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IN order to make clear the relation which the topic treated in this book bears to the general subject of economics, some primary definitions are necessary.
In the first place, economics itself may be defined as the science of wealth, and wealth may be defined as material objects owned by human beings. Of wealth, therefore, there are two essential attributes: materiality and appropriation. For it is not all material things that are included under wealth, but only such as have been appropriated. Wealth does not include the sun, moon, and other heavenly bodies, nor even all parts of the surface of this planet, but only such parts as have been appropriated to the use of mankind. It is, then, appropriated parts of the earth's surface and the appropriated objects upon it which constitute wealth.
For convenience, wealth may be classified under three heads: real estate, commodities, and human beings. Real estate includes the surface of the earth and the other wealth attached thereto—improvements such as buildings, fences, drains, railways, street improvements, [2]and so on. Commodities include all movable wealth (except man himself), whether raw materials or finished products. There is one particular variety of commodity—a certain finished product—which is of especial importance in the subject of which this book treats; namely, money. Any commodity to be called "money" must be generally acceptable in exchange, and any commodity generally acceptable in exchange should be called money. The best example of a money commodity is found to-day in gold coins.
Of all wealth, man himself is a species. Like his horses or his cattle, he is himself a material object, and like them, he is owned; for if slave, he is owned by another, and if free, by himself.3
But though human beings may be considered as wealth, human qualities, such as skill, intelligence, and inventiveness, are not wealth. Just as the hardness of steel is not wealth, but merely a quality of one particular kind of wealth,—hard steel,—so the skill of a workman is not wealth, but merely a quality of another particular kind of wealth—skilled workman. Similarly, intelligence is not wealth, but an intelligent man is wealth.
Since materiality is one of the two essential attributes of wealth, any article of wealth may be measured in physical units. Land is measured in acres; coal, in tons; milk, in quarts; and wheat, in bushels. Therefore, for estimating the quantities of different articles of wealth, all the various physical units of measurement [3] may be employed: linear measure, square measure, cubic measure, and measure by weight.
Whenever any species of wealth is measured in its physical units, a first step is taken toward the measurement of that mysterious magnitude called "value." Sometimes value is looked upon as a physical and sometimes as a physical phenomenon. But, although the determination of value always involves a psychical process—judgment—yet the terms in which the results are expressed and measured are physical.
It is desirable, for the sake of clearness, to lead up to the concept of value by means of three preliminary concepts; namely, transfer, exchange, and price.
A transfer of wealth is a change in its ownership. An exchange consists of two mutual and voluntary transfers, each in consideration of the other.
When a certain quantity of one kind of wealth is exchanged for a certain quantity of another kind, we may divide one of the two quantities by the other, and obtain the price of the latter. For instance, if two dollars of gold are exchanged for three bushels of wheat, the price of the wheat in gold is two thirds of a dollar per bushel; and the price of the gold in wheat is one and a half bushels per dollar. It is to be noticed that these are ratios of two physical quantities, the units for measuring which are quite different from each other. One commodity is measured in bushels, or units of volume of wheat, the other in dollars, or units of weight of gold. In general, a price of any species of wealth is merely the ratio of two physical quantities, in whatever way each may originally be measured.
This brings us, at last, to the concept of value. The value of any item of wealth is its price multiplied by its quantity. Thus, if half a dollar per bushel is the price [4] of wheat, the value of a hundred bushels of wheat is fifty dollars.
Hitherto we have confined our discussion to some of the consequences of the first prerequisite of wealth—that it must be material. We turn now to the second prerequisite, namely, that it must be owned. To own wealth is simply to have the right to benefit by it that is, the right to enjoy its services or benefits. Thus the owner of a loaf of bread has the right to benefit by it by eating it, by selling it, or by otherwise disposing of it. The man who owns a house has the right to benefit by enjoying its shelter, by selling it, or by renting it. This right, the right to or in the benefits of wealth—or more briefly, the right to or in the wealth itself—is called a "property right" or simply "property."
If things were always owned in fee simple, i.e. if there were no division of ownership,—no partnership rights, no shares, and no stock companies,—there would be little practical need to distinguish property from wealth; and as a matter of fact, in the rough popular usage, any article of wealth, and especially real estate, is often inaccurately called a "piece of property." But the ownership of wealth is frequently divided; and this fact necessitates a careful distinction between the thing owned and the rights of the owners. Thus, a railroad is wealth. Its shares and bonded debt are rights to this wealth. Each owner of shares or bonds has the right to a fractional part of the benefits from the railway. The total of these rights comprises the complete ownership of, or property in, the railway.
Like wealth, property rights also may be measured; but in units of a different character. The units [5] of property are not physical, but consist of abstract rights to the benefits of wealth. If a man has twenty-five shares in a certain railway company, the measurement of his property is twenty-five units just as truly as though he had twenty-five bushels of wheat. What he has is twenty-five rights of a specific sort.
There exist various units of property for measuring property, as there are various units of wealth for measuring wealth; and to property may be applied precisely the same concepts of transfer, exchange, price, and value which are applied to wealth.
Besides the distinction between wealth and property rights, another distinction should here be noted. This is the distinction between property rights and certificates of those rights. The former are the rights to use wealth, the latter are merely the written evidence of those rights. Thus, the right to receive dividends from a railroad is property, but the written paper evidencing that right is a stock certificate. The right to a railway trip is a property right, the ticket evidencing that right is a certificate of property. The promise of a bank is a property right; the bank note on which that promise is engraved is a certificate of property.
Any property right which is generally acceptable in exchange may be called "money." Its printed evidence is also called money. Hence there arise three meanings of the term money, viz. its meaning in the sense of wealth; its meaning in the sense of property;4and its meaning in the sense of written evidence. From the standpoint of economic analysis the property sense is the most important.
[6]What we have been speaking of as property is the right to the services, uses, or benefits of wealth. By benefits of wealth is meant the desirable events which occur by means of wealth. Like wealth and property, benefits also may be measured, but in units of a still different character. Benefits are reckoned either "by time,"—as the services of a gardener or of a dwelling house; or "by the piece,"—as the use of a plow or a telephone. And just as the concepts of transfer, exchange, price, and value apply to wealth and property, so do they apply to benefits.
The uses (benefits) of wealth, with which we have been dealing, should be distinguished from the utility of wealth. The one means desirable events, the other, the desirability of those events. The one is usually outside of the mind, the other always inside.
Whenever we speak of rights to benefits, the benefits referred to are future benefits. The owner of a house owns the right to use it from the present instant onward. Its past use has perished and is no longer subject to ownership.
The term "goods" will be used in this book simply as a convenient collective term to include wealth, property, and benefits. The transfer, exchange, price, and value of goods take on innumerable forms. Under price alone, as thus fully applied to goods, fall rent, wages, rates of interest, prices in terms of money, and prices in terms of other goods. But we shall be chiefly concerned in this book with prices of goods in terms of money.
Little has yet been said as to the relation of wealth, property and benefits to time. A certain quantity of goods may be either a quantity existing at a particular [7] instant of time or a quantity produced, consumed, transported, or exchanged during a period of time. The first quantity is a stock, or fund, of goods; the second is a flow, or stream, of goods. The amount of wheat in a flour mill on any definite date is a stock of wheat, while the monthly or weekly amounts which come in or go out constitute a flow of wheat. The amount of mined coal existing in the United States at any given moment is a stock of mined coal; the weekly amount mined is a flow of coal.⚓✪
There are many applications of this distinction; for instance, to capital and income. A stock of goods, whether wealth or property, existing at an instant of time is called capital. A flow of benefits from such capital during a period of time is called "income." Income, therefore, is one important kind of economic flow. Besides income, economic flows are of three chief classes, representing respectively changes of condition (such as production or consumption), changes of position (such as transportation, exportation, and importation), and changes of ownership, which we have already called "transfers." Trade is a flow of transfers. Whether foreign or domestic, it is simply the exchange of a stream of transferred rights in goods for an equivalent stream of transferred money or money substitutes. The second of these two streams is called the "circulation" of money. The equation between the two is called the "equation of exchange"; and it is this equation that constitutes the subject matter of the present book.
A study of Juglar's or Thom's tables will show that, in general, bank note circulation and bank deposit circulation increase before a crisis and reach a maximum at the time of the crisis. Index numbers of prices show the same general trend.⚓✪
[268]Thus,115for the United States, the crisis of 1837-1839 shows that circulation of state banks increased each year from 61 millions in 1830 to 149 in 1837 and fell to 116 in the next year; that individual deposits rose each year from 55 millions in 1830 to 127 in 1837 and fell to 84 the next year; that from 1844 to 1848, the date of the next crisis, circulation rose from 75 millions to 128, falling back to 114 the next year, and that the deposits rose from 84 millions to 103, falling back to 91; that from 1851 to 1857, the date of the next crisis, circulation rose from 155 millions to 214, falling the next year to 155, and that the deposits rose from 128 millions to 230, falling the next year to 185. These facts—that prices and deposits rose, culminated, and fell together in reference to the crises of 1837, 1846, and 1857—are confirmed by figures for per capita circulation and deposits given by Sumner.116These show the characteristic sharp check to expansion in the crisis years, mild in the mild crisis of 1846 and pronounced in the more pronounced crises of 1837 and 1857. Corresponding phenomena occurred at the next crisis, 1863-1864. After this time, the chief statistics are for national banks, and these show similar results. Thus, from 1868 to 1873, national bank circulation rose from 295 millions to 341 and then fell, while in the same period deposits rose from 532 millions to 656 and then fell. Similar, though less marked, movements occurred in the milder crises of 1884 and 1890, which is the last included in Thom's tables. The crisis of 1893 was exceptional and largely confined to the United States, being chiefly due to the fear as to the [269] stability of the gold standard without much reference to currency and deposit expansion.117Whereas in the typical speculative cycle the ratio of deposits to reserves gradually increases until it reaches a maximum just before the crisis, as it did in 1873, 1884, and 1907, this did not happen in 1893. It is true that the deposits of national banks were larger in 1892 than in 1890 or 1891, but they were no larger relatively to reserves, though possibly this fact is to be accounted for by an increase of reserves following the slight crisis of 1890-1891. It is true, also, that the ratio of the deposits of national banks to reserves was high in 1893, but this was due, not to an expansion of deposits, for deposits decreased during that year, but to the runs on the banks and consequent depletion of their reserves.118The crisis of 1907, on the other hand, was, like that of 1857, typically a crisis of currency expansion. The facts in reference to this crisis will be discussed more fully in the following chapter.
In France the same tendency of circulation and deposits to reach a maximum at or about a crisis and recede immediately afterward is illustrated fairly well,119especially for deposits.
[270]For the Bank of England we find the same general correspondence between crises, circulation, and private deposits.120
Not only do money and deposit currency (M and M') rise regularly to a maximum at the time of a crisis, but their velocity of circulation, so far as statistics indicate, goes through the same cycle. Pierre des Essars has demonstrated this beyond peradventure, so far as velocity of circulation of deposits is concerned.121
For the United States we have scarcely any statistics of velocity of circulation of deposits, but those for two New Haven banks and for an Indianapolis bank, which I have secured for the last few years, show a maximum in the crisis year 1907.
After a crisis, a decrease occurs in M, M', V, and V'. Bank reserves are increased, and this causes a decrease in M.
Since, then, currency and velocity both increase before a crisis, reach a maximum at the crisis, and fall after the crisis, it is small wonder that prices follow the same course. That they do is the real meaning of a crisis. In fact, as we have seen, Juglar defines a crisis as an arrest of a rise of prices. The index numbers of prices show the rise, maximum, and slump for almost every crisis year for which price statistics exist.122
[271]The following figures are designed to present a picture of the crisis of 1907 in the United States as illustrating the culmination of a typical credit cycle:—
| 123.[1] The figures for deposits and reserves of national banks are those given in the Reports of the Comptroller of the Currency, and represent the condition of the banks at their third report to the Comptroller (generally about July 1) of each year. The ratio column explains itself. | |||||||||
| 123.[1] The figures for deposits and reserves of national banks are those given in the Reports of the Comptroller of the Currency, and represent the condition of the banks at their third report to the Comptroller (generally about July 1) of each year. The ratio column explains itself. | |||||||||
| 123.[1] The figures for deposits and reserves of national banks are those given in the Reports of the Comptroller of the Currency, and represent the condition of the banks at their third report to the Comptroller (generally about July 1) of each year. The ratio column explains itself. | |||||||||
| 124.[1] The figures for clearings are taken from the Financial Review for 1910, p. 33. Those for M'V' are constructed from the figures for clearings by a method explained in § 5 of Appendix to Chapter XII. | |||||||||
| 124.[1] The figures for clearings are taken from the Financial Review for 1910, p. 33. Those for M'V' are constructed from the figures for clearings by a method explained in § 5 of Appendix to Chapter XII. | |||||||||
| 125.[1] The index numbers of prices are those of the Bureau of Labor (Bulletin 81, March, 1909), and relate to January of each year in question. The next column, therefore, headed "Per cent rise of prices during year" indicates the rise from January of the year in question to January of the next. | |||||||||
| 125.[1] The index numbers of prices are those of the Bureau of Labor (Bulletin 81, March, 1909), and relate to January of each year in question. The next column, therefore, headed "Per cent rise of prices during year" indicates the rise from January of the year in question to January of the next. | |||||||||
| 126.[1] The figures for interest rates are taken from the Appendix of The Rate of Interest, p. 418, brought through 1908 by computations from the Financial Review. The per cent rise of prices is subtracted from money interest to get virtual interest. | |||||||||
| 126.[1] The figures for interest rates are taken from the Appendix of The Rate of Interest, p. 418, brought through 1908 by computations from the Financial Review. The per cent rise of prices is subtracted from money interest to get virtual interest. | |||||||||
| Year | Deposits123of National Banks (millions) | Reserves123of National Banks (millions) | Ratio123of National Banks to Reserves | Clearings124(billions) | M'V'124(billions) | Index125Number of Prices, P.(Jan.) | Per Cent125Rise of Prices during Year. | Money Interest126New York Price, m,Two-name 60-day Paper | Virtual126Interest |
| 1904 | 3.31 | 658 | 5.0 | 113 | 228 | 113.2 .7 | 4.2 | 3.5 | |
| 1905 | 3.78 | 649 | 5.8 | 144 | 279 | 114.0 | 5.3 | 4.3 | -1.0 |
| 1906 | 4.06 | 651 | 6.2 | 160 | 315 | 120.0 | 6.6 | 5.7 | -0.9 |
| 1907 | 4.32 | 692 | 6.2 | 145 | 323 | 127.9 | -1.7 | 6.4 | 8.1 |
| 1908 | 4.38 | 849 | 5.1 | 132 | 294 | 125.7 | — | 4.4 | — |
We notice, in the first column, a steady and rapid increase in the deposits of national banks up to, and including, the crisis year. Though deposits for 1908 do not decrease, yet they remain almost stationary as [272] compared with those of the previous year. The second column, that for reserves, shows, as we should expect, a large increase in the year after the crisis, the banks having fortified themselves against the decrease of business confidence. We find, then (third column), an increase in the ratio of deposits to reserves, the highest ratio being reached in 1906 and 1907, not because reserves were depleted,—on the contrary, they were expanding,—but because deposits were expanding still more rapidly. If the theory presented in Chapter IV is correct, it is precisely this high ratio of deposits to reserves, brought about by failure of interest to rise with rise of prices, which forced the banks to raise their rates of discount and so check further expansion of credit. Then came the crisis and the short succeeding depression. The next column, headed "clearings," is indicative of the volume of check transactions, the circulation of deposit currency. As a fairly constant proportion of checks is settled through the various clearing houses of the country, clearings may fairly be regarded as somewhat of a criterion of M'V'. The fifth column is derived from the fourth and from other data, and is intended as an estimate of M'V'. These two columns increase through 1906, but (since they relate to the whole year and not to a point in the middle of the year) begin to show the effects of the credit slump in the fall of 1907, so that their growth is arrested somewhat in that year, and still more in the year after. We should expect to find, then, a rise of prices reaching a maximum with 1907 and falling in 1908, and this we do find in column six. Column seven shows the per cent rise during each year. Thus, for January, 1904, the index number or P is 113.2, and for January, 1905, it is 114.0. The rise, therefore, is a little less than 1 percent. [273] The minus sign signifies a fall. The eighth column is for rates of interest and indicates, as we should expect, a rise, culminating in 1907. Virtual interest—that is, the interest in terms of commodities—was exceedingly low during the years immediately preceding 1907, because prices were rising so fast. This is shown in column nine, where the nominal interest (measured in money) is corrected by the rise or fall of prices to give interest as measured in actual purchasing power. With the culmination of the cycle in 1907 and the resultant fall of prices, we find virtual interest suddenly becomes very high. No wonder that borrowing enterprisers often found it hard to make both ends meet.
The facts as to credit cycles, then, completely confirm the analysis already given in previous chapters and indicate that prices rise and fall with cycles of currency and velocity. For the benefit of those who doubt whether the expansion of deposit currency raises prices, or whether the rise of prices creates deposit currency, it may be added that facts, as well as theory, show that the former relationship is the true one (although temporarily, as during 1904-1907, there exists a reaction of prices on deposits). Miss England has shown, for instance, that loans and deposits expand before prices rise, and that, though prices often fall before loans and deposits shrink, this anomalous order of events is explainable by the revival of trade following a crisis.127
No attempt has been made in this chapter to review all the phenomena or even all the typical phenomena of crises. We are not here concerned with crises [274] except in relation to currency. Our concern is with the magnitudes entering the equation of exchange, especially M, M', and V', for these are the immediate elements the variations in which affect the price level and cause it to rise and fall.
This chapter has been devoted to an historical study of changes in the quantity of currency and of the effects of these changes on prices. We have seen that, on the whole, increases in the amount of money have tended to raise prices from century to century during the last thousand years, and especially since the discovery of America. The changes in the last century, or more exactly, from 1789 to 1909, have been considered in somewhat more detail, covering five periods of alternately rising and falling prices. We have seen evidence to connect these price movements with changes in the quantity of money and in the volume of business. The periods 1789-1809, 1849-1873, and 1896-1909 were periods of rising prices and large increases of the money supply. In the period 1809-1849 prices fell presumably because of a falling off in gold and silver production and a continuing increase of business; while between 1873 and 1896, although the world's stock of precious metals was increasing slowly, prices in gold countries fell, because in addition to the increasing volume of business there was a stampede of nations to adopt the gold standard and demonetize or limit the coinage of silver.
We have observed the recent continual increase of gold production and found reasons for the tentative prediction that the gold production of the future would continue excessive and probably cause the present rise of prices to continue for some time in the future.
[275]We have described some of the chief examples of paper money inflation and shown that the records for circulation and price changes bear out in a general way the principles set forth in previous chapters. The paper money experiences of France during the French Revolution, of England during the Napoleonic wars, of Austria, the American colonies, the United States, and the Confederacy have been briefly reviewed. We have noted that in these cases, as in others, prices depended on the quantity of money, its velocity, and the volume of business. We have seen that the apparent exceptions due to lack of confidence in paper money are not really exceptions, because lack of confidence works itself out through the magnitudes in the equation of exchange. Distrust increases the velocity of circulation, and decreases the trade performed by the money. We have shown that the general effect of irredeemable paper money issues, which are almost always in large quantities, despite pledges to the contrary, has been to raise prices.⚓✪
Finally, our study of deposit circulation and crises has afforded further illustration. Preceding a typical crisis, there is, in general, a tendency for deposits to increase and also for their velocity of circulation to increase, while prices tend to rise. Following the crisis comes a decrease in bank deposits and their velocity of circulation, an increase in bank reserves, with a corresponding tendency to diminish money in circulation, and a fall of prices. In the years of the principal crises these took place simultaneously in different countries.
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