The Value of Money Part 7

Confidence in these conclusions is much increased by a study of the views of Professor Taussig.[180] Professor Taussig is, in his initial formulations of his doctrine, a quant.i.ty theorist. In a situation where only money is used, credit being excluded, in effecting exchanges, he would hold that the quant.i.ty theory correctly accounts for prices. He is fond of the old formulation, as a first approximation, even in dealing with the complex facts of modern banking. But he does not dodge the complex facts, and his theory becomes, substantially, first, a general formula, and second, an elaborate body of qualifications and exceptions, the latter making up the major part of the theory. His doctrine regarding the relation of money and credit is as follows: there is, in the long run, a real _limitation_ on elastic credit instruments in the quant.i.ty of _specie_. (This is very different from the a.s.sertion that there is a _fixed_ ratio between _deposits_ and _money_ in circulation, including paper, bank-notes, etc., in money. The present writer has no quarrel with the doctrine that the gold supply of the _world_ imposes _outside_ limitations on the _possible_ expansion of credit.) The limitation, Taussig holds, comes in two ways: (1), in the connection between prices in any one country, and prices in the world at large; (2), in various links of connection between the volume of deposits (and of notes elastic like deposits) and the quant.i.ty of specie. I shall consider at a later point the relation between prices in different countries.[181] I shall there maintain that the quant.i.ty theory, which explains gold movements on the basis of price-_levels_ in different countries, is inadequate; that not price-levels, but particular prices, of goods most available for international trade, are of primary importance, and that of these particular prices, one, namely the "price of money," or the short time money-rate, is most significant of all. For the present, I wish to a.n.a.lyze the linkages which Taussig finds between elastic credit instruments and specie, and to see how far they would go, not in proving Taussig's point (with which I have little quarrel) but in proving Fisher's contentions. The points involved are: (a) _Direct necessity_ constrains the bankers to keep _some_ cash on hand.[182] This fixes a _minimum limit_ (Taussig's contention), but does not at all suggest a "normal ratio" (Fisher's contention). (b) _Binding custom_, as to the proper amount of reserve that banks should carry, particularly important in connection with the Bank of England, but also in evidence in the Banque de France and the Reichsbank. Here again, however, minimal, rather than fixed, ratios are suggested. Limitations on the _expansion_ of credit these customs may impose, but they by no means determine a normal, or average amount of credit expansion--in England least of all, since there is so large a flexible element in the deposits of the Joint Stock Banks, whose reserves are largely secret. The statement _supra_ quoted from Keynes, together with the testimony of European bankers, may be considered in connection with this point, also, as to the factors determining the reserve policies of the great European banks. The extent to which custom really binds is doubtful. (c) _Direct regulation by law_, peculiar to the United States. Here again, a minimum, rather than a fixed ratio, is indicated. Some _limitation_ on credit expansion by the banks is caused by this at times, but Fisher's argument would require vastly more. (d) _The interaction in the use of deposits, notes, and other const.i.tuents in the circulating medium._ The point involved here is that different kinds of business call for different kind of media. Small retail business is not done with hundred dollar bills, nor are stocks and bonds bought with pennies. Limiting the size of bank-notes to five pounds in England compels the use of a large amount of gold for smaller transactions, and keeps a larger amount of gold in use than would otherwise be the case. Expanding business draws cash from the banks for circulation, trenching on reserves. That Professor Taussig has a point here is not to be doubted, but how closely it limits the expansion of credit will depend on the degree to which different kinds of media of exchange really _are_ thus specialized. In a country like the United States, where checks may be used for virtually any transaction of over a dollar, and where small change for less than a dollar will be increased by the Government to meet the demands of trade, the point would not seem to involve a practically serious limitation.

Finally, Professor Taussig recognizes a coefficient with the quant.i.ty of specie in the _temper of the business community_. Whether or not deposits are to expand, depends not only on reserves, but also on the att.i.tude of borrowers.

Taussig concludes: "Thus there is only a rough and uncertain correspondence of bank expansion with bank reserves; much play for ups and downs which have no close relation to the amount of cash in bank vaults, _and still less direct relation to the amount of money afloat in the community at large_. Where bank media, whether in the form of deposits or notes, are an important part of total purchasing power, the connection between general prices and quant.i.ty of 'money' is irregular and uncertain." (Italics mine.)

This conclusion would be of little service in supporting Fisher's rigorous contentions! Our constructive theory concerning the relations of reserves and deposits, or reserves and demand liabilities, must wait for later discussion, in the chapter on "Bank a.s.sets and Bank Reserves"

in Part III. It will there be maintained that there are no "normal" or "static" laws governing the percentage of reserves to demand liabilities, or to deposits, that the reserve function of money is a _dynamic_ function, and that its whole explanation must be found in dynamic considerations. For the present, I am content to have a.n.a.lyzed two widely divergent views, one the extreme view of Professor Fisher, representing the quant.i.ty theory in its utmost rigor, and the other, the view of Professor Taussig, who virtually surrenders the quant.i.ty theory in complex modern conditions.

In between these two writers, verging more toward Fisher than toward Taussig, will be found, with great individual variation, the rest of the quant.i.ty theorists. The quant.i.ty theory, as an instrument of prediction, becomes important only to the extent that Fisher's view is maintained.

CHAPTER X

"NORMAL" VS. "TRANSITIONAL" TENDENCIES

The Quant.i.ty Theory, as a causal theory, is, then, little altered by the pa.s.sage from a hypothetical, creditless economy to the actual world, where a vast deal of credit is used,--particularly in Professor Fisher's hands. Of the different kinds of credit, only deposits subject to check are recognized as directly influencing prices, and deposits subject to check are controlled by the volume of money. The causal theory[183]

remains, then, as follows: if M be increased, it will increase M'

proportionately; it will not change the V's; it cannot increase T; to keep the equation straight, therefore, P must rise in proportion to the rise in M. A decrease of M, reducing M' proportionately, leaving V's and T unchanged, must proportionately reduce P. P is pa.s.sive. A change in P cannot sustain itself, unless it be due to a prior change in T, the V's, M or M'.

This theory is set forth with the qualification that these effects are the "normal" effects of the changes in question. The proportion between quant.i.ty of money and price-level is not strictly maintained during "transition periods." I now approach the most difficult question which I shall have to answer as to the meaning of Fisher's terms. The same problem arises for all quant.i.ty theorists. Precisely what is the distinction between "transition periods" and "normal periods"? What limitations and qualifications does he admit to the rigorous statement of his theory so far given? I may first express the opinion that the line shifts greatly in his own mind, or at least shifts greatly in the exposition. I do not find an explicit statement in which definitions are given. The matter is chiefly discussed by Fisher in ch. 4,[184] which is called "Disturbance of Equation and of Purchasing Power during Transition Periods." There we find, as I have stated, no definitions, but the initial statements would suggest the following: a transition period is the period following a change in any one of the factors in the equation during which a readjustment among all the others is taking place; the normal period is the period preceding such a change, or following the transition after such a change, and is characterized by the fact that all the factors are at rest, in stable equilibrium.

Equilibria during transition periods are unstable. During the transition, the relations among the factors vary: M and M' need not keep their fixed ratio; P need not be wholly pa.s.sive; M and P need not keep the same proportion. But until M and M' get back into the normal ratio, until P becomes proportional to M (in the proportion prior to the initial disturbance), there is no rest; the equilibrium is unstable. How long is a transition period? How realistic is the notion of a transition period? Is the transition period a theoretical device, to aid in isolating causes, or is it supposed to be a real period in time? Is the normal period a real period in time, or is it merely a theoretical hypothesis? It is not easy to answer these questions. Thus (p. 72) the seasonal fluctuations are declared to be "normal and expected," and, at the same time, one gets the impression that Fisher considers them ill.u.s.trations of his "transitions," in which the normal theory does not strictly hold (pp. 72, 169). What is described chiefly in the chapter on transition periods is the business cycle--a theory of the business cycle, based primarily on the notion that the failure of interest to rise as fast as prices rise causes the "boom," and that the draining of bank reserves precipitates the crisis. I shall not discuss this theory, as a theory of business cycles, further than to say that Wesley Mitch.e.l.l's study would indicate that the interest rate is a minor factor, and that, while as a theoretical possibility, the drains on bank reserves may check prosperity if something else doesn't do it first, practically something else always does come in ahead, so far as his studies have gone.[185] My interest here is primarily in seeing the limitations Fisher imposes on his theory, and the qualifications he admits. If the business cycle is the typical transition period, during which his normal theory doesn't hold, when does the normal theory hold?

When are the "normal periods"? There is no concrete period during which prices are neither rising nor falling, during which no important changes are taking place among the factors.[186] At times, Fisher seems to indicate that the normal period is imaginary (pp. 56, 159). Is, then, the contrast between a realistic "transition period" and a hypothetical "normal period" or are both hypothetical? Is the equation of exchange, too, a mere hypothesis? It should be, if it is to set forth a merely hypothetical theory. But no, Fisher insists on putting concrete data into it, and, indeed, gives an elaborate statistical "proof" of the equation. It, at least, is realistic. I confess that my certainty as to Fisher's meaning grows less, as I study his book with greater care. If the typical transition period be the business cycle, then the normal period could come only once, say, in ten years--or whatever period, regular, or irregular, one chooses to a.s.sign to the business cycle. The concrete price-levels for the greater part of the time are then surrendered to other causes. And the one-year cycle described in the equation of exchange is quite irrelevant. The equation of exchange should cover the whole business cycle, to fit in with the theory.

Indeed, a realistic equation of exchange would then have no meaning at all, as the average price-level during the business cycle, played upon by a host of causes other than the factors described in the quant.i.ty theory, would not be the same as the average price-level which _would have_ obtained had only the "normal" causes been in operation.[187]

The distinction between "normal" and "transition" _periods_ suggests a dangerous fallacy: namely, that during one period one sort of causation is working, with the other in abeyance. In fact, whatever causes there are are working all the time. The only legitimate thing is to abstract from one set of causes, and see what the other set, if left to themselves, will bring about. But this sort of abstraction has many dangers, one of which is that the causes abstracted from are frequently thought of as non-existent. The chemist, in his laboratory, can in actual physical fact abstract impurities from his chemicals, and see what they will do. He can even perform experiments in what is practically a vacuum. But the economist has no right to _think in vacuo_! All that he has a right to do is to a.s.sume the factors which he does not wish to study _constant_. And even that he must not do if (1) changes in the factors which he wishes to study do in fact lead to changes in the factors abstracted from, or (2) if the factors which he wishes to study can only change _because_ of prior or concomitant changes in the factors from which he is abstracting. Is it, for example, legitimate to a.s.sume an increase in M' apart from its usual accompaniment, an increase in PT?

The notion, too, that causation can be seen in a state of stable equilibrium should be critically a.n.a.lyzed. Causation is only _revealed_ by a _course of events_, when mechanical causation is involved. The relation of cause and effect may be a contemporaneous relation in fact, and it is possible, where conscious, psychological phenomena are involved, to discern causal relations among the elements in a mental state by direct introspection. It is the not uncommon practice, also, in the theory of mechanics, or in theoretical economics, where the method of investigation is deductive rather than inductive, to abstract from the temporal sequence, and to construe causal relations as timeless, logical relations. But even here, the cause of a _change_ in the general situation precedes the change in time, and it is only by abstraction that the time element is left out. If there is no question as to the causal relations, this abstraction is legitimate, but if all that one knows about the situation be that in a stable equilibrium certain constant ratios obtain, then the question as to which term in the ratio is cause and which is effect remains unanswered. In Fisher's situation, then, a.s.suming that it be true--which I shall deny--that the only stable equilibrium is that which the normal theory requires, it still remains true that the causal relations among the factors can only be revealed by a study of the transitions, by seeing the temporal sequence of changes in the factors of the equation. Even if it be granted that M, M' and P tend to keep a constant relation to one another, the quant.i.ty theory falls if, for instance, it can be shown that a change may first occur in P, spread to M', and finally reach M last of all, leading to a new normal equilibrium which is stable. I shall later show cases of this sort.[188]

The abstract formulation of Fisher's contrast will not, I believe, give us an answer as to the extent to which he thinks his quant.i.ty theory realistic. I find myself particularly in genuine uncertainty as to the point mentioned above: would an actual equation of exchange for the whole business cycle, made up of the averages of M, M', V, V', P and T for the whole period, exhibit the "normal" relations among these factors? Or would this "normal" relation only emerge concretely at some moment of time in the course of the cycle when the abnormal causes affecting the price-level happened to offset one another? Or is it true that no actual figures which might be found, either for a moment of time, or as averages for any given period, will exhibit the relations required, and that only a hypothetical equation, based on the figures for M, M', V, V', P and T that _would have been realized_ had there been no "disturbing" causes, will show these "normal" relations? If, as Fisher at times indicates--as in his reference to Boyle's Law (p.

296)--he is stating only an abstract tendency, which may be neutralized by other tendencies in the situation, so far as concrete results are concerned, then it is this last doctrine which we must take, and the concrete equation of exchange has little if any relevance. If, moreover, this last interpretation be given, then the whole of Fisher's elaborate statistical "proof" is pointless. The only sort of statistical proof which would be relevant would be of a much subtler sort, not a mere filling out of the equation of exchange by means of annual figures, but an effort to disentangle and measure the _importance_ of his tendency, as compared with other tendencies. But we have the other tendencies merely mentioned in qualitative terms, and we never find any definite statement, of mathematical character, as to how important they are.

It seems pretty clear, however, that on the whole, despite occasional suggestions that his theory is abstract, Fisher means his theory to be the overwhelmingly important point in the explanation of actual price-levels. He is particularly insistent on the high degree of the generality of his contention that P is pa.s.sive. Thus: "So far as I can discover, _except to a_ LIMITED _extent during transition periods, or during a pa.s.sing season_, (_e. g._, _the fall_) (capitals mine, italics Fisher's), there is no truth whatever in the idea that the price-level is an independent cause of changes in any of the other magnitudes, M, M', V, V', or the Q's."[189] On p. 182 he enumerates in a series of propositions his general normal theory, and adds, as the first sentence of proposition 9: "Some of the foregoing propositions _are subject to_ SLIGHT _modification during transition periods_." (Italics and capitals mine.) And the general drift of the argument, particularly in chapter 8, where the heart of Fisher's causal theory is presented, would indicate that the concessions he is disposed to make are very slight, indeed.

The question as to how long a _time_ is required, in Fisher's view, for a transition to occur, and for his normal tendencies to dominate, is nowhere made clear. The quant.i.ty theory, in the hands of some writers, is a very long run theory, for others, it is a short run theory. Thus, Taussig would make the "run" exceedingly long.[190] Mill makes it a short run theory. "It is not, however, with ultimate or average, but with immediate and temporary prices, that we are now concerned. These, as we have seen, may deviate widely from the standard of cost of production. Among other causes of fluctuation, one we have found to be, the quant.i.ty of money in circulation. Other things being the same, an increase of the money in circulation raises prices, a diminution lowers them. If more money is thrown into circulation than the quant.i.ty which can circulate at a value conformable to its cost of production, the value of money, so long as the excess lasts, will remain below the standard of cost of production, and general prices will be sustained above the natural rate."[191] I pause to note that it is really strange that a single name should describe theories so different, resting on such essentially different logic. Long run or short run theories, all are "quant.i.ty theories," whether "money" be defined as gold, or as all manner of media of exchange, or as only those media of exchange which pa.s.s from hand to hand without endors.e.m.e.nt. Fisher would doubtless call his theory a long run theory. From the standpoint of the notion that "prices ... lag behind their full adjustment and have to be pushed up, so to speak, by increased purchases,"[192] however, we get a short run quant.i.ty theory doctrine. The logic of these two is very different. The short run doctrine seeks to explain the actual process of price-making in the market. Money is offered against goods, and the actual quant.i.ties on each side determine the momentary price-level, concretely. Or, when credit is considered, money and credit offered against goods, at a given time, or in a given short period, determine the actual price-level reached. This is the logic of the equation of exchange--actual money paid is necessarily equal to actual money received. The long run doctrine is fundamentally based on a different notion. Surrendering the actual or average of price-levels to other causes, in part, it still a.s.serts that, given time enough, and barring new disturbing tendencies, a price-level will ultimately be reached which will bear it out. I find no recognition, on Fisher's part, of the fact that these two doctrines are different, and, in fact, I find them blended and confused in the course of his argument. He would doubtless maintain that his is a long run doctrine. But how long is the "run"? Sometimes it seems to be, as already shown, a whole business cycle. Sometimes a pa.s.sing season, as the fall. When he undertakes to apply his theory to a practical proposal for regulating the value of money, he relies on the quant.i.ty theory tendency to bring about adjustments so quickly that it is worth while to make _monthly_ adjustments in antic.i.p.ation of it.[193] When discussing the changes in gold premium on the Greenbacks during the exciting times of the Civil War, he relies so thoroughly on his theory that he will not allow even the rapid change of four per cent in a single day following Chickamauga to occur except in conformity with the quant.i.ty theory. This last statement is so remarkable that I must quote Fisher himself: "It would be a grave mistake to reason, because the losses at Chickamauga caused greenbacks to fall 4% in a single day, that their value had no relation to their volume. This fall indicated a slight acceleration in the velocity of circulation, and a slight r.e.t.a.r.dation in the volume of trade" (263). It would be indeed remarkable if the changes in the gold market, which got war news before the newspapers got it, and where changes in gold premium occurred before the rest of the country could possibly react to the war news, should be controlled by V and T! I had not supposed that the most rigorous of short run quant.i.ty theorists would make any such demands on his theory as that. Indeed, I had not supposed that the quant.i.ty theory would feel called on to explain the gold premium, as such, except in so far as the gold premium is an index of general prices.

Finding it impossible to limit Fisher to any single statement of the quant.i.tative importance of his normal theory as compared with the other tendencies at work, but concluding that, on the whole, he considers it of high importance, I shall now proceed to an a.n.a.lysis of the reasoning by which he seeks to justify it as a _qualitative_ tendency. I shall maintain that, however long or short the period required, however strong or weak the tendency he defends, the reasoning by which he seeks to justify it is unsound, and that even as a qualitative tendency, the quant.i.ty theory is invalid. At a later part of the book, as in an earlier part,[194] I shall undertake to find the modic.u.m of truth which the quant.i.ty theory contains, and shall show that no quant.i.ty theory is needed to exhibit this modic.u.m of truth.

CHAPTER XI

BARTER

In the statement of the quant.i.ty theory, the proviso is commonly made that all exchanges must be made by means of money, or of money and bank-credit. Barter is excluded by hypothesis. If resort to barter were possible, then people might avert the fall in prices due to scarcity of money, or increase in trade, by dispensing with money in part of their transactions, and the proportional decrease in prices which the quant.i.ty theory calls for would be lacking. Is this a.s.sumption true? Is barter banished from the modern world, or does it remain reasonably possible, and, to a considerable degree, actual?

Fisher maintains the thesis--the failure of which he admits would spoil the quant.i.ty theory[195]--that barter is practically impossible, and negligible in modern business life. "Practically, however, in the world to-day, even such temporary resort to barter is trifling. The convenience of exchange by money is so much greater than the convenience of barter, that the price adjustment would be made almost at once. If barter needs to be seriously considered as a relief from money stringency, we shall be doing it full justice if we picture it as a safety valve, working against a resistance so great as almost never to come into operation, and then only for brief transition intervals. For all practical purposes and all normal cases, we may a.s.sume that money and checks are necessities for modern trade."[196]

This contention seems to me untenable. I think it can easily be shown that barter remains an important factor in modern business life, especially if one extends the term barter, a little, to cover various flexible subst.i.tutes for the use of money and checks in effecting exchanges. Clearly from the standpoint of the present issue, such an extension of the meaning of barter is legitimate, as any such subst.i.tutes would equally spoil the proportionality in the supposed relation between prices and money, or prices and trade.

Where does one find barter? Well, not to be ignored would be the advertis.e.m.e.nts which fill many columns of such a paper as the New York _Telegram_ in the course of a week; "Wanted: to trade a well-trained parrot for a violin"--a trade that might, or might not, be a wise one!

There is a good deal of such simple barter among the people. Then, perhaps more important, is the regular practice of sewing machine, piano, automobile, and other similar companies of taking part of the payment for a new machine, piano,[197] or automobile in the similar thing which the owner is discarding. The old machine, piano, etc., are then repaired, repainted, and sold again. This is a very extensive practice. Again, there are companies which combine the business of wrecking old houses and building new ones, who regularly take the old materials as part of their pay. This is a highly important feature of the organized building trade in great cities, and is frequently done in small towns. The building trade is no negligible matter. The "horse-trade" still thrives in rural regions, and barter of various kinds, of live stock, of grain and hay, of fresh and cured meat, and of labor, is an important feature in rural life in many sections. Much of agricultural rent in the South is still paid in kind, under the "share system." Much labor, especially farm and domestic labor, is still paid for partly in kind. Where payments for labor are made in orders on company stores, we have again what is virtually barter, from the standpoint of the point at issue. _Real estate_ transactions make large use of barter. Farms are exchanged for one another, with some cash (or more usually, a promissory note) "to boot." The writer has repeatedly heard real estate men say to customers: "I can't sell it for you very easily, but I can trade it off, and maybe you can sell what you trade it for." This is perhaps more frequent in rural real estate transactions, and in the smaller cities, than in large cities, but it is very extensive in New York City.[198]

Again, when corporations are to be combined, various plans are possible.

There may be a merger; there may be a holding corporation; there may be a lease. If the money market is easy, one of the former methods will be used,--most frequently, for legal reasons, the holding corporation, if there are any valuable franchises involved. But mergers and holding corporations commonly involve buying out the interests which are to be absorbed, and call for the use of checks. If the money market is tight, therefore, the promoter of the combination may frequently find the lease the more advantageous form of consolidation.[199] The great advantage of the lease is that, when the money market is tight, it involves no _financial plan_, no underwriting, no outlay of "cash." This is, therefore, an equivalent of barter, so far as the point at issue is concerned. Even where a holding corporation is formed, however, there may be considerable barter: the stockholders of the corporation which is absorbed may receive payment for their stocks, in whole or in part, in the securities of the holding company, rather than in checks. An era of financial consolidation, such as we have been pa.s.sing through, and through which we have not by any means gone, though the movement toward _monopoly_ has been in great degree checked, presents a great deal of this sort of barter, or equivalents of barter.[200] A striking thing to notice here, moreover, is the flexible margin between use of bank-credit and barter, a margin depending primarily upon the condition of the money market, and particularly upon the money-rates.

Not yet has the most important element in modern barter been mentioned.

I refer to the "clearing-house" arrangements of the stock and produce exchanges. Under these arrangements, brokers who have sold ten thousand shares of Westinghouse El. and M. Common during the day, and bought seven thousand shares, buying and selling being in smaller lots, with a number of different houses, no longer are obliged to deliver ten thousand shares, receiving therefor $700,000, and to receive seven thousand shares, paying therefor $490,000. Instead, they deliver three thousand shares only to the clearing house, and receive from the clearing house only $210,000 when the transaction is, from the standpoint of the particular broker involved, completed. This is a far remove, in technical perfection, from primitive barter, but it is barter, and it saves the using of a vast deal of bank-credit as between brokers. How important it is, from the standpoint of the stock exchange, may be judged from the following statement in Sprague's _Crises Under the National Banking System_: "A much more fundamental change in the organization in the New York money market came with the establishment of the stock exchange clearing house in May, 1892. It led to a very considerable reduction in the _clearing-house exchanges of the banks_ and also, and more important, in the volume of certified checks.

[Italics mine.] Overcertification of checks ceased to be a factor of the first magnitude in the banking methods of the city. Had not this arrangement for stock-exchange dealings been set up, it is probable that it would have been necessary to close the stock exchange in 1893 and in 1907, and it is also probable that the volume of business transacted in the years after 1897 could not have been handled." (P. 152.)

The same arrangements have been widely introduced in other stock exchanges, and in the produce exchanges.[201]

In general, with reference to barter, this point is significant. The money economy has made barter _easier_ rather than harder. It has made possible a host of refinements in barter, which make it at many points more convenient and cheaper than check or money exchanges. It is common to find our present methods of conducting foreign trade described as a "system of refined barter," which indeed, from the standpoint of the present issue, it is: bills of exchange are neither money nor bank-credit! Where bills of exchange are used in internal trade extensively--as in Germany, where they pa.s.s from hand to hand in several transactions before being discounted at banks[202]--we have a highly important subst.i.tute for money and deposits, which functions as barter,--flexibility of subst.i.tutes for money and deposits is strikingly evident. The feature of the money economy which has thus refined and improved barter is the _standard of value_ (_common measure of value_) function of money.[203] This standard of value function, be it noted, makes no call on money itself, necessarily. The _medium of exchange_ and "_bearer of options_" functions of money are the chief sources of such additions to the value of money as come from the money-use. But the fact that goods have money-prices, which can be compared with one another easily, in objective terms, makes barter, and barter-equivalents, a highly convenient and very important feature of the most developed commercial system. And so we reject another essential a.s.sumption of the quant.i.ty theory.[204]

CHAPTER XII

VELOCITY OF CIRCULATION

For the quant.i.ty theory, it is important to treat velocity of circulation of money and of deposits, as self-contained ent.i.ties, really independent factors. This is true of Fisher's theory. It is particularly necessary that V and V' should vary from causes unconnected with M and M'. The V's are to be a sort of inflexible channel, through which M and M' run in their influence on the pa.s.sive P, which is to rise or fall proportionately with them. If an increase of M or M' should lead to a reduction in the V's, if people, having more money available, should be less a.s.siduous in using every bit of it in effecting exchanges, then P would not rise in proportion to the increase in M. Complete demonstration of Fisher's thesis, therefore, requires the proof of the negative proposition that V does not change as a consequence of changes in M or M'. This proof Fisher finds in the contention that the V's are fixed by the habits and conveniences of individuals, whence they are not influenced by such a cause as a change in the amount of money.[205]

V is defined,[206] not as the number of times a given dollar is exchanged in a given year (the "coin-transfer" notion), but as a social average based on the average number of coins which pa.s.s through _each man's_ hands, divided by the average amount held by him (the "person-turnover" concept of velocity.) V' is similarly defined. Fisher a.s.serts that both concepts, if correctly employed, lead to the same result. I would point out one important difference between them here: if money is _short-circuited_, if, _i. e._, a part of the economic community loses its incomes, or finds its incomes reduced, then the "velocity of money," on the "coin-transfer" basis is reduced, provided the "person-turnover" average remains the same, while on the "person-turnover" basis the velocity will remain unchanged. It is clearly the "coin-transfer" concept which is fundamental, from the standpoint of the equation of exchange, and Fisher feels justified in using the other method only because he considers it an equivalent of the "coin-transfer" concept. I shall later show cases where the distinction between the two concepts is all-important, particularly in the case where T is reduced by the elimination of _middlemen_.[207]

The conception of velocity of circulation as a real, unitary ent.i.ty, a _cause_, in the process of price-determination, is, I suppose, almost as old as the quant.i.ty theory itself. It is an essential part of the quant.i.ty theory. To me "velocity of circulation" seems to be a mere name, denoting, not any simple cause or small set of causes, which can exert a specific influence, but rather a meaningless abstract number, which is the non-essential by-product of a highly heterogeneous lot of _activities of men_, some of which work one way, and others of which work in another way, in affecting prices. It is at best a pa.s.sive _resultant_ of conflicting and divergent tendencies, and has, to my mind, no more _causal_ significance than the average of the abstract numbers of yards gained by both sides, heights and weights of players, kick-offs, and minutes taken out for injuries, would have on the result of the Yale-Harvard game. The real causes of changes in prices lie deeper! I should expect V and V' to be the most highly flexible factors in the equation of exchange, and should expect to be able to keep the equation straight, in a great variety of situations, by allowing the V's to vary.

Before undertaking detailed a.n.a.lysis of the causes governing V, I shall discuss Fisher's specific argument, typical of the quant.i.ty theory, that an increase of money cannot change the V's. "As a matter of fact, the velocities of circulation of money and deposits depend, as we have seen, on technical conditions, and bear no discoverable relation to the quant.i.ty of money in circulation. Velocity of circulation is the average rate of 'turnover,' and depends on countless individual rates of turnover. These, as we have seen, depend on individual _habits_. Each person regulates his turnover to suit his individual _convenience_....

In the long run, and for a large number of people, the average rate of turnover, or what amounts to the same thing, the average time money remains in the same hands, will be closely determined. It will depend on density of population, commercial _customs_, rapidity of transport, and other technical conditions, but not on the quant.i.ty of money and deposits nor on the price-level." (Italics mine.[208]) He proceeds to a.s.sume that money is doubled with a _halving_ of the V's, instead of a _doubling_ of P. Everybody now has on hand twice as much money _and deposits_ as his convenience has taught him to keep on hand. He will then try to get rid of this surplus, and he can only do it by buying goods. But this will increase somebody else's surplus, and he will likewise try to get rid of it. This will raise prices. "_Obviously_ this tendency will continue until there if found another adjustment of quant.i.ties to expenditures, and the _V's are the same as originally_."[209] The foregoing argument rests in part, it will be seen, on the a.s.sumption that a fixed ratio between M and M' obtains, else the increase of _money_ in everybody's hands would not mean a corresponding increase in their _deposits_. I have already criticised this doctrine. For the contention that the V's will finally be _just the same_ as before, I find no specific argument at all--"_obviously_"

presumably making that unnecessary.

As the point immediately at issue is that V's will be _unchanged_ by the increase in M (otherwise P would not increase _proportionately_--let us see if considerations can be adduced which will make this a little less "obvious." First, it will be noticed that Fisher, in the foregoing, in one sentence speaks of the matter as resting on _habit_, and in the next sentence, on _convenience_. He speaks, also, of business _custom_. Now it is important to note that habit and custom, on the one hand, and considerations of convenience on the other, do not necessarily coincide.

Many habits and customs are highly inconvenient. And it is not at all likely that habit and custom should govern so highly complex a thing as the ratio between cash on hand and the price-level. Rather, in so far as custom and habit rule, one would expect them to relate to a simpler matter, namely, the _amount of cash on hand_. If the amount of cash kept on hand should remain controlled by habit, while the amount of money is increased, then V, instead of remaining unchanged, would actually be increased, unless the habits should be broken in on. I shall show in a moment that considerations of convenience would probably lead to a reduced V, in so far as individual turnover is concerned. But which tendency will prevail? Well, that will depend on the degree to which custom and habit rule as compared with considerations of convenience--_i. e_., there would be no rule valid for all communities.

That convenience would lead to a larger amount of money on hand--and I am following Fisher's temporary hypothesis that there has been no rise in prices prior to the movement to restore the V's to their old magnitudes--will appear from considerations like these. Few men have as much on hand as they would like to have, including both their cash in hand and their deposit balances. Most people have the tendency to h.o.a.rd, though it is usually held in check by necessity. If money on hand be increased suddenly, without prices being increased, and without any prospect of increased incomes in the future--and there is nothing in Fisher's provisional hypothesis to call for increased incomes, as they could, in fact, come only from an increase in prices--why might not there be a considerable saving of money, with a corresponding reduction in V? If it be objected that people, in saving their money, will in considerable degree put it into the banks, and that the banks, with larger reserves, will increase loans and deposits, I would urge, that it is on the part of banks that this tendency to increase h.o.a.rds in times of abundant money is particularly marked, and for proof would point to the figures quoted from Keynes[210] for the great banks and treasuries of Europe in the last fifteen years. It is not necessary for my purpose at this point to do more than show that there is reason to expect an increase in money to _change_ the V's. Fisher's argument rests on the contention that the V's will be neither increased or reduced--otherwise an increase in money will not _proportionately_ raise prices. The appeal to habit and custom in the matter is particularly unsatisfactory. Custom and habit could not possibly regulate things so complex as velocities of money and bank-deposits.

Whatever be the ultimate effect of an increase in money, the immediate effect is commonly to reduce the money-rates. Banks have less inducement to pay interest on deposits, and charge lower rates for loans. Now merchants, especially small merchants, are often embarra.s.sed in making change for customers. The man who has tried to make payment with a ten dollar bill in a country store has not infrequently put the storekeeper to much inconvenience. To offer a ten dollar bill, or even a five dollar bill, to a storekeeper on Amsterdam Avenue in New York City may well mean that the one clerk in the establishment, or the proprietor's wife will run out with the bill to three or four neighboring stores before finding change with which to break it. If money is more abundant, if money-rates are easier, for a time, it may easily happen that many small merchants will experience the superior convenience of having a more adequate amount of change in the till, and will, even after the money-rates have risen--if they do rise again to the old figure--find a new reason for keeping more cash on hand. There is a marginal equilibrium between the interest on the capital invested in cash in the till, and the wages of the clerk,[211] whose active legs a.s.sist the velocity of money. Not only banks and small dealers, however, find it advantageous to increase their supply of ready funds, held idle for special occasions. The United States Steel Corporation has kept as much as $50,000,000.00 to $75,000,000.00 in idle cash or idle deposits, as a means of being independent of banks in times of emergency.[212] The motive for acc.u.mulating reserves and h.o.a.rds, either of cash or deposit accounts, is at all times strong. In times of financial ease, it may easily find the difficulties which ordinarily repress it give way, and, by being gratified, grow stronger.

I conclude that there is positive reason for expecting an increase of money to reduce the velocity of money.

Horace White, in his _Money and Banking_, in the earlier editions, speaks of the velocity of money, "_alias_ the state of trade." Is not this the truth? Is not money circulating rapidly, when business is active, and slowly when business is dull? Is not the velocity of circulation a highly flexible and variable average, a _cause_ of nothing, and an index of business activity? Or, better, perhaps, are not the V's and T both governed, in large degree, by more fundamental causes which are largely the same for both? Fisher would admit something of this for transition periods. Even for normal adjustments, he admits that an increase in T, unaccompanied by an increase in M, leads to some increase in the V's, though he doesn't say how much.[213] He denies, however, that an increase in the V's will increase T.[214] In general, it is clear that he regards the V's and T as governed by different causes. The control of the V's by T is not the only or the chief control of the V's. The V's can increase greatly without an increase of T, in his scheme. That this is so, will appear from a comparison of the list of causes which he gives as governing the V's and T respectively:

Causes governing V's: