The Natural Law of Money
MONEY is not capital, nor is capital money, though these words are often, in common parlance, used interchangeably; but there is a marked difference in their signification which should not be lost sight of. Strictly speaking, money is never anything but the common medium of exchange, whereas capital is an investment, producing some income. The term capital is commonly applied to the kind of investment known as personal property, such as the bonds or stock of railroads, or the capital stock of a business, which may include the money in use at the time and the building in which the business is conducted; but the name is not applied to land, nor to real estate, nor to money in general, though it may be applied to metallic money. When we speak of a capitalist, the idea conveyed is not merely of a man of wealth, but of one who has his wealth so at command that it is readily convertible into money, or into other forms of wealth through the agency of money. It is doubtless because of the intimate relationship between capital and money, and the mobility of both, that the words overlap occasionally, even when their significance is understood; but the distinction between them becomes important when we inquire into the real purport and function of money.
Let us suppose that A has capital in England which he finds he can invest more profitably in the United States, and so concludes to transfer it from England to this country. It is stock in a brewery, paying him six per cent. per annum, and he finds he can make a similar investment here that will pay him nine per cent., so he sells his English stock, receiving English money therefor; with this money he buys a bill of exchange on New York, and with the American money received upon it here he pays for the American brewery stock. In this example, no English money passes from England to the United States—the thing transferred is capital. The English money which bought the bill of exchange remains in England, and the American money which paid for the American brewery stock remains in America, and goes immediately back into circulation to continue the performance of similar services: this is all that money ever does.
If, instead of a bill of exchange, gold had been sent to America, it would have been a transfer of capital. Bills of exchange, though not money in the strict sense, may not inappropriately be termed the paper-money of international commerce, as they perform in commercial dealings between different countries precisely the kind of service that paper-money performs for people of one country. Drawn mainly against exports of commodities which thereby become security for the payment of these Bills in gold (that metal being now the common measure of value in international commerce) they economize the use of gold, reducing the amount to one or two per cent. of what would otherwise be required.
There is a limit to the amount of money that may be used productively, but there is no limit to the amount of capital that may be used productively; the use of money is limited by the number of transfers to be made; the use of capital has no limit short of the exhaustion of nature's productive resources—which is practically no limit.
In the old world a vast amount of floating capital has accumulated from past ages; but in the United States the supply of capital is insufficient for the employment of all our labor and the development of our immense natural resources; the effect of these conditions is to make the normal rate of interest much higher with us than it is in Europe. In lending money, the rate of interest is influenced, first, by the degree of safety with which the loan may be made, and secondly, by the scarcity or abundance of money at the time the loan is made; but underlying these two changing conditions is the relative proportion of capital to opportunities for profitable investment of capital, which is the governing condition in fixing what may appropriately be termed the normal rate of interest; this normal rate is the more permanent rate which appears in first-class long-time loans. These three factors—the sense of safety, the supply of money as proportioned to the need for money, and the supply of capital as proportioned to the need for capital—dominate and govern the rate of interest.
All attempts to regulate interest artificially by legislative enactments which ignore these natural conditions, are but interferences which tend to lower the standard of business integrity, to advance and make unsteady the rate of interest, and to limit productiveness.
Every one knows that the rate of interest is affected by a sense of safety or of distrust on the part of the lenders and investors of money; but that it is differently affected by money and by capital is not so generally realized. Indeed, much of the confusion of thought in regard to money and interest arises from the want of a clear perception of the differing functions of money and of capital. It is a very common mistake to suppose that more money is needed where it is really capital that is needed. All peoples have it in their power to supply themselves amply with a money of such efficiency as is best adapted to the stage of their industrial development; but the same cannot be said of capital, for capital is wealth, and the accumulation of wealth is a slow process even in a country as rich in natural resources as ours. On the other hand, money, as now constituted, may be nine-tenths credit, and all that is required of a people in order to have an ample supply of efficient money is an intelligent recognition of this fact, and the formulation of its monetary laws in accordance with it.
Now let us apply these principles to the question of interest. If we may assume all transactions in money to be equal in point of safety, it may be stated as a general principle that the more permanent or normal rate of interest is regulated by the volume of capital, and that its temporary fluctuations are produced by abnormal fluctuations in the volume of money: if the quantity of money in circulation is less than is actually needed, the rate of interest will be above the normal level; if it is more than is needed, the rate will be below. Hence it follows as a corollary that if a people can keep the volume of its money just equal to the needs, the rate of interest will be just equal to the normal rate. Hence it follows also that temporary and violent fluctuations in the rate of interest, which are so common with us and so disturbing to individual enterprise, would not occur if the volume of money were self-regulative, as it would be if the supplying of the money were left, as is the supplying of commodities, entirely to individual action.
If we may now assume the disturbances to interest, proceeding from abnormal fluctuations in the volume of money, to be eliminated, the rate of interest will then be affected only by capital, and will be a steady, though not a stationary rate; it will fall with the increase of capital and rise with its decrease; but as changes in the volume of capital take place slowly, changes in the rate of interest will be correspondingly slow. The rate of interest will not be the same in all parts of the country, because the proportion of capital to profitable investment of capital, is not the same everywhere; but as the movement of capital is always from points of less profit to points of greater profit and equal safety, there is a general and constant tendency towards an equalization of the rate of interest; and as in our country there is a constant accretion of capital, the natural tendency of the rate of interest is downward.
Another point to be considered in this connection is that there is a fixed relation between the volume of capital and the volume of money: where there is much capital, more money will be needed than where there is little, for the number of transactions will be greater, and the volume of money must be exactly sufficient to accomplish all the exchanges required, or productiveness will be diminished; additional money without additional capital can add nothing to wealth production.
As an illustration, let us take the fixed property of a railroad as analogous to capital, and its rolling-stock as analogous to money. It will be readily seen that when the number of cars is exactly equal to the traffic, the earning power of the road, in so far as it is dependent upon car equipment, is at its maximum. Similarly, when money is exactly equal to the exchanges to be made, the earning power of capital, in so far as it is dependent upon money, is at its maximum. What would be thought of a rail-road company that should increase its car equipment beyond the possible requirements of its traffic? Yet this is precisely the character of our work in enlarging the volume of money regardless of capital; nay more, to further this purpose we have abstracted an immense amount of capital from productive industry, thus at one stroke increasing the volume of money and lessening the possible need for it; by so doing we have placed ourselves in the position of a railway company that sells a portion of its road-bed in order to buy an excess of rolling-stock.
By making a money of doubtful stability, we drive capital away from our country, because with an indefinite measure of values it is impossible for foreign capitalists to calculate the outcome of their investments here. If Congress should enact that twenty inches shall be the equivalent of thirty-six inches, so that measurements made by a yard-stick of either length would be an equivalent legal tender, such an act would be no more absurd than the monetary law which declares a silver dollar to be the equivalent in value of a gold dollar. Definite standards of weights and measures are absolutely essential to trade and commerce, and a definite money-measure is equally so.
Within the twenty years following the close of our civil war we had a remarkable example of the beneficial effects produced by the introduction of foreign capital into a country. Our government having established its power to maintain itself, had inspired the world with confidence in us, and this confidence was reinforced and our credit greatly strengthened by the Act of January 14, 1875, which authorized the resumption of specie payment on January 1, 1879. Capital began to come to us soon after peace was restored, but after the passage of the Resumption Act an increasing inflow gave decided impetus to all our industries; this was more especially manifested by the yearly increase in railway mileage. The number of miles of railway built in 1875 was seventeen hundred and eleven, which was nearly doubled in the following year, and in the year appointed for resumption there were built four thousand seven hundred and forty-six miles, while in 1882, the increase in construction had risen to eleven thousand five hundred and sixty-eight miles. Resumption had actually taken place in 1878; the mere announcement of our intention to put our money on a sound metallic basis had brought capital to us in such abundance that resumption was not only made easy, but the normal rate of interest was reduced. The normal rate in the city of New York, which had formerly been six per cent. per annum, dropped to four per cent., and a corresponding decline took place in other parts of the country. This remarkable reduction in the rate of interest occurred within a space of two or three years, and is explainable only on the ground of a large influx of foreign capital, as it was not possible for us to have created in so short a time sufficient new capital to produce so great a change.
The year of actual resumption (1878) was also the year in which we entered upon that anomalous silver legislation, which has since so greatly disturbed the confidence inspired by the Act of Resumption; but as in that year the market value of silver was not much below our legal ratio, and as the decline that had taken place was supposed to be temporary, being attributed mainly to the action of Germany in demonetizing silver in 1871, the evil effect of that legislation was not immediately felt. Not until it became apparent that silver was declining from increasing production, as well as from demonetization, was confidence at all disturbed, and even then no serious apprehension was felt, because as yet nothing had occurred in the history of the United States to justify the least fear in any mind that our government would permit a law to continue in force which endangered the stability of its money.
In view of the discredit into which our country has recently been brought by mistaken legislation in reference to silver, it is of the first importance that every American should understand and appreciate that the United States, from its beginning as a nation down to the present silver legislation, has held a record for monetary integrity not surpassed by that of any nation in the world. In the founding of the Republic and in the framing of the Federal Constitution, there was no subject that received more solicitous consideration than that of making our measure of values honest and stable. Impoverished as the country was at that time by the drain of a long war, no hint of compromising this principle was ever uttered in the national councils; and as the foundation was laid, so the superstructure was built.
When in 1834 the legal ratio of silver and gold was changed from fifteen to one to sixteen to one, the object was to restore gold to the circulation, as it was undervalued in the first ratio and had been practically out of circulation since 1792. Although under the ratio of sixteen to one the difference in the market value of the two metals was but slight, this difference had nevertheless the effect of displacing the undervalued metal, which in this case was silver. There is but one way in which the two metals can be held in circulation at a parity under any ratio that may be adopted, and that is to close the mints to the free coinage of the cheaper metal and make it redeemable in the other. In referring again to this phase of our subject, our object is to call attention to the fact that in changing the legal ratio of the precious metals in 1834, due regard was paid to preserving the stability of the national money. Although in adjusting the ratio (which is always difficult to do with values that are never stationary), silver went out of circulation and gold came in, the change was so gradual that it did not sensibly affect the monetary standard.
Clearness of definition as to the measure of values has characterized the monetary legislation of the United States down to the time that the silver question made its appearance in politics. Even the civil-war period of specie suspension cannot be regarded as an exception to this rule; the issuance of the greenbacks did not demonstrate that the national sense of honesty was growing weak, for there was no indefiniteness in the legislation that put that money into circulation; the terms of redemption were plainly stated on the bills themselves, so that the holder was just as competent to judge of their character and value as was the government that issued them. Nobody had occasion to ask, as is now asked about our silver money: What is the purpose of the government in reference to it? Immediate redemption was not then deemed possible, but all means were used that were practicable under the stress of civil war to make a stable money. It was made exchangeable for government bonds paying six per cent. interest in coin, and this feature of the Act of 1862 testifies to the honesty of its framers, and to their intelligent solicitude that the money should remain in circulation no longer than the exigency required. Their mistake was in making the greenbacks a legal tender, though they doubtless believed, as we do not, that this feature would contribute to promote the stability of the money.
In order properly to compare the Greenback Act of 1862 with our late silver legislation, we must keep distinctly in mind that the act was passed as a means of raising money to meet the extraordinary expenditures of the war. There was no pretence of making a better money than we already had; it was in fact a borrowing act, and was not regarded by its authors as in any true sense a monetary act, nor was there any misunderstanding at home or abroad as to its character in that respect. Nevertheless this act was the beginning and the source of the monetary delusions that subsequently took possession of the public mind—delusions which gave us a Greenback Party, followed in turn by a Silver Party; but for this misdirection of the public thought, the framers of the act cannot be held responsible; they realized fully the imperfect character of the money they were issuing, and in making it exchangeable for government bonds they did the best that could be done to secure its retirement from circulation so soon as the people should be able to replace it by a more stable and efficient money. That it was a serious mistake to make the greenbacks a legal tender, we need not doubt, for it could have no other effect than to lower the credit of the United States, and to prompt the withdrawal of capital from the country. We may well believe that if the money had rested solely on the credit of the nation, it would not have declined to thirty-five cents on the dollar, as it did in July, 1864. The issuance of mandatory money is in its essence a declaration of bankruptcy; how then can it strengthen the borrowing power of a state?
Return to top