I shall also undertake to show that in many important cases the quantity theory leads to conclusions regarding the price-level which contradict other laws of prices, notably the capitalization theory, the cost of production doctrine, and the law of supply and demand. I have previously pointed out that these three doctrines are inapplicable to the problem of the value of money itself. On the assumption of a value of money, however,—using value in the absolute sense—they are applicable to the problem of prices, and, since the price-level is merely an average of particular prices, they should be applicable to the problem of the price-level also. It will be shown, in the course of the criticism which follows, first that the quantity theory contradicts each of these doctrines, in certain situations, and second, that in these cases, the conclusions based on the cost theory, the supply and demand theory, and the capitalization theory are right, and the conclusions based on the quantity theory are wrong. It has been maintained by certain writers, as Knut Wicksell[106] and Irving Fisher,[107] that cost of production and supply and demand are inapplicable to the problem of the general price-level. I shall maintain the contrary, holding that while these doctrines are inapplicable to the problem of the value of money, they are applicable to the problem of general prices, on the assumption of a fixed value of money. By the value of money I mean its absolute[108] value, and not—what the quantity theorists commonly mean—its "purchasing power," or the "reciprocal of the price-level."
I shall undertake to show that no sound conclusion reached on the basis of quantity theory reasoning is the peculiar property of the quantity theory school; that every valid conclusion which may be based on the quantity theory may also be deduced from the theory maintained in this book, and, indeed, that most of them may be deduced from several other theories of money, notably the commodity or bullionist theory. I shall show a number of false and misleading doctrines which logically spring from the quantity theory, and shall undertake to show that the quantity theory fails to give an adequate basis for several important parts of the theory of money, among them Gresham's Law, the theory of international gold movements, and the theory of elastic bank-notes and deposit-currency.
So much for the theses to be maintained. The detailed proof of these contentions will best be given in connection with a critical account of various versions of quantity theory doctrine. Attention will be given in this summary to the expositions of Nicholson, Mill, Taussig, and Kemmerer, and very special attention to I. Fisher, though some other writers will also be taken into account.
CHAPTER VII
DODO-BONES
Must money have value from some source outside its money-functions? It is a part of the quantity theory that this is unnecessary. I have cited, in the preceding chapter, Irving Fisher and J. S. Nicholson to this effect. Nicholson's statement is interesting and picturesque, exhibiting the quantity theory in all the nakedness of its poverty, and I shall present it at some length. "For simplicity," to isolate his phenomenon, he assumes a hypothetical market, in which the following conditions obtain: (1) No exchanges are to be made unless money (which he assumes to consist of counters of a certain size made of dodo-bones) actually passes from hand to hand. No credit or barter. (2) The money is to be regarded as of no use whatever except to effect exchanges, so that it will not be withheld for hoarding, i. e., will be actually in circulation. (3) There are ten traders in the market, each with one kind of commodity and no money, and one trader with all the money (one hundred pieces), and no commodities. Further, let this moneyed man put an equal estimation on all the commodities. Now let the market be opened according to the rules laid down; then all the money will be offered against all the goods, and, every article being assumed of equal value, the price given for each article will be ten pieces, and the general level of prices will be ten. It is perfectly clear that, under these suppositions, if the amount of money had been one thousand pieces, the price-level would have been one hundred per article, etc. Under these very rigid assumptions, then, it is obvious that the value of money varies exactly and inversely with the amount put into circulation.—The rapidity of circulation he regards as coördinate, in fixing the price-level, with the volume of money. To illustrate this, he assumes again his hypothetical market, and "dodo-bones," assuming as before that one merchant has all the money (one hundred pieces), and that ten have commodities of equal value. Instead, however, of the merchant with the money desiring all the commodities equally, he is made to desire only the whole of that of trader one, who in turn desires the whole of number two's stock; and so on to the ninth merchant, who wants the commodity of number ten, who wants the dodo-bones. In this case, each article will be exchanged only once, as formerly, but the money will change hands ten times, and the price of each article will be one hundred instead of ten. "We now see that, under these circumstances, with the same quantity of money, and the same volume of transactions, the level of prices is ten times as great as before, and the reason is that every piece of money is used ten times instead of once." Whence he concludes: "The effect on prices must be the same when, in effecting transactions, one piece of money is used ten times as when ten pieces of money are used once."[109]
Ricardo, too, expresses the dodo-bone theory very explicitly. "If the state charges a seigniorage for coinage, the coined piece will generally exceed the value of the uncoined piece of metal by the whole seigniorage, because it will require a greater quantity of labour, or, which is the same thing, the value of the produce of a greater quantity of labour, to procure it.
"While the state alone coins, there can be no limit to this charge of seigniorage; for, by limiting the quantity of the coin, it can be raised to any conceivable value. It is on this principle that paper money circulates; the whole charge for paper money may be considered a seigniorage. Though it has no intrinsic value, yet, by limiting its quantity, its value is as great as an equal denomination of coin, or of bullion in that coin."[110]