The Purchasing Power of Money

Fisher, Irving
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First Pub. Date
New York: The Macmillan Co.
Pub. Date
2nd edition. Harry G. Brown, assistant.
19 of 27


§ 1


WE have seen that the purchasing power of money (or its reciprocal, the level of prices) depends exclusively on five factors, viz.: the quantity of money in circulation, its velocity of circulation, the quantity of deposits subject to check, its velocity, and the volume of trade. Each of these five magnitudes depends on numerous antecedent causes, but they do not depend on each other except that:—


(1) Deposits subject to check depend on money in circulation, the two normally varying in unison.


(2) The velocities of circulation of money and deposits tend to increase with an increase in the volume of trade.


(3) Any two or more of the five factors may be indirectly related by virtue of being dependent on a common cause or causes. Thus, the same invention may cause an increase in both velocities, or in both money and trade, or in both deposits and their velocity. To take an historical case, we know that the growing density of population has operated to increase all of the five factors.


(4) During transition periods certain temporary disturbances or oscillations occur in all six magnitudes, the extremes of which are crises and depressions. Normally, the price level is an effect and not a cause in the equation of exchange; but during such transition periods its fluctuations temporarily react on the other five factors, and especially on deposits. A rise will thus temporarily generate a further rise, while a fall temporarily operates in the opposite direction.


The price level, then, is the result of the five great causes mentioned, normally varying directly with the quantity of money (and with deposits which normally vary in unison with the quantity of money), provided that the velocities of circulation and the volume of trade remain unchanged, and that there be a given state of development of deposit banking. This is one of the chief propositions concerning the level of prices or its reciprocal, the purchasing power of money. It constitutes the so-called quantity theory of money. The qualifying adverb "normally" is inserted in the formulation in order to provide for the transitional periods or credit cycles. Practically, this proposition is an exact law of proportion, as exact and as fundamental in economic science as the exact law of proportion between pressure and density of gases in physics, assuming temperature to remain the same. It is, of course, true that, in practice, velocities and trade seldom remain unchanged, just as it seldom happens that temperature remains unchanged. But the tendency represented in the quantity theory remains true, whatever happens to the other elements involved, just as the tendency represented in the density theory remains true whatever happens to temperature. Only those who fail to grasp the significance of what a scientific law really is can fail to see the significance and importance of the quantitative law of money. A scientific law is not a formulation of statistics or of history. It is a formulation of what holds true under given conditions. Statistics and history can be used to illustrate and verify laws only by making suitable allowances for changed conditions. It is by making such allowances that we have pursued our study of the last ten centuries in the rough and of the last decade and a half in detail. In each case we found the facts in accord with the principles previously formulated.


From a practical point of view the most serious problem revealed by this historical and statistical study is the problem of stability and dependability in the purchasing power of money. We find that this purchasing power is subject to wide variations in two ways: (1) It oscillates up and down with the transitional periods constituting credit cycles; and (2) it is likely to suffer secular variations in either direction according to the incidents of industrial changes. The first transition is connected with the banking system; the second depends largely upon the money metal.


One method of mitigating both of these evils is the increase of knowledge as to prospective price levels. As we have seen, the real evils of changing price levels do not lie in these changes per se, but in the fact that they usually take us unawares. It has been shown that to be forewarned is to be forearmed, and that a foreknown change in price levels might be so taken into account in the rate of interest as to neutralize its evils. While we cannot expect our knowledge of the future ever to become so perfect as to reach this ideal, viz. compensations for every price fluctuation by corresponding adjustments in the rate of interest—nevertheless every increase in our knowledge carries us a little nearer that remote ideal. Fortunately, such increase in knowledge is now going on rapidly. The editors of trade journals to-day scan the economic horizon as weather predictors scan the physical horizon; and every indication of a change in the economic weather is noted and commented upon. Within the past year a certain firm has instituted a statistical service to supply bankers, brokers, and merchants with records, or "business barometers," and forecasts based thereon, with the avowed object of preventing panics. Yet it is probably in regard to the fundamental mechanism by which such forecasts are based that there is the greatest need of a wider diffusion of knowledge. The range of the ordinary business man's theoretical knowledge is extremely narrow. He is even apt to be suspicious of such knowledge, if not to hold it in contempt. The consequences of this narrowness are often disastrous, as, for instance, when, in pursuance of the advice of New York business men, Secretary Chase issued the greenbacks, or when the ill-advised legislation to close the Gold Room was enacted. And it is not altogether in unusual predicaments such as those brought by the Civil War that the business man's limitations in knowledge react injuriously upon him. Every day he is hampered by a lack of understanding of the principles regulating the purchasing power of money; and in proportion as he fails to understand these principles he is apt to fail in predictions. The prejudice of business men against the variability of, and especially against a rise of the rate of interest, probably stands in the way of prompt adjustment in that rate and helps to aggravate the far more harmful variability in the level of prices and its reciprocal, the purchasing power of money. The business man has, in fact, never regarded it as a part of the preparation for his work to understand the broad principles affecting money and interest. He has rather assumed that his province was confined to accumulating a technical acquaintance with the nature of the goods he handles. The sugar merchant informs himself as to sugar, the grain merchant as to grain, the real estate trader as to real estate. It scarcely occurs to any of them that he needs a knowledge as to gold; yet every bargain into which he enters depends for one of its two terms on gold. I cannot but believe that the diffusion among business men of the fuller knowledge of the equation of exchange, of the relation of money to deposits, of credit cycles and of interest, which the future is sure to bring, will pay rich returns in mitigating the evils of crises and depressions which now take them so often unawares.

§ 2


But while there is much to be hoped for from a greater foreknowledge of price changes, a lessening of the price changes themselves would be still more desirable. Various preventives of price changes have been proposed. We shall first consider those which are more particularly applicable to secular price changes, and afterward consider those more particularly applicable to the price changes involved in credit cycles. The secular price changes are, as we have seen, chiefly due to changes in money and in trade. There has been for centuries, and promises to be for centuries to come, a race between money and trade. On the results of that race depends to some extent the fate of every business man. The commercial world has become more and more committed to the gold standard through a series of historical events having little if any connection with the fitness of that or any other metal to serve as a stable standard. So far as the question of monetary stability is concerned, it is not too much to say that we have hit upon the gold standard by accident just as we hit on the present railway gauge by the accident of previous custom as to road carriages; and just as we hit upon the decimal notation by the accident of having had ten fingers, and quite without reference to the question of numerical convenience in which other systems of numeration would be superior. Now that we have adopted a gold standard, it is almost as difficult to substitute another as it would be to establish the Russian railway gauge or the duodecimal system of numeration. And the fact that the question of a monetary standard is today so much an international question makes it all the more difficult. Yet, as Professor Shaler, the geologist, has said, "It seems likely that we shall, within a few decades, contrive some other means of measuring values than by the ancient device of balancing them against a substance of which the supply is excessive."*35


I shall not attempt to offer any immediate solution of this great world problem of finding a substitute for gold. Before a substitute for gold can be found, there must be much investigation and education of the public. The object here is to call attention to the necessity for this investigation and education, to examine such solutions as have been already proposed and, very tentatively, to make a suggestion which may possibly be acted upon at some future time, when, through the diffusion of knowledge, better statistics, and better government, the time shall become ripe.


One suggestion has been to readopt bimetallism. This has already been discussed in Chapter VII. We were then concerned, however, chiefly with the "mechanics of bimetallism" and not its influence on price levels. We have now to note the claim of advocates of a bimetallic standard that such a standard would tend to steady prices.*36 As we have seen, by connecting the currencies of both gold and silver countries, bimetallism, as long as it continues in working order, has the effect of spreading any variation of one particular metal over the combined area of gold, silver, and bimetallic countries. If variations occur simultaneously in both metals, they may be in opposite directions, and neutralize each other more or less completely; while, even if they happen to be in the same direction, the combined effect on the whole world united under bimetallism would be no greater than on the two halves of the world under silver and gold monometallism respectively. Even if bimetallism did not enlarge the monetary area, it might reduce monetary fluctuations. Thus a world-wide gold standard might prove more variable than bimetallism.*37 But if the amount of one metal used in coinage increases faster or more slowly than business, while the amount of the other maintains a constant ratio to business, then the use of the two metals results in less steadiness than would result from the less variable of the two, though in somewhat more steadiness than would result from the use of the more variable.


Two variable metals joined through bimetallism may be likened to two tipsy men locking arms. Together they walk somewhat more steadily than apart, although if one happens to be much more sober than the other, his own gait may be made worse by the union.*38


The table in the footnote shows that in the seventeenth and nineteenth centuries the two metals were about equally unsteady. In the eighteenth century gold was the more steady. During the first half of the nineteenth century silver was the more steady, while for 1851-1890 gold was the more steady. Since then, silver has been the more steady. On the whole, there is not much to choose between the behaviors of the two.


Bimetallism, then, even could it be maintained, would offer but an indifferent remedy for the variations in the price level, and, moreover, there is always the objection previously noted that the system may break down. We then saw that whatever the ratio at which both metals are to circulate, one metal is likely, sometime, to be produced in such abundance as completely to fill the money reservoir, driving the other metal altogether out of circulation. Such a result may be long in coming, but eventually it is practically sure to come.


A more important objection remains to be noted. Since bimetallism, as usually proposed, would greatly overvalue one of the two metals, the first great effect of its adoption might be not to steady prices but to disrupt them and upset the relation of debtor and creditor. While the great overvaluation of one metal is not a necessary feature of bimetallism, it has always been the feature which has made it politically popular. Thus, the bimetallism advocated in the United States during the last twenty or thirty years has been a bimetallism which would grossly overvalue silver. It proposed that 16 ounces of silver should circulate as the equivalent of an ounce of gold, when during much of this time it really required 30 or 35 ounces of silver to be equivalent to one of gold. Such an overvaluation of silver would mean that silver would be imported from Mexico, India, China, and other silver countries, as well as mined in larger quantities and coined in the United States, thus depreciating the currency both greatly and suddenly. The proposal was well satirized by a cartoon in the "free silver" campaign of 1896 representing the United States as a ship sailing over Niagara Falls in order to reach smooth sailing below the falls,—if only it survive the shock of the fall!


Bimetallism is the only scheme of steadying the monetary standard which has ever secured political momentum; and even its popularity lay far less in its potency for ultimately steadying than in its potency for immediately unsteadying the standard. We now pass on to consider schemes which have never reached the stage of practical proposals, but are still wholly academic.


The first is polymetallism, a generalization of bimetallism. The theory of bimetallism contemplates the circulation side by side of two metals; that of polymetallism looks to the contemporaneous circulation of more than two. So long as several metals could be maintained in circulation together, the price level might fluctuate less than if one metal only were used. But all of the theoretical objections against bimetallism apply also against polymetallism. One metal would eventually drive all the others out of a country, or,—if polymetallism were international,—into the arts.

§ 3


Recognizing the force of the arguments against bimetallism (and polymetallism), Professor Marshall has suggested as a substitute a system which has been called symmetallism. Under this scheme—symmetallism—two (or more) metals would be joined together physically in the same coin or in "linked bars." Evidently any ratio could be used, and neither metal could push the other out of circulation. The value of the composite coin would be the sum of the values of its two constituents, and the fluctuations in its value would be the mean of the fluctuations of its constituents.*39


Many other schemes for combining metals have been suggested. Among them are the "joint-metallisms" of Stokes and Hertzka, which are kinds of bimetallism at a variable instead of at a fixed ratio. Another, advocated by Walras,*40 is the gold standard with a "silver regulator," which is simply the limping standard such as now prevails in the United States, France, or India except that the quantity of silver in circulation, instead of being fixed, would be systematically manipulated by the government in such a manner as to keep prices steady. But these, like symmetallism and bimetallism, offer a remedy which at best is only partial. For instance, in Walras's scheme, in order to maintain prices, the amount of silver might need to be reduced to zero—after which no further regulation would be possible; or it might need to be increased so far as to expel all gold, after which the system would be no longer a gold standard, but would become an inconvertible silver standard. Worst of all, every one of these proposed remedies would be subject to the danger of unwise or dishonest political manipulation.


It is true that the level of prices might be kept almost absolutely stable merely by honest government regulation of the money supply with that specific purpose in view. One seemingly simple way by which this might be attempted would be by the issue of inconvertible paper money in quantities so proportioned to increase of business that the total amount of currency in circulation, multiplied by its rapidity, would have the same relation to the total business at one time as at any other time. If the confidence of citizens were preserved, and this relation were kept, the problem would need no further solution.


But sad experience teaches that irredeemable paper money, while theoretically capable of steadying prices, is apt in practice to be so manipulated as to produce instability. In nearly every country there exists a party, consisting of debtors and debtor-like classes, which favors depreciation. A movement is therefore at any time possible, tending to pervert any scheme for maintaining stability into a scheme for simple inflation. As soon as any particular government controls a paper currency bearing no relation to gold or silver, excuses for its over-issue are to be feared.


Even if, in times of peace, these persistent pleas for inflation could be resisted, it is doubtful if they could be resisted in time of war. In time of war many plausible defenses can be given, notably the need of government supplies. The history of our own country in this respect is not reassuring. It is natural, therefore, that such schemes should have gotten in bad odor. Indeed, their odor has been so bad that many have impulsively concluded that the "quantity theory" which has been appealed to as making possible government manipulation of prices must be fundamentally unsound. Experience has shown, however, that the evil feared need not always be realized.


Another method by means of which government could theoretically keep the price level more stable is by confining the primary money to a precious metal, say gold, and regulating the quantity of this metal in the currency by means of a system of seigniorage. Thus, as the supply of gold from the mines increased, and gold tended to depreciate in value, the value of gold coin could be kept up by making a continuously higher charge for coinage, in the shape of seigniorage. This charge would become higher as gold bullion became cheaper, in such proportion as to keep the currency in the same relation with the volume of business, and thus to keep the level of prices stable. If, later, the annual production of gold should become very small, and gold, in consequence, should begin to appreciate in value, stability might be maintained by a reversal of this policy, i.e. by gradually reducing the seigniorage so as to prevent appreciation of the currency. There would, however, be a limit to the power to regulate in this direction similar to the limit we noted in the case of Walras's scheme. The seigniorage could never be reduced to less than zero. Money can never be materially cheaper than the metal composing it, since the slightest tendency in this direction will result in coin being exported or melted into bullion. In a period of rising prices, regulation would be easy; in a period of falling prices, regulation might be quite impossible.*41


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.


It is true that this scheme, like a simple paper-money scheme, would be liable to abuse,—but it would have two practical advantages. Having a metallic basis, it would inspire more confidence than a pure paper-money plan, while it would offer less excuse for abuse and less chance to delude the public. Every change in the weight of the gold dollar would be definitely measurable, and would have to be justified to the public. A reduction in weight not fully explained by a fall in prices would be a clear confession of depreciation.

§ 4


The next plan to be considered is that advocated by Professor Marshall and the Committee of the British Association.*42 It is, in essence, the revival of the tabular standard proposed and discussed by Lowe,*43 Scrope,*44 Jevons,*45 and others; a standard which is relatively independent of special legislation. This involves the passing of a law—first merely permissive—by which contracts could be expressed in terms of an index number. Such a law would not be necessary, but it might serve to draw attention to the index method. The money of the country would continue to be used as a medium of exchange and as a measure of value, but not as a standard for all deferred payments. The standard of deferred payments, when advantage was taken of the law, would be the index number of general prices; and contracts involving deferred payment could, when desired, call for the exchange of a given purchasing power, or of an amount of money varying directly with the index number. To facilitate such a change, it might be well for the government to inaugurate an authorized system of index numbers, but government action would not have to go farther than this, or indeed, necessarily, so far. The aim would no longer be to keep the level of prices absolutely stable. Gold or silver or both would furnish the primary money, and their value would consequently fluctuate with that of the constituent metal or metals. But the contracts based on index numbers would not be affected because made in terms of the index number. Doubtless the plan would encounter much opposition,*46 but it would appeal strongly to certain classes.*47 For instance, those "living on their incomes" would like to be guaranteed a stable purchasing power. A widow, or a trustee, or other long-time investor, would prefer to buy bonds which guaranteed a regular yearly purchasing power over subsistence, rather than those which merely promised a given sum of money of uncertain value. A few precedents already exist, suggestive, at least, of what the new system would be. In England, the "tithe averages" have been made to vary with the value of grain, so that the tithe was in effect so much grain, not so much money; also the Scotch fiars prices have existed for more than two centuries for similar purposes, establishing the price of grain on the basis of which rents contracted in grain should be paid in money.*48


As has been already indicated, government action looking to this result need not necessarily be taken. The beginnings of such a plan for "a tabular standard of value" could be made at any time by private contracting parties, some index number already in vogue, such as Sauerbeck's or the Bureau of Labor's, being used as a standard. Should the results of such experiments, on the whole, satisfy the contracting parties, others might follow their lead. At first contracts would be interpreted as having been made in terms of money except when otherwise provided. A specific proviso would therefore be required in contracts made in terms of the index number. If the latter form of contract should become more general, however, legislation could be passed, making the index number the standard in all cases, except where specifically provided that payment should be based on a different standard.


It is to be noted that such a custom, however general it might become, would not do away with the desirability of having an elastic currency to respond to seasonal variations of business. Seasonable readjustments of wages, for instance, and of many other prices, are difficult. Custom tends to establish standards holding through successive seasons. Since there is more business at some seasons than others, there will be an element of strain unless there is also an expansion of credit. An elastic banking system, facilitating credit-expansion, would, therefore, remain a desideratum.


The system of making contracts in terms of the price level is not intended directly to prevent fluctuations in price level. Its purpose is rather to prevent these fluctuations from introducing a speculative element into business. But an incidental result of the system would be that fluctuations in the level of prices would be less than before, because credit cycles would no longer be stimulated. The alternate abnormal encouragement and discouragement of loans would cease. Hence, credit fluctuations would become less, and the level of prices would be comparatively unaffected by them.*49 Even if panics should occur, accompanied by sharp falls of prices, they would not be as severe as now. At present, loans must be liquidated in terms of a given amount of money, though that money may buy more (or less) at the time of liquidation than when the loan was contracted, and though the borrower must dispose of more (or less) commodities to raise the given amount. He is compelled to pay, when prices have fallen, on the same basis in terms of money, and a much higher value in terms of goods, than when prices ranged higher. Hence failure often results, credit currency contracts still further because of the general distrust, and depression becomes more severe. With payment in terms of purchasing power, the situation would be altogether different. Falling prices would neither injure borrowers nor benefit lenders.


On the whole, the "tabular standard" seems to have real merit.*50 Certainly there could be no material harm in trying a "permissive" law. But the tabular standard is subject to serious if not fatal objections: One is the fact that it would involve the trouble of translating money into the tabular standard and would therefore fail to attract the public sufficiently to warrant its complete adoption by any government. Another objection is that its halfway adoption would really aggravate many of the evils it sought to correct, and therefore discourage, rather than encourage, its further extension. Even were the system adopted in its complete form for any one country, it would have the disadvantage of isolating that country commercially, and thus reintroducing the inconveniences of an uncertain rate of international exchange. An analogous inconvenience would arise by its partial adoption in any one country. Business men naturally and properly prefer a uniform system of accounts to two systems warring with each other. They would complain of such a double system of accounts in exactly the same way, and on exactly the same grounds, as they have always complained of the double system of accounts involved in international trade between gold and silver countries. A business man's profits constitute a narrow margin between receipts and expenses. If receipts and expenses could both be reckoned in the tabular standard, his profits would be more stable than if both were reckoned in money. But if he should pay some of his expenses, such as interest and wages, on a tabular basis, while his receipts remained on the gold basis, his profits would fluctuate far more than if both sides, or all items of the accounts, were in gold. In fact, his expected profits would often turn into losses by a slight deviation between the two standards, in precisely the same way as the importer or exporter of goods between China and the United States may have his profits wiped out by a slight variation in the exchange. In either case, he would prefer to have the same standard on both sides of the account, even if this standard fluctuated, rather than have two standards, only one of which fluctuated; for his profits depend more on the parallelism between the two sides of his account than on the stability of either. It was to escape the evils from having two standards that, after lengthy debate and experiment, the present gold-exchange standard was adopted in India, the Philippines, Mexico, Straits Settlement, Siam, and Panama.

§ 5


The mention of the gold-exchange standard brings us to the proposal which is here tentatively suggested,—a proposal which, it is believed, may one day be found both practicable and advisable. This plan involves a combination of the tabular standard with the principles of the gold-exchange standard.


We have already described briefly the gold-exchange standard, and given references to other and fuller sources of information. While the gold-exchange standard purports to be a system of redemption, or partial redemption in gold of the native coin, yet as a matter of fact, no gold is necessarily required in the country itself where the system is in operation. Thus, the Philippine government does not offer gold for silver pesos, even when gold is wanted for export to New York. Instead, it keeps a reserve of gold in New York, and "redeems" the Filipino's pesos in merely a draft upon this gold. As this draft may be forwarded to New York, it serves the purpose of gold redemption for export. The price of the sale includes a premium on exchange corresponding to the usual excess above the "gold point"; that is, the government charges the Filipino the equivalent of freight, insurance, and other expenses on gold to New York.


It will be evident that the gold-exchange system is only nominally a redemption system. In actual fact, it is a system of manipulating the silver currency in such a manner as to prevent its value from diverging from par with gold by more than the usual premiums on exchange between gold countries. This manipulation consists in contracting the currency when the rate of exchange reaches a certain point above par, and expanding the currency when it reaches a certain point below par. The contraction of the currency is secured by selling foreign bills of exchange and locking up the currency received therefor, while the expansion of the currency is secured by releasing this currency to circulation, or, if necessary, by coining more currency.


The successful operation of the system is not only compatible with, but actually requires, an overvaluation of the metallic content of the silver currency. In fact, in the Philippines it was found necessary to reduce the silver pesos from 374 grains to 247 grains, to prevent their disappearance. Without a margin between the coin-value and the bullion-value of the peso, the power to regulate its circulation would exist only in one direction—contraction; with such a margin, the power exists to expand as well as to contract.


After once becoming familiar, the system would operate just as successfully if the weight of the silver coins were still further reduced, or, in fact, if a paper currency were substituted instead. It will be seen, therefore, that at bottom the gold-exchange standard is practically the same standard as that which is now in operation for paper currency in Austria. In that country the paper is really irredeemable, but is kept at par by the sale of exchange on London.


The plan by which the bullion content of the coins is kept below their value as coins not only prevents melting and exportation, and the consequent loss of control of their quantity and value, but also has the advantage of economy. The reduction of the weight of the pesos was, in fact, used as a means of defraying the expense of maintaining the gold reserve and the other expenses of inaugurating and operating the system in the Philippines.


The gold-exchange standard was at first regarded with great suspicion, and its advocates scarcely dared claim for it any better virtue than that of a practical makeshift, affording, as it did, a means of easy transition from the previously existing system to the gold standard, without shock, or introducing an unfamiliar coinage.


But the results have been so satisfactory that it may well be asked whether those who devised the gold-exchange standard did not build better than they knew. While the system bears a close, though somewhat superficial, resemblance to a fiat money system, it has now little or none of the odium or suspicion attached to it which we associate with that name. So simple are the duties of maintaining the gold-exchange par, and so unfailingly has the system been faithfully executed, that even those who at first most strenuously opposed it seem now inclined to trust it implicitly. There is, indeed, no reason why, under almost any conceivable circumstances, there should be even the fear of this system being abused.


Now that there has been actually constituted a new form of governmental machinery, which can be as fully trusted to perform its functions of regulation as the mint, there seems to be no reason why the system should not be extended. It is well known that the par of exchange which has been adopted for the gold-exchange standard is quite arbitrary, and it must be evident that this par could be changed. The par of exchange between the English and Indian system is 16d. per rupee. This par could be easily changed to 15d. or 17d., and gradually changed further in either direction. By such changes of the gold par of exchange, the currency of those countries now having a gold-exchange standard could, if desired, be kept at par with a tabular standard. Thus, when it is found practicable to measure by index numbers the exact shifting of the gold standard, a corresponding shifting of the par of exchange or price of rupees in gold could be effected.


As the system is now operated, the coinage is manipulated to keep it at par with gold, that is, to follow the fluctuations of the gold standard wherever they may lead. We have, therefore, the spectacle of India, and other countries formerly having a silver standard, now clinging to the skirts, as it were, of the gold standard countries, and following that erratic standard where-ever it may lead them, although it is within their power, by exactly the same machinery, to keep their course steady.


I would not, however, for a moment suggest that these countries should give up their par of exchange with gold standard countries. Although much might be said in favor of such a course, it would, to a large extent, be a step backward by again restoring the uncertainties of international exchange which have been mentioned. What is needed is to induce the entire civilized world to do what is now within the power of the gold-exchange countries to do, viz. to keep pace with a tabular standard. It is a little anomalous that these gold-exchange standard countries now have a power to regulate their price level, which is not possessed by the gold standard countries themselves. The latter are, by their present system, kept absolutely at the mercy of the accidents of gold mining and metallurgy, while the former can keep or change the par of exchange with gold countries at will.


But evidently the gold countries could do precisely what the silver countries have done, namely, inaugurate the system of a gold-exchange standard by closing their mints to gold, reducing, if need be, the weight of gold coins (although with the depreciation now going on in gold, this would probably not be necessary), and operating an exchange standard system in precisely the same way that the Philippines and the other countries mentioned now operate their gold-exchange system.


To make this clear we shall suppose, at first, that one country, say Austria, would continue on the gold standard while England, Germany, France, the United States, and the other chief countries of the world should close their mints to the free coinage of gold. They could then maintain a gold-exchange standard with a (varying) par of exchange with Austria. By suitably changing the par of exchange from time to time, the whole commercial world, excepting Austria, could then keep the purchasing power of money stable, instead of allowing it to fluctuate with gold. The same relation which India now bears toward England would then be held by both India and England toward Austria. But it would not even be necessary that one country like Austria should hold aloof in commercial isolation. The system, when put in operation, should include all the countries concerned and sufficiently interested to enter into a treaty agreement. Instead of sacrificing its own interests by serving as a gold standard country in terms of which all the other countries of the world should in common adjust their pars of exchange, Austria could itself adjust its currency by buying and selling gold. In other words, precisely the same principles which regulate the currency of India or the Philippines, by buying and selling exchange on gold abroad, could be operated more directly through buying and selling gold itself at home. Austria might be a good country in which to do this, because it has long operated substantially this system, and by it kept its irredeemable paper money at a fixed par with gold. Should suitable treaty arrangements be effected, Austria might maintain a par, not with a fixed weight of gold, but with such a weight of gold as should have a fixed purchasing power, and could do this by buying and selling gold at these adjusted prices, selling gold bullion for golden to contract the currency, and buying gold bullion for gulden to expand the currency. All other countries could maintain their par with Austria, or each other, by the methods by which now India maintains its par with England, or, if they chose, by exactly the same process as proposed for Austria. In fact, it is evident that the method of maintaining par by selling exchange on other countries, and by exchanging currency directly for some commodity, such as gold, are at bottom much the same thing.


In order that such an international system should work, we might imagine three separate functions: (1) the function of maintaining an exchange par with the Austrian gulden to be performed by Foreign Exchange Offices exactly as at present in the Philippines under the gold-exchange system; (2) the similar function of regulating the currency in at least one country, say Austria, by a Bureau of Currency Regulation through buying or selling gold, at the option of the public, at an official price, changing from time to time according to the decisions of the Statistical Office about to be mentioned; (3) the function of fixing this official price of gold according to the price level. An international Statistical Office at, say, The Hague, could be established to do this in a purely clerical manner; its duties would consist in ascertaining the index number of prices in the usual way and then dividing the market price of gold by that number.


For instance, if, a year after the system was started, it were found by the Statistical Office that prices had risen one per cent, this Office would, in order to neutralize the rise, issue an official declaration to the Bureau of Currency Regulation fixing the official price of gold at substantially one per cent lower than the ruling market price. At this cheap price the public will buy gold bullion of the government and surrender currency in return. Therefore the currency will be contracted and general prices will fall until no more gold is called for, or until there is declared a new official gold price. Should the next official gold price be set above the market price, the government would become a buyer of gold and would thus reissue some of the currency previously called in, or if need be, issue new currency.


The plan, as above outlined, fixes a single price of gold at which the government must be ready either to buy or sell. There would be practical advantages, however, in fixing a pair of prices differing slightly from each other, the higher for selling and the lower for buying. The device of a pair of prices was proposed by Ricardo.*51 It is also employed, as we have seen, in the gold-exchange standard to simulate the "gold-points." The Austrian paper currency, although usually called irredeemable, is kept at par with gold by a similar arrangement under which the Austro-Hungarian bank stands ready to buy gold at k. 3,278*52 per kilo and to sell gold-exchange on London at a slightly higher rate.


It will be seen that the plan here proposed requires no revolution of the world's currencies. It requires little more than to assemble, into one working whole, operations already existing separately, viz. (1) calculating Index Numbers as done at present by our Bureau of Labor; (2) buying and selling exchange, as done at present by the Philippine Government; (3) buying and selling gold, as done at present in Austria; (4) periodically readjusting the gold pars as was done at least once when the present system was inaugurated in India, the Philippines, Panama and Mexico. The readjustment of par is the only feature which could be called new, and this should not be condemned as causing fluctuations in values; for its only object is to prevent the fluctuations from which we now suffer. Neither this periodic readjustment nor any other feature of the plan would require changes in the circulating medium. Each nation would continue to use its old familiar currency, whether gold, silver, or paper. The ordinary man would be unaware of any change.


The cost of maintaining the gold-exchange system has been slight and the cost of maintaining the system here proposed, whatever it might be, could be as nothing compared with the benefits it would render the entire civilized world.


One incidental benefit which could easily be secured would be the oft-proposed readjustment of relative values of various coins; for the first adjustment of pars would naturally make the sovereign equivalent to five dollars, the ruble to fifty cents, the Japanese yen to fifty cents, the Dutch florin to forty cents, the mark to twenty-five cents, the franc to twenty cents, the Austrian crown to twenty cents, and the Portuguese crown to ten cents.


The plan as above outlined contemplates the regulation of the world's currencies by buying and selling gold; but of course silver or any other commodity could be used instead. The less variable the commodity relatively to commodities in general, the less would be the readjustments needed and the less active the buying or selling of that commodity by the government.


The objections which could be urged against this system are doubtless many, but they do not seem to be as serious as the objections which have already been urged against the adoption of the gold-exchange standard, and which have been satisfactorily answered by the course of events. In fact, there would seem to be no greater danger in trusting Austria, under treaty agreement, to maintain her gulden at an ideal par with commodities in accordance with an index number, than to trust her, as at present, to maintain stable exchange with London, or than to trust the Indian, Mexican, Panama or Philippine governments to maintain their overvalued silver at par with gold. The functions involved are clerical; the acts required are specific. Departures from a strict compliance with the law or treaty would be instantly recognized, and would bring upon the culprit wrath and punishment proportionate to the international gravity of the offense. The plan does not require and would not permit any experimental dosing of the circulation dependent on the judgment of an official. The official who regulates does so merely by buying and selling at specific prices fixed by others; and he must buy or sell at the pleasure of the public. He would have no more choice than a broker who is ordered to buy or sell at prices specified by his customers, or than his prototype, the present official in the Philippines, who now buys or sells foreign exchange. The danger of abuse or fraud in the Statistical Office, the work of which is based on published market prices and is necessarily done in the light of day, would seem negligible.


Not only would the scheme seem to be entirely free from the possibility of mismanagement by individual officials, but it would seem also to be fully safeguarded against the danger of inflationistic legislation. No individual nation could inflate the currency without withdrawing from the international arrangement and isolating itself accordingly, while it is quite inconceivable that all the civilized nations of the world should voluntarily and simultaneously commit the folly of inflationistic legislation.


But, before any control of the price level be undertaken, the public must learn to realize its necessity. So long as the rank and file even of business men fail to realize that they are daily gambling in changes in the value of money, a fact of which they are blissfully unaware, they will exert no demand for preventing those changes. They are the parties whose interests are chiefly involved, and the first essential step in the reform process is that they shall be made to comprehend the benefits of a stable purchasing power.*53 Until this time arrives, any political proposals will be premature.

§ 6


At the beginning of this chapter we reviewed the principles determining the purchasing power of money and the practical problems involved. We then considered the possible methods of avoiding the evils of variability in purchasing power. Among these, one of the most feasible and important was found to be an increase of knowledge,—both specific knowledge of conditions and general knowledge of principles. Next, the claims of bimetallism and polymetallism as means of maintaining a stable level of prices were considered. It was seen that there was no guarantee of keeping two or more metals in circulation indefinitely at an agreed ratio, and it was pointed out that, even could this be done, the gain in stability of prices would be likely to be inconsiderable. The latter objection was brought also against symmetallism—the proposal to have more than one precious metal in each standard coin—as well as against joint metallism, etc.


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.


It was suggested that the first step in this needed reform would be to persuade the public, and especially the business public, to study the problem of monetary stability and to realize that, at present, contracts in money are as truly speculative as the selling of futures,—are, in fact, merely a subdivision of future-selling.


The necessary education once under way, it will then be time to consider schemes for regulating the purchasing power of money in the light of public and economic conditions of the time. All this, however, is in the future. For the present there seems nothing to do but to state the problem and the principles of its solution in the hope that what is now an academic question may, in due course, become a burning issue.


For a fuller explanation of the above described plan to "standardize the dollar," the reader is referred to pages 494 ff.

Notes for this chapter

Man and the Earth, New York (Duffield), 1906, p. 62.
See Jevons, Investigations in Currency and Finance, London (Macmillan), 1884, pp. 331-333.
Cf. F. Y. Edgeworth, "Thoughts on Monetary Reform," (British) Economic Journal, September, 1895, p. 449.
The variabilities of gold and silver production have been calculated by one of my students, Mr. Morgan Porter. He finds the following mean percentage variations from the mean productions for each period named:—

  % %
1601-1701 5 periods of 20 years each 7.8 7.7
1701-1800 5 periods of 20 years each 15.6 27.4
1801-1900 5 periods of 20 years each 69.0 67.0
1801-1850 5 periods of 10 years each 52.4 22.3
1851-1885 7 periods of 5 years each 8.1 40.8
1886-1890 5 periods of 1 year each 5.9 10.5
1891-1895 5 periods of 1 year each 13.3 6.3
1896-1900 5 periods of 1 year each 12.3 3.4
1901-1905 5 periods of 1 year each 10.7 1.9

See F. Y. Edgeworth, "Thoughts on Monetary Reform," (British) Economic Journal, September, 1895, p. 448.
"Monnaie d'or avec billon d'argent régulateur," Revue de droit international, December, 1884; reprinted in Études d'Économie politique appliquée, Lausanne (Rouge), 1898, pp. 3-19.
For the effect of the legal prohibition of exportation see Kemmerer, Money and Credit Instruments in their Relation to General Prices, 2d Edition, New York (Holt), 1909, p. 39 n. Cf. Kemmerer, "The Establishment of the Gold Exchange Standard in the Philippines," in the Quarterly Journal of Economics. Vol. XIX, 600-605 (August, 1905); Second Annual Report of the Chief of the Division of Currency, etc., 14, 15, 21-28; and "A Gold Standard for the Straits," II, in the Political Science Quarterly. Vol. XXI, p. 665-677 (December, 1906).
See Report of the British Association for the Advancement of Science, 1890, p. 488, containing a draft of a proposed Act of Parliament for this purpose.
Present State of England in regard to Agriculture, Trade, and Finance. London, 1622.
Principles of Political Economy, London, 1833, p. 406.
Investigations in Currency and Finance, London (Macmillan), 1884, p. 122; also Money and the Mechanism of Exchange, London, (Kegan, Paul), 1893, Ch. XXV.
Cf. Francis Walker, Money, New York (Holt), 1891, pp. 157-163.
See Joseph French Johnson, Money and Currency, Boston (Ginn), 1906, p. 175.
See Edgeworth, Reports of the British Association for the Advancement of Science for 1888, p. 182.
See Jevons, Money and the Mechanism of Exchange, London (Kegan Paul), 1893, p. 333.
See J. Allen Smith, "The Multiple Money Standard," Annals of the American Academy of Political and Social Science. March, 1896.
Proposals for an Economical and Secure Currency, 2d Edition, London (Murray), 1816, p. 26.
See L.V. Mises, "The foreign exchange policy of the Austro-Hungarian Bank," Economic Journal, June, 1909, p. 201.
A recent popular pamphlet by A.C. Lake, Currency Reform the Paramount issue, Memphis (28 N. Front St.), Tenn., proposes to stop the free coinage of gold. As I write, other evidences of the spread beyond academic circles of the idea that gold is an unstable standard come to hand. The rapid rise in the cost of living has of course thrust the subject on the attention of the magazine and newspaper press. Mr. Edison, in a recent interview, predicts the further downfall of gold, through the discovery,—sure to be made sooner or later—of cheap methods of extracting immense quantities of gold from some Southern clays. He asks the pertinent question: "Is it not absurd to have, as our standard of values, a substance, the only real use of which is to gild picture frames and fill teeth?" Mr. Carnegie, in his last gift of ten millions of dollars to the Carnegie Institution of Washington, stipulates that a certain part of the income shall be set aside as a sinking fund against "the diminishing purchasing power of money." This is significant as one of the first cases in which a business man has taken cognizance, in a practical way, of the instability of gold.

Notes for Appendix to Chapter II

End of Notes

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