Lectures on Political Economy

I. THE CONCEPTION AND FUNCTIONS OF MONEY

BIBLIOGRAPHY.—The literature on the subject of money is abundant. According to an estimate of C. Menger (in his article “Geld” in Conrad’s Handwörterbuch) an approximately complete bibliography would fill an octavo volume of over 300 pages. Yet its importance is not proportionate to its scope; of course, the innumerable special treatises on the money of different countries and different ages have their value, but the standard works which have advanced our knowledge of the nature and laws of money are comparatively few. As regards the general theory of money, the views of the classical school are represented by the works of Adam Smith, and especially of Ricardo and J. S. Mill (Principles, book iii, ch. vii-xiii and xix-xxiv). Mill’s presentation is, however, marred by his attempt to combine two fundamentally opposite outlooks.

For a general survey of modern money and monetary theories we recommend the excellent essay by E. Nasse, in Schönberg’s Handbuch (supplemented by W. Lexis, and by C. Menger’s essay in the Handwörterbuch, which is more theoretical). Jevons’s Money and the Mechanism of Exchange (which is available in several languages) is substantial and very readable, though without great originality. A new, exhaustive, and in every respect valuable work is Helfferich’s Das Geld, in the Frankenstein collection, Hand- und Lehrbuch der Staatswissenschaften. G. F. Knapp makes some noteworthy contributions to terminology in his Staatliche Theorie des Geldes (1905), and his account is attractively written, though somewhat one-sided.

The chapters relating to money in T. H. Aschehoug’s Socialökonomik (ch. 58 et seq.) are of special interest for Scandinavian readers.

Further references will be given under the main headings.

In the introduction to the first volume an account was given of the plan and general arrangement of these lectures. In that plan the theory of the medium of exchange, money and credit, occupied the fifth and last of the sub-divisions of the general or theoretical part, of which three have been treated in Volume I.1 Similarly this volume is primarily theoretical.

To preserve continuity, however, we shall, in passing, also deal with certain technical questions relating to currency and credit, although, strictly speaking, these belong to the next section, which is devoted to applied economics. Meanwhile, it is to be noted that we are concerned here only with one part or phase of the extensive field of credit; namely that which is indissolubly bound up with money, in so far as credit forms, in common parlance, a substitute for ready money (or, as we prefer to express it, a means of accelerating the real or virtual velocity of circulation of money—since, for the present, we mean by money only metallic money). The other phases of credit will be more suitably treated in the various sections on practical economics—e.g. under agriculture and industry (agricultural and industrial credit) and especially under trade; for not only does trade regularly employ credit, but it also has a special branch which consists of trade in credit; dealing in shares, the issuing system, and the stock exchange, with which a large part of banking is concerned.

The theory of money, delimited in this way, constitutes a complete and rounded whole, which eminently belongs to the province of economic science. In all other economic spheres other circumstances, such as technique, natural conditions, individual or social differences, play a role which science can only imperfectly survey and control. But, with regard to money, everything is determined by human beings themselves, i.e. the statesmen, and (so far as they are consulted) the economists; the choice of a measure of value, of a monetary system, of currency and credit legislation—all are in the hands of society, and natural conditions (e.g. the scarcity or abundance of the metals employed in the currency, their chemical properties, etc.) are relatively unimportant. Here, then, the rulers of society have an opportunity of showing their economic wisdom—or folly. Monetary history reveals the fact that folly has frequently been paramount; for it describes many fateful mistakes. On the other hand, it would be too much to say that mankind has learned nothing from these mistakes. Undoubtedly, we have advanced far in the theory and practice of money in the last 100 to 150 years. Meanwhile there still remain in this field a number of dark places which must be illuminated; there are still different, even diametrically opposed, opinions on the most vital questions, which is the more to be regretted since transactions involving money and credit daily gain ground at the expense of the old system of barter. Consequently even smaller errors may nowadays have serious consequences, since every disturbance makes itself felt in a much higher degree and over a much wider area than formerly.

For various reasons, it is impossible to give an account here of all the different views which have been held concerning money. Even a summary review of them would, I fear, produce in most readers a sense of confusion and insecurity. I shall therefore content myself in the main with a connected account of the view which seems to me most correct. Only on certain specially important points, in which the conflict between opposing theories has been of epoch-making and world-wide importance, will a full and exhaustive account be given.

1. The Economic Importance of Money

We have hitherto considered production, distribution, and exchange as if they were effected without the assistance of money; in other words, as if labourers, landowners, and capitalists received an apportionment of the product in kind—as regards the two first categories, moreover, an apportionment in advance, from a pre-existing supply or stock of similar goods—and then exchanged among themselves the products so acquired. In such a case, we are not concerned with any other price than the relative prices of the commodities. Interest was regarded as the direct expression of the marginal productivity of real capital itself, or as the difference between the marginal productivity of saved and current (present) labour and land; or, more correctly, as the marginal productivity of “waiting”, in which it was of no importance whether the owner of productive capital was himself regarded as the entrepreneur or whether he was regarded as having lent his capital to another entrepreneur. We did not, in principle, take any entrepreneur’s profit, strictly so-called, into consideration, but assumed that as soon as the field of production was large anough to permit full and free competition between entrepreneurs, it would tend towards zero. This simplification of the problem is absolutely necessary in a preliminary treatment of economic phenomena, because actual economic life is usually too complex to be examined directly with any chance of success. It is also permissible—as a first approximation—because there can be no doubt that, in many cases, transactions which are made with the assistance of money can be conceived as having been made without its intervention. Among the many similes which have been employed to illustrate the nature and functions of money that which describes it as the oil in machinery is, from many points of view, the most appropriate. Oil is not a component part of a machine; it is neither a motive force nor a finishing tool; and in an absolutely perfect machine a minimum of lubrication would be required. Naturally, however, our simplification is only provisional. Economists frequently go too far when they assume that the economic laws which they have deduced on barter assumptions may be applied without qualification to actual conditions, in which money actually effects practically all exchanges and investments or transfers of capital. The ideal machine, running without friction, and therefore without a lubricant, has not yet been invented, even though we have perhaps approached nearer to perfection in the economic field than in the mechanical field. The use—or the misuse—of money may, in fact, very actively influence actual exchange and capital transactions. By means of money (for example by State paper money) it is possible—and indeed this has frequently happened—to destroy large amounts of real capital and to bring the whole economic life of society into hopeless confusion. On the other hand, by a rational use of money, it is possible actively to promote the accumulation of real capital and production in general. Not that either money or credit is a substitute for, or can really replace, real capital; but by its aid it is possible to facilitate the process of saving, the restriction of present consumption which is the source of the accumulation of real capital or even to enforce it—by no means always an unqualified gain. Credit, in its widest sense, contributes to the greatest possible productivity of capital. Broadly speaking, a closer study of money and its functions will reveal a number of more or less unexpected relationships, both in the field of production and in that of consumption. And in so far as money, qua money—at least in metallic form—can be made superfluous, it is only by a study of its laws that the necessary conditions can be ascertained.

2. Money as a Measure and Store of Value

The conception of money is involved in its functions and it is usual to distinguish three such functions: as a measure of value, as a store of value, and as a medium of exchange. Sometimes more or less distinct variations, such as the medium of savings, loan medium, medium of payment (the latter for unilateral payments such as taxes and so on) are added to these. Of the three main functions, only the last is in a true sense characteristic of money; as a measure of value any commodity whatever might serve. Indeed, compared with the two others, this is not really a function at all, for it has no relation to the thing itself or to any of its external physical properties. The only quality which is essential in a commodity which is to serve as a measure of value is that it should have, as nearly as possible, a constant value: what this implies we shall examine later. And however desirable it may be that the commodity which is adopted as the medium of exchange should have such a constant value, this is not indispensable; still less is it inherent in the conception of a medium of exchange. For a long time past one class of commodities, the precious metals, has been employed as a medium of exchange, whilst another, such as grain, has been used as a measure of value, especially in the fixing of wages and taxes. (Until quite recently the stipends of the country clergy in Sweden were reckoned partly in grain, although they were paid in money in accordance with the so-called Markegang scale; and this is still true of existing free-farm rents.) A remedy for fluctuations in the value of money proposed in more recent times is that in agreements extending into a more or less remote period of time the measure of value (unit of value) should be something other than money, for example the average price of a number of commodities (the so-called multiple standard). It is clear, however, that a commodity which serves as a medium of exchange naturally comes to be used also as a measure of value for transactions in goods and service which are near or simultaneous in time; and since it then becomes difficult or undesirable to prescribe any fixed limit, money has gradually been transformed into a general measure of value, even for valuations which are separated by a considerable period of time. Commodities which are subject to violent fluctuations in value have therefore proved unsuitable as media of exchange wherever they have been so employed. The establishment of a greater, and if possible absolute, stability in the value of money has thus become one of the most important practical objectives of political economy. But, unfortunately, little progress towards the solution of this problem has, so far, been made.

Similarly, the function of acting as a store of value is not essentially characteristic of money. One might even go so far as to say that, from the social point of view, money never has this function, but only from the individual or private point of view. Society as a whole only requires to preserve useful things, certain utilities for the future. It is true that the precious metals, if carefully preserved, are almost indestructible, since they are not destroyed by the acids in the air. Their utility as ornaments, or for certain technical purposes, can therefore be preserved indefinitely. This utility is, however, too limited and specialized. It is never this utility which is contemplated by those who hoard money (and seldom by those who hoard ornaments) but the object in view is nearly always that of procuring something else for it at a future time. In other words, it is the exchange value which it is desired to preserve; it is money as a future medium of exchange which is hoarded. On further reflection it will appear that this is only possible or effective on certain definite assumptions. In so far as somebody else at the same time hoards a sum equal to that which I withdraw from my hoard, for immediate use as a medium of exchange, the amount of money in circulation and, presumably, the price level, will remain much the same. From the economic point of view of the individual the saving achieves its purpose, since the person saving will at a future date consume what he now forgoes and which somebody else will then forgo. From the social point of view, the only result will be that some part of the supply of money will habitually be withdrawn from circulation; or, as we prefer to express it, that the velocity of circulation of all existing money will be retarded. Again, if everybody adopted the same procedure at the same time, this result would not be achieved. So long as saving is continued the price of commodities falls, and if everybody saves uniformly, everybody will continue to obtain just as many commodities for their remaining income as if they had not saved and were in fact not compelled to restrict their consumption. But when once the money so accumulated is returned to circulation, the prices of all commodities will rise, and nobody will be able to increase his consumption. Thus saving will not have involved any sacrifice, and the result will prove to be exactly nothing. Thus it follows that the accumulation of money in concreto, which was once so common, may have been a good means—at least as long as none better was discovered—of protecting one’s children, for example, or one’s old age, against want. Over against those age groups which were bent on saving there were, in the nature of things, other classes which were obliged to encroach on preexisting savings. But on the other hand, this was clearly useless as a protection against a general calamity such as famine, especially in olden times when grain could not easily be transported from one country to another. In less progressive countries, such as India, this custom of hoarding money, qua money, still persists. Even the poorest have some bits of silver buried in the ground beneath their beds, or else wear them on their persons as ornaments. Their object is primarily to possess a reserve during the oft recurring crop-failures. If the failure is only local and a neighbouring district has a good harvest, the means is good and effective; but if the failure is general, over a wider area, these accumulated stocks of money are (and were still more so before the building of railways in India) quite useless and serve only to drive up the prices of foodstuffs to a dizzy height.

We are reminded of how common this hoarding was all over the world, even in comparatively modern times, by a story in Macaulay’s History of England. A London merchant of the name of Pope, the father of the famous poet, retired from business towards the end of the seventeenth century to one of his country estates, taking with him the sum of £20,000 in gold and silver coin—a considerable sum, especially in those days. From time to time during the remainder of his life he withdrew from this reserve the amounts he required for his own maintenance and that of his family.

In France, the custom of keeping large amounts of ready cash has been preserved until the present day. A witness before the English Gold and Silver Commission in 1887 said that he had spoken with a hotel-owner in the South of France whose annual turnover amounted to a million francs or more. When he was asked his banking connections, he is reported to have pointed to a safe in the corner of the room and to have said, “That is my bank.”

The hoarding regularly practised in earlier times by princes, chiefly with the object of creating a reserve for future wars, was of a somewhat different character. In peace time, the taxes imposed on subjects, for the accumulation of these funds, were probably not too oppressive, in so far as the reduced personal incomes were more or less counterbalanced by cheaper prices of commodities. On the outbreak of war, when the state war-treasuries were broken into and came into circulation, the consequent rise in prices compelled all the population to restrict their consumption, whereby supplies became available for the unproductive consumption of the opposing armies, thus assuming the character of a disguised war tax. The state issues of paper money, so common during war periods in the eighteenth and nineteenth centuries, had substantially the same effect, but were the more dangerous because they could be expanded indefinitely; for which reason also the promise of a future withdrawal of such paper money was rarely fulfilled.

Similarly, from the individual point of view the use of money as a standard of future payments over longer periods is unsatisfactory and incomplete, since the capital saved is not employed in production and thus does not, as a rule, yield any interest. Owing to the development of credit, private hoarding has fallen almost entirely into desuetude in the more progressive countries and has been replaced by a more economic method of storing value. The money capital saved, usually through the medium of banks and savings banks, is loaned as quickly as possible and is thereby returned to circulation. From the individual’s point of view, this means the transformation of dead capital into fruitful capital, with an interest-bearing claim guaranteed by the bank. Even if the money bears no interest there is still the advantage that the individual is spared the anxiety of guarding his hoard.

On the other hand, the question may be raised whether the general economic advantage of this arrangement is, broadly speaking, very considerable. At first sight it might appear as if it would be restricted to making all existing stocks of money available for circulation. That, of course, would be a great advantage to any individual country, for the money which was not required in circulation could be, and in fact automatically would be, sent abroad in exchange for goods or as interest-bearing loans. But this again would only be to the economic advantage of individuals. In a closed economy, the result, it may be supposed, would be—if we may assume it in anticipation—that the increased volume of money would bring about a corresponding rise in the prices of commodities. There would be no direct gain since the larger volume of money with higher prices performs the same service as the smaller volume with lower prices. Yet even in this case there would be an ultimate gain in so far as the production of the precious metals would become less profitable—so that the labour and capital employed in this fundamentally unproductive activity would find more useful employment.

In reality, however, the economic significance of the change from hoarding to the modern forms of saving and (private) accumulation of capital is more fundamental than that. Anyone who saves a part of his income and locks it away, thereby withdrawing it from circulation, to that extent exercises a depressing influence on prices, even though it may be infinitesimal as regards each individual. Other individuals thereby obtain more for their money; in other words they divide among themselves that part of consumption which is renounced by those who save. The subsequent use of these savings, say in old age, involves sharing in the consumption of others. The total effect may thus be compared with a sort of consumption, loan which those who save give to their contemporaries and of which they subsequently claim the capital (though without interest), from the same generation or from the next.

By saving in the modern sense a man entrusts his savings as they are accumulated to a bank, which lends them as quickly as possible to some enterprise which employs them productively in one way or another. Money is thus withdrawn from circulation only for a moment, if at all. No drag on prices need then arise. The commodities of which the saver forgoes the consumption will not, in a properly ordered system, be produced at all, since the units of labour and natural resources which would have been employed in their production will now be employed in preparations for future production. Apart from some inevitable economic friction everything else will remain unchanged at the moment of saving, but production will have become more capitalistic, i.e. directed more towards the future, and consequently, as a rule, more fruitful. When, at some future time, the saver claims the return of his capital, he will therefore receive an additional sum in the form of interest—which can be, and usually is, paid in the interim. He does not deprive the future generation of anything, but has rather assisted generally in increasing its real income and consumption, because of the effect of more intensive capitalistic production in raising wages and rents.

The view so frequently expressed by the classical economists, such as Mill, that savings immediately furnish other persons with increased means of subsistence in proportion to the consumption which is renounced thereby, is, however, untenable with the modern form of saving—which the classics also assumed. The benefits which saving confers only become visible at a future time, when, thanks to those savings, the production of society is increased.

If we imagine an organic and progressive accumulation of capital and expansion of production, the payments to the original factors in production, wages and rents, would no doubt as a rule increase from the beginning, though certainly not by an amount equal to the new savings.

Reverting to the highly simplified example of the laying down of wine in Volume I (p. 175), if we increased the original capital of 314 million shillings, then the price of the grape juice V0, which was previously 67 shillings per hectolitre, would immediately rise, and with it wages (and rent); whilst, at the same time, interest—still assuming a four years’ storage-period—would fall till V0 equalled 68·30 shillings and interest had sunk 10 per cent, for which reason a five year storage-period would have been as profitable as a four year. At the same time, capital, both new and old, with V0 unchanged—or rather under the pressure of an infinitesimal rise in the price of grape-juice—would be diverted more and more to five-year storage, until it was all so invested, whereupon V0 would again begin to rise and interest to fall, etc.

If, alternatively, we assume an organic extension of production, wages would of course rise uninterruptedly with the growth of capital. In the highly simplified instance of the laying down of wine alluded to above, we also found that a growth of capital due to new savings from 314 to 422 million shillings, or an increase of 108 million shillings, produced an increase in the annual sum of rent and wages of only a bare 3 million shillings. Thus the workers were very far from “sharing in the consumption which existing savers renounced”.

The principal error committed by the older economists was that they constantly regarded production as taking place in one year and neglected to take into consideration the lengthening of the period of production. In the present case, the new capital is absorbed mainly in the gradual laying down of a further year’s vintage, by which no additional labour, but only a year’s postponement of the sale of the four years’ wine, is required.

In the second part of Marx’s Capital (p. 490 et seq.) this error of the classical economists is rightly pointed out. The figures there cited by Marx, and quoted subsequently by Tugan-Baranowsky, and others, are, however, unsuitable in so far as they assume not only the growth of capital but also a simultaneous growth in all three factors of production: labour, capital, and natural resources.

The transition from hoarding to modern forms of saving introduces further peculiar phenomena. If banks are opened in a country which formerly possessed none, and in which the greater part of the money was hidden in “safes and coffers”, then this money is put into circulation, and the consequence is, apart from increased enterprise, a more or less marked rise in prices. The latter is, in fact, a necessary condition of the former, for the enforced general reduction of consumption which results from it constitutes just that accumulation of real capital which is the indispensable preliminary to a higher degree of capitalistic production. In other words, increased enterprise withdraws some labour and natural resources from the production of present commodities in order to employ them in preparation for future production, and this would be impossible in the long run if present consumption were not restricted in the same degree. As we shall see later on, the banks can achieve the same result independently, without obtaining control of already existing stocks of money, by increasing the volume of credit.

The only substantial accumulations of money which exist in our days in the economically most progressive countries are, as is well-known, the metallic cash reserves of the banks; though in countries still using metallic currency to any large extent this does not prevent the aggregate of the small sums in the hands of the public from exceeding—in some cases very greatly exceeding—the amount of precious metals in the hands of the banks. This latter circumstance is indeed of great importance in judging the monetary and interest policy of the banks. In such countries, the primary function of the banks is to control the supplies of metallic money for current needs or to prevent a surplus from arising, thus regulating prices and the value of money. These reserves can scarcely be called standards of future payment, for in reality they neither bring to nor withdraw from society any real values.

At the same time, it is well-known that the metallic reserves of the banks constitute reserves for international payments, and to that extent they are undoubtedly to be regarded as standards of future payment. But, when these supplies of money in any country as such are taken into account, that country appears to some extent as an individual vis-à-vis other countries, so that even this function of money, seen from the world point of view and that of international currency, assumes fundamentally a private or individual economic character. In recent times, attempts have often been made and proposals put forward to render this last remnant of the old hoarding practice superfluous. We shall deal in another place with the conditions of its successful achievement.

3. Money as a medium of exchange. The exchange value of money and the “need” for money

There remains the function of money as a medium of exhange or a means of payment, which includes, as has been said, the storing of value over a short period; i.e. the period between a sale and a subsequent purchase or, more generally, between a payment received or advanced and a payment by the receiver. What is meant by a medium of exchange? It is an object which is taken in exchange, not on its own account, i.e. not to be consumed by the receiver or to be employed in technical production, but to be exchanged for something else within a longer or shorter period of time. Now this is also true of a merchant’s goods, but in that case it is a question of continued production, since commerce and distribution may be regarded as a part of production, as the final phase of the process of production; or—in the case of trade in raw materials or semi-manufactures, as well as machinery or tools—as an intermediate link in the process. Fundamentally, therefore, these commodities are means of production, and not mere media of exchange. But even with this limitation our definition is still too wide to describe money accurately. Something more must be added, namely the quality of being general or conventional. We shall illustrate the importance of this latter qualification by means of an example and shall thus discover the essence of the nature of money.

For this purpose, we shall revert to the case described in Volume I on p. 64, in which three or more kinds of goods, A, B, C, etc., are exchanged for each other on the same market. Once again, we ignore, for the present, the time-element, though in fact it enters into every exchange transaction. If there are two kinds of commodities on the market they can be exchanged directly against each other without any medium of exchange, and the use of such a medium would not, under these assumptions, confer any benefit, though it might, of course, still serve—and in exchanges in kind does, in fact, serve—as a measure of value. If, on the other hand, there are more than two kinds of goods, then, as Walras has shown, there cannot be any general equilibrium in the market so long as the owners of the goods are constrained to exchange their supplies directly with one another. It is true that, even under such conditions, the influence of supply and demand in the market would bring about a certain equilibrium: one unit of A would be exchanged for so many units, or for such and such a fraction of a unit, of B; and, similarly, one unit of B for C, etc. But these prices would not generally be correlated. Whereas, in ordinary price formation, the price of A in terms of C must always be the same as the product of the price of A in terms of B and the price of B in terms of C—or, if it be preferred, the quotient between the prices of A and C, both expressed in terms of B—this is generally not the case here, but A can have an exchange value in terms of C either more or less than the said product or quotient. If, for example, 1 lb. of A is exchanged for 3 lb. of B and 1 lb. of B for 2 lb. of C, it might happen that 1 lb. of A would nevertheless not exchange for 6 lb. of C, but for, say, 5 or 7 as the case might be.

But should this happen, the operation which in the international money and exchange market is known as arbitrage would necessarily appear in the market; this is more or less the function of a middleman. If, for example, the price of A in terms of C is higher than the said product or quotient, then it will be to the advantage of the owner C, as can easily be seen, to obtain his requirements of A in an indirect manner by first acquiring B for C and then A for B. In other words, in such circumstances an indirect exchange always develops, to a larger or smaller extent, out of the direct exchange; and only in this way is there established that general market equilibrium by which all prices are correlated in such a manner that one exchange relation can always be expressed by the quotient or product of two or more of the others. This relationship becomes most marked in extreme cases, also described in the passage referred to above; as in the case where the owner of A has no demand for C but only for B, the owners of B only want C, but not A, and the owner of C only A and not B. In this example, suppose that A represents forest products, B fish, and C corn, and that the owners are the populations of the three Scandinavian countries. In such circumstances, no direct exchange is, of course, possible, though an indirect exchange is. For example, the owners of A, the population of Sweden, might obtain in exchange for their staple goods (timber) a certain quantity of C, Danish corn, not in order to consume it themselves but in order to exchange it for B, Norwegian fish, and in this manner to acquire this latter commodity, which is in demand.

In this transaction, the commodity C clearly plays the role of a medium of exchange and is, in contrast to commodities intended for further production, or for trade in the ordinary sense, a real medium of exchange. The sole purpose of the process was to facilitate an exchange which would otherwise have been impossible, even though the required commodities existed in the immediate vicinity of the consumers. But it is not a general medium of exchange; it is a medium only for intermediaries, whilst remaining for producer and final consumer a commodity, like any other. For this reason the whole operation is very clumsy and incomplete. The medium of exchange must be obtained and transported in quantities equal to the total value of the commodities offered or demanded—an entirely unnecessary double transport of what may be perishable and fragile goods.

Conditions are quite different where we have available a general medium of exchange, i.e. a commodity which is habitually, and without hesitation, taken by anybody in exchange for any commodity—especially if it is at the same time durable, easily transported and of high value in proportion to its bulk. An owner of A having in his possession a quantity of this commodity, which we will call P, sends the latter in exchange for the quantity of commodity B which he requires. The owner of B exchanges it in turn for a quantity of the commodity C from whose owner it passes in exchange for a quantity of A; thus it comes once again into the hands of an owner of A. The latter will generally be a different person from the one who first put the medium of exchange into circulation. The last seller, with the help of the medium of exchange, now effects his purchases of B, whereupon the new seller of B makes his purchases of C etc., until the commodity P (the medium of exchange, or money) after a larger or smaller number of revolutions in its coil-like movements, returns to its original starting-point. It will now have facilitated the exchange of a quantity of the commodities A, B, and C equal to its exchange value multiplied by the number of times it has circulated. Owing to the peculiarity that, at the conclusion of one purchase or sale, it is immediately ready to effect a new one, returning after a longer or shorter period of time to its starting point, money is differentiated from all other commodities, even if the latter can sometimes incidentally serve as (individual) media of exchange in carrying trade.

In real life, at any rate in larger communities, it is true that a coin once spent returns less often in corpore to its former owner; and, naturally, still less frequently does it return before he requires to make a new payment. But, sooner or later, he obtains in its place another coin of the same size and value, so that the circulation of money is complete on this occasion so far as he is concerned. Money possesses in the highest degree—and this is one of its most important characteristics—the quality of a res fungibilis. It behaves in much the same way as the circulation of the blood, to which, as has often been pointed out, the circulation of money bears a resemblance, even if only a superficial one. Broadly speaking, the whole volume of the blood circulates incessantly through the blood vessels, but it must be very unusual for the same drop of blood to pass the same capillary vessel twice, least of all twice in succession.

That, however, constitutes an imperfection from the point of view of money, and logically there would be nothing—provided that we could disregard the time-element required for purchase and payments—to prevent all money transactions in a country or in the whole world from being effected with one and the same penny piece. The paradox in this idea will be less unfamiliar to the imagination if we remember that the greater part of international trade, at any rate, is conducted by payments in which money is not, in fact, used at all.

It has been said that other goods, considered as goods, and not as exchange media, only reach the market in order to leave it again. They move as a rule in a simple path, easily traced out from producer to consumer, with a few, if any, intermediaries; for which reason the expression “circulation of goods”, which is sometimes employed, is rather unreal. Money, on the other hand, always remains in the market, though in different hands. Indeed, its function is to pass from hand to hand. The well-known Dutch economist, N. G. Pierson, has very happily likened money to a shunting locomotive at a railway station: at one moment it pulls one line of trucks, at the next it pushes another; its function being to bring each truck on to the right rails in order that it may be able to reach its destination. But the locomotive never leaves the station.

These observations may appear simple and even trivial, though in nine cases out of ten they are forgotten when reasoning about money. But one of their consequences is that the characteristics of money as a commodity (its concrete qualities) are forced more and more into the background when it is used as a medium of exchange. They may emerge again, but only when it ceases to be money and becomes an ordinary commodity. Money is thus converted into an abstract symbol, a mere quantity of value. Even the Roman jurist Paul knew that money performed its services “non tam ex substantia quam ex quantitate”. It would perhaps be more correct to say that, economically speaking, money is a quantity in two dimensions, quantity of value on the one hand and velocity of turnover or circulation on the other. These two dimensions multiplied together give the efficiency of money (Helfferich) or its power to facilitate the turnover of goods during a given time, in the course, for example, of one consumption year. Greater velocity of circulation achieves, from the point of view of the community, the same result as a larger quantity or, what is exactly the same from the point of view of society, a more valuable substance of money; and vice versa. Consequently, the laws determining the exchange value of money, or, what is the same thing seen from the obverse side, the laws governing the general level of concrete commodity prices and its changes, are quite different from the laws determining the exchange value of the commodities themselves. It is a great, and unfortunately a common, error to forget this and to imagine that what applies to commodities in general and to commodities in terms of each other can also be applied without qualification to “the commodity money” and its relation to commodities proper. This is not true, simply because money is not a commodity like other commodities.

The formulæ by which we endeavoured to express the laws of price formation in the previous volume and which all relate to the exchange value of commodities in terms of one another, become meaningless when we consider the exchange value of money or the actual level of commodity prices. It is true that the exchange of goods effected by money is regulated in the main by those laws: in equilibrium, the supply of, and demand for, every commodity must still coincide; the marginal utility of a commodity, to every individual consumer, will still remain proportional to its price. But money itself has no marginal utility, since it is not intended for consumption, either directly or at any ascertainable future time. It has, perhaps, an indirect marginal utility, equivalent to the goods which we could obtain in exchange for it, but this depends in turn on the exchange value, or purchasing power, of the money itself and and it thus does not itself regulate the latter. Similarly, “supply” and “demand”, expressions so conveniently applied to almost everything under the sun, become obscure and, in reality, meaningless when applied to money. The individual seller who offers his goods at a certain price may, it is true, be said to “demand” money to an amount equal to the selling price; and the buyer who demands goods can be said to offer or “supply” a corresponding amount of money. But these individual offers or demands constitute in combination only an abstract value, not a total demand or supply of society for a definite physically determined quantity of money; for the same pieces of money may function, from one day to the next, several times over in sales and purchases and thus constitute the object of both supply and demand. In this sense, therefore, the demand for money can neither exceed nor fall short of the supply. However small the quantity of money, it could in a given time effect any number of transactions, at whatever price, if only it could circulate with sufficient velocity; and, on the other hand, the quantity of money required for the annual turnover of goods may assume any magnitude if only it circulates slowly enough.

It is very common to seek to establish a difference between “money on the wing” and “money in hand” because the latter lies idle for longer periods in the till. This is done by C. Menger, in the article “Money” in the Handwörterbuch der Staatswissenschaften (but cf. 3rd edition, pp. 606 and 909). Only the first kind of money, it is said, influences prices. This view, however, is unscientific, and in any case it is quite impossible to draw the line between circulating and non-circulating money. A fund, in order to fulfil its functions, must be so large that it is never exhausted and only rarely falls below a certain minimum amount. For that reason, some money may often lie untouched for years in the same till, though it has not, on that account, ceased to serve as a means of circulation. If we liked we could, from time to time, change it for other money, so that in the end every coin would have the same velocity of circulation as every other, i.e. the average velocity of the whole volume of money, upon which everything depends.

In the case of hoarding in the strict sense, which is becoming more and more rare in civilized countries, it is of course possible to say that certain parts of the stock of money in a country are withdrawn from circulation, but even this is unnecessary; in any case, there is no objection to including the whole monetary stock of a country in the conception of the general velocity of circulation of money. If commodity prices should change so much that a favourable opportunity arose for the purchase of durable goods, such as real property, we should soon see the hoarded money become effective as an automatic regulator of the velocity of circulation and hence of commodity prices.

Attempts have sometimes been made to render the definition of demand for money more precise by taking into account only those sums which are due for payment at certain agreed or statutory dates for payment, the end of a month or of a quarter, etc. But little is gained thereby, for of the persons who must make payments on those dates many, and perhaps most, will certainly have arranged their affairs in such a way that at those dates money is due to them in the form either of payment or of a loan; for which reason the velocity of circulation is much greater at such fixed payment dates than during the intervening intervals.

In a word, there is nothing in the act of exchange as such which can determine the value of money or concrete commodity prices. This is the more obvious since, at bottom, it is only goods, which are exchanged against each other. To the individual, it is of no importance whatever if he has to pay three or four times as much money as usual for the goods he demands provided that he will receive payment for his own goods in the same proportion; for the result will be, as before, that the money will return to him after the exchanges are effected. This will happen in any case if we do not take into account the time required for the exchange transactions. To society, as a whole, the matter is of even smaller importance. Nothing, at least so far as internal trade is concerned, can be of less importance to a country than the question whether it has little or much money, or whether this is of great or little value. The quantity of money, the velocity of circulation, and the prices of commodities always adjust themselves in such a way that all money intended for circulation, that is, all the money in the country will be exchanged against all the goods which are turned over.

We have assumed, however, that the goods which are finally exchanged against each other by the mediation of money are in the market simultaneously, in the widest sense of the term: i.e. are turned over at the same time. In such a case there is, strictly speaking, no other limit to the velocity of circulation of money, and thus no other minimum limit to the demand for money with a given turnover and a given price level than that determined by the time interval necessary for its actual payment or its transport. This latter is not without importance as regards payments between remote places, but with modern communications such transport does not, as a rule, often require more than a few days. Furthermore, the virtual circulation of money, especially in international payments, is greatly increased by the familiar procedure of cancelling out debits and credits.

The above assumption, however, seldom holds true in practice. In reality the seller is seldom transformed into a buyer; rather he remains a seller and leaves the market without buying anything himself. The money he acquires then remains in his hands both as ready money for anticipated future purchases or payments, and as a reserve for unforeseen liabilities. His money thus becomes his means of storing value (though usually only for a shorter period), his potential purchasing power, or future medium of exchange. In other words, it becomes a pledge or guarantee—de facto not de jure—for the future performance of counter-services to which he is economically entitled by virtue of the services he has performed. And since the money in his possession cannot, at the same time, serve as a medium of payment or exchange for somebody else, the real limit to the velocity of circulation of money, at any given moment, is to be found here. It is the total of individual cash balances which regulates and limits the demand for money, and thereby modifies the value of money. In this sense it may be said that money has by no means exhausted its function as a store of value, but that the latter remains of vital importance, expecially as a factor influencing its exchange value or purchasing power. In countries using a metallic currency, especially where banking technique is imperfectly developed, these private reserves, though small individually, nevertheless constitute a considerable total. They tend to increase with the growth of population and the development of the monetary system. Moreover, if the production of the precious metals does not keep pace with the increasing demand for cash, the inevitable consequence must be an increase in the value of money and pressure on commodity prices.

On the other hand, there exists a persistent, and in many cases very successful, endeavour to employ credit, to supersede the last remnant of the ancient function of money as a means of storing value. Theoretically, this process may proceed to any desired extent, since a promise to pay—if properly secured and redeemable at will—is just as good a pledge or reserve as is a supply of the medium of exchange. Thus, in this case also, the limits of the velocity of circulation and of demand for money are at first sight very indefinite and variable, and their close examination requires thorough investigation.

4. The Relation between Money and Credit

Clearly, there is a close connection between money and credit, in so far as credit is the best lever for increasing the velocity of circulation and thus diminishing monetary requirements. But this connection has another and very important aspect, in so far as the granting of credit or the transference of capital is itself frequently made in the form of money—which is also the way in which capital accumulations, or savings, are made. Money is usually said to constitute a means of saving and of transferring capital (loans). By capital here we mean only real capital employed in production, including trade, and this can, as we have already shown, always be referred back to one or both of the two elements: accumulated labour and accumulated natural resources. The simplest imaginable form of capital accumulation and capitalistic production would be where the possessors of labour and natural resources employed them themselves in the creation of objects destined for future production and consumption. But, especially as regards labour, this is practically never the case. Labour usually constitute one group and the entrepreneurs who employ it in the service of production constitute another. A third group consists of those who accumulate capital (savers) who voluntarily postpone the present consumption which they are economically in a position to enjoy, and thereby render production for the future possible. Capital accumulation and transfer are almost always effected by means of money, usually in accordance with the following simple scheme.

A landowner who saves a part of his income subscribes and pays for shares or bonds in a neighbouring railway which is under construction. With the money so obtained, the railway board pays a number of workmen, who provide themselves with milk and other foodstuffs from the landowner’s land. The landowner, in proportion as the money flows back to him, re-invests it in shares or bonds; and so on. The landowner might, if he so wished, directly consume the product of this labour, if, for example, he employed the same workmen as beaters in a hunt. Instead, the labour is now used in a saved-up form in order to render future railway traffic possible. This is the accumulation of real capital. If we add to our illustration horses, which in the one case may be used for hunting and in the other may be hired out by the landowner for a cash payment as beasts of burden for building the railway, we shall thereby include another element in capital, saved up natural resources, in so far as we regard the value of pasturage, hay, oats, etc., used for the feeding of such horses, as essentially representing the rent of land. Even the most complex forms of capital accumulation and transfer, as well as the transformation of existing capital, may be analysed in the same way. Here, too, as we have seen, money transactions only represent the form of real economic phenomena; any quantity of money, however small, would evidently be adequate to effect any amount of capital accumulation or capital transfer whatever. In other words, the quantity of money and the quantity of capital in a country bear no necessary relation to each other whatever.

In this respect the well-known Danish economist, W. Scharling, is of the opposite opinion. In his view, money, in addition to acting as a medium of exchange, also “represents capital”. “It is too often thought,” he says (Bankpolitik, ch. 1, p. 43) “that every increase in gold production increases the volume of money in circulation correspondingly—but in reality only a part of this quantity of metal comes into circulation, often only an infinitesimally small part, in so far as the constant increase in the supply of capital requires a constant increase of money, capital, etc.” In support of this opinion Scharling adduces that the total metallic holdings of the great metallic banks increased in the years 1873-1886 from 3,329 million reichsmarks to 6,044 million, whereas the amount of notes issued against this metallic reserve at the same time went down from 11,328 millions to 10,389 millions. Since the amount of notes always exceeded the metallic cover, it is scarcely possible to maintain that some part of the latter had been “withdrawn from circulation”. Scharling appears also to have overlooked the immense simultaneous increase in the use of cheques which, in most cases, perform exactly the same services as paper or metallic currency; the “idle capital” may therefore be said to have been in circulation just as much as if a corresponding note issue had been based upon it.

A fact which might appear to lend support to Scharling’s view is that, in a period of depression, metallic currency usually accumulates in the banks while at the same time large stocks of goods accumulate in the hands of manufacturers (accumulated real capital). When better times arrive the money flows out into circulation, and the accumulated stocks begin to be consumed by the labourers and other producers of fixed capital; in other words, some circulating capital becomes fixed. But this relation is more apparent than real. It is usually incipient unemployment, low wages, and decreased consumption, as well as falling prices, which reduce the demand for metallic currency; whereas just the contrary is evidently true of better times.

On several occasions, moreover, Scharling has stated that the metallic cover in the central banks is superfluously large, which would scarcely be the case if it were required to represent the, in all probability, vastly greater volume of real capital in process of accumulation.2

But since the various phases of credit, both of the kind which constitutes a transfer of capital and of the kind which replaces money as a store of value and thereby increases the velocity of circulation, constantly overlap, and can never be differentiated fully, the money market and the capital market (credit market) will always—not only in popular opinion and speech but also to a large extent in reality—be one and the same; or, more correctly, they will mutually influence one another, so that now one and now the other will predominate. The interest on loans of money in particular, which should theoretically be only a form, a market embodiment of the natural rate of interest on real capital used in production, may diverge from the latter for a longer or shorter period, especially with the assistance of credit institutions. Two consequences then ensue. In the first place, the monetary institutions may, as we have pointed out, exert considerable influence, either by stimulating or retarding economic life. In the second place, and more important, a change in the relation between the natural and the market rate of interest cannot fail to exercise a determining influence on the extent to which credit is used, and thus on the factor by which the value of money, or its purchasing power, is finally regulated.

It will be our purpose in the following pages to examine more closely the fundamental nature and functions of money. Our subject will then naturally fall into three divisions: (1) the theory of money itself—currency—by which for the sake of simplicity we mean, unless otherwise expressly stated, metallic money, (2) the theory of the velocity of circulation of money in the widest sense; or, what is the same thing, the theory of credit and banking, in so far as we shall consider the subject, (3) the theory of the value of money or its purchasing power over goods and services, as well as the practical applications of the theory, i.e. the means of preserving the stability of money in space and time, of establishing a medium of exchange which will, as far as possible, function at the same time as a stable store of value payments.

These three divisions of the subject cannot, of course, be kept entirely apart, especially the third from the first two. Indeed, just as we have already expressed some preliminary views on the causes of changes in the value of money, so also in the following pages we shall be obliged to do the same. A consistent presentation of the whole theory of the value of money, unfortunately neglected hitherto by economists, will, however, constitute the final, the most difficult, and at the same time the most important section of our inquiry.

 

• 1This expression is perhaps not entirely suitable, since, as will easily be seen, the essence of the argument is in both cases the same. It is therefore also possible that I ought to have endeavoured to combine sections II, 2, C and D in a single uniform presentation. I have found myself unable, however, for various reasons, to do this. As they now stand, these two collateral presentations may materially support and explain each other.
• 2Some of the matter included in this book had been published in Conrad’s Jahrbücher in the preceding year.