With this distinction between volume of money and volume of money-income[347] clearly held, we are prepared to go further in our attack on the quantity theory, granting the quantity theorist all his most rigorous assumptions, and still demonstrating that prices can vary independently, without prior change in quantity of money, volume of trade, or velocity of money. Let us assume the extreme case of the quantity theory: a closed market; no credit; no barter; a fixed supply of money; a fixed volume of trade; a fixed set of habits affecting velocity, namely, that everyone spends, in the course of the month, all that he has accumulated by the first of the month. The quantity theorist could not ask a more iron-clad set of assumptions than this! If the quantity theory is not valid here, if the price-level is not absolutely fixed, helpless to change, with these assumptions, then the quantity theory, even as a minor tendency, must be surrendered, and the quantity theorist must admit that the whole line of thought has been fallacious. But is the price-level passive? Suppose we assume a combination of employers of maid-servants, which forces down the wages of maid-servants from $20 to $10 per month. Assume further that there is no alternative employment for the maid-servants, so that they all remain at work.[348] So far, we have made a change in one price, the price of domestic service. What of the general average of prices, the price-level? Well, so far, the price-level is down. If nothing else takes place, we have reduced the price-level by reducing one price. What else can take place? Two things: (1) the masters now have $10 per month each more to spend for other things than before. That tends to raise prices in their other channels of expenditure. (2) The maid-servants now have $10 each less to spend,—the same ten dollars! That lessens prices in the lines of their expenditure. These last two changes exactly neutralize one another. The first change, in the price of domestic service, remains unneutralized. The general price-level is, then, lowered—by a cause acting from outside the equation of exchange, directly on prices. The first change comes in one price. In the final adjustment, that change remains unneutralized. How is this possible? Is the equation of exchange still valid? As a mathematical formula, yes. As expressing a causal theory, in which prices are effect, and money, trade, and velocity causes, no. The equation is kept straight by a reduction in velocity. Because the wages of maid-servants are reduced, less money goes through their hands; $10 per month per maid are short-circuited. But the cause is with the prices. The price-level, even under these absolutely rigorous assumptions, is not passive.
In general, I conclude that the price-level, under the laws governing particular prices, supply and demand, cost of production, the capitalization theory, the imputation theory, etc., can vary of its own initiative, independently of prior changes in the quantity of money, or of volume of trade, or other factors that the quantity theory stresses; and that these changes in the price-level (or in the particular prices which govern the price-level) can maintain themselves, and compel a readjustment in trade, credit, money and velocities, to correspond. This conclusion strikes at the very heart of the quantity theory, and, if valid, leaves the quantity theory disproved. More fundamentally, I should put it, prices can change because of changes in the psychological values of goods. These values are social values, and are to be explained only by a social psychology. But for the present it has seemed best to me, as a means of attracting sympathetic attention from a wider circle of economists, to make use of the less debated doctrines of the science in attacking the quantity theory. It is not necessary to rest the case on my own special theory of value. Supply and demand, cost of production, the capitalization theory, the imputation theory—the general laws of the concatenations and interrelations of prices—are quite adequate for the confutation of the quantity theory. They are laws concerned with particular prices, and the price-level is nothing but the average of particular prices. Whatever explains, really explains, the particular prices, also explains the price-level.
Fisher, as we have seen, is not of this opinion. Although he has defined the price-level as an average of particular prices[349] he none the less exalts this average into a causal entity, prior to and master of the particular prices out of which it is derived, of which it is a mere average.[350] This average, he maintains, is presupposed in the determination of all particular prices.[351] This seems to me a wholly untenable position. Ex nihilo nihil fit. There cannot be more in the average than there is in the particulars from which it is derived. In point of fact, there is necessarily vastly less. All the concrete causation is lost. The average, in itself, is nothing but a statement, a summary of results. I know nothing more metaphysical in the history of economic theory than this hypostasis of an average.[352]
I reject Fisher's notion that the average of prices is an independent entity. But I do not consider that the idea lying behind this untenable doctrine is absurd. Cost of production, supply and demand, and the other price theories do presuppose something more fundamental. They do presuppose money, and the value of money, as has been shown at length in Part I. The trouble with Fisher's notion comes in his definition of the value of money in purely relative terms as the reciprocal of the price-level, and his contention that the study of the value of money is identical with the study of price-levels.[353] Value is not a mere exchange relation.[354] Rather, every exchange relation involves two values, the values of the two objects exchanged. These two values causally determine that exchange relation. In the case of particular prices, then, we must consider not only the value of goods, but also the value of money. And the causes determining the general price-level will therefore include not alone the values of goods, but also the value of money. In the foregoing arguments by which I have shown that the price-level can vary independently of the other factors in the quantity theory scheme, I have been concerned only with changes in the values of goods, measured by a constant unit of value. If the value of money should also be varying, the concrete results on the price-level would have been different. On the face of things, there was nothing in the cases I discussed to require us to suppose that the value of money would also vary. The argument ran on the assumption of a fixed value of money. I have shown, in earlier chapters, that the assumption of a fixed value of money is fundamental to the laws of supply and demand, cost of production, and the capitalization theory. In point of fact, this assumption is rarely true—never strictly true. For causes which are in considerable degree independent of the causes governing the values of goods (as the causes governing their values are in considerable degree independent of one another), the value of money varies, now in the same direction as the values of goods in general, now in an opposite direction. Further, money itself does not escape the general laws of concatenation of values. The value of money has causes which are bound up with the values of other goods. Thus, when prices are rising and trade expanding, there is a tendency—commonly a minor tendency—for money also to rise in value, and so prices do not go quite as high as they would have gone had money remained constant. This tendency arises from the fact that there is more work for money to do in a period of active trade and rising prices. Gold also tends to rise in value in the arts, with prosperity. The reverse tendency manifests itself when prices are falling: money tends, in some measure, to fall in value with the goods,[355] and so prices do not fall as far as they would fall if money remained constant. But in general, the causes governing the values of goods, and the causes governing the value of money, are sufficiently independent to justify us in studying each separately, in abstraction, on the assumption that the other is unchanged. Hence, supply and demand, cost of production, and the other price theories, which assume a fixed value of money, are proper tools of thought for the study of the prices of goods.
CHAPTER XVI
THE QUANTITY THEORY AND INTERNATIONAL GOLD MOVEMENTS
The quantity theory explanation of international gold movements is as follows: if money comes into a country, it raises prices. If the price-level of the country is raised more rapidly than the price-levels of other countries are rising, then the country becomes a bad place in which to buy and a good place in which to sell; its exports fall off, its imports increase, and finally the inflow of money is checked, and, perhaps, money flows out again. The equilibrium of the gold supplies of different countries is thus dependent on the price-levels of the countries involved. The quantity of gold in a country determines its price-level, and no more gold can stay in a country, on this theory, than that amount which keeps its price-level in proper relation to the price-levels of other countries. It is not necessarily asserted that the price-levels of all countries must be equal—the facts too obviously contradict that. But when this precise statement is not made, the substitute statement of some "normal" relation between the price-level of one country and that of another becomes a very vague one, and the theory becomes pretty indefinite.
I am here concerned chiefly with one contention: the price-level, the average of prices, is not a cause of anything—not of gold movements or anything else. It is a mere summary of many concrete prices. Some of these concrete prices have highly important influence on international gold movements, tending, if they are low, to bring gold in, and if they are high, to repel gold. Others work in the opposite direction, tending if they are low to attract less gold than if they are high. Finally, among all the prices affecting international gold movements, the one which is most significant is commonly not included in the price-level at all: I refer to the "price of money," the short-time interest rate.