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Money and Credit By IRVING FISHER, PH. D. ;/ Professor of Political Economy, Yale University. - American Economic Association, 1918. President of Author, "The Nature of‘ Capital and Income," “The Rate of Interest," "The Purchasing Power of Money," “Satbilizing the Dollar," etc. 352-, l:5_/IVY‘-D AMERICAN INSTITUTE OF FINANCE BOSTON 789109 Stacks Copyright. 1922. by American Institute of Finance TABLE OF CONTENTS Chapter I. The Nature of Money An Essential Characteristic Wealth and Its Measurement Exchange and Price Value . . Common Fallacies . “Making” Money_. Chapter II. Currency Two Chief Classes of Currency “Mystery” of Circulating Credit . Bank Loans . . Functions of Banking . Regulating Bank Reserves Chapter III. Capital and Income Fund and Flow Distinguished Difference Between Capital and Income Capital-Goods, Capital-Value - Capital Accounts . _ . . . ‘Function of the Capital-Balance . A Stream of Services Income and Outgo . Psychic Income Chapter IV. 18 19 19 20 20 21 22 24 Interest Rates Connection Between Capital and Income Interest Periods . . . . . The Principle of Present Worth . Interest Rates, High or Low . . Individual Traits and Differences Real and Nominal Variations Chapter V. 11 12 13 14 16 25 25 26 28 29 30 Money’s Purchasing Power Recent Price Movements . Popular Explanations . 31 31 4 Table of Contents Page Chapter V. Money’s Purchasing Power (continued) Extravagance or Luxury . . . . . . . “Proﬁteering" . . . . . . . . . Changing Price Levels Historically Considered Money’s Changing Purchasing Power . . . Five Factors Regulating Purchasing Power . Standardizing the Dollar . . . . . . . Chapter VI. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 33 34 34 35 35 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 38 39 39 40 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 42 43 44 45 45 Controlling the Price Level Increased Knowledge . . . . . . . Outlook for Increased Knowledge . . . Lessening the Price Changes . . . . . Government Regulation of Money Supply . A Proposed Method . . . . . . . Chapter VII. . . . . . . A Stabilized Dollar The Plan Brieﬂy Stated . . . Two Vital Questions . . . . Changing the Dollar's Weight . Making Proper Adjustments . . Summary . . Why Not Standardize the Dollar?‘ . . . . . . . . . . . . CHAPTER I THE NATURE‘ OF MONEY* An Essential Characteristic We live in a complicated civilization in which we talk in terms of money. Is this talk accurate and effective in the conduct of business? Or has money, in the way we commonly use the term, come to be a sort of veil that hides the other and more important wealth of the world? An examination into the nature of money represents the best ‘way to ahswer these questions. Money is well deﬁned as goods generally acceptable in exchange for other goods. The facility with which it may be exchanged, or its general acceptability, is money’s chief charac teristic. This general acceptability very commonly in modern states has behind it the reinforcement of law, the money thereby being made “legal tender”; yet such reinforcement is not an essential element. All that is necessary in order that any goods may be made money is that general acceptability shall attach to them. Without legal sanction, for example, gold nuggets served as money among frontiersmen, tobacco in the colony of Virginia, and wampum among the Indians of New England. The origin of money, and the choice of certain goods as money, came about, not through government decree, but because the commodity was very salable for other uses than money and could readily be resold. Gold was readily sold and resold. Many wanted it for jewelry, and many others could easily be *We are indebted to the Macmillan Company, 64 Fifth Avenue, New York, publishers of the author's various works on economics. for permission to reproduce here certain extracts from them. We are also indebted to the American Economic Review for permission to repro duce certain passages from the author's address before the American Economic Association, which appeared in the American Economic Review Supplement, March. 1913, pp. 20-28. 6 Money and Credit 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, due to its superiority over other commodities for the purpose to be served, as the most important form of money. The use made of this money, the service it performs in furthering the interests of business men in their manufacturing, sales and other activities, renders it desirable to consider the more basic subject, wealth itself.' Wealth and its Measurement Wealth includes all those parts of the material universe that have been appropriated to the uses of mankind. It includes the food we eat, the clothing we wear, the dwellings we inhabit, the merchandise we buy and sell, the tools, machinery, factories, ships and railroads by which other wealth is_ manufactured and transported, the land on which we live and work, and the gold by which we buy and sell other wealth. Dealings in these various forms of wealth for the purpose of gain we term business. The desirability of a measure for wealth is apparent upon a moment’s thought. Many articles are measured conveniently by units of space, whether of volume, of area, or of length. Other kinds of wealth are measured by weight. This is true, for instance, of coal, iron, beef, and in fact most “commodities.” Units of weight have been handed down to us in considerable diversity. In England, besides the avoirdupois pound and the Troy pound, there is the pound sterling, used for measuring gold coin. This is much smaller than any other pound, owing partly to the frequent debasements of coinage that have occurred and partly to changes in the past from silver to gold money. In the United States a dollar of “standard gold” is a unit of weight employed for measuring gold coin. It is equivalent to 25.8 grains, or to 7% of a pound avoirdupois, since there are 7,000 grains in a pound avoirdupois. The Nature of Money 7 The fact can scarcely be too much emphasized that the pound sterling and the dollar are units of weight. They should be understood as such before any attempt is made to under stand them as units of “value.” Exchange and Price Wealth is more or less continually being transferred from owner to owner. While some of these transfers are involuntary, as in the case of robbery; and others are one-sided, as gifts and bequests; the great majority are reciprocal transfers, or ex changes. An exchange is a pair of mutual and voluntary trans fers of wealth between two owners, each transfer being in con sideration of the other. When a certain quantity of wealth of one kind is exchanged for a certain quantity of wealth of another kind, we may divide either of the two quantities by the other and obtain what is called the price of the latter. That is, the price of wealth of any given kind is the amount of any other kind of wealth supposed to be exchanged for one unit of the given kind of wealth. Thus if 100 bushels of wheat are exchanged for 75 dollars of gold, the price of the wheat in terms of gold is 75—:—l00, or three quarters of a dollar of gold per bushel of wheat. Contrawise, the price of gold in terms of wheat is 100+75, or one and one third bushels of wheat per dollar of gold. Thus there are always two prices in any exchange. Practically, however, we usually speak only of one price, viz., the price in terms of money, obtained by dividing the number of units of the article exchanged for that money. It follows that, in practice, the price in money of any particular sort of wealth is the amount of money for which a unit of that wealth is exchanged. Value The value of a given quantity of wealth is that quantity multiplied by the price. In other words, the value of a certain quantity of one kind of wealth at a given price is the quantity 8 Zlloney and Credit of some other kind for which it can be exchanged, if the whole quantity were exchanged at the price set. The distinctions between quantity, price and value of wealth may be -illustrated by an inventory such as the following: Quantity Shoes . . . . . . . . . 1000 pr. Beef . . . . . . . . . . .300 lb. Dwelling house. .1 house Wheat . . . . . . . . .100 bu. Pris; iwnh'l;rtms 4% bushels per pair % bushels per pound 10,000 bushels per house 1 bushel per bushel Valu‘ev::ie;I;erms 4,250 bushels 60 bushels 10,000 bushels 100 bushels The measurement of various items of wealth in respect to “value,” expressed in terms of a single commodity, such as wheat or money, has one great advantage over its measurement in respect of “quantity.” This advantage is that it enables us to translate many kinds of wealth into one kind and then add them all together. To add up the “quantity” column would be ridiculous, because pairs of shoes, pounds of beef, houses, and bushels of wheat are unlike quantities. But the items in the value column, being expressed in a single common unit (the bushel), may be added together despite the diversity of the various articles thus valued in bushels of wheat. 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 different things by expressing them all in a common denominator. Common Fallacies The service which money performs having now been surveyed in brief, we are in a position more readily to see why certain ideas held concerning money are fallacies. The tendency to confuse wealth with money is extremely common. Few persons, The Nature of Money 9 to be sure, are so naive as to imagine that a millionaire is one who has a million dollars of actual money stored away; but, because money is that particular kind of wealth in terms of which the value of all other kinds of wealth is measured, it is at times forgotten that not all wealth is money. A curious result of this confusion is the claim occasionally heard that the people of the earth can never pay off their debts because their 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 part 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. A fallacy much more common, and more mischievous in its ill effects, is the notion that sometimes there is not enough money with which to do the world’s business, and that unless at such times the quantity of money is increased, the wheels of business 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 ad justed to that quantity. The signiﬁcance of this fact will be explained more fully in Chapter V which follows. A more subtle form of money fallacy is one which admits that money is not identical with wealth, but contends that money is an indispensable means of getting wealth. At a recent meeting _ of the American Economic Association the assertion was made by a very intelligent gentleman 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 California 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. 10 Money and Credit “Making” Money If money in itself could make the world rich, we should not need to wait for gold discoveries. We could make paper money. This, in part, has again and again been tried. The French people once thought they were going to get rich by having the government print unlimited quantities of paper money. Austria, Germany, Italy, Japan, as well as many other countries, including the American colonies and the United States, and, to cite the worst recent example, Russia have tried the same ex- . periment with the same result — no real increase in wealth, but simply an increase in the amount of money to be exchanged for wealth. The only result of such emissions of money is an in crease in prices. Money fallacies of the kinds here described, and similar, must be carefully avoided. Propositions concerning money should undergo strict scrutiny and all catch phrases need to be avoided. Having considered the nature of money, we are ready to examine more closely in the next chapter the ways which have been devised for its effective use. Q CHAPTER II CURRENCY Two Chief Classes of Currency Currency 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. Currency consists of two chief classes: (1) money; (2) bank deposits. Through the use of checks, bank deposits serve as a means of payment in exchange for other goods. Checks are the evidence of the transfer of bank deposits. While they are acceptable to the respective payers only by their consent and would not be accepted by strangers, checks, bank deposits, even more than money, do actually serve as a medium of exchange. So fully are the people of this country accustomed to make use of checks in their various business transactions that bank de posits subject to check, or, as they are sometimes called, “de posit currency,” are by far the most important kind of currency or circulating medium. _ ' But, although a bank deposit transferable by check is in cluded in circulating media, it is not money. A bank note, on the other hand, is both circulating medium and money. Be tween these two lies the ﬁnal line of distinction separating what is money and what is not. The line is delicately drawn, es pecially in the case of such checks as cashier’s checks,“travellers’ checks” or certiﬁed checks. The latter are extremely 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 by “legal tender” laws or by a well established custom. 12 Money and Credit “Mystery” of Circulating Credit The transfer of bank deposits gives rise to the so-called “mystery of banking” which we term circulating credit. Many persons, including some economists, have supposed that credit is a special form of wealth which may be created out of whole cloth, as it were, by a bank. Others have maintained that credit has no foundation in actual wealth at all, but is a kind of unreal and inﬂated bubble with a precarious if not wholly il legitimate existence. Let us illustrate the real nature of bank deposits by supposing that several persons secure a vault, under proper custodianship, for the safe keeping of their money. This money is deposited to the amount of, let us say, $100,000 in gold, each person accepting a receipt for the amount of his deposit. A, we assume, deposited $10,000; B, $10,000; and all others $80,000. The accounts of this vault or bank then would be: Assets Gold . . . . . . . . . . . . , $100,000 Liabilities Due depositor A. . . Due depositor B. . . Due other depositors $100,000 $10,000 10,000 80,000 $100,000 A, it is assumed, owes, and wishes to pay B, $1,000. The former could draw out $1,000 in gold, upon his order, or receipt, for the same; and B, upon receiving this coin, could then carry it back to the place of deposit, securing his receipt for it. This would represent in practice, as a rule, considerable inconvenience. Instead, consequently, of both persons Visiting the place of deposit and of counting and otherwise handling the money itself, A might give B a check for $1,000, which would effect the same result of reducing A’s holdings from $10,000 to $9,000 and in creasing B’s holdings from $10,000 to $11,000. then would read: The accounts Currency . Assets Gold . . . . . . . . . . . . $100,000 13 Liabilities Due depositor A . . . Due depositor B. . . . Due other depositors $100,000 $9,000 11,000 80,000 $100,000 The orders upon the bank, or checks, would in practice cir culate in place of cash among the various depositors. What really circulates, or changes ownership, is the right to draw money. The check is merely the evidence of this right and of the transfer of this right from one person to another. Bank Loans The gold on deposit, however, could in addition make a proﬁt were some of it lent on interest. This would be entirely feasible, for the depositors do not expect to get back the identi cal gold they deposited but want, primarily, to be able at any time to obtain the same amount of gold. The idle gold repre sents an opportunity for those in charge of it to make loans. A loan is really an exchange of money for a promissory note (or similar evidence of indebtedness) which the lender — in this case the bank — receives in place of the gold. Assuming a loan of $50,000, which the borrowers draw out, the books then read: Assets Gold . . . . . . . . . . . . Promissory notes . . Liabilities $50,000 $50,000 $100,000 Due depositor A. . . . Due depositor B . . . . Due other depositors $9,000 11,000 80,000 $100,000 It is seen that now the gold in bank is only $50,000, while the total deposits are still $100,000. In other words, the deposi tors now have more “money on deposit” than the bank has in its vaults! But this form of expression involves a popular fallacy in the word “money.” Something of equivalent value is behind each loan, but not necessarily money. 14 Money and Credit Very commonly in practice, however, those granted loans do not draw the money, but leave it on deposit in the bank and draw checks upon it. What the borrower secures is the right to draw; the gold really does not budge. Since the average banker prefers that the borrower should not withdraw actual cash but that he be a depositor and place the amount of the loan to the credit of his account, the result of the foregoing transaction in which $50,000 was borrowed would in all proba bility be thus: Assets Gold . . . . . . . . . . . . Promissory notes . . Liabilities $100,000 50,000 Due Due Due Due depositor A. . . . depositor B . . . . other depositors new depositors, $9,000 11,000 80,000 i.e. the borrowers 50,000 $150,000 $150,000 Besides lending deposit rights, banks may also lend their own notes, called “bank notes.” And the principle governing bank notes is the same as the principle governing deposit rights. The holder simply gets a pocketful of bank notes instead of a bank account. Assuming that the bank issues $50,000 of notes, the balance sheet becomes: Assets Gold .. .. . . .. . . .. Liabilities $100,000 Loans (Promissory notes) . . . . . . . . . . $100,000 $200,000 Due depositors .... Due note holders $150,000 50,000 $200,000 Functions of Banking The deposits and notes of a bank, by means of credit, may evidently exceed its cash. There would be nothing mysterious or obscure about this if these operations were thought of not as Currency money but as credit operations. 15 What really is transferred are promises to pay money on demand. There is wealth somewhere behind these promises, whether an individual’s or company’s promissory.note or a bank’s note; though this wealth has dif ferent degrees of accessibility. The noteholder’s promise is secured by his assets; and the bank’s promise is secured by the bank’s assets. The noteholder has “swapped” his own less known credit for the bank’s better known credit. The bank ﬁnds itself in the course of its business operations 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, and the basis of these liabilities in turn is actual wealth — real estate, goods in storage, equipment, etc. 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, just such wealth. By the banking laws, in part, banks are compelled to take the notes instead of the actual wealth. 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 visible, tangible wealth to circulate. If the acres of a landowner or the iron 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 ex change 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 10, his comparatively unexchangeable wealth becomes liquid currency. To put it crudely, banking is a device for coining into dollars land, stoves, and other wealth not otherwise generally acceptable in exchange. 16 Money and Credit Regulating Bank Reserves The lending operation described, in which the bank loans its credit to various borrowers and itself owes money on demand, involves risks which the depositors as such would be unwilling to assume. Consequently, the responsibility and expense of running the bank are taken by another class of people— stockholders —who are willing to assume the risk for the sake of the chance of proﬁt. Stockholders, in order to guarantee the depositors against loss, put in some cash of their own. Their contract is, in effect, to make good any loss to the depositors. 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 falls of its purpose when it is caught with in sufﬁcient cash. Yet it makes proﬁts partly by tying up its quick property, i.e., lending it out where it is less accessible. Its problem is to tie up enough to increase its earnings, but not to tie up so much as to get tied up itself. Where insufﬁciency of cash impends, the bank tries to forestall 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 demand cash payment. All their “money in the bank” is never really there. The bank, in coping with the situation described, aims to so regulate its loans and note issues as to maintain a sufﬁcient cash reserve. This reserve can be regulated in various ways. For instance, it can increase its reserves relative to its liabilities by “discounting” less freely—by raising the rate of discount and thus discouraging would-be borrowers, by outright refusal to lend or even to renew old loans, or by “calling in” loans sub ject to call. Reversely, it can decrease its reserve relatively to its lia bilities by discounting more freely—by lowering the rate of discount and thus attracting borrowers. The more the loans Currency I 17 in proportion to the cash on hand, the greater the proﬁts, but the greater the danger also. Through alternately raising and lowering the rate of interest, a bank keeps its loans within the sum which the reserve can support, but endeavors to keep them (for the sake of proﬁt) as high as the reserve will support. CHAPTER III CAPITAL AND INCOME Fund and Flow Distinguished The foregoing chapters have described brieﬂy what wealth is and the means whereby it is exchanged. They have paved the way for consideration of the relation of wealth, services, prices and values to that great “independent variable” of human experience, time. When speaking of certain quantity of wealth we may have reference either to a quantity existing at a particular instant of time, or to a quantity produced, consumed, exchanged, or transported during a period of time. The ﬁrst quantity is a stock (or fund) of wealth; the second quantity is a ﬂow (or stream) of wealth. The contents of a manufacturer’s store room at noon January 1, 1922, is a stock of ﬁnished parts; the amount brought from the factory into this room or shipped out to branch houses during a week, or a year, is a ﬂow of ﬁnished parts. The term “wealth” by itself is insufﬁcient to determine which of these two kinds of magnitudes is meant. Similarly, when we speak of property or of value, we may have in mind either a fund or a stream. The value of the checks held at noon of any day by one bank drawn on other banks constitute a fund of value; the value of the checks which pass through a clearing-house in twenty-four hours consitutes a How of values. Services and satisfactions, unlike wealth and property, can exist only as a ﬂow; a fund of either is impossible. A fund is fully speciﬁed by one. magnitude only; a ﬂow re quired two — the amount of ﬂow and the duration of ﬂow. From these two a third follows—the rate of ﬂow or the quotient of the amount divided by the duration. The rate of ﬂow is often more important than the amount of How. Thus the aggregate Capital and Income 19 earnings of a corporation extending, as it possibly would, over a half century, interest us less than knowledge of how fast the earnings are running now. Difference Between Capital and Income The most important application of the distinction between a fund and a ﬂow is to differentiate between capital and income. Capital is a fund and income a ﬂow. This difference between capital and income is, however, not the only one. There is another important difference, namely, that capital is wealth and income is the service of wealth. The railroads of the country are capital; their services of transportation or the dividends from the sale of that transportation are the income they yield. Thus we have the following deﬁnitions: A stock of wealth existing at an instant of time is called capital. A ﬂow of service through a period of time is called income. Capital-Goods, Capital-Value A full view of capital would be afforded by an instantaneous photograph of wealth. This would reveal, in addition to the durable wealth, a large amount of goods of rapid consumption. It would disclose, not the annual procession of such goods, but the members of that procession that had not yet been trans muted in form or passed off the stage of existence, however swiftly they might be moving across it. Trainloads of meat, eggs and milk in transit, leather and iron in process of manu facture into ﬁnished products, the clothes in one’s wardrobe, the tobacco in a smoker’s pipe, the gasoline in a motor car, would all be elements in this ﬂash-light picture of capital. Such a collection of wealth is, however, heterogeneous; it cannot be expressed in a single sum. VVe can inventory the separate items, but we cannot add them together. They may, however, be reduced to a homogenous mass by considering, not their kinds and quantities, but their values, as has been shown in Chapter I. We have seen in Chapter I, also, that wealth may be meas 20 Money and Credit ured either by quantities (such as so many bushels of powder or so many shares or bonds of a particular description) or by value (such as so many dollar’s worth). When a given collection of capital is measured in terms of the quantities of the various goods of which it is composed, it is sometimes called capital goods; when it is measured in terms of its value, it is sometimes called capital-value. The business man ordinarily uses the term “capital” in the sense of capital-value. Capital Accounts A statement of the amount and value of the property of a speciﬁc owner at any instant of time, is a capital account. It consists of two columns —~ the assets and the liabilities. Each item in the account is an element of the owner’s total capital, the assets being positive elements and the liabilities being negative. The items in a capital account are constantly changing, and their value also. However, accountants are accustomed to keep the item “capital” intact from the beginning of their account and to denominate any increase of it as “surplus” or “undivided proﬁts.” Often the surplus also is put in round numbers and kept at the same ﬁgure for several successive reports. All the smaller ﬂuctuations have an effect simply on the latter item, “undivided proﬁts.” The distinction between surplus and undivided proﬁts is thus merely one of degree. The three items, capital, surplus, and undivided proﬁts—together make up the present net capital. Of this, “capital” represents the original amount, “surplus” the later and minor. The un divided proﬁts are likely soon to disappear in dividends, that is, to become divided proﬁts, although this may happen to the surplus, or even in certain cases to the capital itself. Function of the Capital-Balance The original capital of a concern, since it is constantly subject to change, in the course of its ﬂuctuations may sometimes shrink to zero, or below zero, as in cases of insolvency. The assets in Capital and Income cases of insolvency fall short of the liabilities. 21 The capital balance is intended to prevent this very calamity; that is, it is for the express purpose of guaranteeing the value of the other liabilities. These other liabilities represent, for the most part, ﬁxed blocks of property carved out, as it were, of the assets, and which the business man or company has agreed to keep intact at all hazards. The fortunes of business will naturally cause the whole volume of assets to vary in value, but all this “slack” ought properly to be taken up or given out by the capital, surplus and undivided proﬁts. Capital thus acts as a buffer to ~keep the liabilities from overtaking the assets. It is the “margin” put up by those most interested in an enterprise, as a guarantee to others who advance their capital to it. ' The amount of capital-balance necessary to make a business reasonably safe will differ with circumstances. A capital balance equal to ﬁve per cent of the liabilities may, in one kind of business, such as mortgage companies, be perfectly adequate, whereas ﬁfty per cent may be required in another. Much depends on how likely the assets are to shrink and how much; and much, likewise, on the character of the liabilities. If the assets have stability of value, less capital will be required than if they consist of speculative securities. The risk of insolvency is, then, the chance that the assets may shrink below the lia bilities. This risk is greater, the more shrinkable the assets, and the less the margin of capital-value between assets and liabilities. A Stream of Services The capital, which we have had under consideration, exists merely for the sake of income, and the ownership of the capital has no other signiﬁcance than the ownership of possible income from that capital. The division of income between different owners constitutes in reality a division of ownership of the capital which bears the income, and the individual shares con stitute what are called 'property rights. Whether the capital 22 Money and Credit brings or other return does not the ﬂowusofmoney its services. I matter; its income is All work done by human beings, all the operations of industry, all the transactions of commerce, are services, and enter into income accounts. A bird’s-eye view of this busy planet would reveal wealth — real estate, commodities, and human beings — ceaselessly at work performing services. Land, men, and implements are changing land, seed, and live stock into grain, beef, lumber and steel. Manufacturing plants are converting raw materials into ﬂour, furniture, cloth, and implements. In domestic establishments, we ﬁnd the services of cooking, warm ing, cleaning and sheltering. Agriculture, mining, transportation and commerce aresimply names that we give to the group of services performed by farm, mine, railroad, and business capital. The owners of capital in part enjoy its services direct, as in the case of a man who lives in his own house; but usually the individual owner does not utilize these services but sells them to some one else, the owner receiving a money payment instead. Whether the income consists partly of other services or beneﬁts than money receipts, all income, like all capital, may be trans lated into terms of money. And to all items of income, as to those of capital, may be applied the concepts of price and value discussed in Chapter I. Income and Outgo Income has its negative side, which is termed outgo, just as the capital account has its liabilities set over against its assets. A railroad, for example, performs a vast service of transporta tion, hauling passengers and commodities, but it requires a prodigious amount of coal supplies, and labor to keep it going. This is typical, rather than otherwise,‘ of the operation of capital in producing services; an instrument very seldom yields services without involving some disservices or costs. When disservices exist they are usually over-balanced, in the estimation of the owner, by prospective services. Should the opposite be the case, the article would be considered “more trouble than it is Capital and Income 23 worth” and, ceasing thereby to be wealth in the estimation of its owner, would be cast aside. The value of any individual service or disservice constitutes an element of income or outgo. The value of all the services ﬂowing from an article of wealth through any period, that is, the sum of all the elements of income, is called its gross income. The excess of the gross income over the outgo, in other words, the algebraic or net sum of all elements of income and outgo, is the net income. If, instead of an excess, there is a deﬁciency, it is called net outgo, or net loss. Net income is of far more importance, both in practice and in theory, than gross income. Gross income may often be measured in more than one way, according as the elements of which it is composed are considered with or without accom panying offsets; but the sum called net income will be the same in either case. \Vere we to construct an income account and enter there the respective services and disservices, those instruments which rendered the services would be credited with the value of such services; while the instruments which received the services, and are thus improved in position on condition, are said to have rendered a disservice and are at the same time debited with exactly the same item. When we thus come to put together the entire total of income, all such pairs of items or “inter actions” cancel. These double-faced events or interactions con stitute the overwhelming mass of items in the actual inventory of income which enter into the accounts of business men. Out of this fact, combined with the fact that every “transaction” is also double-faced, grows the entire theory of double-entry bookkeeping. This leads us to the important conclusion, very commonly overlooked, that most of what is termed “cost of production” is, in the last analysis, not cost at all. It costs ﬂour to produce bread; but all that the ﬂour costs to the baker is income to the miller. The same is true of wages. The employer counts his pay roll on cost of production, but the laborer counts it as earnings. Viewed from the standpoint of society as a 24 Money and Credit whole, these items are neither costs nor beneﬁts but mere interactions. The “cost of production,’ as the term commonly is used, refers only to money payments. These payments usually from person to person, are interactions, or items which balance and thus, in the ﬁnal total, wipe themselves off the slate. Psychic Income The only ultimate item of cost, we conclude from the fore going, is the labor cost, or, if the term “labor” be not itself sufﬁciently broad, labor, anxiety, trouble, annoyance, and all the other subjective experiences of an undesirable nature which are necessary in order that the experiences of an agreeable nature may be secured. Income, in the last analysis, consists of satisfactions and outgo of efforts to secure satisfactions. Between efforts and satisfactions intervene as a rule in our com plicated civilization innumerable interactions, the machinery connecting these efforts and satisfactions. Out of the entire mass of instruments, or forms of capital, thus acting and reacting upon each other, there ﬁnally emerges an uncanceled or net income which does not represent a mere transfer from one category to another within the mass, but an actual contribution issuing from the mass to the beneﬁt of man, the owner. These ﬁnal elements are his real income. In the last analysis they consist purely of subjective or psychic satis factions, that is, of conscious desirable experiences. CHAPTER IV INTEREST RATES Connection Between Capital and Income Capital and income, we have seen, are strictly correlative; all capital yields income and all income ﬂows from capital———at least when the term “capital” is used in its broader sense, which includes human beings. The nature of the connection existing between them, however, needs examination: what is the bridge over which we can pass from capital to income or from income to capital? The bridge, or link, between capital and income is the rate of interest. This rate of interest is the ratio of the value of income to the value of capital. Thereby the relations between capital and income are expressed in terms of money value. The rate of interest, according to the views current among business men, is the “price of capital” or the “price of ready money.” We may also deﬁne it as the premium on goods in hand at one date in terms of goods of the same kind to be in hand one year later. Present and future goods seldom exchange at par. Today’s ready money will always buy the right to more than its full value of next year’s money. The rate of interest enables us to translate, as it were, present money-value into its equivalent future money-value, or future money-value into its equivalent present money-value. Thus it serves to link values at any two points of time, enabling us in this way to compare values at different dates. Interest Periods The saying that the rate of interest is “the price of money” or “the price of capital” is based upon the thought that any capital sum is the equivalent of some annuity. “Five per cent” 26 Money and Credit or “seven per cent” postulates a uniform and perpetual ﬂow of income at this rate. Although such an annuity does not actually exist, it is often convenient to employ it as a vehicle of thought. Suppose $10,000 today will secure a perpetual annuity of $600 per year Payable annually, the ﬁrst payment accruing one year from the day of purchase; then the rate of interest is said to be six per cent per annum payable annually; that is the rate of interest (when the interest is payable annually) is the ratio between the rate of ﬂow of a perpetual annuity and its equivalent in present capital. In practice, interest payments are at times made quarterly, semi-annually, etc.; for short-time loans, actually less than a year, “the rate of discount” often is employed; and the price of income in terms of capital gives us “the rate of capitalization” —the number of years during which there would ﬂow an amount of income equal to the capital. However, these present no new principles nor real difﬁculties; they are but variations, readily to be translated into the commonly accepted magnitude here employed; the rate of interest per annum reckoned annually and considered as a premium on the goods of one year compared with those of the year following. The Principle of Present Worth Consideration of the value-return, or the ratio of the value of income to the value of capital, leads us to the fundamental principle that the value of capital at any instant is derived from the value of the future income which that capital is expected to yield. The expected service may, of course, not be the actual service. In our ignorance of the future we ﬁx our present valuations on the basis of what we expect the future to be. The principle of present worth is of fundamental importance in all consideration of value and prices. It means that the value of any article of wealth or property is dependent alone on the future, not the past. Of course, past costs of production are not to be lost sight of, yet their real signiﬁcance lies in the insight they afford into future costs. However determined, it Interest Rates 27 is only these future costs which enter into the calculation of present value. The buyer of any article of capital values it for its expected services to him, and “at the margin” of his purchases the price he will pay is the equivalent to him of those expected services, or, in other words, their “present worth,” their “discounted value” or “capitalized value.” Professional buyers and sellers simply speculate as to the possible demand, selling for what they can get, afﬁxing whatever price they believe will, in the end, proﬁt them most, sometimes making out of the transaction more than their costs of acquisition, sometimes less. The same principle applies all the way back in the production process. The labor expended is staked (either by the laborer or his employer) in anticipation of the prices which the buyers will be willing to pay. If -these anticipated prices are not ex pected to cover the value of the labor and other 'costs plus the interest upon them, the result will be that the labor and other costs will not be expended. Hence by trial and error the labor . and other costs will, under normal conditions, gradually be ﬁtted to the prices. VVhen prices ﬁnd this normal level at which costs plus interest are covered, it is not because the past costs of production have determined prices in advance, but because the sellers have been good speculators as to what prices would be. If they had foreseen that prices would not cover costs and interest on costs, they would have refrained from production entirely, while if they had foreseen the opposite condition, that of large proﬁts, competition would have tended to reduce these proﬁts to the usual dimensions. We see, then, that although prices bear a normal relation to past costs, this relation does not always hold true; and that, whether it holds true or not, the costs do not predetermine the prices except in the sense that the producers have skillfully adapted the stocks available now, and those to be available at succeeding points of time, to the expected demand for them. 28 Money and Cre -, \ Interest Rates, High or Low The rate of interest in any community, we concluh§\ from the foregoing considerations, is an index of the preference, . that community, for a dollar of present over a dollar of futu 1” income. What are the deeper economic courses which, through their inﬂuence upon this preference, operate in determining whether interest rates themselves shall be high or low? The incomes which ﬂow from the use of capital goods are more or less varied in nature, with the consequence that each individual possesses with respect to them a certain range of choice. This range of choice, which actually may be narrow or extremely wide, depends principally upon the amount and character of the capital-property which the individual possesses. It follows that, for society as a whole, the range of choice of incomes will depend upon, ﬁrst, the existing capital of the country, that is, its “resources” or the amount and character of the different capital-goods existing within it at the instant of time considered; and, secondly, the distribution of ownership of these capital-goods throughout the community. In short, the available range of choice depends upon capital and its dis tribution. A wide range of choice causes the rate of interest to tend to be steady. When the range of choice is narrow, the rate of interest will be comparatively variable. A range of choice relatively rich in the remote future income as compared with the more immediate income, brings about a high interest rate. Thus the United States in its abundant undeveloped resources has favored a remote future income, which chieﬂy explains the fact of its high interest rates. Should the range of choice tend to favor immediate income as compared with remote future income, however, the rate of interest will be low. The range of choice in any community is subject to many changes as time goes on. The progressive decrease of natural resources tends to make the income-stream decrease, which in turn tends to keep the rate of interest low. The discovery of new resources or means of developing old resources with ' ‘~'~<~ Interest Rates 29 increased effectiveness, tends to make richer the income-stream of the remote future, with a corresponding tendency to increase the rate of interest. The character of the income-stream is subject to variation in another respect, which operates strongly in all attempts to measure the preference of present income over future income and hence to determine the rate of interest. This is the element of risk. In general, risks tend to raise the degree of impatience and hence tend to increase the rate of interest with respect to a given period in comparison with other and lower risk periods. Individual Traits and Differences Though the rate of preference for immediate as compared with remote income depends upon the character of the income stream selected, as we have seen, the manner of this dependence is subject to great variation and change. The manner in which a spendthrift reacts to an income-stream is very different from the manner in which the shrewd accumulator of capital will react to the same income-stream. Much is due, in short, to a difference in personal characteristics. There are ﬁve traits which in this connection exercise deci sive importance: 1. Foresight and self-control. I 2. Love of offspring or regard for posterity. 3. Prospective length and certainty of life. 4. Habit. 5. Fashion. It is evident that each of these traits, or personal character istics, is subject to change. The causes most likely to effect such changes are, ﬁrst, education and training in thrift, whether accomplished through the home, the school, charitable organi zations, or banks for small savings, building and loan associa tions, and other similar institutions calculated to have an educational inﬂuence; second, the tendency toward or away I from a spirit of extravagance and ostentation through social 30 Money and Credit rivalry; third, the changes in the character of the institutions of marriage and the family which, in one direction or the other, will profoundly affect the love of offspring and regard for the welfare of posterity; fourth, the development of the science of hygiene, which may tend to make human life longer and more certain; ﬁfth, the causes which tend to make the distribution of wealth either more concentrated or diffused, and also those which tend to make the existing economic stratiﬁcation of classes ﬁxed and stereotyped or elastic and variable. These various factors will act and react upon each other, and will affect profoundly the rate of preference for present over future income and thereby inﬂuence greatly the rate of interest. The foregoing enumeration renders clear the fact that the rate of interest depends upon very unstable inﬂuences, many of Which have their origin deep down in the social fabric and in volve considerations not strictly economic. Any causes tending to affect intelligence, foresight, self-control, habits, the longevity of men, and family affection will have their inﬂuence upon the rate of interest. For the rate of interest is not a phenomenon restrictedto money markets but is omnipresent in economic and social relations. It is the link, which binds man to the future and by which he makes all his far-reaching decisions. Real and Nominal Variations The foregoing deals with the deeper economic and social causes which operate in determining the rate of interest. These causes explain what may be termed the real variations in interest rates. But there is also a nominal variation in the rate of interest, due to the fact that interest is not only the price of money but it is the price in money. This latter element, the fact that it is the price in money, renders the interest rate subject to those important inﬂuences involved in the changing purchasing power of money over other goods. The nature, and practical applications, of these inﬂuences will now be examined. CHAPTER V MONEY’S PURCHASING POVVER Recent Price Movements Prices, beginning with 1896 or 1897, have moved upward, accompanied by world-wide complaint over the “high cost of living.” This upward movement has been in sharp contrast with the downward movement occurring in the period between 1873 and 1896. The upward movement during the past decade, however, has occurred in every country for which statistics are available, in all gold-standard countries. While statistics do not agree in all respects as to the extent of this movement, they ' do all agree as to its direction. The price movement under consideration refers to the average of many commodities, and the rise shown by it does not, of course, hold true with respect to every commodity. Some prices have not risen but have actually fallen. Others have risen much more than the average. The prices of se curities have also moved, some up and some down. Bonds, both public and private, have fallen. Good stocks, in general, have risen. We must not make the mistake of looking at the prices of particular commodities when our question is one of the general price level. The events connected with the World War have emphasized in a most striking way the movement upward of prices already under way. Prices mounted skyward the world over, until few subjects received more discussion in the newspapers nor have been brought home more clearly to the masses. That the price level does change has now come to be almost universally recognized. Popular Explanations The reasons for this changing price level are accounted for in various ways; all of the following having been brought forward 32 Money and Credit at one time or another: the tariff, the trusts, the labor unions, shortened hours of labor, the middleman, cold storage, longer hauls on railroads, marketing by telephone, the free delivery system, the individual package, the enforcement of sanitary laws, advertising, unscientiﬁc management, extravagance, con centration of population in cities, poor rural conditions, arma ments, and wars. The tariff — to take up for brief consideration some of these alleged causes, does obviously tend to keep certain individual prices high, but whether or not it increases the general price level is not so obvious. Such reasoning from individual to general prices is usually fallacious. The American tariff cer tainly 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 tariﬂs. Similarly have prices risen in countries with and in countries without trusts. In addition, trust-made goods have apparently risen in price less than goods in general. Extravagance or Luxury Extravagance or luxury is another item which has not been conﬁned to the period under discussion; prices fell in former times while luxury existed, just as truly as prices have risen in recent years. The increase in extravagance and luxury during the last twenty or thirty years — so far 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 today than formerly, and partly to the fact that the rise of prices itself has shifted wealth into the hands of an easy spending class. People spend more today on automobiles, electric lights, bath tubs, etc., because these modern conveniences have only recently been perfected and been made generally available. And with respect to the second reason for increased extravagance, 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 Money’s Purchasing Power 33 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 specu lator, 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 the cost of high living are reversing cause and effect. ‘ ‘Proﬁteering’ ’ 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 production. Such an explanation merely explain 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 each other and must always move in sympathy. One of these prices cannot go up very much without the other going up also, but when the baker tells 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. Such a method of explanation never strikes at the root of the matter. The rise of prices of things in general, is what is to be ex plained. 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 retailer likes to excuse himself by putting it off on the wholesaler, and the wholesaler in turn explains that he is charged more by the jobber. The jobber in turn accuses the manufacturer, and the manufacturer points to his increased wage bill; but this does not give us any ﬁnal result. The wage-earner tells us that he has to get higher wages be cause of the higher retail prices which he has to pay. So this effort to explain the high cost of living merely comes round ' 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, 34 Money and Credit each labelled and each pointing an accusing ﬁnger at his neighbor around the circle from retailer to wholesaler, jobber, producer, wage-earner, and retailer again. Changing Price Levels Historically Considered Were we to view not merely recent events but survey a century and more of price movements, the inadequacy of all the foregoing popular explanations will become more apparent. Between 1789 and 1809 prices doubled in England; between 1809 and 1849 they fell all the way back, and more; between 1849 and 1873 they rose 50%. Between 1873 and 1896, in gold standard countries prices fell, while in silver standard countries prices rose. Between 1896 and 1914 prices in the United States and Canada rose 50%, and in the United Kingdom 35%. During the war, prices in the United States rose seven or eight times as rapidly as in the last-named period. In Europe the rise was even faster—fastest of all in Russia. Prices doubled in the United States and England, trebled in western Europe, and increased a hundred fold in Russia. The purchasing power of a dollar in 1920 was about that of 35 cents in 1896. Detailed examination of these price movements (which cannot be presented here in view of the limits of space) shows that the foregoing theories in explanation of the high cost of living are none of them in agreement with the facts. Money’s Changing Purchasing Power The true cause of changes in the level of prices, and of the present high prices, lies in the mechanism by which the scale of money prices is determined. This mechanism has been brieﬂy referred to in Chapter I and II. The principles determining the general scale of prices, even though few people realize the fact, are quite distinct from the principles determining the in dividual prices themselves. The money price of any commodity, to cite another fact commonly overlooked, has to do not only Money’s Purchasing Power 35 with that commodity but also with money, and therefore a monetary element enters into every price. A dollar consists of 25.8 grains of gold. But these 25.8 grains of gold in their power to exchange for other goods vary from time to time. Five Factors Regulating Purchasing Power What particular factors, we may now go a step further and ask, regulate the purchasing power of money, or its reciprocal, the level of prices? There are ﬁve deﬁnite factors: 1. Volume of money in circulation. 2. Velocity of circulation. 3. Volume of bank deposits subject to check. 4. Velocity of its circulation. 5. 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. The facts of history, so far as we have evidence, agree with the foregoing conclusions. 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 monetary standard; have moved differently among countries having different monetary standards (gold, silver, paper); and, when we have statistics for all the causes affecting price levels, have changed from year to year by almost exactly the amounts to be expected from the conclusion above stated. Standardizing the Dollar The world for a hundred years has been suffering from periodic changes in the scale of prices, affecting and producing alternate expansive and depressions of trade. These evils of a 36 Money and Credit variable monetary standard, it is not too much to say, are among the most serious. economic evils with which civilization has to deal. With conditions as they are, we all take our chances as to what the future dollar will buy. Are there .not means, however, whereby the purchasing power of a dollar can be made stable, so that a dollar may be a dollar—the same in value at one time as another? The chapter which follows deals with this problem. CHAPTER VI CONTROLLING THE PRICE LEVEL Increased Knowledge The course of prices, like the course of true love, never runs smoothly. 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. Should prices during the next ten years 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-ﬁve years ago. The real evils of changing price levels, viewing the matter now from the standpoint of business men and investors, do not lie in these changes per se, but in the fact that they usually take us unawares. The present monetary system, in fact, makes every one interested in long-time contracts, whether debtor or creditor, stockholder or bondholder, wage-earner or savings bank depositor, to some extent a partaker of chances in that future dollars will buy less, or more, than present dollars. In a sense every one of us who uses gold as a standard for deferred payments becomes a speculator in gold. Increased knowledge represents one method for dealing more effectively with these risks, and thus mitigating the evils with respect to prospective price levels. To be forewarned is to be forearmed, and a foreknown change in price levels may be so taken into account as to neutralize its evils. While we cannot expect our knowledge of the future ever to become so perfect as to reach the ideal in which compensations for every price ﬂuctuation are made by corresponding adjustments in the rate of interest, nevertheless every increase in our knowledge carries us a little nearer this.ideal. 38 Money and Credit Outlook for Increased Knowledge Fortunately, the increase of knowledge here under consider ation is now rapidly going on. The editors of trade journals today scan the economic horizon as weather predictors scan the physical horizon; and every indication of a change in the economic weather is noted and commented upon. The situation with respect to ﬁnance has been well described by Messrs. Holt and Williams in their Text on “Market In formation.” They have shown how wide, sensitive, rapid, and accurate the news'gathering mechanism is; and how these data are used in the making of forecasts. It is with respect to the latter point, the fundamental opera tions under which forecasts are made, that there exists the greatest need of a wider diffusion of knowledge. The range of the ordinary business man’s theoretical knowledge is extremely narrow. He is even apt to be suspicious of such’ knowledge, if not to hold it in contempt. The consequences of this narrow ness are often disastrous. Every day the business man is hampered by a lack of understanding of the principles regulating the purchasing power of money; and in proportion as he fails to understand these principles he is apt to fail in predictions. The prejudice of business men against the-variability of, and especially against a rise of the rate of interest, probably stands in the way of prompt adjustment in that rate and helps to aggravate the far more harmful variability in the level of prices and its reciprocal, the purchasing power of money. The busi ness man has, in fact, never regarded it as a part of the prepara tion for his work to understand the broad principles affecting money and interest. He has rather assumed that his province was conﬁned to accumulating a technical acquaintance with the nature of the goods he handles. The sugar merchant in forms himself as to sugar, the grain merchant as to grain, the real estate trader as to real estate. It scarcely occurs to any of them that knowledge as to money is needed; yet every bargain into which he enters depends for one of its two terms on money. I cannot but believe that the diffusion among business men of Controlling the Price Level 39 the fuller knowledge of the equation of exchange, of the relation of money to deposits, of credit cycles and of interest, which the future is sure to bring, will pay rich returns in mitigating the evils of crises and depressions which now take them so often unawares. Lessening the Price Changes While there is much to be hoped for from a greater foreknowl edge of price changes, a lessening of the price changes themselves would be still more desirable. Various measures to effect such result have been proposed, of which we shall consider here brieﬂy those more particularly applicable to secular price changes — those due chieﬂy to changes in money and in trade. There has been for centuries, and promises to be for cen turies to come, a race between money and trade. On the results of that race depends to some extent the fate of every business man. The commercial world has become more and more committed to the gold standard through a series of historical events having little if any connection with the ﬁtness of that or any other metal to serve as a stable standard. So far as the question of mone tary stability is concerned, it is not too much to say that we have hit upon the gold standard by accident just as we hit on the present railroad gauge by accident of previous custom as to road carriages, and just as we hit upon the decimal notation by the accident of having ten ﬁngers, and quite without reference to the question of numerical convenience in which other systems of numeration would be superior. Now that we have adopted a gold standard, it is almost as difﬁcult to substitute another as it would be to change the gauge of railroads or to adopt the duodecimal system of numeration. And the fact that the question of a monetary standard is today so much an inter national question makes it all the more difﬁcult. Government Regulation of Money Supply It is true, and at ﬁrst thought appears perhaps an easy solution to our problem, that the level of prices might be kept 40 Money and Credit almost absolutely stable merely by honest government regu lation of the money supply with that speciﬁc purpose in view. One seemingly simple way by which this might be attempted would be by the issue of inconvertible paper money in quantities so proportioned to increase of buiness that the total amount of currency in circulation, multiplied by its rapidity, would have the same relation to the total business at one time or at any other time. If the conﬁdence of citizens were preserved, and this relation were kept, the problem would need no further solution. But sad experience teaches that irredeemable paper money, while theoretically capable of steadying prices, is apt in practice to be so manipulated as to produce instability. In nearly every country there exists a party, consisting of debtors and debtor-like classes, which favors depreciation. A movement is possible therefore at any time, tending to pervert any scheme for maintaining stability into a scheme for simple inﬂation. As soon as any particular government controls a paper currency bearing no relation to gold or silver, excuses for its over-issue are to be found. The history of our own country in this respect is not reassuring. It is natural, therefore, that such schemes should be in bad odor. A Proposed Method The most practical method for dealing with our problem of controlling the price level does not appear to lie in the direction of inconvertible paper nor bimetalism nor kindred schemes; but rather, in taking the present gold standard as a working basis, and modifying, and improving the manner of its operation. Working along this line, the author has evolved a plan, the essentials of which will now be outlined. CHAPTER VII A STABILIZED DOLLAR The Plan Brieﬂy Stated The remedy which is here proposed for price ﬂuctuations consists in the “standardization” of the dollar. That there are other remedies is not overlooked, nor is the claim made that the remedy proposed constitutes a panacea for all the ills asso ciated with the “high cost of living.” The plan does not take the place of economics of production, neither does it concern itself with incomes and earning power. It aims merely to establish a more stable unit in which to measure all these things, to convert our dollar into a ﬁxed yardstick of purchasing power. Brieﬂy stated, the plan is to introduce the multiple stand ard, in which the unit is a “composition” or “composite package” of many staple commodities, not of course by using such a package in any physical way but by employing instead its gold bullion equivalent. In essence it would simply vary the weight of gold in the dollar or rather behind the dollar. The aim is to compensate for losses in the purchasing power of each grain of gold by adding the necessary number of grains of gold to the dollar. Both on the basis of theory and of facts, we may accept as sound the principle that the lighter the gold dollar the less its purchasing power and the more magniﬁed the scale of prices; and that the heavier the dollar the greater its purchasing power and the more contracted the scale of prices. Evidently if we can ﬁnd some way to increase the weight of the dollar just fast enough to compensate for the loss in the purchasing power of each grain of gold, we shall have a fully “compensated dollar” that is, a dollar which has constantly restored to it any pur chasing power it may lose by gold depreciation. 42 Money and Credit VVe now have a dollar of ﬁxed weight (25.8 grains), but varying purchasing power. Under the plan proposed, we should have a dollar of ﬁxed purchasing power, but varying weight. Two Vital Questions But how is it possible to have a dollar of varying weight without the annoyance of a constant recoinage of gold coin? Moreover, if this can be done, how can we know at any time what weight the dollar ought to have without leaving this to the tender mercies of some political official? Here are two vital questions. As a preparation for answering these questions, it will be a little easier to explain the principle of the proposal if we assume that there are no actual gold coins in circulation, but only gold certiﬁcates. This supposition is, in fact, not very far from the truth in the United States; for, outside of California, there is very little actual gold coin in circulation. We have instead nearly a billion dollars of gold certiﬁcates in circulation, repre senting gold in the Treasury of the United States. We are supposing that gold circulates in no other way. Under these circumstances it is evident that the ultimate gold dollar is out of sight in the Treasury of the United States in bars of gold bullion. Every 25.8 grains of this gold bullion is a virtual dollar behind a dollar of gold certiﬁcates outstanding. A gold bar (of standard bullion) weighing 25,800 grains virtually contains 1000 gold dollars. ‘ The gold miner takes such bars of standard gold to the mint and deposits them withoutwaiting for their coinage, receiving gold certiﬁcates in return, one dollar of gold certiﬁcates for each 25.8 grains of standard gold which he deposits. On the other hand, holders of gold certiﬁcates may at any time receive gold bullion in return,'when they desire this for export or for use in the arts of jewelry, dentistry, gilding, etc., receiv ing 25.8 grains for each dollar of gold certiﬁcates. Thus the government on demand gives or takes money at the rate of 25.8 A Stabilized Dollar 43 grains of bullion per dollar; the virtual, though invisible, dollar being this 25.8 grains of gold bullion, nine-tenths ﬁne. Changing the Dollar’s Weight The proposal here made is to adjust and readjust the weight of the dollar. this. If there are no gold coins, it is very easy to do For example, if there should be a decrease of 1% in the value, or purchasing power of gold, then the weight of gold bullion which constitutes the virtual dollar would be declared 1% greater, becoming 26.058 grains instead of 25.8. If there should be an increase in the purchasing power of gold, the weight of the virtual dollar would be reduced accordingly. Whenever the gold miner took gold to the mint, he would receive a gold certiﬁcate not necessarily at the rate of one dollar for each 25.8 grains of standard gold, but for a larger or smaller amount as the case might be, the amount always being that amount which would possess the same purchasing power. Similarly the holder ' of gold certiﬁcates who wishes them redeemed in bullion for export or for the arts, would not always get exactly 25.8 grains for each dollar or certiﬁcate, but a larger or smaller sum as the case might be. Then the government would be receiving gold from the miner and giving it out to the jeweler just as at present, but in varying weights per dollar, instead of at the arbitrarily ﬁxed weight of 25.8 grains. The weight of gold per dollar in which, at any particular time, gold certiﬁcates were redeemable would constitute the virtual and only gold dollar. Under these circumstances it is clear that it would be entirely feasible to change up and down the weight of the gold dollar (that is, the amount of gold bullion interconvertible with a dollar of gold certiﬁcates) and without any recoinage or other interference with the outward appearance of the currency in our pockets. VVe should familiarize ourselves with another way of stating all this. Instead of saying that the government receives gold bullion at the mint and uses this for redeeming gold certiﬁcates, we may, if we prefer, say that the government buys and sells gold. It buys gold from the miner, paying for it in gold certiﬁ cates; it sells gold to the jeweler, who redeems these certiﬁcates. 44 Money and Credit At present, the price at which gold is bought and sold by the government is $18.60 an ounce (for standard gold nine-tenths ﬁne). This is easily ﬁgured out from the weight of the gold dollar; for 25.8 grains of gold being our present dollar, each ounce (or 480 grains) of gold bullion contains 480-:—25.8 or 18.60 virtual dollars. To say, then, that we now have a fixed weight in our gold dollar, 25.8 grains, is the same thing as to say that we have a ﬁxed government price for gold, $18.60 per ounce. To raise the weight of the gold dollar 1%, or from 25.8 grains to 26.058 grains, is the same thing as to lower the government price of gold from $18.60 to $18.42 per ounce. Making Proper Adjustments We come now to the second question: How would it be possible to know the proper adjustments to be made in the . weight of the virtual dollar—the gold bullion interconvertible with each dollar of gold certiﬁcates — without putting a danger ous power of discretion in the hands of government ofﬁcials? In other words, how can the adjustment in the weight of the virtual dollar be made automatic? The answer is: By means of statistics called “index numbers of prices.” Such statistics are today published by the London Economist, the United States Bureau of Labor, the Canadian Department of Labor, and several commercial agencies, such as Bradstreet. The index number of the Bureau of Labor is based on the wholesale prices of 257 commodities, and shows from year to year the extent to which prices on the whole advance or fall —— the average movement of all the 257 prices. There are various systems of index numbers, but they practically all agree remarkably well with each other. When once a system of index numbers is decided upon, their numerical calculation becomes a purely clerical matter. A statistical bureau (as for instance the present Bureau of Labor or an international statistical ofﬁce) would compile and publish these statistics periodically and the actual prices on which they were based. If, at any time, the ofﬁcial index number showed that the price A Stabilized Dollar 45 bond had risen 1% above par, this would be the signal for an increase of 1% in the virtual dollar. Summary The plan, then is: First, to provide for the calculation of an ofﬁcial index number of prices; second, to adjust correspondingly the ofﬁcial weight of the virtual dollar at which the government shall issue gold certiﬁcates to mines or redeem them for jewelers, in other words, to adjust the ofﬁcial prices of gold at which the government stands ready to buy or sell at the option of the public.* It is a plan virtually to mark up or down the weight of the dollar (that is, to mark down or up the price of gold bullion) in exact proportion to the deviation above or below par of the index number of prices. Why Not Standardize the Dollar? We have standardized every other unit in commerce except the most important and universal unit of all, the unit of pur chasing power. What business man would consent for a mo ment to make a contract in terms of yards of cloth or tons of coal, and leave the size of the yard or the ton to chance? Once the yard was the girth of a man. In order to make it constant, we have standardized it. We have standardized even our new units of electricity, the ohm, the kilowatt, the ampere, and the volt. But the dollar is still left to the chances of gold mining and banking systems. At ﬁrst we could not standardize units of electricity because we had no adequate instruments for measuring those elusive magnitudes. But as soon as such measuring devices were invented, these units were standardized. We have hitherto had a similar excuse for not standardizing the dollar as a unit of purchasing power, and so a standard for deferred payments; we have had no instrument for measuring *Various details essential to the working of the plan and numerous supposed objections to the plan and of the exact way in which it would work. merit consideration at this place did space permit. The reader. consequently. will be cited to the author's work on “Stabiliz ing the Dollar,” for treatment of these points, as well as a more detailed explanation of the plan itself. 46 Money and Credit it or device for putting the results in practice. With the develop ment of index numbers, however, and the device of adjusting the seigniorage according to those index numbers, we now have at hand all the materials for scientiﬁcally standardizing the dollar and for realizing the long-coveted ideal of a “multiple standard” of value. In this way it is within the power of society, when it chooses, to create a standard monetary yardstick, a stable dollar. TEST QUESTIONS “MONEY AND CREDIT” The Test Questions which are unstarred can be answered directly from the Text discussion. You will ﬁnd them helpful for purposes of review. The questions which are starred call for original thought, the ability to apply the knowledge gained from the Text to the solution of new problems. ANSWERS TO THESE STARRED QUESTIONS ARE ENCLOSED OQIQH . What is credit? . What is the relation between money and wealth? VVhat effect upon prices does a material increase in the amount of money have? Why? *4. VVhat has been the effect of the emission‘of quantities of paper money in Europe? Does the abandonment of the gold standard, per se, affect the actual wealth situation of these countries, considered purely from an internal point of view? *5. Why should the credit of the United States be high, while that of France is low? 4 Does the item of loans on a bank balance sheet go on the asset or liability column? Why? . What is the relation of actual gold (or gold equivalents such as gold notes) in deposit in the treasury of a bank to the amount of business the bank does? . Which is more important to consider—gross or net income ? *9. Why have we recently been through a period of high interest rates? 10. What is capital-balance? What is its function? ANSWERS TO STARRED QUESTIONS “MONEY AND CREDIT” *4. Money is a medium of exchange; therefore, an increase in the amount of this medium in circulation necessarily means that the exchange relation must be readjusted. If you have two men, one with a bushel of wheat and the other with one dollar on a desert island — where the situation could be tested out purely — the price of the wheat would be one dollar. But if the purchaser had two dollars, and the seller still had one bushel only, assuming, of course,_ that the purchaser wanted the wheat and the seller wanted to sell, the price would be two dollars. This is what has gone on throughout the world, but particularly in Europe. The difﬁculty in Europe is that the quantity of paper money is so great. In our civilization, gold has come to be accepted as a standard of value. Its abandonment at present iri Europe does not in itself mean much, but the fact that the paper which has been put out is so great in quantity as to pile up obligations and so to lessen its value as credit instruments is what is serious. *5. This has been answered to some extent by Question 4. The debt, interest requirements and circulation outstanding, as shown in the chapter on Government Bonds in “Investment Securities," is low as compared with the wealthof the United States. Just the reverse is true in France. *9. Money is, ﬁrst of all, a commodity, and interest rates represent the price paid for the use of this commodity. Therefore, a period of high prices generally means high interest rates. In addition, also, because of the shortage in goods, due to the war, we have been in a period where uncertain future developments play a relatively more important part than present developments. money rates. This also means higher For clients who desire to go into"this subject at greater detail, we give below other books by the author devoted to a discussion of the principles treated in this text book. “THE PURCHASING POWER OF MONEY” “The prediction may be ventured that the book will become a classic 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. “THE RATE OF INTEREST” “It contains some conclusions of great value to ﬁnanciers, bankers, under writers, etc. ———knowledge that put millions of dollars into the pockets 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 understood, subject of interest rates.” Editorial in Moody's Magazine, January, 1908. “THE NATURE OF CAPITAL AND INCOME” “A great book, and analytical, logical, and philosophic in a high degree." Marcus C. Knowlton, Chief Justice of Massachusetts. “ELEMENTARY PRINCIPLES OF ECONOMICS” A survey of the principles of economics intended for use in the classroom but valuable to the general reader as well. “STABILIZING THE DOLLAR” This new work presents a complete statement of the plan worked out by Professor Fisher for combatting the rise in the cost of living by “standardizing” or stabilizing monetary units. The author shows how such a standardiza tion is a remedy for the ﬁnancial crises from which society periodically suffers. Garden City Press, Inc. Newton, Mass.