Essentials of Economic Theory / As Applied to Modern Problems of Industry and Public Policy

by John Bates Clark

Accepted Facts concerning Money.—We may accept without argument the conclusion that both theory and experience have reached concerning the superiority of gold and silver over other materials of which a currency can be made. They possess the universally recognized utility which makes them everywhere in demand. They have the "imperishability," the "portability," and the "divisibility" which are needed, and when made into coins, they have the "cognizability" by which they can, more readily than many other things, be identified and distinguished from cheap imitations. There remain to be settled the questions whether an expanding volume of currency is necessary for prosperity, and whether the expansion can better be secured by using two metals than it can by using one.

Effects of Free Coinage.—It is evident that when a government coins without charge all the gold and silver that are brought to it for that purpose, either metal will be worth about as much in the form of bullion as it is in the form of coin. If, for uses in the arts, an ounce of gold is worth more than the number of dollars that can be made of it, the coining of this metal will temporarily cease and some coins already made will be melted. Moreover, where both of the precious metals are used as money, neither of them can long be worth in a coin much more than is the bullion contained in the less valuable of the two. If a gold dollar will buy more silver than is needed to make a silver dollar, because of the higher value of the bullion in the former coin, silver will be bought and taken to the mint for coinage, while gold dollars will be melted. The gold will go farther in the way of paying debts when it is in this way exchanged for silver money.

The Effects of Inflation of Currency on Prices.—We are citing a further accepted fact when we say that, other things being equal, enlarging the volume of currency in use raises the prices of goods. By what particular mechanism this is brought about we do not here inquire. Not everything that is claimed under the head of a "quantity theory of money" is generally believed, but there will be little disposition anywhere to deny that, if no other dynamic movement should take place, adding fifty per cent to the volume of metallic money in circulation would make prices higher than they were before the addition.

Rising Prices and Business Profits.—If we assert, further, that permanently rising prices mean prosperity,—profits for the entrepreneur and a brisk demand for labor and capital,—we assert what, in the practical world, is too generally accepted. Sound theory and current belief are at variance on this point, and the current opinion appears at first glance to have the facts on its side. Periods of rising prices have actually been periods of prosperity. It is considered hard for either a merchant or a manufacturer "to do business on a falling market," and easy to make money on a rising one. This impression is entirely correct in so far as it concerns those fluctuations of price which occur suddenly and continue only briefly. What it is of great importance to know is whether a steady rise of prices which should continue permanently would mean permanent profits for the entrepreneur; and it can be asserted without hesitation that it would not do so if the final productivity theory of interest is sound, that is, if capital commands in the market a rate of interest which corresponds to the amount that the marginal increment of it will actually produce.

The Rate of Expansion of Currency distinguished from the Absolute Amount of Increase.—The extent to which any currency is capable of raising prices by a continued expansion depends, not on the absolute amount of that expansion, but on the percentage of enlargement that takes place within a given time. Moreover, a given percentage of increase per annum may be maintained as well by one metal as by two. If the gold and the silver money of the world were each increased by one per cent a year, prices would have the same trend under a currency made of one metal as under a currency made of both. If, on the other hand, all the currencies were based on gold only, a change to a bimetallic system would at once make a single great enlargement of the volume of money; but after this the rate of enlargement would be no greater than it was under the single standard. In the transition from a gold to a bimetallic currency, we should get rapidly rising prices; after the change had been completed, we should have a currency expanding as before at the one per cent rate. If the volume of business were to increase at the rate of two per cent a year, while other influences affecting prices were to remain unchanged, the currency would not expand as rapidly as the demand for it, and prices would not only fall, but would fall at the same rate as if only one metal had been used. Use ten metals instead of two,—make coins of tin, platinum, copper, nickel, etc.,—and if the grand composite still insures the one per cent rate of general increase of metallic money, prices will vary as they would have varied with a currency of gold alone. Wholly transitional, under such circumstances, is the rise in prices secured by the adoption of bimetallism. It is gained by adding to the stock of gold now used for ultimate payments an existing stock of silver.

Why Metallic Currency of Any Kind gains, in the Long Run, in Purchasing Power.—In the long run, almost any metallic coin of a fixed weight will gain in its purchasing power. Silver would do this as well as gold; and so would a composite coinage made of ten metals. The law of diminishing returns applies to mining as well as to agriculture. The more silver you want, the deeper you must dig for it, and the more refractory ores you must smelt. The transmuting of a raw metal into finished articles becomes a cheaper and cheaper process; but the extracting of the metal itself becomes dearer. A larger and larger fraction of the labor that is spent in making wares of silver, of gold, of copper, or of tin must be spent in getting the crude material out of the earth. There are improvements in mining, as there are in other industries, and there are large improvements in smelting; but in spite of this the continual working of more difficult mines and of more difficult ores makes the getting of the crude material, in the long run, relatively costly. Since a coin consists chiefly of raw metal, we may therefore count on having before us a régime of falling prices, whatever metallic currency we adopt. The rate of the fall and the degree of steadiness in it will be greater with some metals than with others. The variations in the value of gold are, on the whole, comparatively steady. This metal fluctuates in amount and in cost, but the changes are less sudden than in the case of most others.

The Steadiness of the Change in the Purchasing Power of Money the Important Fact.—A second fact to be noted is that the best currency is one the purchasing power of which shall change, if at all, at a comparatively uniform rate. This fact is of paramount consequence, and the verification of it will repay any amount of study. It is not the rapidity with which gold gains in purchasing power, but the steadiness of the gain from year to year that determines whether it is the best money that can be had by the business world. A change in the rate of increase in the purchasing power of the coinage metal has a really disturbing effect; a steady and calculable appreciation does not. There exists in some acute minds what I venture to call a delusion about the effect on business classes of an advance in the purchasing power of gold that proceeds for a long time at a uniform rate. Conceding the prospect of a decided gain in the value of this metal, we may deny absolutely that, if it is steady, it plays into the hands of creditors, burdens the entrepreneur, blights enterprise, or has any of the effects that certain men whom we are bound to respect have claimed for it. Irregular changes of value would, indeed, produce these results. Let gold gain three per cent in value this year, one per cent next year, and four per cent in the year following, and injurious things will happen; but let it gain even as much as three per cent each year for a century, and at the test points in business life there will ensue the essential effects that would have followed if it had not gained at all.

This means that with a steadily appreciating currency the things will happen that make for prosperity. The debtor will get justice, enterprise will be safe, and wages will gain while industry gains. The entrepreneur, in whose behalf bad counsel has lately been given, will best do his strategic work, not with that currency which varies in value the least, but with that which varies most uniformly. If it appears that gold is likely to appreciate more than silver, and to appreciate more steadily, it is decidedly the better metal. It is not inflation on which the entrepreneur permanently thrives, nor is it contraction through which, in the long run, he suffers; it is changes in the rate of inflation or of contraction that produce marked and damaging effects at the critical points of business life.

Loan Interest as related to the Increase of Real Capital.—How does a slow and steady appreciation of any metallic currency affect the relations of business classes? Does it rob borrowers and enrich lenders? Does it favor the consumers by giving falling prices, and hurt producers in the same degree? Does it tax enterprise and paralyze the nerves of business? The answer is an emphatic No. Steadiness in the rate of appreciation of money is the salvation of business. Not by one iota can such a slow and steady movement, in itself alone, rob the borrowing class. This is a sweeping claim; let us examine it.

It has been shown that true interest is governed by the marginal productivity of capital. As the utility of the final increment of a commodity fixes the price that a seller can get for his whole supply, so the productive power of the final unit of capital expresses what the owner of capital can get by lending his entire supply. This earning capacity expresses itself in a percentage of the capital itself. If the final unit can create a twentieth of itself in a year, any unit can get for its owner about that amount.