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Money and Credit

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.



Copyright. 1922. by
American Institute of Finance

Chapter I.

The Nature of Money

An Essential Characteristic
Wealth and Its Measurement

Exchange and Price



Common Fallacies .
“Making” Money_.

Chapter II.


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.


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.



Money’s Purchasing Power

Recent Price Movements .
Popular Explanations .




of Contents

Chapter V.

Money’s Purchasing Power (continued)

Extravagance or Luxury . . . . . . .
. . . . . . . . .
Changing Price Levels Historically Considered
Money’s Changing Purchasing Power . . .
Five Factors Regulating Purchasing Power
Standardizing the Dollar . . . . . . .

Chapter VI.























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 . .
. .
Why Not Standardize the Dollar?‘




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
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

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.


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


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.


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.
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.
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


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:


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
bushel per bushel


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


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


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


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
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.


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.


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.


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.


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:

Gold . . . . . . . . . . . .


Due depositor A. . .
Due depositor B. . .
Due other depositors



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


Gold . . . . . . . . . . . .



Due depositor A . . .
Due depositor B. . . .
Due other depositors



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:
Gold . . . . . . . . . . . .
Promissory notes . .



Due depositor A. . . .
Due depositor B . . . .
Due other depositors



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.


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:


Gold . . . . . . . . . . . .
Promissory notes . .




depositor A. . . .
depositor B . . . .
other depositors
new depositors,


i.e. the borrowers




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:


.. .. . . .. . . ..


Loans (Promissory
notes) . . . . . . . . . . $100,000

Due depositors


Due note holders




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

money but as credit operations.


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
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
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


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


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.

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.


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


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


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
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


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.

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
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

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


Money and Credit

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


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.
of this fact, combined with the fact that every “transaction” is
also double-faced, grows the entire theory of double-entry

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


The same is true of wages.

The employer counts his

pay roll on cost of production, but the laborer counts it as
Viewed from the standpoint of society as a


Money and Credit

whole, these items are neither costs nor benefits but mere

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.

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”


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
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


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


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”

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


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
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


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.

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


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.

Recent Price Movements
Prices, beginning with 1896 or 1897, have moved upward,
accompanied by world-wide complaint over the “high cost of
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.


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

Popular Explanations
The reasons for this changing price level are accounted for
in various ways; all of the following having been brought forward


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


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


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,


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

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


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
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


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


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.

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.


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


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
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


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
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.

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

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.


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

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


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


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.


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.


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.


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


bond had risen 1% above par, this would be the signal for an
increase of 1% in the virtual dollar.
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.


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.

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.

. 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?


*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?
Does the item of loans on a bank balance sheet go on the

asset or liability column?


. 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?

*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

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 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.

“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.

“A great book, and analytical, logical, and philosophic in a high degree."
Marcus C. Knowlton, Chief Justice of Massachusetts.

A survey of the principles of economics intended for use in the classroom
but valuable to the general reader as well.

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.