As illustrating Withers' statement about the views of "practical men" on this point, the following extract from a recent address by Theodore Price, quoted with approval in a "market letter," written by Byron W. Holt,[237] is interesting: "The fact seems to be that the exigencies of war in Europe are leading to an extension of credit such as would not have been possible in peace, because the hesitant conservatism of bankers would have then prevented it, and we are finding that instead of working harm it is doing good, because huge masses of fixed capital are thereby made productive, and are circulating with the increased velocity that always quickens enterprise and accelerates the wheels of industry.... All the precedents of history indicate that accelerated activity will come with peace and continue until the exuberance of success has led men to build faster than the world has grown and to demand credit upon the basis of future rather than of present values."
What is the essential causation in the matter? Well, viewed merely as a matter of mechanical equilibration, the quantity theory view is not strictly true, by any means. For a given country—and Fisher's quantity theory is always a theory for a given country, and, indeed, for any separate market, even a single city[238]—an increase of banking credit means an increase in non-monetary capital, because, to a greater or less extent it dispenses with the use of gold, which goes abroad, bringing back wealth in other forms in exchange. Adam Smith saw this clearly, and phrased it strikingly, likening gold and silver coins to the wagon-roads of Scotland, which are necessary for transportation, but which none the less prevent the use of the roadways for raising grain; whereas bank credit is like a wagon-road through the air, which restores the roadbeds to cultivation. Increased non-monetary capital, other things equal, should mean increased trade.
But, more fundamentally, an increase in gold itself within the country, if not bought by the export of an equivalent amount of other goods, is an increase of capital. Not all capital is money, but standard coin is capital. Money is a tool of exchange, and exchange is part of the productive process. More money means more exchanging. That is what money is for. Part of the mechanism is in the money rates, which go down as money becomes more abundant, making it profitable to effect exchanges which would not have been profitable had the money rates been higher. Granted that the money-rates and the general rate of interest tend, in the long run, to keep—I will not say at the same figure[239]—a certain fairly definite relation to one another, it still does not follow that the new "normal" equilibrium will give us an interest rate which is the same as the general rate of interest was before the influx of gold. On the strictest static theory, this is not to be expected. Because the total amount of capital in the country is increased, and this means a lowered interest rate all around, in the marginal employment of capital. The margin of the use of capital will be lowered everywhere, including the margin for the use of money. This means permanently lowered money rates in the country, even though the permanent level be higher than the initial money rates immediately following the access of new gold. I have put the argument in terms that suggest the productivity theory of interest, because it is more simply stated that way. I do not accept the productivity theory, as a fundamental explanation of interest, but for many purposes, the results to be obtained by it coincide with the psychological time theories,—which also, in their present form, seem to me imperfectly developed. I need not try to construct a theory of interest here, however, as the familiar theories lead to no trouble at this point. It is enough to point out that the increased amount of capital, meaning better provision for present wants—wants concerned with gold in the arts and with money for productive exchanges, as well as goods generally since part of the new gold will be exported for other things—will lessen the pressure of present as compared with future wants, and so lessen the rate of interest on the time-preference theory. The final outcome will be an extension of the marginal use of money, and a greater volume of exchanges. Of course, the increase in the supply of any kind of capital good, apart from a prior increase in the demand for its services, will, on the mechanical view of economic causation, necessarily lead to some fall in its capital value. Gold money will be no exception to this rule. As to how much the increase in its quantity will lead its capital value to fall, however, we are unable to say. For the quantity theory, the fall will be in proportion to the increase. For the theory just outlined, the fall will depend on the elasticity of demand for gold in the arts, and on the elasticity of "demand" for money, meaning by demand for money simply the demand for the short-time use of money as a tool of exchange, a demand which governs directly, not the capital value of money, but rather the "money-rates." The relation between the money rates and the capital value of money will best be discussed at another point.[240] We have no reason at all to suppose that either of these demands[241] exhibits the tendency to obey the law of proportional variation which the quantity theory requires of money.
It is further important to note that as a country gets more abundant capital, there seems to be a tendency to extend the use of money rather more than the use of many other capital goods. Where the interest rate is 10 and 12%, as in Arizona and New Mexico, money, even when brought in, tends to leave in large degree to bring in other forms of capital which the situation calls for more imperatively. The early American colonies, needing money pressingly, and making shift with a great variety of substitutes for good metallic money, thoroughly acquainted with the advantages of a money-economy from their European experience, and having "habits" as to the carrying and using of money which they had brought with them from Europe, still found it impossible to keep a great deal of metallic money, in view of the still greater importance of other forms of capital. It is in the most highly developed commercial communities, commercial centres, and par excellence, in the speculative centres, that the demand for the money-service is most elastic.[242] A country where the rate of interest is low, loses other forms of capital, and gains money, in the process of reëquilibration, as compared with a new and undeveloped section, although the new section also extends the margin of the money service, in effecting a greater number of exchanges, when money is increased.
And this leads to a vital distinction, which quantity theorists almost always lose: the distinction between the volume of production, and the volume of trade. Even in the mechanical system of causation which they describe, it is true only of production and transportation that technical and physical[243] factors are of primary significance, and that money is of minor significance. For trade and commerce, money is always highly important. To the extent that a region is primarily given over to the primary productive activities, mining, and agriculture, such trading as is necessary can be done by means of a small amount of money, supplemented by barter and long-time book-credit. A region or a city whose chief business is commerce, however, needs a large part of its capital in the form of money, and of banking capital, which is largely invested in money for banking reserves. Trade, as distinguished from industry (and it is after all trade that is under discussion), is helped or hindered as its tools are more or less abundant. These considerations would suggest that the elasticity of the demand for the use of money is greater than the elasticity of demand for the use of capital in almost any other form. Production is, indeed, limited by labor supply and natural resources, in considerable degree. Trade,[244] however, even from the standpoint of mechanical causation, is limited chiefly by the relation between the profits to be made in commercial transactions, and the "price" that must be paid for the money and credit that are required to put them through. There are enormous numbers of transfers that could be made to advantage if there were no cost at all involved. They are not made, because exchanging requires pecuniary capital. Let the pecuniary capital increase, however, and sub-marginal exchanges become worth while, the general margin is lowered. Commerce is the most highly flexible and elastic portion of the whole productive process. The elasticity of demand for commercial capital is, thus, greater than the elasticity of demand for any other form of capital.
How widely the volume of trade differs from the volume of production, and how great is the element of speculative transactions in trade, will best appear, I think, from an analysis of the figures which Fisher gives[245] for the volume of trade in the United States. His figure for the volume of trade in the year 1909 is $387,000,000,000.00, three hundred and eighty-seven billions of dollars! This figure is reached by equating the figures he has reached for MV plus M´V´ to PT, and assuming P to be one dollar, by making the "unit" of T, arbitrarily, a dollar's worth of each sort of commodity, at the prices of 1909. I have already commented on the legitimacy of this method of summarizing T,[246] and need not say more here, beyond calling attention to the fact that "volume of trade," as commonly used, does in fact mean, not T alone, but PT. Fisher for years other than 1909, however, makes use of a different method of getting at T: he takes certain indicia of relative amounts of trade, compares them with the same indicia for 1909, and estimates the trade for other years as being such a percentage of the trade for 1909 as their indicia are of the indicia of 1909. The indicia chosen are: (1) quantities of certain commodities, cotton, fruit, cattle, etc., received at principal cities of the United States, taken as typical of the variations of the internal commerce of the United States; (2) quantities of 23 articles of import and 25 articles of export, for each year, taken as typical of variations in the foreign trade of the United States; (3) sales of stocks. These three indicia, weighted in a manner to be described in a moment, are then averaged. There is a second element in the index, made up by taking the figures for railroad tonnage, and the figures for receipts on first class mail, which are averaged. The first average and the second average are then combined into a third average, which is the final index. The relation between this index for every year other than 1909 and the same index for the year 1909 determines the amount of T for each year—the two indicia, together with the figure, $387,000,000,000.00, giving the required amount by the "rule of three." I shall not go into details with the method of constructing these averages, but I wish to make clear the comparative weight given to each element in the final index: The first three elements count twice as heavily as the last two, and so constitute the biggest factor. In the first average, based on the first three elements, the item taken as typical of internal trade is weighted by 20, the item taken as typical of foreign trade is weighted by 3, and sale of stocks by 1. It appears from Fisher's figures (p. 479), that the one really big variable among all the indicia is the sale of stocks, but the weight given it is so small that it makes virtually no difference in the final result. Thus, as between 1898 and 1899, stock sales increased over 50%, but total trade, as shown by Fisher, increased only 5%. In the following year, stock sales decreased over 21%, but total trade, on Fisher's figures, increased. The following year, 1901, stock sales virtually doubled, but Fisher's final figure shows only an increase around 13%. Two years later, in 1903, stock sales fell off about 40%, from the figures for 1901, but again, as compared with 1901, total trade on Fisher's figures shows an appreciable gain. The influence of stock sales on Fisher's index is, virtually, negligible. The dominating factor is the receipts of selected staples, cattle, cotton, rice, pig iron, etc., in the principal cities of the United States. There is not a single year in which his final figure for T does not move in harmony with this factor (p. 479). He gets, thus, for the volume of trade through the fourteen years under consideration, a surprising steadiness, and a pretty uniform progressive development.
In defence[247] of his method of weighting, Fisher says, simply: "These weights are, of course, merely matters of opinion, but, as is well known, wide differences in systems of weighting make only slight differences in the final averages." (Italics mine.)[248]
Are these figures valid? Well, first one is struck with the absolute magnitude assigned to T. The figures seem vastly greater than would have been anticipated. The method of calculating it, for 1909, I shall discuss in detail in the chapter on "Statistical Demonstrations of the Quantity Theory." For the present, it is enough to note that the absolute magnitude is derived from figures collected by Dean David Kinley for the National Monetary Commission,[249] of deposits, exclusive of deposits made by one bank in another, made in about 12,000 banks (out of 25,000) on March 16, 1909. These deposits were classified as (1) money (with subdivisions) and (2) checks and other credit instruments. A cross-classification divided them into (1) retail deposits; (2) wholesale deposits; (3) all other deposits. Kinley's object was to determine the extent to which checks are used, as compared with money, in payments, particularly in wholesale and retail business. Fisher's total, briefly, was obtained as follows: Kinley's figures, for the one day, were increased to make an allowance for the non-reporting banks; they were further increased on the assumption that March 16 was below the average for the year; the figure finally obtained for the day was then multiplied by 303, assumed as the number of banking days in the year, and the product, 399 billions, was taken as representing the total circulation of money and checks in trade. For some reason not made clear, this total was subsequently reduced to 387 billions. Counting the average price, P, as $1, T was considered to be 387 billions.[250]
In the statistical chapter to follow, it will be shown that this estimate is a very decided exaggeration. Deposits made in banks greatly overcount trade. Very many payments represent duplications, loans and repayments, taxes, etc., and are in no sense trade. This is true of all classes of deposits, wholesale and retail, as well as "all other." But for the present, I am concerned with the question, not of the absolute magnitude of the volume of trade, but rather, the questions of its character, of the elements that enter into it, and, above all, of the extent to which it is physically determined by technical conditions of production, and the extent to which it is flexible, a matter of speculation, etc.
We may approach this question from the angle of several bodies of statistical information. First, the question may be raised: what is there in the country which could be bought and sold enough in the course of a year to give us anything like so great a total? The subtractions which we shall find it necessary to make will still leave us an enormous total.