The Value of Money Part 11

THE VOLUME OF TRADE AND THE VOLUME OF MONEY AND CREDIT

In the argument so far I have said nothing of the reverse relationship, the dependence of the volume of money and the volume of credit on trade.

The two are indeed _inter_dependent. Interdependence suggests circular theory, and is often a phrase to cover circular reasoning.[313] In the case of the relation under discussion, however, I have, I trust, already abundantly protected myself against the charge of circular reasoning by _denying_ that either volume of money and credit on the one hand, or volume of trade on the other hand, is a true cause at all. Both are mere abstract names, designating highly heterogeneous individual occurrences, which, _individually_ are cause or effect. In general, both volume of money and credit, on the one hand, and volume of trade on the other hand, are results of common causes, which are the _verae causae_ of economic phenomena--values, psychological phenomena. The whole thing is to be explained immediately and primarily in terms of social relationships and mental processes,--in terms of social values.

To show that increasing trade tends to increase money and credit is not difficult. If one may venture a hypothetical ill.u.s.tration--and the sort of hypothetical ill.u.s.trations, like the dodo-bone case, of which quant.i.ty theorists are fond make one hesitate to do so--let us a.s.sume a communistic community, isolated from other markets, with a developed system of production, including an extensive use of gold in the arts.

Let the communistic regime gradually pa.s.s over to an individualistic regime. a.s.sume that the inhabitants are acquainted with the use of gold as money, and that their government is willing to coin it freely. As individualism spreads, and trade grows, will not more and more gold be taken to the mints? I am not here concerned with the principles determining the apportionment of gold between the money employment and the arts. It is enough to show that expanding trade tends to increase the volume of money.

a.s.sume that the money supply meets difficulties in its expansion. Is there not at once an incentive to extend credit? The seller finds his customers unwilling to buy for cash, in amounts as great as before. In order to sell as much as before (a.s.suming that the use of credit is known, to avoid trouble with historical origins), he extends credit,--which, when practiced generally, lightens the strain on the money supply.

I have so far said nothing of the case where there are stocks of the money metal to be got from outside markets. But if a country is expanding its trade, does not money come in? The quant.i.ty theorists would, indeed, admit this, in general, though their reason is a bad one, namely: that expanding trade lowers prices, and lower prices make the market attractive to foreign buyers, who then send in money for the goods. I shall later discuss this aspect of the theory.[314] For the present, I merely interject the question as to the probability of an expansion of trade when prices are falling. Increasing _stocks_ of particular goods may well mean lower prices for these goods and if they be articles of export the lower prices may well increase the export trade, and bring money in. But this increase in _stocks_ of articles of _export_ is very different from total _trade_ within the country; and lower prices in articles of export are very different from a generally lower price-level.[315]

Will expanding trade in a country increase credit? I come here to one of the striking features of Fisher's doctrine--a feature in which I think he is fundamentally true to the quant.i.ty theory. He finds no way in which expanding trade can directly increase credit. Expanding trade can increase credit, (a) only by changing the habits of the people, so as to alter the ratio, M to M', or (b) by reducing the price-level, and so bringing in money from abroad, whence, as M is now increased, M' rises proportionately. "An increase in the volume of trade in any one country, say the United States, ultimately increases the money in circulation (M). In no other way could there be avoided a depression in the price-level in the United States as compared with foreign countries. [He should say, from the standpoint of his theory, that increasing trade will cause a fall in the price-level, and so bring in more money.] _The increase in M brings about a proportionate increase in M'._[316] Besides this effect, the increase in trade undoubtedly has some effect in modifying the habits of the community with regard to the _proportion_ of check and cash transactions, and so tends somewhat to increase M'

relatively to M; as a country grows more commercial the need for the use of checks is more strikingly felt."[317] In a footnote to this paragraph, he defines the issue still more sharply. "This is very far from a.s.serting as Laughlin does that 'The limit to the increase in legitimate credit operations is always expansible with the increase in the actual movement of goods'; see _Principles of Money_,[318] New York (Scribner), 1903, p. 82. We have seen, in Chapter IV, that deposit currency is proportional to the amount of money; a change in trade may indirectly, _i. e._, by changing the _habits_ of the community, influence the proportion, but, except for transition periods, it cannot influence it directly."[319]

My own explanation of the causal sequence whereby expanding trade brings money into a country would be radically different from that given by Fisher in the first quotation. I should expect, first, that rising _prices_ would encourage rising trade; I should then expect the rising volume of trade, with higher prices, to lead borrowers to need, and secure, larger loans from the banks, with, as loans and deposits rise in proportion to reserves, some slight increase in "money-rates," just enough to draw to the country the extra gold which bankers felt desirable to add to their reserves. I should expect the causal sequence to be the exact reverse of that which Fisher indicates. With falling prices, or waning volume of trade--which would usually come together,[320]--I should expect loans to be reduced, deposits to be reduced, money-rates to fall, and gold then to leave the country again.

I should expect this sort of thing to happen normally, and not infrequently, and I should expect gold to come in and go out many times in the course of a business cycle. This would seem to be the sort of explanation which our modern theory of _elastic_ bank-credit would give in connection with this problem. I shall not here go into details with the theory of elastic bank-credit. The theory has been too well established in the debates between the "Currency School" and the "Banking School"[321] in regard to bank-notes to need elaboration and defence here, and the essential ident.i.ty of deposits and elastic bank-notes from this angle is one of the commonplaces of the literature of banking. What I am here concerned with is the highly significant fact that Fisher's "normal" theory finds no place for this highly important phenomenon. The quant.i.ty theory has no explanation of elasticity to give. On the basis of the quant.i.ty theory, and for all that the quant.i.ty theory can say, the Currency School was right! Fisher offers us, virtually, a "currency theory" of deposits. "Suppose, as has actually been the case in recent years, that the ratio of M' to M increases in the United States. If the magnitudes in the equations of exchange in other countries with which the United States is connected by trade are constant, the ultimate effect on M is to make it less than what it would otherwise have been, by increasing the exports of gold from the United States or reducing the imports. In no other way can the price-level of the United States be prevented from rising above that of other nations in which we have a.s.sumed this level and the other magnitudes in the equation of exchange to be quiescent." (P. 162.) If "bank-notes" be subst.i.tuted for "M'", in this quotation, we have here a perfect statement of the position of the "Currency School" in that great debate.

Must this old issue be fought all over again? And yet, I defy any consistent quant.i.ty theorist to find any flaw in Fisher's argument on this point. There is no place for a theory of elastic bank-credit within the confines of the quant.i.ty theory. Fisher's recognition of this seems full and complete. He relegates all mention of elastic bank-credit to "transitions." The footnote quoted above, in which Laughlin's (somewhat extreme) doctrine based on the theory of elasticity is stated, denies categorically that there is any validity in it, except for transition periods. There is nowhere in the book any explanation of the theory of elasticity.[322] The references to it are few and grudging, and _always_ in connection with the notion of transitions. The most important statement regarding elasticity (less than a page long) is on page 161, where again transitional influences are under discussion. What is a theory of money worth which can offer no explanation of so fundamental, important, and notorious a feature of modern money and banking?

There is a further, related, feature of banking for which the quant.i.ty theory can find no explanation. Among the items in a bank's balance sheet, the quant.i.ty theorist seizes upon reserves on the a.s.sets side, and deposits on the liability side, and builds his theory on the supposed close relation between them. We have seen that this close relation does not, in fact, exist. The range of variation is enormous.[323] But there is one close relation in the balance sheet of the bank concerning which the quant.i.ty theory is silent, and that is the relation between deposits and _loans_. For individual banks and for banks in the aggregate, for long run periods and for short run periods, for reasons that are clear and inevitable, these two magnitudes (or for banks of issue on the Continent of Europe, _notes_ and loans), vary closely together. The relationship between them is the only relationship which does stand out as clearly beyond dispute, among all the items in the banking balance sheet. No a.s.sumptions of a "static state" are needed for its demonstration! The relation varies, of course. As banks increase or reduce their capital, as their reserve-percentages rise or fall, as they increase or decrease their holdings of bonds, we find reasons which alter the proportion between deposits and loans. But, despite this, the variation, as shown by figures for the United States, is slight. a.s.sume, for example, a statement showing "loans and discounts" of $1,000,000, deposits, $1,000,000, cash reserve, $200,000. Reserves are then 20% of deposits, and loans are 100% of deposits. If reserves be increased by $100,000 and loans and discounts reduced, to compensate, by $100,000, we have a 50% variation in the ratio of reserves to deposits, with only a 10% variation in the ratio of loans and discounts to deposits. Since cash reserve is much the smaller item, almost always, the same absolute variation in it will affect it, in percentage, vastly more than it will affect loans and discounts. It is strange that a theory should seize on this highly variable ratio of reserves to deposits, and ignore the much more constant ratio[324] of loans and discounts to deposits.

That this close relation between deposits and loans should obtain follows naturally from the theory of elastic bank-credit. The two are built up together. When there are expanding business and rising prices, men borrow more from the banks; as they borrow, they receive deposit credits; the individual who receives the deposit credit may check against it, but it is redeposited by another man, and so, while the deposits of one bank need not grow out of its loans, still, for banks in general, deposits are large because loans are large. For a given bank, the relation holds closely, because the bank lends, in general, to active business men, who will have income as well as outgo, and whose income will, on the average, at least balance their outgo. Thus, _through loans_, deposits are linked with volume of trade and prices.

Trade and deposits wax and wane together.[325] On the other hand, in the absence of rising prices and increasing trade, reserves may increase greatly without forcing an increase in deposits. Loans cannot increase without an increase in deposits. The linkage between deposits and trade is definite, causal, positive, statistically demonstrable. The linkage between reserves and deposits is, at most, negative--if reserves get too low, deposits and loans may be checked in their expansion. But this--to the extent that it is true, which we leave, for detailed a.n.a.lysis, for Part III--gives a very much looser relation indeed than the direct relation between loans and deposits.

The quant.i.ty theory has offered no explanation of this relation between loans and deposits. What explanation could a theory offer, which rests in the notion that volume of trade on the one hand, and volume of money and bank-credit on the other hand, are independent magnitudes?[326] I do not mean that quant.i.ty _theorists_ are silent regarding the relation of loans and deposits. I mean that they do not attempt, in any discussion I have found, to apply the quant.i.ty _theory_ to the explanation of that relation. What shall we say of a theory which, ignoring these easily proved, easily explained, and vital facts regarding bank-credit, offers as its sole explanation of volume of bank-credit a theory so untenable as that of a fixed ratio between volume of bank-credit and volume of money _in circulation_, with causation running from money to deposits?

Professor Fisher says little about bills of exchange. Here, surely, we have a credit instrument which grows directly out of trade, in general, and whose volume expands and contracts with trade. When banks discount bills of exchange, and issue notes, or grant deposit credits, against such discounted bills, the connection of bank-credit and volume of trade is obvious. The same thing holds largely, however, when promissory notes are discounted. Such notes are usually given by those who plan to use the credits granted in commercial or speculative transactions. The bill of exchange differs from the promissory note in practice, however, in that it itself is often a medium of exchange, without going into the bank's portfolio. "The bill of exchange, therefore, before it gets to the bank _usually_[327] performs a series of monetary transfers, for the small dealer naturally prefers to pa.s.s on the bill, if possible, in making a payment, instead of handing it over to his bank, which would either deduct a certain percentage in the way of discount, or else accept the bill at its face value, crediting the customer with the amount on the date of maturity, while business men (other than bankers) are in the habit of taking bills of exchange as they would cash."[328]

This quotation describes conditions in Germany. The same authorities (p.

176) give figures showing a rapid development in the volume of bills of exchange, rising from about 13 billions of marks in 1872 to about 31 billions in 1907. These figures show that bills of exchange are a big factor in German business life,--a conclusion that is strengthened when they are compared with the figures for giro-transfers on pp. 188-189 of the same article, or with the figures for note issue on p. 209.[329] In the United States, of course, the use of bills of exchange has become comparatively unimportant in domestic commerce,[330] though there is a movement to revive them, since the new Federal Reserve system has come in. Their chief importance is in connection with foreign trade. Is it possible that Professor Fisher's reason for wishing to minimize foreign trade[331] is the unconscious desire to get rid of the annoying bills of exchange, which so obviously tend to make bank-credit and volume of trade interdependent, and which further spoil the quant.i.ty theory by serving as a flexible subst.i.tute for both money and deposits?

I regret the necessity for this elementary exposition of familiar things. But Fisher's theory has no place for these familiar things--and Fisher has merely made very explicit the logic of the quant.i.ty theory!

As applied to modern conditions, the quant.i.ty theory is obliged to a.s.sert--and Fisher does a.s.sert:

(a) that there is a causal dependence of bank-credit on money, and "normally" a fixed ratio between them;

(b) that velocity of circulation of money and credit instruments are independent of quant.i.ty of money and credit instruments;

(c) that, in general, money and volume of credit (taken together), velocities, and trade, are independent magnitudes, each governed by separate laws, though Fisher concedes _some_ reaction of trade on velocities;

(d) in particular, that volume of money and credit has no influence on trade, and that trade has no direct influence on volume of credit.

All these doctrines are necessary if the contention that an increase of money will proportionately raise prices is to be maintained, or if it is to be maintained that a decrease in trade will proportionately raise prices. I have a.n.a.lyzed each of these contentions, and I find justification for none of them.

Not yet, however, have we reached the least tenable aspect of the quant.i.ty theory. There remains the contention that prices are pa.s.sive, that a change, _originating_ in prices, and involving a change in the average price, or the general price-level, cannot maintain itself--that P is a pa.s.sive function of the other five magnitudes of the equation of exchange. To this central fortress of the quant.i.ty theory we shall devote the next chapter.

CHAPTER XV

THE QUANt.i.tY THEORY: THE "Pa.s.sIVENESS OF PRICES"

Is the price-level pa.s.sive? Is it true that while change may occur from causes outside the equation of exchange in volume of money, volume of trade, and velocities of circulation, a change in the price-level from causes outside the equation is impossible? Must the average of prices be a pa.s.sive function of M, the V's, M' and T? Such is the general contention of the quant.i.ty theory, and such, very explicitly, is Fisher's contention. The price-level is always effect, and never cause (with slight modifications of the doctrine for transition periods) in its relations to the other magnitudes in the equation of exchange.

Now in one sense, it is my own contention that the price-_level_ can never be a _cause_ of anything. The price-level is an _average_.

Averages may be _indicia_ of causation, but they are not themselves causes. They are not, in reality, anything _at all_. Causation is a matter which pertains to the particulars of which the average is made.

But this is not the doctrine of the quant.i.ty theory. The quant.i.ty theory does, in certain connections, a.s.sign causal influence to the level of prices, particularly in the theory of foreign exchange, where the explanation of international gold movements rests on the doctrine that a price-level in one country, higher than the price-level of another country, drives money away.[332] It will be seen, in a moment, that Fisher relies on this principle to prove that the price-level of a country cannot rise without an increase of money--if it did so rise, it would drive out the money, and so be forced down again. The point at issue may be stated in terms of particular prices. The quant.i.ty theory is that, while particular prices may rise from causes affecting them, as compared with other prices, without a change in money, velocities, etc., still there cannot be a rise in the general average, because other prices will be obliged to go down to compensate. The issue is as to the possibility of a rise in particular prices, uncompensated by a corresponding fall in other particular prices, without a _prior_ increase in money, or velocities, or decrease in trade. I take up the issue in this form. I shall maintain that particular prices can, and do, rise, without a _prior_ increase in money or bank-deposits, or change in the volume of trade, or in velocity of money or deposits and also without compensating fall in other particular prices. Putting it in terms of Fisher's equation, I shall maintain, as against Fisher, that P can rise through the direct action of factors _outside_ the equation of exchange, that as a _consequence of such rise_ the other factors readjust themselves, and that a new equilibrium is reached which, in the absence of new disturbances from causes outside the equation, tends to be as permanent and stable as the old equilibrium was.

In the argument which follows, I shall respect thoroughly the distinction between "normal" and "transitional" effects. I do not think that this distinction is properly drawn by Fisher. In my discussion of the relation between the volume of bank-credit and the volume of trade, and in other connections, I have shown that Fisher leaves out of his normal theory most of the concrete factors which do affect both the concrete magnitudes, and the long run _averages_, of the factors in his own equation. But for the present, I shall meet him on his own ground, give his distinctions their fullest weight, and carry my argument through the "transition" to a point where no further change among the factors in the equation can be expected as a consequence of the initial change a.s.sumed.

Fisher's argument to show the pa.s.siveness of prices takes the form of a _reductio ad absurdum_. "To show the untenability of such an idea let us grant for the sake of argument that--in some other way than as effect of changes in M, M', V, V', and the Q's--the prices in (say) the United States are changed to (say) double the original level, and let us see what effect this will produce on the other magnitudes in the equation."[333] Then, if the equation of exchange is to be maintained, either M or M' or their velocities must be increased, or trade must be reduced. But he holds that none of these is possible. (1) Money will be reduced. High prices drive money away to other countries. Nor can gold come in via the mints. "No one will take bullion to the mints when he thereby loses half its value."[334] On the contrary, men will melt down coin. Nor will high prices stimulate mining. Rather, by raising the expenses of mining, they will discourage mining. (2) Bank-deposits cannot increase. Bank-deposits depend on the amount of money, and as that is reduced, they must be reduced, to keep their normal ratio to the volume of money. (3) The appeal to velocities is no more satisfactory.

These have been already adjusted to individual convenience.[335] (4) Nor can trade be decreased. Since the average person will not only pay, but also receive, high prices, there is no reason why he should reduce his purchases. "_The price-level is normally the one absolutely pa.s.sive element in the equation of exchange._"[336]

"But though it is a fallacy to think that the price-level in one community can, in the long run, affect the money in _that_ community, it is true that the price-level in one community may affect the money in _another_ community. This proposition has been repeatedly made use of in our discussion, and should be clearly distinguished from the fallacy above mentioned. The price-level in an outside community is an influence outside the equation of exchange of that community, and operates by affecting its money in circulation and not by directly affecting its price-level. _The price-level outside New York City, for instance, affects the price-level in New York City only_ via _changes in the money in New York City_."[337]...

"Were it not for the fanatical refusal of some economists to admit that the price-level is in ultimate a.n.a.lysis effect and not cause, we should not be at so great pains to prove it beyond cavil." To explain this "fanatical refusal," Fisher alludes to the "fallacious idea" that the equation of exchange cannot determine the price-level, because the price-level has already been determined by other causes, usually alluded to as "supply and demand." He urges, however, that supply and demand, cost of production, etc., relate, not to the price-level, but only to particular prices: that the price-level is a factor prior to, and independent of, the particular prices, and is presupposed by theories like supply and demand, cost of production, etc.[338]

The _reductio ad absurdum_, at first blush, looks impressive. One obvious criticism suggests itself, however, and it will be found to give a clue to a much more fundamental criticism: is it reasonable to a.s.sume a doubling of _all_ prices? Above all, must the a.s.sumption involve the doubling of the price of gold bullion? Part of the argument to show that gold bullion would not be minted rests on that a.s.sumption. But, more fundamental, for such an all round doubling of prices, no _cause_ could be a.s.signed. Of course the hypothesis of an increase in prices without any cause is absurd, and Fisher easily disposes of it. But suppose we a.s.sign some _concrete causes_, outside the equation of exchange, which might affect prices, and see how the thing works then!

Fisher states on p. 95 that "other elements in the equation of exchange than money and commodities[339] cannot be transported from one place to another." And in the pa.s.sage quoted above he maintains that price-levels in one country can influence price-levels in another country, or even price-levels in one city can influence price-levels in another city, only _via_ changes in money, in the second country or city. But other elements in the equation are _directly_ transferable, in fact.

_Deposits_, _e. g._, in London, to the credit of New York bankers, may be transferred to Paris, directly, by _cable_ or by _letter_, and _prices_ are constantly being directly pa.s.sed from one country or market to another by the same media. Let us suppose a strong case, to put our principle in relief. a.s.sume an island, which produces a staple widely used, whose chief centre of production is outside the island. a.s.sume that this staple, an agricultural product, rises greatly in price, owing to a blight, which promises to be permanent, in the main producing region. The blight does not affect the island, however. Let this product be the main product of our island, which we shall a.s.sume to be small.

Let the island have communication with the outside world by boat only once in three months. Let it be, however, in constant communication by cable. Word comes by cable of the rise in the price in the staple. The staple at once rises in the island. No new money has come in to cause it. Will this be a rise in the price-level? Will there be compensating reductions in the prices of other things to leave the price-level unchanged? What prices can fall? Not the prices of goods that have been imported to the island, surely. They will rather tend to rise, because everybody on the island will feel richer than before, and will be disposed to buy more freely. Meanwhile, merchants and bankers on the island will be more ready to extend credit than before, so that they will be able to buy more freely. What else can fall? Not the prices of the land! Rather, the land will rise in price greatly, because the increased price of the staple, expected to be permanent, will promise bigger rents, and the price of the land, being a _capitalization_ of the annual rental, will rise very much more than anything else--it will rise to the extent of the capitalized price of the increase in the rents.

Wages, likewise, will rise, since the price of the product of labor has risen. And the capital instruments in use in producing the staple will also rise, though not so much as land and wages, inasmuch as they can be brought in from outside at the end of three months. What is there that can fall--except, perhaps, such goods as are exclusively designed for the construction of poorhouses! A significant particular price rises--that is the first step; then, from causes familiar to all students of economics, other related prices rise; there is a general _sympathetic_ rise in prices, the _price-level_ has risen independently, from causes _outside the equation of exchange_. But now, can this rise sustain itself? Well, what can bring it down? When the ship comes, at the end of three months, it will bring in additional supplies of the articles of import, and they will go down to their old level. Will they go any lower than the old level? What is there to cause them to do so?

The outside price-level should be higher now, rather than lower, since the _stock_ of the staple in question is reduced, and nothing else increased to compensate. Nor can any reason be a.s.signed why other prices on the island: the staple in question, lands, wages, etc., should fall at all from the level they reached when the news first came.

Incidentally, our ship may also bring in more gold. The bankers, finding their deposits expanding, may feel it well to cable orders for more gold to increase their reserves, especially as they have been subject to somewhat unusual calls for cash for hand to hand circulation--though this last need they might well have been meeting by expanding their note issue.

Is there anything else to be said? Is not the new equilibrium stable?

And is not the causal sequence precisely the reverse of that a.s.signed by the quant.i.ty theory? _First_. a rise in prices; _second_, an expansion of credit, book-credit, notes and deposits; _third_, money comes in. If anyone is particularly anxious about the equation of exchange in this process, he may add to my expansion of credit an increase in velocities to keep it straight!

I may add that I see nothing in the "transition" I have described to cause trade to be reduced. Rather, I should expect the rising prices to make trade more active--or better, I should expect the rising _values_ of goods, etc., of which rising prices are the symptom, to make trade more active, particularly as there would be an increase in speculation to bring about readjustments, and to "discount" the prosperity. Nor can I find any reason why trade should be reduced below the old level in the new normal equilibrium. It would make no difference, however, if trade were reduced either transitionally or normally, since the point at issue is the possibility of a rise in prices originating from causes outside the equation of exchange, and compelling a readjustment of a permanent character in the other factors of the equation. The quant.i.ty theorist is at liberty to make this readjustment in any way he pleases. My point is made if he has to make the readjustment, and if the price-level stays up!

I have put my ill.u.s.tration in an extreme form to throw the whole thing in relief, and to make the demonstration free from a host of complexities. But is not the causal process essentially the same if we subst.i.tute, say, the Southern States for our island, and cotton for our staple? So long as the telegraph bringing news of the ruin of cotton production in India and Egypt, with the higher price of cotton, can come in ahead of the money that the quant.i.ty theorist might imagine rushing in a race with it on the train to be offered for the cotton, my point is made. In point of fact, there would be a general rise in prices and wages in the South, which, leading to an expansion of credit, would only gradually and in no definite ratio lead to an increase in money drawn from outside. Buyers outside would pay, not with money, but with checks drawn on New York, and Southern bankers would use their discretion as to how much actual cash they would bring in. With the elastic note issue of our Federal Reserve system, I see no reason to antic.i.p.ate that money would be drawn to the South in an amount proportionate to the increase in prices. Even if it were, the causation would not run from money to prices, and that is the point at issue. If _rising_ prices can cause increasing money, the whole quant.i.ty theory is upset, whatever the proportions involved.

It will be noted that my ill.u.s.tration might be put partly in the form of the supply and demand argument. Increasing demand for cotton in the South leads to higher price of cotton; higher price of cotton makes cotton-growers richer, and enables them to increase their demand for imported goods, for land, and for labor. Supply and demand comes into conflict with the quant.i.ty theory, and does not suffer in the conflict!

Supply and demand determine particular prices, and particular prices determine the price-level!

Now I wish to generalize this point. I shall show that the quant.i.ty theory conflicts with most of our doctrines of prices, as worked out in our systems of economics. I shall show that, in important cases, the quant.i.ty theory conflicts with the law of supply and demand, with the doctrine of cost of production, with the capitalization theory, and with the doctrine of imputation as worked out by the Austrians, whereby the prices of labor, land, and other agents of production rise or fall with the prices of the consumption goods which they produce. I shall show the conflict in important cases, and shall show also, in those cases, that it is not the quant.i.ty theory which can be sustained.

The general form of the conflict may be stated for all these theories.

They are theories of the _relations_ of particular prices, concerned with showing that individual prices are so related that they tend to _vary together_. A rise in one price, according to these theories, tends to bring about _rises_ in others, and _vice versa_. The quant.i.ty theory, on the other hand, a.s.serts a relation among individual prices such that a rise in one tends to bring about a _fall_ in others--it requires a _compensatory_ fall at one point, if there has been a rise somewhere else.

Let us take some cases. I shall take, first, the conflict between the quant.i.ty theory and the capitalization theory, as I can use the ill.u.s.tration just given in connection with it. I have, in a preceding chapter, given a statement of the capitalization theory. It is a theory concerned with the prices of long-time goods and income-bearers, as lands, houses, capital goods of various sorts that give forth their services through a series of years, stocks, bonds, etc. The prices of things of this sort, according to the capitalization[340] theory, depend on two factors: one, the money income expected from the income-bearer, the other, the prevailing rate of interest. This money income, except in the case of bonds, commonly depends on the prices of the products of the income-bearer, or (in the case of stocks) of the products of the concrete capital-goods to which the income-bearer gives t.i.tle. If we may follow the Austrian division of goods into higher and lower "orders," or "ranks," we may say that the prices of the goods of higher ranks are the capitalizations of the prices of the goods of lower ranks specifically produced by them. Thus, concretely, if the price of wheat rises, we may expect the prices of land to rise, if the rate of interest remains the same. If the price of steel rises, we may expect the stocks of the U. S.

Steel corporation to rise, also. If the prices of smokeless powder, and other war munitions soar, we may expect the prices of the stocks of the corporations involved to do precisely what they have done in the recent course of the stock market. All this, on the a.s.sumption that the rate of interest does not change, and that the risk factor remains constant. If these factors vary, the results will not present the mathematical exact.i.tude that the formula calls for, but the general tendency will remain the same. On the other hand, if the incomes remain unchanged, but the rate of interest rises, then we may expect the capitalized prices to fall, and if the rate of interest falls, we may expect the capitalized prices to rise. From the standpoint of the present discussion, I suppose it might be fairest and best to state the capitalization theory on this point as Fisher himself states it. In his _Elementary Principles of Economics_ (ed. 1912) after giving a table showing in figures the difference made in different capital prices by different rates of interest (p. 125) he states (126): "If the value of the benefits derivable from these various articles continues in each case uniform, but the rate of interest is suddenly cut down from 5% to 2-1/2%, there will result a general increase in the capital values, but a very different increase for the different articles. The more enduring ones will be affected the most." And in his book, _The Rate of Interest_: "The orchard whose yield of apples should increase from $1,000 worth to $2,000 worth would itself correspondingly increase in value from, say, $20,000 to something like $40,000 and the ratio of the income to the capital value, would remain about as before, namely, 5%."

(P. 15.) On the next page, he generalizes his notion: "One cannot escape this conclusion (as has sometimes been attempted) by supposing the increasing productivity to be universal. It has been a.s.serted, in substance, that though an increase in the productivity of one orchard would not affect the total productivity of capital, and hence would not appreciably affect the rate of interest, yet, if the productivity of all the capital in the world could be doubled, the rate of interest would be doubled. It is true that doubling the productivity of the world's capital would not be entirely without effect upon the rate of interest; but this effect would not be in the simple direct ratio supposed.

Indeed, an increase of the productivity of capital would probably result in a decrease, instead of an increase, of the rate of interest. _To double the productivity of capital might more than double the value of the capital._" (_Rate of Interest_, p. 16.)[341] Fisher reiterates this doctrine in his reply to Seager, in the _American Economic Review_, Sept. 1913, pp. 614-615.