Money and the Mechanism of Exchange

The Quantity of Money Needed by a Nation

Chapter XXVI

It might seem natural that one most important point for discussion in an Essay on Money would be the quantity of money required by a nation. Nothing would seem more desirable than to decide how much each person needs of paper, gold, silver, or bronze currency, so that the government might take care to provide sufficient for every one. In almost every country great complaints have from time to time been made as to the scarcity of the circulating medium, and the urgent need of more. All the evils of the day, the slackness of trade, falling prices, declining revenue, poverty of the people, want of employment, political discontent, bankruptcy, and panic, have been attributed to the want of money, the remedy suggested being in former days the setting of the mint to work, and in later times the issue of paper money.

The true answer to all such complaints is that no one can tell how much currency a nation requires, and that to attempt to regulate its quantity is the last thing which a statesman should do. In almost every case the apparent scarcity of currency arises from unskilful management of the metallic currency, bad regulation of paper representative money, illegitimate speculation, or some unsoundness in commerce which would be aggravated by a further increase of the paper currency. We shall find that to ascertain how much money is needed by a nation is a problem involving many unknown quantities, so that a sure solution can never be obtained.

Quantity of Work to be done by Money.

To decide how much money is needed by a nation, we must, firstly, determine the quantity of work which money has to do. This will be proportional,
ceteris paribus, to the number of the population; twice the number of people, if equally active in trade and performing it in the same way, will clearly want twice as much money. It will be proportional, again, to the activity of industry, and to the complexity of its organization. The more goods are bought and sold, and the more often they pass from hand to hand, the more currency will be needed to move them. It will be proportional, again, to the prices of goods; and if gold falls in value, and prices are raised, more money will be needed to pay the debts increased in nominal amount.

Few of the quantities concerned in such considerations are known. We know the number of the population approximately, and the amount of foreign trade, but the quantities of goods bought and sold in inland trade are almost entirely unknown. It is needless to dwell on this side of the question, as our knowledge is still more defective in other respects.

Efficiency of the Currency.

By the efficiency of the currency we mean the average number of exchanges effected by each piece of money in a unit of time, such as a year. The aggregate work done by money will be measured by its quantity multiplied into the average number of times which each coin or note passes from hand to hand during the year. Now we know very imperfectly what is the quantity of currency in most countries, and we know nothing at all as to the average rapidity of circulation. Some coins, especially small silver or bronze coins, may pass several times in the course of a day. Other coins or notes may be kept in the pocket for weeks, or may be laid by for months and years. I have never met with any attempt to determine in any country the average rapidity of circulation, nor have I been able to think of any means whatever of approaching the investigation of the question, except in the inverse way. If we knew the amount of exchanges effected, and the quantity of currency used, we might get by division the average number of times the currency is turned over; but the data, as already stated, are quite wanting.

There is no doubt that the rapidity of circulation varies very much between one country and another. A thrifty people with slight banking facilities, like the French, Swiss, Belgians, and Dutch, hoard coin much more than an improvident people like the English, or even a careful people with a perfect banking system like the Scotch. Many circumstances, too, affect the rapidity of circulation. Railways and rapid steamboats enable coin and bullion to be more swiftly remitted than of old; telegraphs prevent its needless removal, and the acceleration of the mails has a like effect. A decrease in the circulation of country banknotes in England, in 1842, was attributed to the effect of the penny postal reform in facilitating presentation of notes by post.

Effects of the Cheque and Clearing System.

Far more important than these considerations is the fact that, where an extensive banking system exists, only a portion of the exchanges are actually effected by money. I do not lay much stress upon the use of bills of exchange as replacing money, because the degree in which they are so used must be comparatively limited, and they are rather articles bought and sold with money than money itself. But we have traced out step by step the way in which the cheque and clearing system enables debts to be balanced off against each other, so that the money is never touched at all, and only intervenes as the unit of value in which sums are expressed. Almost all large exchanges are now effected by a complicated and perfected system of barter. In the London Clearing House, transactions to the amount of, at least, £6,000,000,000 in the year are thus effected, without the use of any cash at all, and, as I have before explained, this amount gives no adequate idea of the exchanges a arranged by cheques, because so many transactions are really cleared in provincial banks, between branches, agents, or correspondents of the same bank, or between banks having the same London agents.

If our knowledge of the amount of transactions in England is highly imperfect, we know still less of the way in which payments are effected in other countries. The New York Clearing House transactions are very extensive, as we have seen, and there is an elaborate banking system extending over all the States of the Union; but it would require much investigation on the spot to enable any one to form a notion whether the correspondence between these banks enables them to economize currency as much as the English system of London agencies. In France and most continental countries the cheque and clearing system can hardly be said to exist except in some of the large towns. Paris has an incipient clearing house, and the Bank of France, moreover, makes transfers between clients to the extent of two or three millions daily. All banks will to a certain extent economize currency, and those of Amsterdam and Hamburg have for some centuries carried on a system of transfers, the true prototype of our system.

Considerable changes, it is true, are taking place in the mode of conducting business in some parts of the Continent. Professor Cliffe Leslie, who is well known to be intimately acquainted with the economical systems of the continental countries, attributes the rise of prices in Germany in a great degree to the quicker circulation of the money, and the freer use of instruments of credit. In the
Fortnightly Review for November, 1870 (pp. 568-9), he says:—”The improvements in locomotion and in commercial activity which have so largely augmented the money-making power of the Germans, have also quickened prodigiously the circulation of money; and the development of credit, likewise following industrial progress, has added to the volume of the circulating medium a mass of substitutes for money which move with greater velocity. A much smaller amount of money than formerly now suffices to do a given amount of business, or to raise prices to a given range; and to the increased amount of actual money now current in Germany we must add a brisk circulation of instruments of credit. Were the circulating medium composed of coin alone, whatever the amount of the precious metals issuing from the mines, or circulating in other countries, and whatever the price of German commodities in markets abroad, no rise in the prices of German commodities at home could take place without additional coin to sustain it.”

So different, then, are the commercial habits of different peoples, that there evidently exists no proportion whatever between the amount of currency in a country and the aggregate of the exchanges which can be effected by it. Even if we had reliable statistics of the amounts of currencies, such data should be regarded as indicating, not the comparative abundance or scarcity of money, but the degree of civilization, of providence, or of complexity of banking organization, in the country.

Conclusion.

From all the above considerations it follows that the only method of regulating the
amount of the currency is to leave it at perfect freedom to regulate itself. Money must find its own level like water, and flow in and out of a country, according to fluctuations of commerce which no government can foresee or prevent. The manner in which paper notes may be used to represent and replace part of the metallic currency should be strictly regulated, because otherwise belief in the existence of metallic money is created when there is no such money to warrant the belief. But the amount of money itself can be no more regulated than the amounts of corn, iron, cotton, or other common commodities produced and consumed by a people. It must be allowed, indeed, to be no easy matter to discriminate precisely and soundly between those points at which the legislator must interfere in the management of the currency and lay down a fixed rule, and those points at which perfect freedom must be maintained.

A comparison of our present laws regarding currency and trade, with those which existed in this country from the tenth to the fourteenth century, will show a curious double progress. Many things which our ancestors attempted to regulate by law are now left free by general consent, and other things which they left free, or nearly so, are now strictly regulated. The rates of wages, the price of the quartern loaf, the exercise of various trades, were then the subject of legislation, though we now know that they cannot be properly brought within the scope of legislative control. On the other hand, an endless diversity of weights and measures were formerly used in different parts of the country, and little or no attempt was made to reduce them to any system or precise definition. Almost every important town, too, had its mint in the earlier centuries, and barons and great ecclesiastics often exercised the right of issuing their own money. There are still a very few persons who advocate free coinage; but, by almost general consent, the work of coining metallic money is now, in every civilized country, committed to the care of the state. We provide for a uniform system of coins with the same care that we establish a national system of weights and measures. But while we thus take the greatest care of the metallic currency in one respect, we have utterly abandoned all the futile attempts which were in former centuries made to bring bullion into the kingdom in order to set the mint to work.

We must deal with the paper currency in analogous manner, and regulate it both more and less than hitherto. Private issues should disappear like private mints, and each kingdom should have one uniform paper circulation, issued from a single central state department, more resembling a mint than a bank. The manner of issuing this paper currency should strictly regulated in one sense; the paper circulation should be made to increase and diminish with the amount of gold deposited in exchange for it. At the same time, no thought need be taken about the amount so issued. The purpose of the strict regulation is not to govern the amount, but to leave that amount to vary according to the natural laws of supply and demand. In my opinion, it is the issue of paper representative notes, accepted in place of coin, which constitutes an arbitrary interference with the natural laws governing the variations of a purely metallic currency, so that strict legislative control in one way leads to more real freedom in another. I am quite willing to allow, however, that questions of great nicety and subtlety arise in this subject, and that only in the gradual progress of economic science can they be finally set at rest.