Economics Volume II: Modern Economic Problems

by Frank A. Fetter

§ 1. #Relative positions of gold and silver: historical.# It is not possible within the limits of our space to enter here into the details of the world's monetary history. It must suffice for our purpose to sketch briefly the period preceding the nineteenth century. Both gold and silver were used as moneys in Europe in the Middle Ages, tho silver was much the more common. The two metals continued to be used side by side in Europe and in the new settlements in America, silver for the smaller and gold for many of the larger transactions. Both were made legalized forms of money (and standards of deferred payments) in units of specified weights and fineness, the weights bearing a certain ratio to each other. Thus it was possible for a debtor to discharge his obligations with that one of the two metals that at the moment was the cheaper at the legal ratio. Fluctuations in the prices of gold in terms of silver were at times such as to cause a large part of the full-weight coins of one or the other metal to leave circulation (in accordance with Gresham's law). So from time to time the ratio was slightly changed by law in the various countries to permit the circulation or to bring back the kind of money that had been undervalued in terms of the other. But it is a very remarkable fact that from the time of Xenophon until the discovery of America (a period of nearly 2000 years), the market ratio of silver to gold bullion in Europe remained pretty close to 10 to 1, being only temporarily altered by sudden and unusual occurrences. From 1492 to 1660 the ratio changed to 15 to 1, where it remained with remarkable stability until about the year 1800. At the establishment of the mint of the United States in 1792 that ratio was found to exist. Men had come to look upon the ratio of 15 to 1 as the natural order, determined (it was sometimes said) providentially by the deposit of the two metals in due proportion in the earth's surface. But as we now see it, this in part was mere chance and in part was due to the equalizing effect of the wide use of both metals so that the one could be easily substituted for the other in case of a divergence of the market ratio from the legal ratio as money. From the year 1500 until 1800 the Western hemisphere was the main source of the precious metals, the alluvial deposits were widely scattered, were gradually discovered, were usually found in small quantities, and were extracted in primitive ways. The existing stock of precious metals, gold and silver, more than other products of mine and field, is at any time the accumulation of many years' production, and is changed very little, proportionally, by a large change of output in any year or short period. It changes in volume as does a glacier fed by the snows of many years, not as does a river, filled by a single rainfall. For a short time after the discovery of America (from 1493 to about 1544) the average coining value[1] of the world's production of gold, nearly all found in America, was about 1-1/2 times as great as that of silver; but thereafter for three centuries from about 1545, the annual value of silver produced was between 1-1/2 to 4 times as great as that of gold, averaging about twice as great. Silver was the money chiefly in use in the ordinary transactions in all of the principal countries of the world.

§ 2. #Gold production, first half of nineteenth century.# We have now to note some great changes in the production of gold in the nineteenth century, changes both absolute and relative to that of silver. The market ratio of the two metals had been gradually changing before 1792 and continued to change. Gold was slowly becoming more valuable in terms of silver and the legal ratio of 15 to 1 in the United States (at which both metals were admitted free to the mint) proved to have undervalued gold. Gold largely left circulation and silver and bank notes formed the greater part of our circulating medium. Then, in 1834, soon after the production of gold had begun to increase somewhat more rapidly than that of silver, the legal ratio of the United States was changed to 16 to 1. This brought a good deal of gold back into circulation and gradually drove out most of the silver (the heavier coins disappearing first).

In the decade 1841-50 the average annual value of the gold production had, for the first time since the early sixteenth century, exceeded that of silver. Then, from 1848 to 1850, came the great gold discoveries in California and in Australia. In 1851 the value of gold produced was one and one-half times that of silver; in 1852 was three times, and in 1853 four times as great; and then slowly declined, but continued every year as late as 1870 to be over twice as great. This caused the displacement of silver by gold and drove out a large proportion of the silver coins of smaller denominations. This led to the law of 1853, authorizing subsidiary coinage (on government account only) of lighter weight.[2] Let us observe the effect on prices that was brought about by the discoveries of 1848-49, and, first, we must consider briefly the method of measuring and expressing general changes in prices.

§ 3. #Concept of the general price level.# The price of any good is some other good or group of goods given for it in trade.[3] The standard unit of money coming to be the most convenient expression for price (whether or not money be actually passed from hand to hand in that particular trade), prices usually are monetary prices, and more specifically are prices in gold, or in silver, or in whatever constitutes the standard money unit. But the price of each good is a definite, separate fact, which expresses the ratio at which that commodity is sold. The price of any particular kind of goods may fluctuate in either direction as compared with the prices of other goods at the same time. For example, iron and many other goods may rise while wheat and many other goods fall in price. There is, therefore, no such thing as an actual general change in the prices of goods in terms of money, but it may be seen that the prices of large classes of goods, often of nearly all goods, change upward or downward at the same time and in the same general direction. We thus have need to distinguish between changes in the valuations of particular kinds of goods in terms of each other and general changes in the valuation of a number of different goods in terms of the monetary unit.

To get some idea of whether such a general trend occurs, the algebraic sum of all the changes in the particular prices of a selected group of goods may be taken, and for convenience this may be reduced to an average price (by dividing the sum by the number of articles). Such an average is called a general price and, when comparing it with the general price of another time, we speak of changes up or down in general prices, or in the general scale of prices, or in the price level.

When gold is the standard unit, its value is the converse of general prices; as prices go up the value of gold goes down, and gold is said to depreciate. As prices go down, the value of gold goes up and gold is said to appreciate. Rising prices mean falling value of gold (and at the same time falling purchasing power), and vice versa.

[Illustration: FIG. 2. INDEX NUMBERS OF PRICES. The four series of prices here shown begin at different periods; the American in 1840 (Aldrich report 1840-1889 and Bureau of Labor from 1890 on); the English in 1846; the German in 1851; the French in 1857. We have adjusted each of these series to a base of the average prices for 1890-1899, in accord with the basic period used by the American Bureau of Labor.

The reader must be on his guard against misunderstanding the diagram. It does not represent the heights of the prices of the different countries compared with each other either at any one date or for the entire period. For example, the heights of the lines at the year 1860, do not indicate that American prices were lowest and French the highest at that date, or, indeed, tell anything whatever directly on that point. The various series of prices are compared within themselves, every year with the average of the prices for 1890-1899 in each country, respectively. The only comparison allowable, therefore, between the several lines, is that between the fluctuations, both as to their times and as to their directions, both as to the larger tidal movements and as to the lesser wave-like movements within the business cycles. The Figure does indicate that both American and German prices have risen somewhat as compared with the English and French prices, since the period before 1860.

This figure should be studied in connection with Figure 1, in ch. 4, sec. 9, on gold production. The Figures indicate that the rapidly growing monetary use of gold offset a large part of the effects of increasing gold production between 1840-1860 and 1884-1914. Between 1884 and 1896 prices actually continued to fall after gold production had begun to climb. Likewise the growing monetary use of gold accentuated strongly the effects, between 1873 and 1883 of a comparatively small decrease in gold production.]

§ 4. #Index numbers.# The process of calculating general prices and changes in them has in it, inevitably, something of arbitrariness and incompleteness. For not all prices can be included, but only those of articles of somewhat standardized grades and those that are pretty regularly sold in markets where prices are publicly quoted. Any list of articles that can be selected is of unequal importance to different persons and classes of persons, at different places, at different times, and for different purposes. And yet the study of general prices as shown by any broadly selected list reveals changes which in some measure affect the interests of every member of the community.