200,000,000 loaves of bread at$ .10 a loaf,10,000,000 tons of coal at5.00 a ton, and30,000,000 yards of cloth at1.00 a yard.
The value of these transactions is evidently $100,000,000,i. e., $20,000,000 worth of bread plus $50,000,000 worth of coal plus $30,000,000 worth of cloth. The equation of exchange therefore (remember that the money side consisted of $5,000,000 exchanged 20 times) is as follows:
$5,000,000 × 20 times a year=200,000,000 loaves×$ .10 a loaf+10,000,000 tons×5.00 a ton+30,000,000 yards×1.00 a yard
This equation contains on the money side two magnitudes, viz. (1) the quantity of money and (2) its velocity of circulation; and on the goods side twogroupsof magnitudes in two columns, viz. (1) the quantities of goods exchanged (loaves, tons, yards), and (2) the prices of these goods. The equation shows that these four sets of magnitudes are mutually related. Because this equation must be fulfilled, the prices must bear a relation to the three other sets of magnitudes—quantity of money, rapidity of circulation, and quantities of goods exchanged. Consequently, these prices must, as a whole, vary proportionally with the quantity of money and with its velocity of circulation, and inversely with the quantities of goods exchanged.
Suppose, for instance, that the quantity of money were doubled, while its velocity of circulation and the quantities of goods exchanged remained the same. Then it would be quite impossible for prices to remain unchanged. The money side would now be $10,000,000 × 20 times a year or $200,000,000; whereas, if prices should not change, the goods would remain $100,000,000, and the equation would be violated. Since exchanges, individually and collectively, always involve an equivalentquid pro quo, the two sidesmustbe equal. Not only must purchases and sales be equal in amount—since every article bought by one person is necessarily sold by another—but the total value of goods sold must equal the total amount of money exchanged. Therefore, under the given conditions, prices must change in such a way as to raise the goods side from $100,000,000 to $200,000,000. This doubling may be accomplished by an even or uneven rise in prices but some sort ofa rise of prices there must be. If the prices rise evenly, they will evidently all be exactly doubled.... If the prices rise unevenly, the doubling must evidently be brought about by compensation; if some prices rise by less than double, others must rise by enough more than double to exactly compensate.
But whether all prices increase uniformly, each being exactly doubled, or some prices increase more and some less (so as still to double the total money value of the goods purchased), the pricesaredoubledon the average.... From the mere fact, therefore, that the money spent for goods must equal the quantities of those goods multiplied by their prices, it follows that the level of prices must rise or fall according to changes in the quantity of money,unlessthere are changes in its velocity of circulation or in the quantities of goods exchanged.
If changes in the quantity of money affect prices, so will changes in the other factors—quantities of goods and velocity of circulation—affect prices, and in a very similar manner. Thus a doubling in the velocity of circulation of money will double the level of prices, provided the quantity of money in circulation and the quantities of goods exchanged for money remain as before....
Again, a doubling in the quantities of goods exchanged will not double, but halve, the height of the price level,providedthe quantity of money and its velocity of circulation remain the same....
Finally, if there is a simultaneous change in two or all of the three influences,i. e., quantity of money, velocity of circulation, and quantities of goods exchanged, the price level will be a compound or resultant of these various influences. If, for example, the quantity of money is doubled, and its velocity of circulation is halved, while the quantity of goods exchanged remains constant, the price level will be undisturbed. Likewise, it will be undisturbed if the quantity of money is doubled and the quantity of goods is doubled, while the velocity of circulation remains the same. To double the quantity of money, therefore, is not always to double prices. We must distinctly recognize that the quantity of money is only one of three factors, all equally important in determining the price level....
We now come to the strict algebraic statement of the equation of exchange.... Let us denote the total circulation of money,i. e., the amount of money expended for goods in a given community during a given year, byE(expenditure); and the average amount of money in circulation in the community during the year byM(money).Mwill be the simple arithmetical average of the amounts of money existing at successive instants separated from each other by equal intervals of time indefinitely small. If we divide the year's expenditures,E, by the average amount of money,M, we shall obtain what is called the average rate of turnover of money in its exchange for goods,E/Mthat is, the velocity of circulation of money. This velocity may be denoted byV, so thatE/M=V; thenEmay be expressed asMV. In words: the total circulation of money in the sense of money expended is equal to the total money in circulation multiplied by its velocity of circulation or turnover.EorMV, therefore, expresses the money side of the equation of exchange. Turning to the goods side of the equation, we have to deal with the prices of goods exchanged and quantities of goods exchanged. Theaverage price of sale of any particular good, such as bread, purchased in the given community during the given year, may be represented byp(price); and the total quantity of it purchased, byQ(quantity); likewise the average price of another good (say coal) may be represented byp´and the total quantity of it exchanged, byQ´; the average price and the total quantity of a third good (say cloth) may be represented byp´´andQ´´respectively; and so on, for all other goods exchanged, however numerous. The equation of exchange may evidently be expressed as follows:
MV=pQ+p´Q´+p´´Q´´+ etc.
MV=pQ+p´Q´+p´´Q´´+ etc.
The right-hand side of this equation is the sum of terms of the formpQ—a price multiplied by a quantity bought. It is customary in mathematics to abbreviate such a sum of terms (all of which are of the same form) by using "Σ" as a symbol of summation. This symbol does not signify amagnitudeas do the symbolsM, V, p, Q, etc. It signifies merely theoperationof addition and should be read "the sum of terms of the following type." The equation of exchange may therefore be written:
MV= ΣpQ.
That is, the magnitudesE,M,V, thep's and theQ's relate to theentirecommunity and anentireyear; but they are based on and related to corresponding magnitudes for the individual persons of which the community is composed and for the individual moments of time of which the year is composed.
The algebraic derivation of this equation is, of course, essentially the same as the arithmetical derivation previously given. It consists simplyin adding together the equations for all individual purchases within the community during the year....
[We are now] ... prepared for the inclusion of bank deposits or circulating credit in the equation of exchange. Weshall still useMto express the quantity of actual money, andVto express the velocity of its circulation.[46]Similarly, we shall now useM´to express the total deposits subject to transfer by check; andV´to express the average velocity of circulation. The total value of purchases in a year is therefore no longer to be measured byMV, but byMV+M´V´´. The equation of exchange, therefore, becomes:
MV+M´V´= ΣpQ=PT[47]....
With the extension of the equation of monetary circulation to include deposit circulation, the influence exerted by the quantity of money on general prices becomes less direct; and the process of tracing this influence becomes more difficult and complicated. It has even been argued that this interposition of circulating credit breaks whatever connection there may be between prices and the quantity of money.[48]This would be true if circulating credit were independent of money. But the fact is that the quantity of circulating credit,M´, tends to hold a definite relation toM, the quantity of money in circulation; that is, deposits are normally a more or less definite multiple of money.
Two facts normally give deposits a more or less definite ratio to money. The first ... [is] that bank reserves are kept in a more or less definite ratio to bank deposits. The second is that individuals, firms, and corporations preserve more or less definite ratios between their cash transactions and their check transactions, and also between their money and deposit balances.[49]These ratios are determined by motives of individual convenience and habit. In general, business firmsuse money for wage payments, and for small miscellaneous transactions included under the term "petty cash"; while for settlements with each other they usually prefer checks. These preferences are so strong that we could not imagine them overridden except temporarily and to a small degree. A business firm would hardly pay car fares with checks and liquidate its large liabilities with cash. Each person strikes an equilibrium between his use of the two methods of payment, and does not greatly disturb it except for short periods of time. He keeps his stock of money or his bank balance in constant adjustment to the payments he makes in money or by check. Whenever his stock of money becomes relatively small and his bank balance relatively large, he cashes a check. In the opposite event, he deposits cash. In this way he is constantly converting one of the two media of exchange into the other. A private individual usually feeds his purse from his bank account; a retail commercial firm usually feeds its bank account from its till. The bank acts as intermediary for both.
In a given community the quantitative relation of deposit currency to money is determined by several considerations of convenience. In the first place, the more highly developed the business of a community, the more prevalent the use of checks. Where business is conducted on a large scale, merchants habitually transact their larger operations with each other by means of checks, and their smaller ones by means of cash. Again, the more concentrated the population, the more prevalent the use of checks. In cities it is more convenient both for the payer and the payee to make large payments by check; whereas, in the country, trips to a bank are too expensive in time and effort to be convenient, and therefore more money is used in proportion to the amount of business done. Again, the wealthier the members of the community, the more largely will they use checks. Laborers seldom use them; but capitalists, professional and salaried men use them habitually, for personal as well as business transactions.
There is, then, a relation of convenience and custom between check and cash circulation, and a more or less stable ratio between the deposit balance of the average man or corporation and the stock of money kept in pocket or till. Thisfact, as applied to the country as a whole, means that by convenience a rough ratio is fixed betweenMandM´. If that ratio is disturbed temporarily, there will come into play a tendency to restore it. Individuals will deposit surplus cash, or they will cash surplus deposits.
Hence, both money in circulation ... and money in reserve ... tend to keep in a fixed ratio to deposits. It follows that the two must be in a fixed ratio to each other.
It further follows that any change inM, the quantity of money in circulation, requiring as it normally does a proportional change inM´, the volume of bank deposits subject to check, will result in an exactly proportional change in the general level of prices except, of course, so far as this effect be interfered with by concomitant changes in theV's or theQ's. The truth of this proposition is evident from the equationMV+M´V´= ΣpQ; for if, say,MandM´are doubled, whileVandV´remain the same, the left side of the equation is doubled and therefore the right side must be doubled also. But if theQ's remain unchanged, then evidently all thep's must be doubled, or else if some are less than doubled, others must be enough more than doubled to compensate....
The factors in the equation of exchange are ... continually seeking normal adjustment. A ship in a calm sea will "pitch" only a few times before coming to rest, but in a high sea, the pitching never ceases. While continually seeking equilibrium, the ship continually encounters causes which accentuate the oscillation. The factors seeking mutual adjustment are money in circulation, deposits, their velocities, theQ's and thep's. These magnitudes must always be linked together by the equationMV+M´V´= ΣpQ. This represents the mechanism of exchange. But in order to conform to such a relation the displacement of any one part of the mechanism spreads its effects during the transition periods [i.e., periods of rising or falling prices] over all parts. Since periods of transition are the rule and those of equilibrium the exception, the mechanism of exchange is almost always in a dynamic rather than a static condition....[50]
[51]It is interesting to make a quantitative comparison of the various magnitudes with the increase in the quantity of money as the most important factor in raising the price level. While it is true, as shown by the diagram, that the volume of deposits subject to check has increased greatly, the major part of the increase has to be ascribed to the increase in the quantity of money. Only so far as the volume of deposits subject to check has increased relatively to the money in circulation, can the increase of deposits be regarded as an independent cause of the rise in prices. We have thus to consider the relative importance of the five causes affecting prices:
1. The quantity of money in circulation (M).
2. The volume of bank deposits subject to check considered relatively to money (M´/M).
3. The velocity of the former (V´).
4. The velocity of the latter (V).
5. The volume of trade (T).
We may best compare the relative importance of these five magnitudes by answering the question: What would the result have been had any one of these magnitudes remained unchanged, assuming that the other four changed in the same manner that they actually did change. We find (1) that if the money in circulation, M, had not changed, between the years 1896 and 1909, for example, the price level of 1909 would have been 45 per cent. lower than it actually was; (2) that if M´/M, the relative deposits, had not changed, during the same period the price level in 1909 would have been 23 per cent. lower than it actually was; (3) if the velocity of circulation of money, V, had not changed, the price level for 1909 would have been 1 per cent. lower; (4) if the velocity of circulation of deposits, V´, had not changed, the price level in 1909 would have been 28 per cent. lower; (5) if T had notchanged, the price level in 1909 would have been 106 per cent.higher.
Thus the changes in the first four factors have tended to raise prices, while the change in T has tended to lower prices. The relative importance of the four price-raising causes may be stated in terms of the per cent. already given which represents how much lower prices would have been except for each of these causes separately considered. According to this test we find the relative importance of the four price-raising factors to be as follows:
The importance of V is represented by 1,
The importance of M´/M is represented by 23,
The importance of V is represented by 28,
The importance of M is represented by 45.
That is, the increase in the quantity of money had an importance nearly double that of any other one price-raising factor, during the period mentioned.
Thus far we have considered the level of prices as affected by the volume of trade, by the velocities of circulation of money and of deposits, and by the quantities of money and of deposits. These are the only influences which candirectlyaffect the level of prices. Any other influences on prices must act through these five. There are myriads of such influences (outside of the equation of exchange) that affect prices through these five. It is our purpose ... to note the chief among them....
We shall first consider the outside influences that affect the volume of trade and, through it, the price level. The conditions which determine the extent of trade are numerous and technical. The most important may be classified as follows:
1.Conditions affecting producers.
(a) Geographical differences in natural resources.
(b) The division of labor.
(c) Knowledge of the technique of production.
(d) The accumulation of capital.
2.Conditions affecting consumers.
(a) The extent and variety of human wants.
3.Conditions connecting producers and consumers.
(a) Facilities for transportation.
(b) Relative freedom of trade.
(c) Character of monetary and banking systems.
(d) Business confidence.
1 (a). It is evident that if all localities were exactly alike in their natural resources, in other words, in their comparative costs of production, no trade would be set up between them.... Cattle raising in Texas, the production of coal in Pennsylvania, of oranges in Florida, and of apples in Oregon have increased the volume of trade for these communities respectively.
1 (b). Equally obvious is the influence of the division of labor....
1 (c).... The state of knowledge of production will affect trade. Vast coal fields in China await development, largely for lack of knowledge of how to extract and market the coal. Egypt awaits the advent of scientific agriculture, to usher in trade expansion. Nowadays, trade schools in Germany, England, and the United States are increasing and diffusing knowledge of productive technique.
1 (d). But knowledge, to be of use, must be applied; and its application usually requires the aid of capital. The greater and the more productive the stock or capital in any community, the more goods it can put into the currents of trade....
Since increase in trade tends to decrease the general level of prices, anything which tends to increase trade likewise tends to decrease the general level of prices. We conclude, therefore, that among the causes tending to decrease prices are increasing geographical or personal specialization, improved productive technique, and the accumulation of capital. The history of commerce shows that all these causes have been increasinglyoperative during a long period including the last century. Consequently, there has been a constant tendency, from these sources at least, for prices to fall.
2 (a).... An increase of wants, by leading to an increase in trade, tends to lower the price level. Historically, during recent times through invention, education, and the emulation coming from increased contact in centers of population, there has been a great intensification and diversification of human wants and therefore increased trade. Consequently, there has been from these causes a tendency of prices to fall.
3 (a). Anything which facilitates intercourse tends to increase trade. Anything that interferes with intercourse tends to decrease trade. First of all, there are the mechanical facilities for transport. As Macaulay said, with the exception of the alphabet and the printing press, no set of inventions has tended to alter civilization so much as those which abridge distance,—such as the railway, the steamship, the telephone, the telegraph, and that conveyer of information and advertisements, the newspaper. These all tend, therefore, to decrease prices.
3 (b). Trade barriers are not only physical but legal. A tariff between countries has the same influence in decreasing trade as a chain of mountains. The freer the trade, the more of it there will be....
3 (c). The development of efficient monetary and banking systems tends to increase trade. There have been times in the history of the world when money was in so uncertain a state that people hesitated to make many trade contracts because of the lack of knowledge of what would be required of them when the contract should be fulfilled. In the same way, when people cannot depend on the good faith or stability of banks, they will hesitate to use deposits and checks.
3 (d). Confidence, not only in banks in particular, but in business in general, is truly said to be "the soul of trade." Without this confidence there cannot be a great volume of contracts. Anything that tends to increase this confidence tends to increase trade....
We see, then, that prices will tend to fall through increase in trade, which may in turn be brought about by improvedtransportation, by increased freedom of trade, by improved monetary and banking systems, and by business confidence. Historically, during recent years, all of these causes have tended to grow in power, except freedom of trade....
Having examined those causes outside the equation which affect the volume of trade, our next task is to consider the outside causes that affect the velocities of circulation of money and of deposits. For the most part, the causes affecting one of these velocities affect the other also. These causes may be classified as follows:
1.Habits of the individual.
(a) As to thrift and hoarding.
(b) As to book credit.
(c) As to the use of checks.
2.Systems of payments in the community.
(a) As to frequency of receipts and of disbursements.
(b) As to regularity of receipts and disbursements.
(c) As to correspondence between times and amounts of receipts and disbursements.
3.General causes.
(a) Density of population.
(b) Rapidity of transportation.
1 (a). Taking these up in order, we may first consider what influence thrift has on the velocity of circulation. Velocity of circulation of money is the same thing as its rate of turnover. It is found by dividing the total payments effected by money in a year by the amount of money in circulation in a year. It depends upon the rates of turnover of the individuals who compose the society. This velocity of circulation or rapidity of turnover of money is the greater for each individual the more he spends, with a given average amount of cash on hand; or the less average cash he keeps, with a given yearly expenditure....
1 (b). The habit of "charging,"i.e., using book credit, tends toincreasethe velocity of circulation of money, because the man who gets things "charged" does not need to keepon handas much money as he would if he made all payments in cash. A man who payscashdaily needs to keep cash for daily contingencies. The system of cash payments, unlike the system of book credit, requires that money shall be kept on handin advanceof purchases. Evidently, if money must be provided in advance, it must be provided in larger quantities than when merely required to liquidate past debts....
But we have seen that to increase the rate of turnover will tend to increase the price level. Therefore, book credit tends to increase the price level....
1 (c). The habit of using checks rather than money will also affect the velocity of circulation; because a depositor's surplus money will immediately be put into the bank in return for a right to draw by check....
We see, then, that three habits—spendthrift habits, the habit of charging, and the habit of using checks—all tend to raise the level of prices....
2 (a). The more frequently money or checks are received and disbursed, the shorter is the average interval between the receipt and the expenditure of money or checks and the more rapid is the velocity of circulation.
This may best be seen from an example. A change from monthly to weekly wage payments tends to increase the velocity of circulation of money. If a laborer is paid weekly $7 and reduces this evenly each day, ending each week empty-handed, his average cash ... would be a little over half of $7, or about $4. This makes his turnover nearly twice a week. Under monthly payments the laborer who receives and spends an average of $1 a day will have to spread the $30 more or less evenly over the following 30 days. If, at the next pay day, he comes out empty-handed, his average money during the month has been about $15. This makes his turnover about twice a month. Thus the rate of turnover is more rapid under weekly than under monthly payments....
Frequency of disbursements evidently has an effect similar to the effect of frequency of receipts;i.e., it tends to accelerate the velocity of turnover, or circulation.
2 (b).Regularityof payments also facilitates the turnover. When the workingman can be fairly certain of both his receiptsand expenditures, he can, by close calculation, adjust them so precisely as safely to end each payment cycle with an empty pocket. This habit is extremely common among certain classes of city laborers. On the other hand, if the receipts and expenditures are irregular, either in amount or in time, prudence requires the worker to keep a larger sum on hand, to insure against mishaps.... We may, therefore, conclude that regularity, both of receipts and of payments, tends to increase velocity of circulation.
2 (c). Next, consider the synchronizing of receipts and disbursements,i. e., making payments at the same intervals as obtaining receipts.... This arrangement obviates the necessity of keeping much money or deposits on hand, and therefore increases their velocity of circulation....
3 (a). The more densely populated a locality, the more rapid will be the velocity of circulation.
There is definite evidence that this is true of bank deposits. The following figures give the velocities of circulation of deposits in ten cities, arranged in order of size:
Paris116Berlin161Brussels123Madrid14Rome43Lisbon29Indianapolis30New Haven16Athens4Santa Barbara1
Madrid is the only city seriously out of its order in respect to velocity of circulation.
3 (b). Again the more extensive and the speedier the transportation in general, the more rapid the circulation of money. Anything which makes it easier to pass money from one person to another will tend to increase the velocity of circulation. Railways have this effect.... Mail and express, by facilitating the transmission of bank deposits and money, have likewise tended to increase their velocity of circulation.
We conclude, then, that density of population and rapidity of transportation have tended to increase prices by increasing velocities. Historically this concentration of population in cities has been an important factor in raising prices in the United States....
[53]The purchasing power ... of money has been studied as the effect of five, and only five, groups of causes. The five groups are money, deposits, their velocities of circulation, and the volume of trade. These and their effects, prices, we saw to be connected by an equation called the equation of exchange,MV + M'V' = ΣpQ. The five causes, in turn,... are themselves effects of antecedent causes lying entirely outside of the equation of exchange, as follows: the volume of trade will be increased, and therefore the price level correspondingly decreased by the differentiation of human wants; by diversification of industry; and by facilitation of transportation. The velocities of circulation will be increased, and therefore also the price level increased by improvident habits; by the use of book credit; and by rapid transportation. The quantity of money will be increased and therefore the price level increased correspondingly by the import and minting of money, and, antecedently, by the mining of the money metal; by the introduction of another and initially cheaper money metal through bimetallism; and by the issue of bank notes and other paper money. The quantity of deposits will be increased, and therefore the price level increased by extension of the banking system and by the use of book credit. The reverse causes produce, of course, reverse effects.
Thus, behind the five sets of causes which alone affect the purchasing power of money, we find over a dozen antecedent causes. If we chose to pursue the inquiry to still remoter stages, the number of causes would be found to increase at each stage in much the same way as the number of one's ancestors increases with each generation into the past. In the last analysis myriads of factors play upon the purchasing power of money; but it would be neither feasible nor profitable to catalogue them. The value of our analysis consists rather in simplifying the problem by setting forth clearly the five proximate causes through which all others whatsoever must operate. At the close of our study, as at the beginning, stands forth the equation of exchange as the great determinant of the purchasing power of money.
J. Laurence Laughlin[54]: To my mind, the following propositions contain the essence of the theory of prices.... As every one will appreciate, only general statements, without any limiting qualifications to speak of, can be given in so small a compass.
1. The price of a commodity is measured by the quantity of a given standard for which it will exchange.
2. A change of prices may be due to changes in the conditions affecting the supply (thus including expenses of production) of goods, as well as to changes in the demand for and supply of gold. A statistical statement of a change of price is not a statement of the cause of the change.
3. Probably there is not so much difference of opinion regarding the theory of prices as is sometimes supposed. Other causes being supposed constant, an increased supply of gold would tend to raise prices. No one can fail to see that, if by "money" is meant gold, a change in its quantity would, other things being equal, be a factor affecting prices. An increasing demand for gold, however, would work against the effect of an increasing supply. If the new demand offset the new supply, then, if changes of prices occurred, their cause must be sought in the influences touching the producing and marketing of goods.
4. The effective demand for goods (granting their utility) is limited by the buyer's purchasing power. This purchasing power is not identical with the quantity of the media of exchange in circulation, any more than the value of the total exchangeable wealth of the community is identical with the value of the total money in circulation.
5. The general level of prices is not independent of particular prices; since there can be no such thing as a general level, or average, of prices which is not the resultant of a number of particular prices each arrived at by individual buyers and sellers. The causes of price changes must be sought in the forces settling particular prices. This does not exclude theconsideration of any causes affecting the value of the standard in which the prices of goods are expressed, because the standard is itself a particular commodity.
6. In particular cases, competitive prices in this country are arrived at by the higgling of the market, which depends on buyers' and sellers' judgment of the demand and supply of the commodity (e. g., wheat); and, when the price is fixed, the credit medium by which the commodity is passed from seller to buyer comes easily and naturally into existence and, of course, for a sum exactly equaling the price agreed upon, multiplied by the number of units of goods. Price-making generally precedes the demand upon the media of exchange, and does not at all imply any necessary demand at the moment upon the standard in which the prices are expressed (cf. 10).
7. The offer of "money" for goods is only a resultant of price-making forces previously at work, and does not measure the demand for goods (cf. 6). That is, the quantity of the actual media of exchange thus brought into use is a result and not a cause of the price-making process. The supposed offer of money has no money as its basis, but is only the offer of a purchasing power, previously existing, based on saleable goods, which at the moment of payment appears expressed in terms of the standard. By credit devices the actual transfer of the standard is reduced to an inconsiderable minimum. In reality (as in foreign trade) goods are exchanged against goods.
8. The effect of credit on prices is to be found mainly in banking facilities by which goods are coined into means of payment, so that, expressed in terms of the standard gold, they may be exchanged against each other. Thus credit devices relieve the standard to an incredibly great degree from the demand for the use of gold as a medium of exchange, and thus remove a demand, as trade increases, which would otherwise have enormously affected the value of gold. Thus the effect of credit on the general level of prices in considerable periods of time is shown by a tendency to reduce the demand on the standard gold, and hence to prevent the tendency toward falling prices.
9. A general proposition is that banks are limited in making loans by the possession of capital, a bank of large capital and deposits being able to make large loans, a bank of small capital and deposits, small loans. A second proposition is that the demand for legitimate loans varies with the exchanges of goods and collateral and the opportunities for investment. With an increasing activity in business, however—either sound or speculative—the expansion of loans is limited by the resources of the bank. Next, a bank trying to carry a certain amount of loans, must hold a specified proportion of reserves to demand liabilities under the rule of banking experience or law. The amount of its capital and the funds left with it determine the relative size of its loan item; and the sum of its loans and resultant deposits determine the amount of its reserves. The reserves of a bank are thus a consequence of the loan operations. This conclusion, however, as it affects the practical problem of the present day, is not, in my opinion, invalidated by the conceivable cases arising, when business tends to outrun banking facilities, in which anything that makes increasing reserves possible would increase the power of the banks to lend. When gold becomes increasingly abundant, the banks having large resources more easily get the gold reserves needed for their operations. It still remains true that the fact of an increased supply of gold does not of itself increase loans, unless conditions of business demand an increase in loans. Therefore, the expansion of business is not a necessary consequence of an increasing supply of gold, any more than an expansion of railway traffic is the necessary consequence of an increasing supply of cars. If increasing goods are in existence to be transported, then, of course, there is an increasing demand for cars. Likewise, if there are more bank resources and loans, there is an increasing demand for that which is lawful reserve; from which it is claimed that the use of new gold in bank reserves, under present conditions, is not the significant causal force which expands business and raises prices (although it may be contemporary with it).
10. The problem of explaining the general level of prices is one of arriving at the adjustment between two terms of a ratio (the standard on the one side, and goods on the other),each of which is influenced by supply and demand. Gold being one, and goods being many, a cause working on gold alone, and important enough to show an appreciable effect, might explain a general movement of prices. In practical operation, however, because of the large existing stock of gold, very considerable additions may take place in the supply of gold without materially changing the world value of gold as related to goods in general. Rapid changes of prices are hence more likely to be due to influences in the market for goods, to speculative changes of demand for goods, or to psychological forces working independently of facts....
In the problem of discovering the causes of changes in the level of prices, it is necessary first to reach a conclusion as to those causes which operate on the gold standard in which our prices are expressed. By so doing we may locate the general level—so far as the standard is concerned—or the one thing which might work as a cause common to all goods. The relation between gold and goods might be illustrated by the familiar mechanical illustration: a rod balanced on a fulcrum, on one end of which works the forces affecting the value of gold, and on the other end the forces affecting the value of particular goods. The relation between goods and gold being a ratio, as one end of the rod goes up, the other necessarily goes down.
There are, as we all know, various forces at work to produce the resultant price level. We may here start from a proposition on which we can all agree. An increase in the quantity of the monetary standard in the world—such as gold—would tend,other things being equal, to lower its value and thus raise prices. In trying to find the causes in the price level at any given time (as in 1896-1909) it is necessary, therefore, after stating the facts as to the increase of gold, to examine into the influence of "the other things."
To begin, we may take up the demand for gold, which, of course, is both monetary and non-monetary. First as to the non-monetary uses, such as abrasion, shipwreck, and disappearance in the arts: The statistics of consumption in the arts are unsatisfactory; at the best they are only estimates. Although the total production of the world, 1493-1850, was $3,158,000,000, there is no evidence as to the available stock in 1850.My belief is that there was not more than $2,000,000,000.[55]In the period of 1851-1895, the production was $5,641,000,000, and the consumption in the arts, at the average rate of $50,000,000 a year requires a deduction of $2,250,000,000, which leaves $3,391,000,000. The arts in recent years are estimated to use more than $100,000,000.[56]In the period, 1896-1905, if $1,000,000,000 be deducted from the production of $2,899,000,000 we have $1,899,000,000. Thus the total available stock in 1905 would be about $7,690,000,000. The production of the last four years, 1906-1910, is about $1,600,000,000, or, less the consumption in the arts, about $1,200,000,000.
The monetary demand for gold, on the other hand, has shown certain definite characteristics. Whether it be prejudice, or enlightened business judgment, the commercial nations of the world have shown a persistent and continuing disposition to adopt a gold monetary system as soon as their own means, or the forthcoming supply of gold, has made it possible. The United States led in 1853, when we declined to change the ratio in order to bring silver into circulation when only gold was in use. From 1871-3, Germany, the countries of the Latin Union, Austria-Hungary, the United States (with the resumption in gold in 1879), and India (in 1893), in response to the preferences of the commercial world, placed themselves on the gold standard by legal enactments. The demand for gold all through this period was based upon considerations independent of the movement of prices. For this was a time of falling prices when much was heard of the appreciation of gold and the need of silver. In spite of this tendency toward falling prices, the movement toward the adoption of gold went on.... It was precisely this large new supply of gold which enabled the commercial nations to gratify their desire for what they believed was a more stable standard.
As we enter the present period (1896-1909) we find this momentum towards the gold standard still in force: and other countries in emulation planned to put themselves on an equallystable standard with those whose means had permitted an earlier action—quite irrespective of the fact that this last was a period of rising prices, while the former was one of falling prices. In this period, Russia, Japan, various states in South America, such as Peru, Argentina, and Brazil, and recently Mexico, have emphasized the movement away from silver to gold. Moreover, as backward lands, like Turkey, parts of Asia, Egypt, and various districts of Africa, have developed their resources and increased their trade, they have taken on gold in their monetary systems. With increasing trade also there are more exchanges of goods; hence, even in countries (like Great Britain and the United States) that do not use gold to speak of, except in reserves, there are increasing loans and deposits and thus a demand for more gold reserves. Consequently, in countries long ago established on the gold standard there will be a steadily increasing demand for gold as exchanges expand. We find thus a special characteristic of the demand for gold (certainly not existing in the demand for silver). The power of developing countries to soak up new gold is as marked a part of present conditions as is the power of a porous and sandy soil to soak up a heavy rainfall. We must, therefore, take full account of the noticeable fact that the recent demand for gold seems about to keep pace with the new supply; that a shipment of gold from the mines to London is to-day eagerly competed for, not only by European countries, but by Egypt, India, Turkey, Argentina, and Brazil.
Consequently it may be of interest to see which countries have taken the largest amounts of gold into their stocks since 1895: