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The Purchasing Power of Money; Fisher, Irving
14 paragraphs found.
Chapter 8

We saw also that an increase of M during a period of rising prices stimulated the Q's. Finally we saw that a reduction in M caused the reverse effects of those above set forth, decreasing V and V', decreasing M' not absolutely only, but in relation to M, and decreasing the Q's partly because of the disinclination to sell at low money prices which are believed to be but temporary, partly because of a slight substitution of barter for sales; for if M should be very suddenly reduced, some way would have to be found to keep trade going, and barter would be temporarily resorted to in spite of its inconvenience. This would bring some relief, but its inconvenience would lead sellers to demand money whenever possible, and prospective buyers to supply themselves therewith. The great pressure to secure money would enhance its value—that is, would lower the prices of other things. This resultant fall of prices would make the currency more adequate to do the business required, and make less barter necessary. The fall would proceed until the abnormal pressure, due to the inconvenience of barter, had ceased. Practically, however, in the world of 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 assume that money and checks are necessities for modern trade.


One reason has already been cited, the fear to give aid and comfort to the enemies of all sound economists,—the unsound money men. Another may now receive attention, viz. the fallacious idea that the price level cannot be determined by other factors in the equation of exchange because it is already determined by other causes, usually alluded to as "supply and demand." This vague phrase has covered multitudes of sins of slothful analysts in economics. Those who place such implicit reliance on the competency of supply and demand to fix prices, irrespective of the quantity of money, deposits, velocity, and trade, will have their confidence rudely shaken if they will follow the reasoning as to price causation of separate articles. They will find that there are always just one too few equations to determine the unknown quantities involved. *7 The equation of exchange is needed in each case to supplement the equations of supply and demand.


The legitimacy of separating the study of price levels from that of prices will be clearly recognized, when it is seen that individual prices cannot be fully determined by supply and demand, money cost of production, etc., without surreptitiously introducing the price level itself. We can scarcely overemphasize the fact that the "supply and demand" or the "cost of production" of goods in terms of money do not and cannot completely determine prices. Each phrase, fully expressed, already implies money. There is always hidden somewhere the assumption of a general price level. Yet writers, like David A. Wells, *8 have seriously sought the explanation of a general change in price levels in the individual price changes of various commodities considered separately. Much of their reasoning goes no farther than to explain one price in terms of other prices. If we attempt to explain the money price of a finished product in terms of the money prices of its raw materials and other money costs of prices of production, it is clear that we merely shift the problem. We have still to explain these antecedent prices. In elementary textbooks much emphasis is laid on the fact that "demand" and "supply" are incomplete designations and that to give them meaning it is necessary to add to each the phrase "at a price."But emphasis also needs to be laid on the fact that "demand at a price" and "supply at a price" are still incomplete designations, and that to give them meaning it is necessary to add "at a price level." The demand for sugar is not only relative to the price of sugar, but also to the general level of other things. Not only is the demand for sugar at ten cents a pound greater than the demand at twenty cents a pound (at a given level of prices of other things), but the demand at twenty cents at a high level of prices is greater than the demand at twenty cents at a low level of prices. In fact if the price level is doubled, the demand at twenty cents a pound will be as great as the demand was before at ten cents a pound, assuming that the doubling applies likewise to wages and incomes generally. The significance of a dollar lies in what it will buy; and the equivalence between sugar and dollars is at bottom an equivalence between sugar and what dollars will buy. A change in the amount of what dollars will buy is as important as a change in the amount of sugar. The price of sugar in dollars depends partly on sugar and partly on dollars,—that is, on what dollars will buy—that is, on the price level. Therefore, beneath the price of sugar in particular there lies, as one of the bases of that particular price, the general level of prices. We have more need to study the price level preparatory to a study of the price of sugar than to study the price of sugar preparatory to a study of the price level. We cannot explain the level of the sea by the height of its individual waves; rather must we explain in part the position of these waves by the general level of the sea. Each "supply curve" or "demand curve" rests upon the unconscious assumption of a price level already existing. Although the curves relate to a commodity, they relate to it only as compared with money. A price is a ratio of exchange between the commodity and money. The money side of each exchange must never be forgotten nor the fact that money already stands in the mind of the purchaser for a general purchasing power. Although every buyer and seller who bids or offers a price for a particular commodity tacitly assumes a given purchasing power of the money bid or offered, he is usually as unconscious of so doing as the spectator of a picture is unconscious of the fact that he is using the background of the picture against which to measure the figures in the foreground. As a consequence, if the general level changes, the supply and demand curves for the particular commodity considered will change accordingly. If the purchasing power of the dollar is reduced to half its former amount, these curves will be doubled in height; for each person will give or take double the former money for a given quantity of the commodity. If, through special causes affecting a special commodity, the supply and demand curves of that commodity and their intersection are raised or lowered, then the supply and demand curves of some other goods must change in the reverse direction. That is, if one commodity rises in price (without any change in the quantity of it or of other things bought and sold, and without any change in the volume of circulating medium or in the velocity of circulation), then other commodities must fall in price. The increased money expended for this commodity will be taken from other purchases. In other words, the waves in the sea of prices have troughs. This can be seen from the equation of exchange. If we suppose the quantity of money and its velocity of circulation to remain unaltered, the left side of the equation remains the same, and therefore the right side must remain unaltered also. Consequently, any increase in one of its many terms, due to an increase of any individual price, must occur at the expense of the remaining terms.


We have seen that the price level is not determined by individual prices, but that, on the contrary, any individual price presupposes a price level. We have seen that the complete and only explanation of a price level is to be sought in factors of the equation of exchange and whatever antecedent causes affect those factors. The terms "demand" and "supply," used in reference to particular prices, have no significance whatever in explaining a rise or fall of price levels. In considering the influence affecting individual prices we say that an increase in supply lowers prices, but an increase in demand raises them. But in considering the influences affecting price levels we enter upon an entirely different set of concepts, and must not confuse the proposition that an increase in the trade (the Q's) tends to lower the price level, with the proposition that an increase in supply tends to lower an individual price. Trade (the Q's) is not supply—in fact is no more to be associated with supply than with demand. The Q's are the quantities finally sold by those who supply, and bought by those who demand.

Chapter 9

Besides the dispersion of price changes produced by the fact that some prices respond more readily than others to changes in the factors determining price levels, M,M', V,V', and the Q's, a further dispersion is produced by the fact that the special forces of supply and demand are playing on each individual price, and causing relative variations among them. Although these forces do not, as we have before emphasized, necessarily affect the general price level, they do affect the number and extent of individual divergencies above and below that general level. Each individual price will have a fluctuation of its own.


Among the special factors working through supply and demand, changes in the rate of interest should be particularly mentioned. Whether or not due to monetary changes, a movement of interest will tend to make the prices of different things vary in different directions or to different extents. The prices of all goods, the benefits of which accrue in the remote future, depend on the rate of interest. The standard example is that of bonds and other securities. Another good example is that of real estate. In the case of farm lands yielding a constant rental, a reduction of interest causes an increase of value in the inverse ratio. If interest falls from 5 per cent to 4 per cent, the value will increase in the ratio 4 to 5. If the benefits or services are not constant each year, but are massed together in the remote future, the price may be still sensitive to a change in the rate of interest. In the case of land used for forest growing from which the trees are to be cut in half a century, the value will be extremely sensitive. A fall in interest from 5 per cent to 4 per cent will cause a rise of the value of the land, in the ratio not of 4 to 5, but nearly of 4 to 7. *16 On the other hand, mining land or quarries with a limited life will be less sensitive. The same is true of dwellings, machinery, fixtures, and other durable but not indestructible instruments, and so on down the scale until we reach perishable and transient commodities, such as food and clothing, which are only indirectly affected by changes in the rate of interest.


Corresponding to changes in an individual price there will be changes in the quantity of the given commodity which is exchanged at that price. In other words, as each p changes, the Q connected with it will change also; this, because usually any influence affecting the price of a commodity will also affect the consumption of it. Changes in supply or demand or both make changes in the quantity exchanged. Otherwise expressed, the point of intersection of the supply and demand curve may move laterally as well as vertically.


In this chapter we have seen that prices do not, and in fact cannot, move in perfect unison. The reasons for dispersion are principally three: (1) Many prices are restrained by previous contract, by legal prohibition, or by force of custom. (2) Some prices are intimately related to the money metal. (3) Each individual price is subject to special variation under the influence of its particular supply and demand. There exists, however, a compensation in price movements in the sense that the failure of one set of prices to respond to any influence on the price level will necessitate a correspondingly greater change in other prices.

Chapter 10

The manner in which each person allows for such future changes as he can foresee is by adjusting the size of loans he makes or takes and the rate of interest thereon. If the average income is rising, the borrower can afford to repay more and the lender should receive more; while, if the average income is falling, the amount paid should be less. The fact is that such are the tendencies where the rise or fall of average income is foreseen. If the average income is rising, the lender will be less anxious to deplete his present income, which is relatively meager, in order to increase his future income, which he sees will probably be larger anyway. Thus, increasing prosperity (by which is meant, not great prosperity, but growing prosperity) tends to restrict the supply of loans. At the same time, it tends to increase the demand and so raise interest. Conversely, a decreasing average income will tend to lower interest. *42

Chapter 12

We conclude that the "rise in the cost of living" is no special movement of food prices nor, presumably, of other particular prices, but is merely a part of the general movement of prices. The cost of living is swept along with the general rising tide of prices of all sorts. It indicates little or no special change in the supply or demand of special classes of goods, but simply reflects the fall in the general purchasing power of money. These remarks apply not simply to the months beginning with January, 1909, but back to 1908. Back of 1908 food prices move somewhat irregularly as compared with general prices, but on the whole maintain an approximately even pace from 1897 to 1909.

Chapter 13

Another plan is a convertible paper currency, the paper to be redeemable on demand,—not in any required weight or coin of gold, but in a required purchasing power thereof. Under such a plan, the paper money would be redeemed by as much gold as would have the required purchasing power. Thus, the amount of gold obtainable for a paper dollar would vary inversely with its purchasing power per ounce as compared with commodities, the total purchasing power of the dollar being always the same. The fact that a paper dollar would always be redeemable in terms of purchasing power would theoretically keep the level of prices invariable. The supply of money in circulation would regulate itself automatically. Should money tend to increase fast enough to impair its purchasing power, the notes would be presented for redemption in gold; for under the arrangement assumed, the gold which would be given would always have the same purchasing power. Should the money tend to become scarce and thus to appreciate, the amount of gold having unchanged purchasing power would be exchanged for the notes.


Several methods were next considered by which a government might regulate the quantity of money relatively to business so as to keep the level of prices constant. One such method was to make inconvertible paper the standard money, and to regulate its quantity. Another was to regulate the supply of metallic money by a varying seigniorage charge. Still another was to issue paper money, redeemable on demand, not in fixed amounts of the basic precious metal, but in varying amounts, so calculated as to keep the level of prices unvarying. Lastly was considered the proposal of the writer,—to adopt the gold-exchange standard combined with a tabular standard.

Appendix to Chapter VII

The foregoing considerations are emphasized for the reason that they are overlooked by those writers who imagine that a fixed legal ratio is merely superimposed upon a system of supply and demand already determinate, and who seek to prove thereby that such a ratio is foredoomed to failure. This is the monometallist's favorite analogy. It is unsound, though its unsoundness does not necessarily involve the unsoundness of the monometallist's general conclusions. Gold and silver or any other two commodities which serve the purposes of money are not analogous to two ordinary and unrelated articles and are not completely analogous even to two substitutes, because, for two forms of money, there is no consumer's natural ratio of substitution. There seems, therefore, room for an artificial ratio. We shall see, however, that there are limits beyond which an artificial ratio will fail.

Appendix to Chapter VIII

In all of the four foregoing illustrations, it was assumed that the fall in the individual price originated in a change in the supply curve or schedule. If the fall in price originates in a change in the demand curve or schedule, there will in general be a rise in other prices and in the general price level, for, there being less of the particular commodity bought and that at a less price, there will be less spent upon it and therefore more on other commodities, the price of which will be higher and, as the reduction in the amount bought of the particular commodity will, in general, imply a reduction in the total volume of trade, the general price level will be raised. *10