The first difficulty is that we are barred from the use of our yardstick. Money is the measure of all things in economic theory—except money and gold bullion! Of course there are economic values other than those of gold which do not actually come into the market, but even there we can commonly, by the accountant's methods, make use of the money measure. In very high degree, our conventional curves of all sorts run in money terms, and assume a fixed value of money. Clearly the money curve of diminishing value for gold would tell us nothing. The value of gold might sink as its quantity increased, but then the value of the money-unit would sink pari passu, and so the curve, with ordinates expressed in numbers of dollars per ounce, would not sink. The value-curve of gold, expressed in money, is a straight line, parallel to the X axis. Possible substitutes in the form of abstract units of value,[501] or of composite units of goods, of an assumed fixed value, will have to be used if anything is used, but they are less satisfactory in the application, and leave the analysis a good deal less realistic.
If this were all, the problem would be easy! But there is a second difficulty. We find the factors requiring gold as money, if summed up in a curve, presenting themselves as a call for the temporary rental of the gold. The money functions are performed, in general, not by keeping gold, and getting an endless series of uses from it, as in the arts, but by passing it on, sooner or later. Even in the case of the reserve function, the bearer of options function, and the store of value functions, it is not expected to hold the gold indefinitely—always there is the anticipation of some time when it will be passed on again. A curve for gold in the monetary employments, therefore, would be a curve showing the diminishing values of rents, or particular services rather than a curve for capital values. The curve for gold in the arts, however, would be a curve showing the diminishing capital values of units of gold, as the supply in the arts is increased. The two curves do not run in common terms. But another and more fundamental difficulty. In the case of wheat, we may construct our curve free from complications, in idea, at least. On the base line, we lay out quantities of wheat. For each quantity of wheat, we erect an ordinate, a sum of money, or a number of abstract units of value, as the case may be. Connecting these ordinates, we have a curve, showing how the value (or the money-price) of wheat descends as the quantity of wheat increases. Given the shape of the curve, and given the number of bushels of wheat, the marginal value of the wheat is given. In idea, at least, it does not matter, for the shape of the curve, whether the amount of the wheat is great or small, whether the marginal value of the wheat is low or high. If there are ten thousand bushels only in the market, wheat will be worth $5 per bushel. With 100,000 bushels, it is worth 40c. The fact that there are 100,000 bushels does not lessen the magnitudes on the higher portions of the curve. The nature of the services which wheat performs is not affected by its value. This is not true of gold, either in the arts or as money. In the arts, I have already shown that one function of gold is as a means of conspicuously displaying wealth. Gold is like diamonds in this. Because gold is a valuable, it gets an additional valuable service. This additional valuable service enhances its value. The thing is checked, however, before an endless circle is created, by the fact that as gold rises in value a smaller amount of gold will display a given amount of wealth. The value-curve for gold in the arts, therefore, is not a simple thing like the curve for wheat. It turns upon itself, in ways that I see no graphic device for presenting. This is even truer for money. Men wish to have, when they seek money, a quantum of value in highly saleable form.[502] The curve for the value of the services of money presupposes a fixed capital value of money. It is the capital value of money which does the money work. Given a value of money, and given the values of goods, we may see how much money is required to effect a given exchange or perform some other money service. Then, knowing how much value will be created by each exchange, or other money service, we may arrange the services in a series, a scale of descending importance, and get a curve. This curve is, in fact, the curve which presents itself in the money market. There we find a curve, running in terms of money itself, so much money for the use of money for such a length of time. But this is a curve of demand for money funds, rather than for gold as such. The "supply" that corresponds to this "demand" is, not gold, but all manner of credit instruments, chiefly bank-deposits, expressed in terms of gold. Such a curve is clearly not to be put into equilibrium with the value-curve for gold in the arts, (1) because it assumes a fixed value for money (2) because it is concerned with temporary rentals, and not capital values, and (3) because the demand it expresses is not for the use of gold alone.
We may get some aid in reducing these complexities to familiar terms if we employ the device of assuming an equilibrium between gold in money and gold in the arts, without trying to explain in quantitative terms how that equilibrium is arrived at, and then see what causes will lead that equilibrium to shift. In getting the laws of change, we may get closer to the causes of the phenomenon itself. The effort to reduce the thing to precise mathematical form requires a degree of simplification which seems to me likely to rob an answer of much significance.
Assuming that the equilibrium is reached, we may see what factors would tend to cause gold to go into the money-use, and what factors would tend to draw gold into the arts use. We may also see how these changes from one side or the other would modify the value of gold.
Assume that a manufacturing jeweler has extra demand for his products. His products, of course, are composites of gold, labor, and other raw materials, etc., but part of the extra value that comes to his products attaches itself to the gold that is in them. He now has an incentive, which was lacking before, to melt down full weight gold coin in his possession, or to buy gold bars which might otherwise have been coined. To buy the gold bars, however, probably means that he must have accommodation at the bank. He borrows from the bank the amount he needs, giving a short-time note, since he expects to make up his gold and market it in a fairly short time. The paper of manufacturers of gold will commonly stand well in the "money market," and this is especially true of those in whose hands the gold is not worked up into such specialized forms that the value of the bullion is a minor matter. (I find it necessary to refer frequently to the money market, though a full analysis of money-market phenomena cannot come till after our discussion of credit.) If he must borrow to get the gold, then the money-rates will come into comparison with the profits he expects to make from working up the gold. This will usually be true even if he melts down gold coin already in his possession. He might deposit that gold, and so reduce his expenses at the bank, either buying back his own discounted paper, or getting interest on daily checking account. If he has to borrow to get the gold, he may get it either by drawing gold from the bank directly, or by giving a check on the bank to a bullion dealer, which may ultimately lead to a diminution in the bank's supply of gold. However he gets the gold, there is bound to be some reaction, (1) on the bank's supply of gold, (2) on the supply of loanable funds in the money market, and hence (3) on the money-rates themselves. If he borrows from the money market, he affects the money-rates directly (even though probably, in a given case, not noticeably); if he melts down coin, instead of depositing it (or paying it out to others who may ultimately deposit it) there tends also to be less gold in the bank's vaults; if he buys gold with his own funds in the bullion market, the supply of current bullion for which the banks also compete is reduced. In any of these cases, the banks have less gold than would otherwise be the case. The relation between gold reserves and the supply of money-funds has been partly discussed already. We have seen that there is no proportional relation, as Fisher, and other quantity theorists contend. Loanable funds, on a given gold reserve, are highly elastic. But the elasticity calls for higher money-rates, and higher money-rates tend to reduce the volume of trading, and check the demand. Borrowings from the money market by workers in gold, therefore, are much more significant than borrowings by other manufacturers or merchants, because the latter are content with credit devices, for the most part, while the workers in gold withdraw gold itself from the money market. It is, moreover, harder for the money market to resist extra demand from the jewelers than from many other interests. The assets of the jewelers, especially from those who do not work the gold up in highly specialized forms, are exceedingly liquid. Their paper, therefore, is exceptionally good in the discount market. Usually, too, the larger jewelry houses have specially good general credit and high reputation. There is, then, less disposition for the market to look askance at an unusual supply of their paper than would be the case with many other sorts of paper. They tend to get about as low rates as anyone else in the market. A money market under centralized control seeking to protect its gold, might tend to raise discount rates on jewelers' paper, but a competitive money market is very unlikely to do so.
An increase in the value of gold in the arts would, thus, reflect itself pretty quickly in the money market, first in the form of added value for the services of money, and then, secondly, in an increase in the capital value of money. Indeed, an increase in the value of a single rental is an increase in the capital value also, since the value of the single rental is one portion of the capital value. Not only does it mean a higher capital value for gold, but it consequently tends to mean a higher "price." It does mean a higher "price" for present money as compared with future money. It tends, also, to mean a higher "price" of money in terms of other goods. Meeting higher money-rates, all borrowers tend to borrow less, and to buy less, to offer less money for goods. It need not follow, however, that the rising value of gold reduces prices. The rise in the value of gold in the arts may well be a manifestation of a general rise of values. General prosperity, rather than causes affecting the value of gold in the arts alone, may have occasioned the increasing demand for gold in the arts. This would mean rising values for goods at large. It might well be, therefore, that the rise in the values of goods would offset the rise in the value of money, and that prices of goods would rise at the same time that gold is being withdrawn from the money market to the arts.
Business in general, as well as the jewelers, may be making increased demands on the money market. This would tend still further to raise the money-rates. It would also, however, tend to increase the supply of money-funds. Commercial and industrial paper, in a time of buoyancy and expansion, is particularly acceptable to the banks, and they are likely to expand their loans despite the failure of gold reserves to keep pace. They simply get along with smaller reserves. Higher money-rates in such a case tend to reduce the volume of business, but need not actually reduce it, if there are bigger profits than before anticipated in business transactions. Not absolute money-rates, but money-rates in relation to anticipated profits from the use of money, are significant. There is large room here for flexibility, elasticity, etc. There is much slack to be taken up by the money-rates, much slack in the fluid substitutes for money in various functions, and much slack to be taken up by the volume of trade. But all this will best appear after our discussion of the money market.
I have said enough to indicate the character of the factors immediately determining the equilibrium between gold in the arts and gold in the money employments. In the preceding discussion, also, I have discussed the more fundamental factors governing the value of gold in both employments. The problem of translating the fundamental theory of value into money market terms, and of translating the phenomena of the money market into terms of fundamental values is not easy. Most of our value theory in the past has been concerned with individual psychology, Crusoe economics, trading in small markets with a few buyers, barter transactions, etc. It has been abstract and unrealistic. The practical students of the money market, who are immersed in the facts of modern money, have got little help from it, and have often been scornful of it. I hope to be able to contribute something to bringing the two methods of approach to common terms. They are correlative aspects of the same problem. Each gives highly important clues to the understanding of the other. Neither can be understood without some understanding of the other. A theory of value which cannot be applied in the money market, the stock exchange, and the great field of modern business generally, has small raison d'être.
In the next chapter I shall take up the problems of credit, and the money market.