they displace from circulation, but,

judging by Occidental experience, they will also cir
culate two or three times as fast . Consequently
their power to affect prices will be ten to thirty
times as much as the money displaced.
The discontinuance of hoarding, therefore, will,
in various ways, tend to raise prices. To be conser
vative, I have assumed in my calculations that the
effect on the velocity of circulation of money will not
214

$ 2.]

THE FUTURE

be sufficient to raise its rate of increase above i per
cent per year. But it would not be surprising if

the truth should be several times this figure, par
ticularly as the extension of rapid transportation will

also tend powerfully in this direction, especially in
slow and backward countries like India .
We see, then , that in the future monetary infla

tion is likely to be at work , both through an actual
increase in the quantity of money and also through
its virtual increase, which will be brought aboutby

the release of the great hoards ofmoney in the East .

Since the discontinuance of hoarding means the
same thing as an increase in the velocity of circula
tion of money, our conclusion may be stated as

follows. Monetary inflation may be expected, both
from an increase in money and from an increase in
its velocity of circulation ; that is, to go back to the

equation of exchange, an increase in both M and V .
§ 2 . As to Credit and Volume of Trade

Wehave just mentioned the effect which the dis
continuance of hoarding money will have on the
volume of deposits subject to check . Let us now
consider in a more general way the importance of
the growth of these deposits all over the world .

When once it is generally recognized that de
posits subject to check are a form of currency
similar in function to bank notes , — in fact , are
today the chief form — the discussion of the price
level will assume a new phase.
215

WHY IS THE DOLLAR SHRINKING ?

(Ch . XII.

In the United States the volume of check trans
actions forms 92 per cent of all transactions. Prob

ably something like this ratio obtains in Canada and
England. Outside of English -speaking lands, how
ever, the ratio is undoubtedly much less. If we
could assume that the volume of check transactions

maintains a constant ratio to that of money transac
tions, the circulation of checks would not then have

to be reckoned with as an independent factor.
Some day in the future, when the use of checks has
grown up to its full capacity, it would not be strange
if the ratio of check expenditure to money expenditure

should thereafter remain fairly constant. At present,
however,the use of checks in place of money is being
extended with prodigious rapidity, and far faster than
the use of money.

This is the dominant feature of the

present situation and forms the chief basis of the fore
cast here attempted . All nations are making a con
tinually larger use of checks relatively to money.
The present rate of increase in France is 7 per cent,
in Germany 13 per cent, Holland 9 per cent, Den
mark 10 per cent, Norway 8 per cent, Sweden 51

per cent, Switzerland 5 per cent, Russia 27 per cent,
Japan 10 per cent, the Austro-Hungarian Bank 17
per cent. In backward India , where deposit bank
ing has only just begun, the rate of increase is 9 per
cent, in Mexico 11 per cent. Even in English

speaking lands, where checks have been used for so
long a time, and where , therefore, if anywhere, we
should expect to find that their use had nearly
216

$ 2 .)

THE FUTURE

reached its limit, the volume of deposits is still in

creasing ; in England at the rate of 33 per cent per
annum ; in the United States, at 7 .3 per cent ; in
Canada, at 12 per cent ; and in Australia , at 31 per
cent.

( The data for Australia are too meagre to be

considered representative.)
Outside of English -speaking countries the use of
checks is still in its infancy. Continental Europe

and Japan during the next few decades, will rep
resent a vast region for the extension of deposit

banking. It would not be surprising if, in Ger
many and other Continental countries, the use

of checks should soon reach the stage when every
business man would begin to realize that he must

employ them . When this feeling appears the use
of checks will increase at an even more rapid rate

than at present. The deposit currency ofthe United
States now far exceeds that of other countries, but
the deposit currency of Continental Europe and
Japan will become more and more prominent, and
by the time — perhaps a generation hence — when
their rate of increase begins to slacken , India and

other of the (now ) backward countries will need to
be reckoned with.
Finally, we have the testimony of the statistics of

clearing-houses. The rate at which these increase is
used as a rough indication of the rate at which the use

of checks increases . Clearings in general show a

more rapid rate of increase than deposits. This in
dicates that the use of checks is increasing faster
217

WHY IS THE DOLLAR SHRINKING ? (CH. XII.
than the deposits against which they are drawn,
which means that the activity or velocity (V ') of

these deposits is increasing.
In the United States the velocity or " activity ”
of deposits has shown a progressive tendency to
increase. Concentration of population in cities
and rapid transportation , etc., tend to increase this

velocity. The activity of deposits varies almost
exactly with the size of the cities, and the range of
variation is surprisingly great. Thus the activity
exceeds 100 times a year in Paris , Berlin , and Brus
sels , but is only 16 times a year in New Haven ,

Connecticut, four times a year in Athens, Greece,
and only once a year in Santa Barbara, California .
These results accord with the fact that the velocity
of circulation of deposits in the United States has
increased very substantially, while the concentration

of population has been going on. During the last
eighteen years it has risen from 37 times a year to

54 times a year, that is,about 2 per cent per annum .
In the world as a whole the rise is probably as great.
Finally, we come to the volume of trade. This
is the one factor which acts to restrain the rise of

prices . The volume of trade will continue to in
crease in the future as in the past; but as far as I

know , there is no evidence that it will expand any
faster in the future than it has in the years which
have just passed by ; and no evidence that it will,
as long as the present development of banking con

tinues, outstrip the expansion of media of exchange.
218

$ 3.)

THE FUTURE

On the contrary, there is some reason to believe
that trade, while it will continue to expand , will

expand more slowly in the future than in the
past. The fuller occupation of the land of the
world and the decrease in the rate of growth of
our population , which is partly a consequence of
this occupation and partly a consequence of the

voluntary decrease in the birth-rate , should tend to
curb the rate of increase , although the rate of in
crease will doubtless continue great.

§ 3. Conclusions
For the gold -standard world as a whole (compris

ing now all the important commercial nations except
China), my estimates, as finally adjusted , indicate
that : -

The quantity of money in circulation is increasing
at the rate of 2 per cent annually,

Its velocity of circulation , 1 per cent,
Deposits, 62 per cent,
Their velocity , 17 per cent.
These four make an increase in the total circulation
ofmedia of exchange of 7 per cent per annum .

This

is outstripping trade, which is growing only 41 per
cent per annum . In short, then , world prices have
been going up 27 per cent a year because facilities
for payment are outstripping the growth of trade by
that amount.
There is every reason to believe that these rates
for the increase of money, deposits, and their ve
219

WHY IS THE DOLLAR SHRINKING ? (CH. XII.
locities will be no less in the future than in the past,
and that the growth of trade will be not much , if
any, greater ; but, to be conservative, I have re
duced the estimates for the growth of money and
deposits.
The following estimates for the future rates of

increase of the primary world factors in the problem
seem , therefore , conservative :

Money, not less than 2 per cent per annum .
Its velocity, not less than i per cent per annum .

Deposits, not less than 6 per cent per annum .

Their velocity, not less than 1 } per cent per annum .
Trade, not more than 41 per cent per annum .
Further calculation results in the estimate that the
total use of money (i.e., the product of money mul

tiplied by its velocity, or MV) will grow at least as
fast as 23 per cent per annum ; and that of checks
( M ' V ') as fast as 77 per cent. Checks being much

more important than money, it can be shown that
the average growth of the combined facilities for
buying goods (by both money and checks) will prob
ably be at least 62 per cent per annum . As trade

promises to grow atmost only 44 per cent per annum ,
I regard the difference (62 – 44), or 2 per cent, as
a fairly safe minimum estimate for the future aver
age annual expansion of the scale of prices, while ,
humanly speaking, I feel perfectly safe in predicting
that the general trend ofworld prices for many years
to come will not be downward .
220

$ 3.]

THE FUTURE

Of course no price curve shows a continuous
movement ; it undulates constantly, and we are

just now recovering from something like a crisis.
Accordingly, there is a temporary subsidence in the
rise of prices. After this is over prices will in all

probability resume their upward course although
they will doubtless continue to undulate somewhat
from year to year. But the general trend during
the next two decades, let us say, will probably be
upward for the world as a whole.

The lowering of the tariff in the United States
will tend to produce an export of gold for a few years

to pay for increased imports and so reduce the
volume of currency and thus tend to reduce prices.
The currency act, on the other hand, must inevi

tably tend to expand the currency, for it will put a
stop to our present uneconomical use of bank re
serves and substitute a system which will virtually
release reserves now locked up .

The tendency of

this change (however desirable on other grounds)
must be to inflate the currency still further and to
raise prices. But as it will accelerate the export of
gold , the ultimate result will simply be to spread

the effect over other countries. For the United
States itself the price level will tend to approximate
that of the outside world . This approach toward
the world 's price level through the export of our gold

may occur either through a fall of our prices or,what
is more likely, a rise in prices elsewhere. In short
the net effect will probably be a distinct arrest for
221

WHY IS THE DOLLAR SHRINKING ? [C # . XII.

perhaps a decade in the rise of prices in the United
States , while prices abroad are rising to catch up
with ours.

These forecasts (that world prices will rise in
the next decade or two with some temporary in

terruptions, including that now due in the United
States while we are adjusting internal trade to a
lower tariff) may, of course, not be realized . Prices
may fall or stand still, but they are not likely to
stand still. Judging from the past, the course of
prices, like the course of true love, “ never did run
smooth ," and it would be surprising if it should run

smooth in the future. In the early '90's the world
was seeking relief from an intolerable fall in prices
and at first the prospect of rising prices was hailed
with delight. But two wrongs do not make a right.
If in the next ten years prices should fall rapidly ,

the world will not be thankful, but will resume the
old complaints of depression of trade, the burden
of debts, and all the evils in men 's minds twenty
years ago. What is needed is neither a rise nor a

fall in prices, but a stable price level. This means
a dollar stable in purchasing power .
It is unfortunate that the purchasing power of
money should be always at the mercy of every
chance of gold -mining. There are few enterprises
more subject to chance than gold -mining. There

are always chances of finding new gold deposits,
chances of their “ panning out” well or ill, and

chances of new methods of metallurgy . On these
222

8 3.)

THE FUTURE

fitful conditions the purchasing power of money is
now dependent. Consequently , every one interested
in long-time contracts, whether debtor or creditor,
stockholder or bondholder, wage -earner or savings

bank depositor, is made to some extent a partaker
in these chances. In a sense every one of us who
uses gold as a standard for deferred payments be
comes a speculator in gold . Weall take our chances
as to what the future dollar will buy. The problem
of making the purchasing power of money stable so
that a dollar may be a dollar — the same in value
at one time as another — is one of the most serious
problems in applied economics.
In another book I hope to show how this problem
of standardizing the dollar can best be solved .

223

கரைக்க

INDEX
certain fallacies connected
· with , 109– 111.
Activity of deposits subject to Bank deposits, one of the two
check , progressive tendency | chief classes of circulating
of, to increase, 216 – 218 .
media, 30 ; are not, however,
Adulteration of food , mistake money, 30 ; explanation of,

of assigning, as a reason for 52 ff.; influences affecting
the high cost of living, 197.
velocity of circulation of
Agricultural statistics, conclu money and, and therefore
sions to be drawn from , con
affecting prices, 93– 101 ; in
cerning farming and the high fluences affecting volume of,
and therefore affecting prices,
cost of living , 200 – 201.
Algebraic illustration of equa
101- 103 ; relation of present
tion of exchange, 44 - 46 .
upward price movement to
Antarctic, promise of new gold increase in, 180- 185 ; effect
supply from the, 209 .
on , of discontinuance of
Aristophanes, quoted to show hoarding, 210 – 215 ; present
recognition of principle of and future volume of, 216 –
Gresham 's Law by the 218 .
ancient Greeks, 121- 122.
Banking, explanation of, 52–

Arithmetical illustration of 59 ; limitations of, 63–68 .
equation of exchange, 34 -41. Banking systems, effect of
Armaments, discussed as a character of, on volume of
cause of the high cost of liv- || trade and on prices, 92 ;
ing, 197 – 198.
effect of, on volume of de
Arts, relation between consump- posit currency and therefore
tion of gold in the, and prices, on prices, 101.
118.
Bank-note, distinguished from a
Australia, diagram of price check asbeing realmoney , 30 .
curves in , 173.
Bank-notes, as examples of
Austria -Hungary, price move- fiduciary money , 32 ; princi
ments in , 171.
ples governing, 58 -59 ; safe

guarding of, by the national
government, 68 .

Bankruptcies during crises, trac
Balance of trade, “ favour- ing causes of, 78 – 80.
able" and " unfavourable," Barter, the exchange of goods
20 ; influence of, on the
quantity ofmoney and there
fore on prices, 104 - 119 ;

225

against goods, 4 , 34 ; be
comes obsolete on account of
its inconveniences and annoy

INDEX
ances, 28 ; will never be Circulating credit, explanation
entirely extinct, 28 – 29.
of, 52 - 58 ; the basis of, 59–
Belgium , diagram of price 63 ; relation between quan
curves in , 168.
tity of, to quantity of
Benefits of wealth , defined , money, 71 -74.
8 – 9 ;measurement of, 9 - 10 ; 1 Circulating media, defined , 29 ;

costs are the opposite of, or

two chief classes of, money

and bank deposits, 29 – 30 ;
negative benefits, 10 .
Bills of exchange, degree of figure indicating classification
exchangeability of, 29.
of, 32.
Bimetallism
, system of, 124 - Circulation of money , acquisi
130 .
tion of wealth not promoted
Book credit, effect of, on ve- by, 19.
locity of circulation and on Clearing houses, significance of
prices, 95 – 97, 101- 102.
I increase in , 217 – 218 .
Business confidence, effect of, Coats, R . H ., statistics by,
on trade and therefore on 160 .
prices, 92.

Coinage ratio, the ratio of the
weight of the silver dollar
to that of the gold dollar,
125 n .

California, price cycle start- Coining, merely the finishing
ing with discovery of gold in ,

touch on money as distinct

82 .
from other exchangeable
Canada, diagram of price curves goods, 27.
164.
in ,
Colbertism , set of doctrines
Capital, price level affected by called , 19 – 20 .
accumulation of, 89– 90 .
Concentration of population as
Certificates of property rights a reason for high cost of
distinguished from the rights living, 200 .
themselves, 14.
Cost of living, dependent upon

“ Charging," effect of, on ve amount of money income it
locity of circulation and on costs to secure real income,
prices, 95 - 96 ; increase of 12. See High cost of living.
deposit currency caused by, Cost of production, fallacy in
and consequent raising of assigning as a reason for
prices, 101- 102.
high cost of living, 195 – 197 .
Check , deposits subject to. Costs of wealth, defined as
See Bank deposits.
negative benefits, 10 .
Checks, exchangeability of, 29 ; Credit, elasticity of, as a safe
wherein

bank-notes

differ

guard against crises, 87.

from , 30 ; notmoney because Credit cycle, course of a, 76 – 83 .
not generally acceptable, 30 ; Crisis, culmination of upward
effect of use of, on velocity of price movement in a, 78 – 80 ;

circulation and on prices, 97, | reaction and recovery after
101.
a , 80 - 83 ; means of avoiding ,

Check transactions, present vol- 83–87 .
umeof, and forecast of future, Cromer, Lord, on boarding by
216 – 218 .
| Orientals, 211.

226

INDEX
Currency act, provisions of the

lation of European bank

new , tending to avert danger deposits, 100 .
of crises, 87 ; effect on prices Exchange, of different kinds of
wealth , 4 ; money as wealth
of the, 221- 222.
which is generally acceptable
as a medium of, 4 ; six pos
D
sible types of, of goods, 69.

David, Edgeworth, cited on Exchangeability, degrees of, 29.
promise of gold in the Ant- Exchanges, classification of, 34 .

Extravagance, as a reason for
arctic, 209.
Debts, fallacy concerning the high cost of living, 198 ;
lack of money to pay all, an effect of the high cost of
16 - 17 .
living rather than a cause,

Del Mar, Alexander, History

199.

of Precious Metals by, cited,
165 .
Denmark , diagram of price
Fallacies, concerning money,
curves in , 169.
Deposit currency , influences 15 – 23 ; underlying popular ex
affecting volume of, and planations of high cost of
therefore affecting prices, living, 189 ff.; important
101 - 103. See Bank deposits. political, social, and economic
Diagrams showing price move effects of, 204- 206 .
Farms and farming and the
ments, 161- 179 .
Division of labour, effect of, high cost of living, 200– 201.
on price level, 89.
Ferguson , J. F., cited , 156 n .
Dollar, purchasing power of Fiduciary money, defined, 31 ;

the, is the reciprocal of the | examples of, 31 –32 ; quality
of making for exchange

general level of prices, 23.

ability, 33 ; proportion of, in
United States, 33 .
Fisher, Irving, The Nature of
England , diagrams showing | Capital and Income by , cited ,
price curves in , 160, 161.
2 ; The Purchasing Power of
Equation of exchange, defined Money by , 155 n ., 158 , 182 ;
as a statement, in mathe- articles by, cited, 182, 184.
matical form , of the total Fleetwood, Bishop, statistics
transactions effected in a by, quoted , 158 .
certain period in a given Foreign trade, influence of, on
community , 35 ; obtained quantity of money and hence
by adding together the equa- on price level, 104 - 111.
tions of exchange for all France, working of system of
individual transactions, 35 – bimetallism in , 128 - 130 ; dia
36 ; arithmetical illustration , gram of price curves in ,
35 -41 ; mechanical illustra - 167.
tion, 41-44 ; algebraic illus- Frederick the Great, mistake

tration , 44 -46 .
made by, concerning circula
Essars, Pierre des, investiga
tion ofmoney and acquisition
tions by, of velocity of circu - l of wealth , 19.
227

INDEX
Freedom of trade, effect of, on
volumeof trade and on prices,
91.

countries, 210 -212 ; lessening
on pricemovements, 212– 215 .
Holland,
diagram of price
curves in , 168.
tendency toward , and effect

Geographical differences in Holt, Byron W ., quoted on
prices and discontent,
natural resources, effect of, | rising
205 .

on price level, 89.
wants, price level af
Germany, diagram of price | Human
fected by, 90.
curves in , 166 .

Gold , manner of coming into
use asmoney , 27 ; discoveries
of which originated price Importation and exportation
cycles, 82 ; continuance of

ofmoney , effect of, on prices,

inflation of,shown to be prob

104 - 111.

able, 208 –210 .

viewed as satisfactions,
Goods, use of the term , 14 ; Income,
11 ; distinction between
classification of, as actual money
and real, 11
money, rights to draw money 12 ; costincome
of living dependent
(deposits), and all other upon amount
money in
goods, 69; six possible types come it costs toof secure
real
of exchange of, 69.
income, 12.
Government bonds, exchange- || Index
numbers of prices, 148–
ability of, 29 .
155 ; history of price levels

Greenback standard in United

as shown by ancient and
States,'s135 ,Law
162.. that the modern,
Gresham
156 ff.
cheaper of two or more kinds | India , price movements in ,
of money tends to drive out 174- 179 ; diagram , 179 .

effects of habits of
the dearer, 121 - 124 ; effect Individual,
the, on velocity of circula

on system of bimetallism ,

tion and so on prices, 93– 97.

124 - 126 .

Individual prices, sympathy

between , and general level
of prices, 23 – 25 .
Herschell, Lord Farrer, on Inflation of money and of
credit currency , as a cause of
hoarding in India, 211.
High cost of living, fallacies upward price movement, 182 –
underlying popular explana 185 .
tions of, 189 ff.; an aid to Insolvency, condition of, 64 ;
socialism , 204 - 205 ; dissatis safeguard against, in bank
faction and unrest among ing, found in large capital and
wage earners and salaried surplus, 65.
men due to , 205.

.

History of price levels in differ-

Insufficiency of cash in bank
ing, 64 ; a large cash reserve
a safeguard against, 65 .

ent countries, 156 – 188 .
Hoarding , effect of, on velocity Interest, the rate of, and condi
of circulation and on prices, tions determining, 21 - 22 .

93 -95 ; extent of, in Oriental

228

See Rate of interest.

INDEX
International trade, regulative Mechanical illustration of equa
effects of, on price levels, tion of exchange, 41 -44 .
104 – 111.
Melting and minting, influence
Italy, diagram of price curves of, on quantity ofmoney and
therefore on prices, 111 - 114 .
Mercantilism , set of doctrines
called , 19 – 20 .
's profits as an ex
Japan, price movements in , Middleman
planation of high cost of
174 - 179; diagram , 178.
living, 194 .
Jevons, quoted on paper money, |Milling
of coins, to prevent
133 ; cited , 169– 170 .
debasement, 124.
Mining, effect on price move
ments of, 114 - 117 , 158 .
in , 170 .

Klondike, price cycle starting Mitchell, Wesley C ., mono
with discovery of gold in , 82. graph on “ Business Cycles"
Knibbs, G . H ., calculations of, by, 84 .
159, 160, 161.
Monetary systems, effect of
Knowledge of technique of character of, on volume of
production , price level af trade and on prices, 92 ;
discussion of operation of,
fected by, 89.
121 ff.; principle enunciated
L
in Gresham 's Law , 121 - 124 ;

, 124 - 130 ; the
Labour, viewed as a cost of bimetallism
“
limping
”
standard,
130 – 134 ;
wealth , 10– 11.
effect
on
price
movements,
Labour unions, not to be held | shown by India and Japan ,
wholly responsible for high 176 – 179.
cost of living, 193 – 194 .
, primarily means wealth
Land, relation between cost of, Money
which
is generally acceptable
and cost of living, 201- 202. in exchange,
4 ; use of, not
Legal-tender money , 26.

asa medium of exchange,
Limit of tolerance of the mint, only
but also as a measure of
124.
6 ; mistakes to be
“ Limping” standard, monetary value,
avoided
in use of, formeasur
system called, 130 – 135 .
ing
wealth
6 –8 ; use of, for
Loans, effect of, on velocity of measuring , the
benefits and
circulation and on prices, 96 the costs of wealth
, 9- 10 ;
97.
fallacies concerning, 15 ff. ;
confusion of wealth and, 15
M
16 ; the idea that if one man
Mail and express, effect of, on makes, another must lose,
velocity of circulation and 16 ; fallacy of therenot being
on prices, 100 .
enough to pay all debts, 16 –
Making money , a catch phrase, 17 ; the notion regarding
insufficiency of, to do the
22 - 23 .
Measurement, of wealth in world 's business and the
value and in quantity, 5 ; / necessity of increasing the
quantity of, 17 - 18 ; the mis
of costs of wealth , 10.
229

INDEX
take of viewing, as an indis- Monopolies, effect of, on prices,

pensable means of getting 92, 102, 192– 193.
the circulation of, does not 29.
promote acquisition of wealth, Murray, Nathaniel C ., agri
19 ; mistaken ideas concern cultural statistics by, 200 .
ing wealth and, giving rise
N
to Colbertism or Mercantil
ism , 19– 20 ; wrong reason New South Wales, price move
ing of majority of protec ments in , 177 .
tionists concerning, 20 ; |Newspapers, effectof, on volume
fallacy concerning the rate
and on prices, 91.
of interest, 21 -22; consider | Newof trade
Zealand, diagram of price
ation of real functions of, curves
in , 175.
25 ff. ; extension of defini
tion to include all goods
generally acceptable in ex
change for other goods, 26 ; Orientals , hoarding of money
legal tender, 26 ; examples of by, 210 - 212 ; lessening ten
commodities at certain places dency of, toward hoarding,
and times generally accept 212- 215 .
able in exchange found in
, viewed as efforts to
gold dust, tobacco , and wam Outgo
secure satisfactions,
11. par
pum , 26 – 27 ; method by Ownership
, complete and
which certain commodities tial, 12 – 13 ; partnership rights
came into use as, 27 ; coin vs. shares of stock , 12 – 13 .
ing is merely the finishing
touch placed on , 27 ; the
most exchangeable of com

wealth , 18 - 19 ; promoting Mortgages, exchangeability of,

modities, 29 ; why checks are Paish, Sir George, English
not, but bank-notes are, 30 ; agricultural statistics by, 200–
primary and fiduciary, 30–33 ; l 201.
what is meant by money in Paper money , mistake of sup
circulation, 34 ; ratio of posing wealth to be created
bank deposits to, 72 ; re- l by , 19 ; an example of fidu
mote causes which influence

ciary money , 32.

circulation of, and so affect Partnership rights, 12 – 13.
prices, 93 – 101 ; influences Payments, effect of systems of,
affecting quantity of, and
therefore affecting prices,

on velocity of circulation
and on prices, 97 – 99.

104- 120 ; increase of, shown Population , effect of density of,
on velocity of circulation and

not to decrease its velocity,
141– 147 ; continued increase
likely in world supply of,

on prices, 100 ; concentra
tion of, in cities as a reason

208 – 215 .

for high cost of living, 200.

Money metals, influence of pro- Price level, three sets of causes
duction and consumption of, affecting, 35 ; effect on, of
on quantity of money and so doubling denominations of
on prices, 114 - 119.
money, of reissuing and re
230

INDEX
coining , of doubling quantity

109 ; effect of protective

of money, and of a seignior tariff on , 109- 110 ; influence
of melting and minting, 111
age charge, 46 –49.
Price levels, history of, 156 ff. 114 ; effect of influence of
Price of money , use of the production and consumption
phrase, 21– 22.
of money metals, 114 - 119 ;
Price of wealth, defined, 5.
influence of monetary and
Prices, the purchasing power of banking systems on , 121 ff . ;
the dollar the reciprocal of computing index numbers of,
the general level of, 23 ;| 148 – 155 ; comparison of
dependence of individual, | levels of, in different periods
upon general level of, 24 ; and countries, 156 ff. ; dis
periods of rise in , 76 – 78 ; cussion of present upward
culmination of period of ris movement of, 180 - 185 ;
ing, in a crisis, 78 –80 ; movement of, in United
period of falling, after crises, States, compared with that
80 – 81 ; remote influences of wages, 186 – 188; popular
which affect trade and there explanations of upward move
fore prices, 88 ff.; effect ment of, and fallacies under
of geographical differences, lying , 189 – 203 ; discontent
division of labour, knowledge and unrest due to high , 204
of technique of production , 205 ; outlook as to future of,
and the accumulation of 207-219 ; conclusions as to fu
capital, 89 – 90 ; effect of ture movements of, 219- 223.
extent and variety of human Primary money , defined , 30 –
wants, 90 ; effect of facilities 31 ; qualities of, making for
for transportation , 91 ; effect | exchangeability, 33; propor
of relative freedom of trade, tion of, in United States, 33.
91 ; effect of character of Production , cost of, given as

monetary and banking sys-

a reason for high cost of

tems, 92 ; effect of business
circulation and therefore
prices, 93 ff. ; effect of
hoarding, 93- 95 ; effect of
book credit and loans, 95- 97 ;

living, 195 – 197.
Property rights, distinction be
tween wealth and, 4 , 13 ;
distinction between , and the
certificates of those rights, 14 .
Protection , Colbert an early
advocate of policy of, 20 ;

effect of use of checks, 97 ;

fallacious reasoning ofmajor

confidence, 92 ; remote influ ences affecting velocities of

effect of systems of payments ity of protectionists concern
in communities, 97 – 99 ; ing, 20 .
effect of density of popula- Protective tariff, effect of, on
tion, 100 ; effect of rapidity price levels, 109– 110 .

of transportation , 100 ; influ - Purchase and sale, the exchange
ences affecting volume of of money against goods, 4, 34.
deposit currency and there
fore prices, 101- 103 ; influ
ence of the “ balance of
trade” on quantity of money Quantity theory of money, that

and therefore on prices, 104 - 1 the price level varies directly

231

INDEX
as the quantity of money in Rising prices, periods of, 76 –78 .
circulation , 35, 46 ; illustra- Rome, cost of living in ancient,
tion and elucidation of, 46 - 1

156 n .

51.

Quantity of money, fallacy
concerning the necessity of Sea -water gold , 210.
increasing , to do the world's
business, 17 -18 ; relation ildbe's | Seigniorage charge, effect of,
tween price level and, 35 ff. ;

on price level, 49, 113.

Phæbe, work by,
means the number of dollars, Sheavyn,
quoted , 157 - 158, 203.
or other monetary units, in | Silver
money, an example of
circulation , 46 ; effect on price
money, 31 ; applica
level of changes in , by four fiduciary
of Gresham 's Law to ,
different methods, 46 –49 ; tion
121- 124 ; under a system of
relation between quantity of bimetallism
, 124 - 130 .
circulating credit and , 71

, high cost of living a
74 ; influence of “ balance of Socialism
force working for, 204- 205 .
trade" on , and therefore on South
, effect on trade
prices, 104 - 111 ; influence of and America
on prices of lack of
melting and minting on , and business
confidence illus
on prices, 111- 114 ; influ - l trated by, 92.
ence of production and con
|
on - Spain, diagram of price curves
sumption of money metals
. , effect of, on volume
in , 172ips
on , and on prices, 114 - 119 ; Steamsh
influence of monetary and 1 of trade and on prices, 91.
banking systems on, and on Stockholders in banks, 63.
prices, 121 ff. ; increase in , Supply and demand,mistake in
shown not to decrease its explaining high cost of liv
velocity, 141- 147 ; forecast of ing
in by, 190 – 191.
future increase in , 208 –215 . Systems
of payments, effect of,

Railways , effect of, on volume

on velocity of circulation and
on prices, 97 – 99.
T
Tariff, false reasoning about a
protective, 20 ; effect of, on

of trade and on prices, 91 ;
effect of, on velocity of circulation and on prices, 100 .
Rapidity of transportation , volume of trade and on prices,
effect of, on velocity of cir
91 ; effect of, on price levels,
culation and so on prices, 100 . 109– 110 ; mistake made in
Rate of interest, a common assigning, as a popular expla
money fallacy concerning the, nation of high cost of living,
21- 22 ; lowering and raising 192 ; effect of lowering of, in
by a bank, to maintain its United States, 221.
cash reserve in right propor- Telegraph and telephone, effect
tions, 67; as a safeguard of, on volume of trade and on
against crises, 83 -86 .
prices, 91; effect of, on
Real estate, one of the least velocity of circulation and
exchangeable of goods, 29.
on prices, 100 .
232

INDEX
Théry , Edmond, article by,
184 – 185 .
Tobacco used asmoney in early
Virginia, 27.
Transportation, effect of facili- |
ties for, on volume of trade

and therefore affecting price
level, 88 – 92 ; is not increasing

in proportion to other factors
in equation of exchange, 218
219 .

W
and on prices, 91 ; effect of
rapidity of, on velocity of Wage earners, dissatisfaction
circulation and on prices, 100. and unrest among, owing to
Trusts, effect of, on prices, 92 ; high cost of living, 205.
effect of, on volume of de- Wages, movement of, in United
posit currency and conse States, compared with move

quent raising of prices by,
102; raising of particular
prices by , does not affect
general price level, 103 ;
mistake generally made in

ment of prices, 186 – 188.
Wampum , used as a medium of
exchange among Indians, 27 .
Wars as a reason for high cost
of living, 197 –198.

giving as a reason for high Wealth , defined , 2 – 3 ; measure
ment of each kind of, in its
cost of living, 192– 193.
own physical units, 3 ; to be
distinguished from the quali
ties of wealth , the use or
United States, system of bimet benefits
of wealth , and the
allism and the present “ limp written certificates
of prop
ing " standard in , 124 - 135 ; erty rights, 4 ; exchange
of
diagram showing price curves different kinds of, and use of
in , 163 ; movement of whole money as a medium of ex
sale and retail prices and of
4 ; price of, defined ,
wages in , 187 ; effect oflower 5change,
; value of, defined , 5 ; ad
ing of tariff in , and of new vantage
ofmeasurementof,
in
currency act, 221–222.
value rather than in quantity ,
5 ; use of money as a measure

Value of wealth , finding the,

of value of, 6 ; care to be used
and fallacies to be avoided in

5 ; use ofmoney as a measure
of, 6 ; care to be used in
expressing the, 6 – 8 .
Variety of human wants, rela
tion between volumeof trade

use of money for measure

Volume of trade, relation be
tween price level and, 35 ff. ;
remote influences affecting,

getting, 18 - 19 ; acquisition
of, not promoted by promot

ing, 6 – 8 ; ownership of, is
the rights to its benefits, 8 ;

benefits of, defined, 8 -9 ;
costs of, defined as negative
and price level and, 90.
benefits, 10 ; division of
Velocity of circulation , relation ownership of, 12 –13 ; dis
between price leveland, 35 ff.; tinction between property
influences affecting, and rights and, 13 ; mistake of
therefore affecting prices, 93
confusing money with , 15 –
101 ; effect on, of discontin
16 ; fallacy of viewing money
uance of hoarding, 214 -215 . as an indispensable means of

233

ing circulation of money, 19 .

"HE following pages contain advertisements of
Macmillan books by the same author.

Irving Fisher's New Work

Standardizing the Dollar
BY IRVING FISHER
Author of “ The Purchasing Power of Money,” “ Nature of Capital
and Income,” etc .

Herein will be found a complete statement of the
plan suggested by Professor Fisher for combating the

rise in the cost of living by “ standardizing " or stabiliz
ing monetary units. The author shows how such a
standardization is a remedy for the financial crises from
which society periodically suffers. The scheme pro

poses to set up a unit which shall be invariable in the
same sense that our units of length and weight are in
variable . It does this by “ compensating " for every
fall in the purchasing power of gold virtually by adding

to the weight of gold in the dollar ; in other words, it
would get rid of the present fixed price of gold and allow
new supplies of gold to lower the price of gold instead
of, as at present, raising the price of goods.

THE MACMILLAN
Publishers

COMPANY

64-66 Fifth Avenue

New York

BY IRVING FISHER

The Purchasing Power of Money
New and Revised Edition , Cloth ,800, $2.25 net
What the Leading Reviewers Say of “ The Purchasing Power

of Money "
“ The prediction may be ventured that the book will becomea clas

sic in the literature of money , and that it will also prove a starting
point for fruitful investigation in the future." - O . M . W . SPRAGUE,

Harvard . The Quarterly Journal of Economics.
“ . . . and may fairly be called , on the whole, themost important
American book of the year in the field of economics." — DAVID
KINLEY, University of Illinois. Journal of the American Economic
Association .

“ As very little of an authoritative nature has been written in this
country on this question, outside the covers of formidable Blue
Books, Professor Fisher 's book should be widely read, especially
since the general level of prices seems to be rising, and the public is
oncemore becoming concerned in the conditions which determine the

purchasing power ofmoney ." — The Economist, London, England.
“ It is one of the most important books of the year on economic
theory . . . ."
“ To the economist, to the general reader ,most of all, perhaps, to

the lecturer and the student, we can recommend the book very

warmly.” — Westminster Gazette, London, England.
“ To investors and business men generally, its chapters will be
found to contain matter of very direct and practical bearing.” —
Canadian Finance.

“ His suggestion of a new and more stable standard of value is so

important, though he says that years of education of the public must

precede any attempt to put it into practice, that we have obtained
permission of the Macmillan Company, publishers of the book , to
present here an abstract of the professor's proposal."

“ Probably no modern writer has studied this question more deeply
than Professor Fisher ,and his suggestion of a new standard of value
deserves the careful thought of every banker, investor, and business
man .” — Moody's Magazine.

What the Leading Reviewers Say of “ The Purchasing Power
of Money "
“ . . . certainly this work of Professor Fisher's will be of great aid
damental conditions.” — ROGER W . BABSON . Weekly Barometer
Letter and Composite Plot Compiling Offices of Babson 's Statistical

to such bankers, merchants, and investors as are now studying fun

Organization .

“ It is the vigorous expression of a keen intellect ; its straightfor
wardness and its definite purpose mark it as distinctly unacademic.

“ This book is challenging, informing, and guiding. It shows the
way and defines the issue." - FRANK HENDRICK . Trend, New York

City.

“ Professor Fisher's book should be read by every one who is in
terested in monetary problems. It lays upon secure foundations
certain essential principles which can never hereafter be reasonably

questioned . It is a very valuable contribution to the new political
science, whose teachings are not to be colored through social or
political prejudice.” – WILLIAM HOWE CRANE. The Public.
“ The volume before us sheds abundant light on what is to most

every one a mysterious subject.” — Engineering Literature.
“ Your work appears to me a most extraordinary one. The book
is absorbingly interesting, and the lucidity , cogency, and accuracy
of its reasoning could hardly fail to carry conviction in an unusual
degree.” – JOHN PERRIN , Chairman of the Board , The Fletcher
American National Bank of Indianapolis.

“ An important study in financial economics is Professor Irving
Fisher's “ The Purchasing Power of Money.'” . . . — American ,
Philadelphia, Pa .

“ . . . there is much of value and illumination in this well-rea
soned scientific yet readable work." — Statesman, Boise, Idaho.
“ The Purchasing Power of Money,' by Irving Fisher, Professor
of Political Economy at Yale , is suggestive of a threadbare topic, but
it is anything but that. The volume of 500 pages is a refreshing

and reconstruction of the quantity theory."" - Leader, Cleve
study Ohio.
land,

“ Few persons are more successful than Professor Fisher in putting
old wine into new bottles. He has taken the most hotly debated of
all economic questions, and, by the use of arguments long familiar
to special students, has produced an imposing work .” – Nation ,
New York City.

OTHER WORKS BY IRVING FISHER

The Rate of Interest
Its Nature , Determination , and Relation to Economic Phenomena
Cloth, 8vo , 442 pages, Index , $3.00 net
EDITORIAL IN Moody's Magazine, January, 1908 :
“ . . . It contains some conclusions of great value to financiers, bankers,
underwriters, etc. — knowledge that put millions of dollars into the pock
ets of some who possessed it and the lack of which cost others (bond
houses, for instance) more millions. It may be said , in passing, that this
recent book is easily not only the most complete, but the most valuable
treatise in the English language on the very important, but little under
stood , subject of interest rates. In fact it is, perhaps, both the latest and

most scientific discussion ofthis subject in any language. . . ."

The Nature of Capital and Income
Cloth, 8vo, 427 pages, $ 3.00 net
MARCUS C. KNOWLTON, Chief Justice of Massachusetts :
“ A great book , and analytical, logical, and philosophic in a high degree.
The definitions and statement impressed me as accurate as well as clear, and
the reasoning is easily followed. It seemsto me logically impregnable.”
UMBERTO Ricci in a 21-page review , “ Rassegna del Movimento Scienti
fico,” in Giornale degli Economisti, September , 1907:
“ Professor Irving Fisher has published a recent volumeon The Nature
of Capital and Income,' which deserves to be considered and discussed at
length . . . . The author is an economist who bridges the gap between his

science and the theory of Bookkeeping . . . . Thisbook of the able Ameri
can economist, because of the coherence of his method , the clearness and

symmetry of his exposition and the acute and ingenious applicationswhich
hemakes, deserves a notable place in the recent literature of our science.”

A Brief Introduction to the Infinitesimal Calculus

Revised Edition . Cloth , 12m0, 84 pages, $.75 net
Journal of Education :
“ This little volume is designed especially to aid in reading mathemat
ical economics and statistics. It is also equally adapted to the use of those
who wish a short course in " The Calculus,' as a matter of general educa
tion . It is admirably adapted to its purpose in either case."

Elementary Principles of Economics
Cloth, 12m0, $ 2.00 net
Teachers who have tested the book in classroomshave become enthusi
astic over its “ teachableness.”

THE MACMILLAN COMPANY
Publishers

64-66 Fifth Avenue

New York

na
net

3 2044 020 502 712

THE BORROWER WILL BE CHARGED
AN OVERDUE FEE IF THIS BOOK IS NOT
RETURNED TO THE LIBRARY ON OR
BEFORE THE LAST DATE STAMPED

BELOW . NON -RECEIPT OF OVERDUE
NOTICES DOES NOT EXEMPT THE

BORROWER FROM OVERDUE FEES.

Cavancemaran
TWIDENERE
LOOK DUE

APARAT

35

MAY
M
WIDENEF

WIDENER '

S

JUN 1 0 1998

7 19DUE
98
MAY 2BOOK

DS