2. Economic freedom does not mean equality of power or of efficiency. It was said in discussing monopoly that it was not to be understood to be merely either scarcity or superiority. To speak of the class of laborers of ability above that of the average day laborer as having a monopoly is certainly a confusion of monopoly with the scarcity of efficiency. The term competition is not easy to define in practice; for it is not easy to see just what part of a man's inability to exchange is due to his own lack of efficiency, and what to things outside of himself which prevent him from exchanging his labor. But the thought is clear that free competition—economic freedom—is limited whenever men are hindered by any power outside themselves from using their economic power as they prefer. The limitations of competition, thus understood, are essentially social limitations, imposed by other men either unconsciously by custom, convention, tradition, or consciously by force or by laws. When, among Polynesian tribes, the custom of taboo prevailed, by which certain things were reserved to the rulers and were forbidden to the common man, there was a limitation on his economic freedom. Contrast such limits with those set by the penury of nature. The savage may like best to hunt, but if there is no game, he must fish; he may like best to make arrowheads, but in need of food he must dig roots. Economic action is limited by lack of knowledge and skill; the resources of nature lie unused under the feet of savages who are suffering from their lack. These are limitations not of economic freedom but of economic efficiency.
3. In early society custom limits economic freedom in many ways. The savage is not a man without law; he is bound in many ways to prescribed lines of conduct. Primitive custom usually takes on a religious sanction, and every member of the tribe is compelled to do as his fathers have done and as his neighbors are doing. He is not free to choose. Custom in some ways is favorable to the welfare of society, for it limits the power of masters and rulers, preserves the rights of individuals to common property, and is in the interest of the weak as well as of the strong. In an age of force if it were not for custom, he who had might on his side could take all. So in early society even economic relations were complex and yet almost fixed—changing only slowly from generation to generation. Every such social custom that limits the choice of men limits economic freedom.
4. Custom ruled a large share of the industrial life of the Middle Ages. Political and economic interests were not clearly divided in the Middle Ages. Land was the all-important kind of wealth. Military and other public services were performed by the vassal, who thus at the same time paid his taxes and the rent of the land. The landlord was at once the ruler, the receiver of rents, and the collector of taxes. The rent, however, was not a competitive price, but consisted of the dues and services the forefathers had been accustomed to pay. This limited slavery, like all other slavery, was wasteful, as it did not give to the individual the strongest motive to increase the quantity and to improve the quality of his service. Trade became limited in almost every direction. Crafts and gilds arrogated to themselves the right of employment in their industries. No matter what talent the son of a peasant might show, he usually found it impossible and always found it difficult to follow the occupation of his choice. Privilege pervaded all the life of that time. In such conditions economic friction is great. Men are kept in trades below their ability, while others gain command of monopolistic and unearned returns.
Yet through all the Middle Ages ran the forces of competition. The inefficiency of customary services was a constant invitation to competitors. Men were striving to break over the barriers of custom and prejudice. The strife for freedom was the vital economic force even of the Middle Ages. The industrial history of that time is largely the story of the struggle of the forces of competition against the bounds of custom.
1. The industrial events following the discovery of America strengthened the forces making for economic freedom. Discoveries in the Western hemisphere opened up a wide field for the adventure and enterprise of Europe. Commerce is the strongest enemy of custom, and new opportunities gave a rude shock to the conservatism both of the manor and of the village. With the rapid growth of industry and manufactures, old methods broke down. In an open market custom declines; it flourishes best in sheltered places. Further, the movement of thought in the Reformation and the spirit of the time, expressing the principle of personal liberty, allowing the individual to follow his own opinions and take the consequences, were favorable to competition. Despite these facts the restraints of the national governments on trade continued great, in some respects increasing during the seventeenth and eighteenth centuries, in France, Holland, and England. The regulation before attempted by towns and villages was employed on a larger scale by national governments with their commercial systems. The colonies in America were used for the economic ends of the "mother countries" and for the selfish interests of the home merchants in Europe. The American Revolution was one of the bitter fruits of the English policy of trade restriction.
2. Adam Smith's work advocating greater economic freedom had a profound influence upon public thought. "The Wealth of Nations," the first great work on political economy, was published in the year 1776. That was the "psychological moment," as public thought was so prepared for it that it had its maximum possible influence. The year of the American Declaration of Independence gave the most striking object lesson on the evils of a selfish colonial policy that interfered on a grand scale with economic freedom. The old customs had become ill fitted to life, ill adapted to the rapid industrial changes that were going on. What was needed in many directions, both in politics and in industry, was negative action by the government, the repeal of the old laws, the overthrow of old abuses. The French Revolution, following a few years later, emphasized this thought in the political field. The philosophers of the time believed in a "natural law" in industry and politics. The reformers of the time wished to throw off the trammels of the past and to give men opportunity to exert themselves "naturally." In America the old abuses never had taken deep root, as the conditions of a new continent were not favorable to monopoly and privilege. Although the movement for the repeal of medieval laws has continued in Europe from 1776 till the present time, yet to-day custom is stronger in Europe than in America. Serfdom was not abolished until the nineteenth century in Austria and southeastern Europe, and not until a few years ago in Russia. Many economic and cultural forces furthered this movement, but the most powerful intellectual force in its favor was the work of Adam Smith. So strong an impression did Smith's book make, that in the minds of men "free trade" became almost identical in thought with political economy, whereas that was but the temporary economic problem of the eighteenth century.
3. The doctrine of the "economic harmonies" is the extremest form of belief in the virtues of competition. Every truth in political philosophy finds some exaggerated expression. The main task of the student is to determine what shade of gray things are, rather than whether they are white or black. The belief in the benefits of competition and the virtues of economic freedom found expression in the doctrine of "the economic harmonies." This is the faith that if men are left entirely free to do as their interest dictates, the highest and best efficiency for all will follow; it is the belief that the economic interests of all men are in harmony. The most striking evidence in support of this thought is the stimulating effect of self-interest freely working in the field of competition. Each strives to do what will bring him the largest return, and the price others pay measures their estimate of the service. Each seeking his own interest is led to make himself more useful to others. Thus are men stimulated to sacrifice, to invention, to preparation; thus is zeal animated and are efforts sustained.
Through self-interest the working force is distributed over the field of industry wherever it is most needed. The remarkable adjustment of industry to the needs of each neighborhood is brought about by individual motives, not by centralized authority. It is not mere chance that produces this harmony. Wherever consumers settle, stores are started and factories are built. Wherever work is to be done, men come in about the right number to do it. Skill is adjusted to needs by the delicate measurement of the market rate of wages. Competition gives a definite rule of price—certainly the only definite impersonal rule; some say the only just rule. The competitive price must be appealed to even in arbitration. It is the standard to which things tend constantly to adjust themselves in an open market.
4. Experience shows that the economic interests of men are only partly, not wholly, in harmony. That there is a great measure of truth in the statements just made, all must admit; but their application is limited. They are partial truths, never to be ignored, but quite false if taken, without modification, as practical rules of conduct. There are three species of competition in every market: that between sellers, that between buyers, and that between sellers on the one hand and buyers on the other. It is to the interest of the buyers that the sellers shall be numerous, eager, and freely competing. It is to the interest of the seller that supply shall be small, that sellers shall be united, and that buyers shall compete sharply. If at any point free competition is hindered, even the disciple of economic harmony must expect a discordant result. But in reality competition is rarely quite complete on both sides, and when it is not, the weak suffer. Men do not start with fair and equal opportunities. All that they may be entitled to under competition may be so little that social sympathy seeks to better the result; hence poor relief, public and private. Society as a whole has an interest in the outcome of the individual's economic struggle. It cannot see men starving or driven into crime. But the argument need not be confined to such crude and extreme cases, for wherever economic interests are not in harmony and it is possible to further the social welfare, will not society be justified in acting?
1. Undoubted evils result from some forms of competition under the conditions actually existing. Complete freedom must remain a somewhat abstract ideal, and actual conditions must be recognized. Entire freedom of choice means freedom to make mistakes, a privilege whose enjoyment society cannot always permit. The child should be raised to good citizenship, and entire freedom of choice makes that impossible or improbable. The freedom of choice of the insane, the feeble-minded, and the criminal, cannot be recognized. Even where competition is the ideal of sound adult humanity, it is not to be too suddenly or extremely applied. The inequality of faculties, the prevailing dishonesty, the mass of inherited abuses, cannot be either ignored or at once ended. The immigrant from Europe, plunged into the trying conditions of city life, suffers in health and in morals, and often becomes a burden upon society. One of many competitors may drive competition to an evil extreme. The "problem of the twentieth man" is presented when nineteen men desire to limit competition in ways not socially harmful, as by closing shops on Sunday or in the evening, and the one man refuses. The appeal to economic harmony often is the cry of "peace, peace, where there is no peace." The highest social result may be attained now by limiting, again by directing, in other cases possibly by fostering, competition.
2. The main rivals of competition are custom, religion, morality, combination, and state action. The first three of these were the strongest forces in the past and they are still operating; but combination and state action are more characteristic of the present. The influence of custom, of morality, and of religion on value, has been touched upon at several points in our study; that of combination has been recently and more fully discussed. But state action, one of the most important of all the limitations, has been reserved for the concluding portion of our work.
3. It is a function of the state to determine in part the ways in which men shall exert their powers. This is not the sole function of the state, nor is its influence toward this end exclusive. The state puts limits to the physical rivalry of men. In the distant past no doubt physical rivalry between men was an agent of progress. The strong drove out the weak; physical contest developed more vigorous limbs, keener senses, and higher sagacity. To-day it is one of the principal functions of the state to suppress the physical contest between men. The citizen is surrounded with a network of rules and regulations of which he is hardly conscious. Most men easily avoid coming into contact with the police and feel no irksomeness in the control of the civil courts. The state regulates economic interests in many other ways; it controls the building of streets; it inspects the material and construction of houses; it forbids acts injurious to the public welfare; it regulates the issue of money; it determines the manner in which credit may be extended, the forms of taxation, and the direction which trade may legally take. The state has a part in shaping great industries of a public or semi-public nature, such as waterworks, railroads, and the postal system.
The state is as wise as the men who constitute it. Men make mistakes, therefore men collectively will make them. The state regulates and limits—now wisely, now foolishly; but its aim is to preserve the benefits of competition without its evils, to lift the competition to a higher plane, and, by determining the direction in which men shall put forth their efforts, to give a higher and truer economic freedom.
1. Money we have defined as a material means of payment and medium of exchange, generally accepted and passing from hand to hand. The origin and function of money were set forth in the study of capital. The subject must now be approached from a different side and with the two-fold purpose of seeing whether there is anything peculiar in the relation of money to the general problem of value, and what is the influence of the action of the state on the value of money. The definition of money implies several ideas. First, the words "generally accepted means of payment" imply that money, as something bearing the stamp of social approval, has a peculiar social character, is not an ordinary good. Second, the definition implies that money itself must be a thing having value, otherwise it could not serve as a medium of exchange. Exchange means the taking and giving of things of value. Money is, therefore, not merely an order for goods, as a card or paper requesting payment; it is itself a thing of value, though this value may be due solely to its possessing the money function. This point is one of the most difficult in the subject. Third, the definition implies that money is a material thing. The telegram when transferring an order for the payment of money, the spoken word, the promise to pay, etc., are not money. Fourth, it implies that money passes from hand to hand, is a thing that can be handled, and is or can be bodily transported.
The application of the definition is not always easy, for money shades off into other things that serve the same purpose and are related in nature. Even special students differ as to the border-line of the concept, but as to the general nature of money there is essential agreement. In many problems it appears to be at the same time like and unlike other things of value, and just wherein lies the difference often is difficult to determine. The use of money is of such social importance, and it touches so many practical interests, that it raises many questions of a political and ethical nature. There are perhaps more popular errors on this than on any other one subject in economics. Yet the general principles of money are as fully understood and as firmly established as any parts of economics.
2. The precious metals, gold and silver, are the standard, or primary, moneys in the world to-day. Primary, typical, standard money is the unit in which the value of the money of a country is expressed, no matter what its form is; the standard is a certain weight and fineness of a particular metal. Coins of this standard are called full, or real, money by some writers who deny the title of money to everything else. It has been shown before that there has been an evolution in the use of money. The more efficient forms, gold and silver, have competed with copper, iron, tin, cattle, salt, tobacco. In this contest silver had proved itself a few centuries ago to be the fittest medium of exchange, but in the last century gold has, among the leading nations, been displacing silver rapidly. In a higher degree than any other material, gold has the qualities of a good standard money in rich and industrially developed communities. The gold-using countries to-day are those of the western world. England for perhaps two centuries practically has had gold as its standard money; the United States since 1834 (except for the period of paper money from 1862 to 1879); France since about the year 1855, at which time she shifted from silver under the working of the bimetallic law; and Germany, then more backward industrially, since 1873. Australia and Japan have reached that result only within the last few years, and Italy, Russia, India, Mexico—even China and other Oriental countries—are striving to attain it.
In all these countries other kinds of money are used side by side with gold and silver. The actual money consists of a wide and confusing variety: silver, nickel, copper, paper in various forms and issued by various authorities. But among all the kinds, either gold or silver is found standing preëminent and in a peculiar position. The difficulties of the money problem must be attacked at the point of standard money where it is nearest to ordinary value problems and is less complicated than when the various money substitutes are included. Most of the fallacies regarding money have arisen not about standard money, but about paper and light-weight silver.
3. Coinage is the act of shaping and marking a piece of metal to be used as money so as to indicate its weight and fineness. The precious metals can and do circulate as money without coinage. Any other mark equally plain and equally recognizable serves for many purposes just as well as the government stamp on the standard metal. The use of metals in antiquity was without coinage, by weight and test of fineness. In backward countries to-day most payments are made by weight. International payments are made by means of gold ingots that bear the mark of some well-known banking-house, and for that purpose gold bullion is money without the coiner's stamp. But for most uses government coinage has marked advantages. It is far more convenient for the average citizen to handle coins uniform in size and design than the diverse coins that would be put out by private enterprisers.
An established rate of fineness insuring uniform quality is a great convenience. In the United States all gold and silver coins are nine tenths fine; in Great Britain, eleven twelfths. The established weight of the gold dollar in the United States is twenty-three and twenty-two hundredths grains of fine gold or twenty-five and eight tenths grains of standard gold. The limit of tolerance is the variation either above or below the standard weight or fineness that a coin is allowed to have when it leaves the mint. The par of exchange between standard coins of different countries is the expression of the ratio of fine gold in them. Thus the par of exchange between the American dollar and the English sovereign (the "pound") is four and eighty-six and two third hundredths, that is, four and eighty-six and two third hundredths dollars contain the same amount of gold as an English gold sovereign. The embossed design, milled or lettered edges, and other similar devices are merely to make the coins easily recognizable and difficult to counterfeit.
4. Seigniorage is the right the ruler or state has to charge for coinage, or it is the charge made for coinage. Coinage as a function of great importance politically as well as economically was early exercised by governments or rulers. The prince, king, or emperor stamped his own device or portrait upon the coin; hence the term seigniorage from seignior (meaning lord or ruler). The right to issue money came to be one of the most essential prerogatives of sovereignty. Coinage is rarely without charge, and often has been a source of revenue to the ruler. In the Middle Ages this right was frequently exercised by princes for their selfish advantage to the injury and unsettling of trade.
When no charge is made for coinage, the coinage is said to be gratuitous. Coinage is said to be free if the subject or citizen can take bullion to the mint whenever he pleases, paying the usual seigniorage. Coinage is limited if the government or ruler determines when coinage is to take place. Thus, coinage may be both free and gratuitous, when citizens are allowed to bring bullion whenever they please and have it converted into coins without charge or deduction. But coinage is free without being gratuitous when any citizen may bring metal to the mint, whenever he chooses, to be coined subject to the seigniorage charge.
5. Where coinage is free and gratuitous the coin is worth the same as the bullion that is in it. This evidently and necessarily must be near the truth if the citizens exercise their right. They will not long keep metal uncoined in their possession when it is worth more in the form of money, nor will they long keep money from the melting-pot when it is worth more as bullion. Yet there may be a slight disparity between the bullion and the money values before the metal is converted into coin or the coin melted down into metal. A motive for action must exist before either change will be made; but a thing cannot have considerably different values in two different uses at the same moment.
There is here no special problem of value. The value of gold as bullion and money is fixed by marginal demand. The several uses of gold are constantly competing for it: its uses for rings, pens, ornaments, championship cups, photography, dentistry, delicate instruments, and as a circulating medium. If the metal becomes worth more in one use, its amount there is increased and correspondingly diminished in the others. The supply likewise is influenced by changes in price. Gold-mining is one among various industries to which men may apply their labor and capital. Some mines are superior, others average, others marginal which it barely pays to work. There is, therefore, a rise and fall of the margin of production with change in price and change in cost of production. If at a given moment, when it barely pays to work a mine, gold becomes worth less, that mine will go out of use. As gold rises, some mines that did not pay before, come into use. A similar variation has been noted in the case of marginal land, marginal factories, marginal forges, and marginal agents of every kind.
The question was once asked in Parliament, "What is a pound?" and a good question to ask in beginning the study of money is, "What is a dollar?" The answer, so far as it refers to the standard money, is: a dollar is a convenient name applied to twenty-three and twenty-two hundredths grains of fine gold or twenty-five and eight tenths grains of standard fineness. The exchange value of gold varies in different places and conditions, but the name remains the same. A dollar exchanges for more wheat in Dakota than in New York or for more iron in Pittsburg than in Oregon, yet it is sometimes asserted that the value is always the same because the name is always the same. The fallacy of this may be seen in the equivalent expression that twenty-three and twenty-two hundredths grains of gold have the same value always and under all circumstances.
The problem of the bullion value of money metal, under gratuitous coinage, presents no special difficulties. The ordinary theory of value applies to it. The difficulties of the money question begin at the point where the money value is seen to diverge from, and depend on, something else than the value of the bullion. Yet in the principles just discussed are found a firm foundation for any further study of the question.
1. The fundamental use that money serves is to apportion incomes of goods so as to make them yield the maximum gratification. Money first increases utility by increasing the ease with which exchange takes place. Like any tool or agent, it is valued for what it does or helps to do. But further, it enhances the sum of enjoyments by the division of goods into proper quantities, making them available at the best time. It follows from the principle of diminishing utility that the particular time at which goods are available for wants has an essential bearing on their value. A hundred loaves of bread in the hands of a single individual would mold long before they could be consumed. Money enables men in society to acquire these hundred loaves in a series so that they can be used when most needed. Money is the most successful device man has ever discovered for distributing the supplies of a journey along its course, and the goods of daily need over a period of time. The use of money as a storehouse of value is merely an extreme case of keeping things for the future when they will have a greater gratifying power.
The fact that money is essentially a valuable good kept on hand as the best possible provision against emergencies points to the essential nature of the money demand. Money is sought, in order to form a cash reserve, up to a point where the loss from keeping it balances the probable gain. The money use is subject to the law of diminishing utility; beyond a certain point its added convenience is purchased at too great cost. Every man may be thought of as having an average, or usual, money demand, which is that proportion of his income that gives him more utility retained in money form than if at once expended. A man with an income and expenditure of fifty dollars a month paid monthly has use ordinarily for no more than fifty dollars as his cash reserve. While under ordinary circumstances this is his maximum demand, various circumstances may diminish it. If his expenses are distributed in two equal parts (the one on pay-day, the other thirty days later) his average money demand is twenty-five dollars, not fifty dollars. If most of his purchasing is done at the beginning of the month, his average money demand may be perhaps ten dollars. Many a workman purchases on credit, spends his fifty dollars within an hour after he receives it, and goes without money for the rest of the month. The average demand of a community for money required as a reserve is affected by the methods of doing business. With a given method of use a reduction in the supply of money results in loss of time and waste of effort; an increase in the supply results in a lowering of its value relative to other things. In either case the equilibrium of the marginal utilities of income must be restored. The thought of an average, rational, money demand relative to money income is the fundamental requisite for clear thinking on the question of money, but to grasp this thought there is needed a certain power of scientific imagination lacking in some minds.
2. The quantity theory of money is that, other things being equal, the value of money falls as its quantity increases, and vice versa. This is an abstract statement of a concrete and difficult problem. The phrase "other things being equal" betokens the statement of a tendency where there are several unknown factors. In recent discussion the quantity theory of money has been questioned by some critics; yet it is held by most economists to be merely the general law of value as applied to money. There are three sets of facts to be brought into relationship with each other in the quantity theory: (1) amount of business or exchanges to be effected; (2) the methods by which this is done; (3) the amount of money available to do it. According to the quantity theory we must expect that when conditions (1) and (2) remain fixed, the value of money will vary inversely as its quantity. This conclusion follows from the conception of the money demand as the value of circulating medium that bears an average proportion to the value of goods exchanged.
Let us consider various conditions. When a number of men, by reason of increasing gold supplies, get larger stocks of money than they have had, the former proportion between their money incomes and their money is altered. In reducing their stock of money by buying goods they bid up the prices of goods until the total value of goods exchanged again bears the same ratio as before to the total value of money. Taking an extreme case: if twice as many dollars get into circulation in a community, either some few men must have several times as many dollars as before, while others have the same; or every man will have his due proportion, just twice as much as before. The latter, "other things being equal," must be the logical result after equilibrium has been restored. Is any other result thinkable? Now if prices of goods remained the same as before, there would be twice as great a value of money available to effect exchanges. There is no reason why each should tie up twice as large a proportion of his income in a supply of the medium of exchange. If, however, there is a concerted movement to spend the surplus money, there results a general bidding down of the exchange value of money, a general bidding up of prices of goods. At what point will this movement stop? The rational conclusion must be that "other things being equal" equilibrium will be reëstablished only when the ratio between the value of money and the price of goods becomes the same as before. The money being doubled, prices must be double, and likewise for any other change in quantity.
3. The quantity theory is misunderstood, and is criticized on the ground that the facts oppose it. If but one kind of metal were used as money, and this were coined of uniform weight and fineness, the problem would be comparatively simple. But in fact gold and silver, full-weight and light-weight coins, circulate side by side. More mysterious still, the money in circulation is partly coin and partly paper. How can the quantity theory hold in these conditions? Several objections to the quantity theory are presented. It is said, first, that prices do not vary exactly with the per capita circulation of different countries at a given moment. The per capita circulation in Mexico may be five dollars and in the United States twenty-five dollars, while prices are much less than five times as great here as in Mexico. Secondly, it is said that prices do not vary directly with changes in the amount of money in a given country. There is now perhaps five times as much money per capita in the United States as fifty years ago and yet prices are not five times as high. Thirdly, it is said that credit methods change, and therefore that money does not fix prices. Fourthly, it is said that even if true of primary money the theory fails to apply to actual conditions with many forms of money in circulation side by side. Fifthly, it is said that there are too many unknown quantities to permit the rule to be used.
4. A reasonable interpretation of the quantity theory makes it a statement of the effect of a change in a single factor. The objections to the quantity theory assume that it is a statement of what occurs under all conditions, instead of what it is, an index to the working of one condition at a time. The foregoing objections need but to be further analyzed to show that in each of them it is not merely the quantity of money, but a number of other factors that differ in each of the propositions. We may note briefly in turn the defects in the arguments of the preceding paragraph.
First, the quantity theory does not remotely imply that prices in different countries differ at a given moment according to the per capita money. In the case of the United States and Mexico not only the amount of exchange per capita but the method of exchange, and the rapidity of the circulation of money differ quite as much, doubtless, as does the per capita circulation. The quantity theory would lead any fairly careful student to a conclusion the exact opposite of that which its critics have twisted from it.
Second, the quantity theory does not imply that during a period of years when a country is changing in a multitude of ways, as in population, methods of industry, modes of exchange and transportation, and in wealth and income, the prices will vary directly either as the absolute or per capita amount of money does. In the light of the quantity theory the inquirer must be led to just the opposite of the ridiculous conclusion imputed to it.
Third, the theory does not overlook the effect of an increased use of credit, for it fully implies that any such a change, by economizing the use of money, would enable the same amount of money to support a higher scale of prices.
Fourth, the theory does not overlook the variety of forms, and is not true merely of primary money. However great this variety, the money demand of individuals and of communities still represents a pretty definite ratio of the value of exchanges effected. If the primary money alone were doubled in quantity, while the various forms of substitute money (smaller coins, bank-notes, government notes, etc.) remained unchanged, the quantity of money as a whole would not be doubled, and according to the theory, prices would not be expected to double. Indeed, in such a case, the method of exchange would be very greatly altered, and the case is fully covered by the statement of the theory.
Fifth, despite the number of changing factors affecting the methods of exchange, the method of business, etc., the quantity theory is a rule usable at any moment. These various factors change slowly, and the quantity theory answers the question, What change occurs in prices as a result of an increase or decrease of the money in a given community at a given moment? Like the law of gravitation, the law of projectiles, and the statement of the chemical reaction to be expected when adding some substance to a given compound, the theory must be interpreted with practical limitations. When the quantity theory is thus stated and understood, its negation is unthinkable, as is evidenced by the involuntary use made of it constantly by every one of its few critics in explaining the simplest monetary phenomena.
5. The quantity theory makes intelligible the great and rapid changes in price that have followed sudden changes in the money supply. Inductive demonstration of broadly stated economic principles is difficult, but in no other economic problem is laboratory experiment so nearly possible as in that of money. Many inflations and contractions of the circulating medium have occurred, now in a single country, again in the entire world, and the local or general results have served to exemplify richly the working of the quantity principle. With the scanty yield of silver- and gold-mines in the Middle Ages, prices were low. After the discovery of America, especially in the sixteenth century, quantities of silver flowed into Europe. The great rise of prices that occurred was explained by the keenest thinkers of that day along the essential lines of the quantity theory, though there were many monetary fallacies current at the time. The experience in England during the Napoleonic wars, when the money of England was inflated and prices rose above those of the Continent, led to the modern formulation of the theory by Ricardo and others. The discovery of gold in California and Australia, in 1848-50, increased the gold supply marvelously, and gold prices rose throughout the world. Between 1870 and 1890 the production of gold fell off greatly while its use as money increased and prices fell. A great increase of gold production has occurred in the period since 1890. In part the rising prices from 1897 to 1902 are explicable as the periodic upswing of confidence and credit, but in part doubtless they are due to the stimulus of increasing gold supplies. These are but a few of many instances in monetary history which, taken together, make an argument of probability in favor of the quantity theory so strong as to constitute practically its inductive proof.
1. When the number of coins issued is limited properly, a seigniorage charge does not reduce their money value; they are worth more as money than as bullion. The coinage thus far considered has been that of full-weight coins without seigniorage. The question now is, What is the effect of a seigniorage charge on the value of the coin as compared with the bullion that is in it? This is one of the most difficult phases of monetary theory. Two values must be thought of: one the value of the coin as money, the other the value of the bullion in it. When coinage is free and gratuitous, these two values are the same. How can they ever be different? The answer to the question is found in the theory of monopoly value. If the supply of coin is limited by the sole agency of issue, the value can be kept above the cost of production (i.e., in this case the bullion value), the seigniorage being the profit of the government. The limit within which the coinage must be kept is the number of coins that would circulate freely if they were made full weight without a seigniorage charge. This is the "saturation point" of the money demand of the country; it is a certain number of pieces of full-weight metal. If more than that amount gets into circulation it becomes worth less as money than as bullion, and it is melted or exported.
If this full supply of money at a given moment is 100,000 pieces or dollars, a seigniorage charge of ten per cent. could be made if the number of pieces were not increased above 100,000. The government alone having the right of coinage, the need of money would give the circulating medium a monopoly value. The value of the money would rise until the coin would buy one ninth more bullion than was in it, but if there were any further rise the citizens would begin to take coins to the mint. After the ten per cent. charge was taken out they would receive a coin which, though containing one tenth less bullion, would be worth very nearly the same as the metal taken to the mint. No considerable depreciation could take place unless the volume of business fell off so that less money was needed than at the old standard. In that case there would be no outlet for the excess of coins until they fell to their bullion value, i.e., till they lost the entire value of the seigniorage, the monopoly element in them. Melting or exporting them before that point was reached would cause the loss of whatever element of seigniorage value they contained.
Assuming that the volume of business, or sum of exchanges, remains unchanged, let us consider what will result if the government begins to issue "on its own account." The number of coins might be increased until at the bullion price the total money value were equal to the original 100,000 full-weight coins, at which point exportation would take place. There being nine tenths as much precious metal as before, it would require ten ninths as many pieces, or 111,111 pieces, to have as great a value as the 100,000 had before. At this point there is no further profit to the government in issuing coins of that weight. To make a further profit it must again reduce the amount of pure metal in the coin.
This is essentially what occurred often throughout the Middle Ages. A ruler debased the quality or reduced the weight of money, but for a time the new coin, having the same money use, circulated as freely as the old coin. If, as so often happened, the ruler yielded to the temptation to issue more in order to get the profit, the older, heavier coins at once began to go abroad or into the melting-pot. Then occurred a fall in value, mystifying alike to the prince and the people. The reason is now perfectly plain: the number of pieces issued had not been kept within the proper limits, and the coins went down to their bullion value.
2. Subsidiary coins of lighter weight than the standard, if properly limited, will remain in circulation at par. Money to serve all of its purposes must be of different denominations. The amount required of each denomination is determined by the volume of exchanges for which each is most convenient. Each kind of money, as the penny, nickel, dime, has its own peculiar demand and its saturation point. For the smaller denominations the standard metal is not suitable. A gold dollar cannot well be cut into twenty or a hundred pieces. Thus copper, nickel, silver remain in restricted use. When these are issued at their bullion value, difficulties arise; not only are they too heavy, but as they vary in bullion value, some of them become worth more as bullion than as coin, and suddenly disappear from circulation.