to buy or sell money. This, however, is merely an accident of language. In point of fact, money is bought and sold like other things, whenever other things are bought and sold _for_ money. Whoever sells corn, or tallow, or cotton, buys money. Whoever buys bread, or wine, or clothes, sells money to the dealer in those articles. The money with which people are offering to buy, is money offered for sale. The supply of money, then, is the quantity of it which people are wanting to lay out; that is, all the money they have in their possession, except what they are hoarding, or at least keeping by them as a reserve for future contingencies. The supply of money, in short, is all the money in _circulation_ at the time.
The demand for money, again, consists of all the goods offered for sale.
Every seller of goods is a buyer of money, and the goods he brings with him constitute his demand. The demand for money differs from the demand for other things in this, that it is limited only by the means of the purchaser.
In this last statement Mr. Mill is misled by his former definition of demand as “quantity demanded.” He has the true idea of demand in this case regarding money; but the demand for money does not, as he thinks, differ from the demand for other things, inasmuch as, in our corrected view of demand for other things (p. 255), it was found that the demand for other things than money was also limited by the means of the purchaser.(228) As the whole of the goods in the market compose the demand for money, so the whole of the money constitutes the demand for goods. The money and the goods are seeking each other for the purpose of being exchanged. They are reciprocally supply and demand to one another. It is indifferent whether, in characterizing the phenomena, we speak of the demand and supply of goods, or the supply and the demand of money. They are equivalent expressions.
Supposing the money in the hands of individuals to be increased, the wants and inclinations of the community collectively in respect to consumption remaining exactly the same, the increase of demand would reach all things equally, and there would be a universal rise of prices. Let us rather suppose, therefore, that to every pound, or shilling, or penny in the possession of any one, another pound, shilling, or penny were suddenly added. There would be an increased money demand, and consequently an increased money value, or price, for things of all sorts. This increased value would do no good to any one; would make no difference, except that of having to reckon [dollars and cents] in higher numbers. It would be an increase of values only as estimated in money, a thing only wanted to buy other things with; and would not enable any one to buy more of them than before. Prices would have risen in a certain ratio, and the value of money would have fallen in the same ratio.
It is to be remarked that this ratio would be precisely that in which the quantity of money had been increased. If the whole money in circulation was doubled, prices would be doubled. If it was only increased one fourth, prices would rise one fourth. There would be one fourth more money, all of which would be used to purchase goods of some description. When there had been time for the increased supply of money to reach all markets, or (according to the conventional metaphor) to permeate all the channels of circulation, all prices would have risen one fourth. But the general rise of price is independent of this diffusing and equalizing process. Even if some prices were raised more, and others less, the average rise would be one fourth. This is a necessary consequence of the fact that a fourth more money would have been given for only the same quantity of goods. _General_ prices, therefore, would in any case be a fourth higher.
So that the value of money, other things being the same, varies inversely as its quantity; every increase of quantity lowering the value, and every diminution raising it, in a ratio exactly equivalent. This, it must be observed, is a property peculiar to money. We did not find it to be true of commodities generally, that every diminution of supply raised the value exactly in proportion to the deficiency, or that every increase lowered it in the precise ratio of the excess. Some things are usually affected in a greater ratio than that of the excess or deficiency, others usually in a less; because, in ordinary cases of demand, the desire, being for the thing itself, may be stronger or weaker; and the amount of what people are willing to expend on it, being in any case a limited quantity, may be affected in very unequal degrees by difficulty or facility of attainment.
But in the case of money, which is desired as the means of universal purchase, the demand consists of everything which people have to sell; and the only limit to what they are willing to give, is the limit set by their having nothing more to offer. The whole of the goods being in any case exchanged for the whole of the money which comes into the market to be laid out, they will sell for less or more of it, exactly according as less or more is brought.
§ 3. —Together with the Rapidity of Circulation.
It might be supposed that there is always in circulation in a country a quantity of money equal in value to the whole of the goods then and there on sale. But this would be a complete misapprehension. The money laid out is equal in value to the goods it purchases; but the quantity of money laid out is not the same thing with the quantity in circulation. As the money passes from hand to hand, the same piece of money is laid out many times before all the things on sale at one time are purchased and finally removed from the market; and each pound or dollar must be counted for as many pounds or dollars as the number of times it changes hands in order to effect this object.
If we assume the quantity of goods on sale, and the number of times those goods are resold, to be fixed quantities, the value of money will depend upon its quantity, together with the average number of times that each piece changes hands in the process. The whole of the goods sold (counting each resale of the same goods as so much added to the goods) have been exchanged for the whole of the money, multiplied by the number of purchases made on the average by each piece. Consequently, the amount of goods and of transactions being the same, the value of money is inversely as its quantity multiplied by what is called the rapidity of circulation.
And the quantity of money in circulation is equal to the money value of all the goods sold, divided by the number which expresses the rapidity of circulation.
This may be expressed in mathematical language, where V is the value of money, Q is the quantity in circulation, and R the number expressing the rapidity of circulation, as follows: V = 1 / (Q × R).
The phrase, rapidity of circulation, requires some comment. It must not be understood to mean the number of purchases made by each piece of money in a given time. Time is not the thing to be considered. The state of society may be such that each piece of money hardly performs more than one purchase in a year; but if this arises from the small number of transactions—from the small amount of business done, the want of activity in traffic, or because what traffic there is mostly takes place by barter—it constitutes no reason why prices should be lower, or the value of money higher. The essential point is, not how often the same money changes hands in a given time, but how often it changes hands in order to perform a given amount of traffic. We must compare the number of purchases made by the money in a given time, not with the time itself, but with the goods sold in that same time. If each piece of money changes hands on an average ten times while goods are sold to the value of a million sterling, it is evident that the money required to circulate those goods is £100,000. And, conversely, if the money in circulation is £100,000, and each piece changes hands, by the purchase of goods, ten times in a month, the sales of goods for money which take place every month must amount, on the average, to £1,000,000. [The essential point to be considered is] the average number of purchases made by each piece in order to affect a given pecuniary amount of transactions.
“There is no doubt that the rapidity of circulation varies very much between one country and another. A thrifty people with slight banking facilities, like the French, Swiss, Belgians, and Dutch, hoard coin much more than an improvident people like the English, or even a careful people, with a perfect banking system, like the Scotch. Many circumstances, too, affect the rapidity of circulation. Railways and rapid steamboats enable coin and bullion to be more swiftly remitted than of old; telegraphs prevent its needless removal, and the acceleration of the mails has a like effect.” “So different are the commercial habits of different peoples, that there evidently exists no proportion whatever between the amount of currency in a country and the aggregate of the exchanges which can be effected by it.”(229) § 4. Explanations and Limitations of this Principle.
The proposition which we have laid down respecting the dependence of general prices upon the quantity of money in circulation must be understood as applying only to a state of things in which money—that is, gold or silver—is the exclusive instrument of exchange, and actually passes from hand to hand at every purchase, credit in any of its shapes being unknown. When credit comes into play as a means of purchasing, distinct from money in hand, we shall hereafter find that the connection between prices and the amount of the circulating medium is much less direct and intimate, and that such connection as does exist no longer admits of so simple a mode of expression. That an increase of the quantity of money raises prices, and a diminution lowers them, is the most elementary proposition in the theory of currency, and without it we should have no key to any of the others. In any state of things, however, except the simple and primitive one which we have supposed, the proposition is only true, other things being the same.
It is habitually assumed that whenever there is a greater amount of money in the country, or in existence, a rise of prices must necessarily follow.
But this is by no means an inevitable consequence. In no commodity is it the quantity in existence, but the quantity offered for sale, that determines the value. Whatever may be the quantity of money in the country, only that part of it will affect prices which goes into the market of commodities, and is there actually exchanged against goods.
Whatever increases the amount of this portion of the money in the country tends to raise prices.
This statement needs modification, since the change in the amounts of specie in the bank reserves, particularly of England and the United States, determines the amount of credit and purchasing power granted, and so affects prices in that way; but prices are affected not by this specie being actually exchanged against goods.
It frequently happens that money to a considerable amount is brought into the country, is there actually invested as capital, and again flows out, without having ever once acted upon the markets of commodities, but only upon the market of securities, or, as it is commonly though improperly called, the money market.
A foreigner landing in the country with a treasure might very probably prefer to invest his fortune at interest; which we shall suppose him to do in the most obvious way by becoming a competitor for a portion of the stock, railway debentures, mercantile bills, mortgages, etc., which are at all times in the hands of the public. By doing this he would raise the prices of those different securities, or in other words would lower the rate of interest; and since this would disturb the relation previously existing between the rate of interest on capital in the country itself and that in foreign countries, it would probably induce some of those who had floating capital seeking employment to send it abroad for foreign investment, rather than buy securities at home at the advanced price. As much money might thus go out as had previously come in, while the prices of commodities would have shown no trace of its temporary presence. This is a case highly deserving of attention; and it is a fact now beginning to be recognized that the passage of the precious metals from country to country is determined much more than was formerly supposed by the state of the loan market in different countries, and much less by the state of prices.
If there be, at any time, an increase in the number of money transactions, a thing continually liable to happen from differences in the activity of speculation, and even in the time of year (since certain kinds of business are transacted only at particular seasons), an increase of the currency which is only proportional to this increase of transactions, and is of no longer duration, has no tendency to raise prices.
For example, bankers in Eastern cities each year send in the autumn to the West, as the crops are gathered, very large sums of money, to settle transactions in the buying and selling of grain, wool, etc., but it again flows back to the great centers of business in a short time, in payment of purchases from Eastern merchants.
Chapter VI. Of The Value Of Money, As Dependent On Cost Of Production.
§ 1. The value of Money, in a state of Freedom, conforms to the value of the Bullion contained in it.
But money, no more than commodities in general, has its value definitely determined by demand and supply. The ultimate regulator of its value is Cost of Production.
We are supposing, of course, that things are left to themselves.
Governments have not always left things to themselves. It was, until lately, the policy of all governments to interdict the exportation and the melting of money; while, by encouraging the exportation and impeding the importation of other things, they endeavored to have a stream of money constantly flowing in. By this course they gratified two prejudices: they drew, or thought that they drew, more money into the country, which they believed to be tantamount to more wealth; and they gave, or thought that they gave, to all producers and dealers, high prices, which, though no real advantage, people are always inclined to suppose to be one.
We are, however, to suppose a state, not of artificial regulation, but of freedom. In that state, and assuming no charge to be made for coinage, the value of money will conform to the value of the bullion of which it is made. A pound-weight of gold or silver in coin, and the same weight in an ingot, will precisely exchange for one another. On the supposition of freedom, the metal can not be worth more in the state of bullion than of coin; for as it can be melted without any loss of time, and with hardly any expense, this would of course be done until the quantity in circulation was so much diminished as to equalize its value with that of the same weight in bullion. It may be thought, however, that the coin, though it can not be of less, may be, and being a manufactured article will naturally be, of greater value than the bullion contained in it, on the same principle on which linen cloth is of more value than an equal weight of linen yarn. This would be true, were it not that Government, in this country and in some others, coins money gratis for any one who furnishes the metal. If Government, however, throws the expense of coinage, as is reasonable, upon the holder, by making a charge to cover the expense (which is done by giving back rather less in coin than has been received in bullion, and is called levying a seigniorage), the coin will rise, to the extent of the seigniorage, above the value of the bullion. If the mint kept back one per cent, to pay the expense of coinage, it would be against the interest of the holders of bullion to have it coined, until the coin was more valuable than the bullion by at least that fraction. The coin, therefore, would be kept one per cent higher in value, which could only be by keeping it one per cent less in quantity, than if its coinage were gratuitous.
In the United States there was no charge for seigniorage on gold and silver to 1853, when one half of one per cent was charged as interest on the delay if coin was immediately delivered on the deposit of bullion; in 1873 it was reduced to one fifth of one per cent; and in 1875, by a provision of the Resumption Act, it was wholly abolished (the depositor, however, paying for the copper alloy). For the trade-dollars, as was consistent with their being only coined ingots and not legal money, a seigniorage was charged equal simply to the expense of coinage, which was one and a quarter per cent at Philadelphia, and one and a half per cent at San Francisco on the tale value.
§ 2. —Which is determined by the cost of production.
The value of money, then, conforms permanently, and in a state of freedom almost immediately, to the value of the metal of which it is made; with the addition, or not, of the expenses of coinage, according as those expenses are borne by the individual or by the state.
To the majority of civilized countries gold and silver are foreign products: and the circumstances which govern the values of foreign products present some questions which we are not yet ready to examine. For the present, therefore, we must suppose the country which is the subject of our inquiries to be supplied with gold and silver by its own mines [as in the case of the United States], reserving for future consideration how far our conclusions require modification to adapt them to the more usual case.
Of the three classes into which commodities are divided—those absolutely limited in supply, those which may be had in unlimited quantity at a given cost of production, and those which may be had in unlimited quantity, but at an increasing cost of production—the precious metals, being the produce of mines, belong to the third class. Their natural value, therefore, is in the long run proportional to their cost of production in the most unfavorable existing circumstances, that is, at the worst mine which it is necessary to work in order to obtain the required supply. A pound weight of gold will, in the gold-producing countries, ultimately tend to exchange for as much of every other commodity as is produced at a cost equal to its own; meaning by its own cost the cost in labor and expense at the least productive sources of supply which the then existing demand makes it necessary to work. The average value of gold is made to conform to its natural value in the same manner as the values of other things are made to conform to their natural value. Suppose that it were selling above its natural value; that is, above the value which is an equivalent for the labor and expense of mining, and for the risks attending a branch of industry in which nine out of ten experiments have usually been failures.
A part of the mass of floating capital which is on the lookout for investment would take the direction of mining enterprise; the supply would thus be increased, and the value would fall. If, on the contrary, it were selling below its natural value, miners would not be obtaining the ordinary profit; they would slacken their works; if the depreciation was great, some of the inferior mines would perhaps stop working altogether: and a falling off in the annual supply, preventing the annual wear and tear from being completely compensated, would by degrees reduce the quantity, and restore the value.
When examined more closely, the following are the details of the process: If gold is above its natural or cost value—the coin, as we have seen, conforming in its value to the bullion—money will be of high value, and the prices of all things, labor included, will be low. These low prices will lower the expenses of all producers; but, as their returns will also be lowered, no advantage will be obtained by any producer, except the producer of gold; whose returns from his mine, not depending on price, will be the same as before, and, his expenses being less, he will obtain extra profits, and will be stimulated to increase his production. _E converso_, if the metal is below its natural value; since this is as much as to say that prices are high, and the money expenses of all producers unusually great; for this, however, all other producers will be compensated by increased money returns; the miner alone will extract from his mine no more metal than before, while his expenses will be greater: his profits, therefore, being diminished or annihilated, he will diminish his production, if not abandon his employment.
In this manner it is that the value of money is made to conform to the cost of production of the metal of which it is made. It may be well, however, to repeat (what has been said before) that the adjustment takes a long time to effect, in the case of a commodity so generally desired and at the same time so durable as the precious metals. Being so largely used, not only as money but for plate and ornament, there is at all times a very large quantity of these metals in existence: while they are so slowly worn out that a comparatively small annual production is sufficient to keep up the supply, and to make any addition to it which may be required by the increase of goods to be circulated, or by the increased demand for gold and silver articles by wealthy consumers. Even if this small annual supply were stopped entirely, it would require many years to reduce the quantity so much as to make any very material difference in prices. The quantity may be increased much more rapidly than it can be diminished; but the increase must be very great before it can make itself much felt over such a mass of the precious metals as exists in the whole commercial world. And hence the effects of all changes in the conditions of production of the precious metals are at first, and continue to be for many years, questions of quantity only, with little reference to cost of production. More especially is this the case when, as at the present time, many new sources of supply have been simultaneously opened, most of them practicable by labor alone, without any capital in advance beyond a pickaxe and a week’s food, and when the operations are as yet wholly experimental, the comparative permanent productiveness of the different sources being entirely unascertained.
For the facts in regard to the production of the precious metals, see the investigation by Dr. Adolf Soetbeer,(230) from which Chart IX has been taken. It is worthy of careful study. The figures in each period, at the top of the respective spaces, give the average annual production during those years. The last period has been added by me from figures taken from the reports of the Director of the United States Mint. Other accessible sources, for the production of the precious metals, are the tables in the appendices to the Report of the Committee to the House of Commons on the “Depreciation of Silver” (1876); the French official Procès-Verbaux of the International Monetary Conference of 1881, which give Soetbeer’s figures to a later date than his publication above mentioned; the various papers in the British parliamentary documents; and the reports of the director of our mint. Since 1850 more gold has been produced than in the whole period preceding, from 1492 to 1850. Previous to 1849 the annual average product of gold, out of the total product of both gold and silver, was thirty-six per cent; for the twenty-six years ending in 1875, it has been seventy and one half per cent. The result has been a rise in gold prices certainly down to 1862,(231) as shown by the following chart. It will be observed how much higher the prices rose during the depression after 1858 than it was during a period of similar conditions after 1848. The result, it may be said, was predicted by Chevalier.(232) Chart IX.
_Chart showing the Production of the Precious Metals, according to Value, from 1493 to 1879._ Years. Silver. Gold. Total.
Chart showing rise of average gold prices after the gold discoveries of 1849 to 1862.
The fall of prices from 1873 to 1879, owing to the commercial panic in the former year, however, is regarded, somewhat unjustly, in my opinion, as an evidence of an appreciation of gold. Mr.
Giffen’s paper in the “Statistical Journal,” vol. xlii, is the basis on which Mr. Goschen founded an argument in the “Journal of the Institute of Bankers” (London), May, 1883, and which attracted considerable attention. On the other side, see Bourne, “Statistical Journal,” vol. xlii. The claim that the value of gold has risen seems particularly hasty, especially when we consider that after the panics of 1857 and 1866 the value of money rose, for reasons not affecting gold, respectively fifteen and twenty-five per cent.
The very thing for which the precious metals are most recommended for use as the materials of money—their _durability_—is also the very thing which has, for all practical purposes, excepted them from the law of cost of production, and caused their value to depend practically upon the law of demand and supply. Their durability is the reason of the vast accumulations in existence, and this it is which makes the annual product very small in relation to the whole existing supply, and so prevents its value from conforming, except after a long term of years, to the cost of production of the annual supply.
§ 3. This law, how related to the principle laid down in the preceding chapter.
Since, however, the value of money really conforms, like that of other things, though more slowly, to its cost of production, some political economists have objected altogether to the statement that the value of money depends on its quantity combined with the rapidity of circulation, which, they think, is assuming a law for money that does not exist for any other commodity, when the truth is that it is governed by the very same laws. To this we may answer, in the first place, that the statement in question assumes no peculiar law. It is simply the law of demand and supply, which is acknowledged to be applicable to all commodities, and which, in the case of money, as of most other things, is controlled, but not set aside, by the law of cost of production, since cost of production would have no effect on value if it could have none on supply. But, secondly, there really is, in one respect, a closer connection between the value of money and its quantity than between the values of other things and their quantity. The value of other things conforms to the changes in the cost of production, without requiring, as a condition, that there should be any actual alteration of the supply: the potential alteration is sufficient; and, if there even be an actual alteration, it is but a temporary one, except in so far as the altered value may make a difference in the demand, and so require an increase or diminution of supply, as a consequence, not a cause, of the alteration in value. Now, this is also true of gold and silver, considered as articles of expenditure for ornament and luxury; but it is not true of money. If the permanent cost of production of gold were reduced one fourth, it might happen that there would not be more of it bought for plate, gilding, or jewelry, than before; and if so, though the value would fall, the quantity extracted from the mines for these purposes would be no greater than previously. Not so with the portion used as money: that portion could not fall in value one fourth unless actually increased one fourth; for, at prices one fourth higher, one fourth more money would be required to make the accustomed purchases; and, if this were not forthcoming, some of the commodities would be without purchasers, and prices could not be kept up. Alterations, therefore, in the cost of production of the precious metals do not act upon the value of money except just in proportion as they increase or diminish its quantity; which can not be said of any other commodity. It would, therefore, I conceive, be an error, both scientifically and practically, to discard the proposition which asserts a connection between the value of money and its quantity.
There are cases, however, in which the _potential_ change of the precious metals affects their value as money in the same way that it affects the value of other things. Such a case was the change in the value of silver in 1876. The usual causes assigned for that serious fall in value were the greatly increased production from the mines of Nevada; the demonetization of silver by Germany; and the decreased demand for export to India. It is true that the exports of silver from England to India fell off from about $32,000,000 in 1871-1872 to about $23,000,000 in 1874-1875; but none of the increased Nevada silver was exported from the United States to London, nor had Germany put more than $30,000,000 of her silver on the market;(233) and yet the price of silver so fell that the depreciation amounted to 20-¼ per cent as compared with the average price between 1867 and 1872. The change in value, however, took place without any corresponding change in the actual quantity in circulation. The relation between prices and the quantities of the precious metals is, therefore, not so exact, certainly as regards silver, as Mr. Mill would have us believe; and thus their values conform more nearly to the general law of Demand and Supply in the same way that it affects things other than money.
It is evident, however, that the cost of production, in the long run, regulates the quantity; and that every country (temporary fluctuation excepted) will possess, and have in circulation, just that quantity of money which will perform all the exchanges required of it, consistently with maintaining a value conformable to its cost of production. The prices of things will, on the average, be such that money will exchange for its own cost in all other goods: and, precisely because the quantity can not be prevented from affecting the value, the quantity itself will (by a sort of self-acting machinery) be kept at the amount consistent with that standard of prices—at the amount necessary for performing, at those prices, all the business required of it.
Chapter VII. Of A Double Standard And Subsidiary Coins.
§ 1. Objections to a Double Standard.
Though the qualities necessary to fit any commodity for being used as money are rarely united in any considerable perfection, there are two commodities which possess them in an eminent and nearly an equal degree—the two precious metals, as they are called—gold and silver. Some nations have accordingly attempted to compose their circulating medium of these two metals indiscriminately.
There is an obvious convenience in making use of the more costly metal for larger payments, and the cheaper one for smaller; and the only question relates to the mode in which this can best be done. The mode most frequently adopted has been to establish between the two metals a fixed proportion [to decide by law, for example, that sixteen grains of silver should be equivalent to one grain of gold]; and it being left free to every one who has a [dollar] to pay, either to pay it in the one metal or in the other.
If [their] natural or cost values always continued to bear the same ratio to one another, the arrangement would be unobjectionable. This, however, is far from being the fact. Gold and silver, though the least variable in value of all commodities, are not invariable, and do not always vary simultaneously. Silver, for example, was lowered in permanent value more than gold by the discovery of the American mines; and those small variations of value which take place occasionally do not affect both metals alike. Suppose such a variation to take place—the value of the two metals relatively to one another no longer agreeing with their rated proportion—one or other of them will now be rated below its bullion value, and there will be a profit to be made by melting it.
Suppose, for example, that gold rises in value relatively to silver, so that the quantity of gold in a sovereign is now worth more than the quantity of silver in twenty shillings. Two consequences will ensue. No debtor will any longer find it his interest to pay in gold. He will always pay in silver, because twenty shillings are a legal tender for a debt of one pound, and he can procure silver convertible into twenty shillings for less gold than that contained in a sovereign. The other consequence will be that, unless a sovereign can be sold for more than twenty shillings, all the sovereigns will be melted, since as bullion they will purchase a greater number of shillings than they exchange for as coin. The converse of all this would happen if silver, instead of gold, were the metal which had risen in comparative value. A sovereign would not now be worth so much as twenty shillings, and whoever had a pound to pay would prefer paying it by a sovereign; while the silver coins would be collected for the purpose