That an increase in the quantity of money raises prices, and a diminution lowers them, is the most elementary proposition in the theory of currency, and without it we have no key to any of the others.
Prices, however, are not fixed by the total amount of money in existence; only that part of the money that is available for use can act on prices.
Mr. Mill says:
Whatever may be the quantity of money in the country, only that part of it will affect prices which goes into the market of commodities and is there actually exchanged for goods of some description. Whatever increases this portion of the money in the country tends to raise prices. Money kept in reserve by individuals to meet contingencies which do not occur, does not act on prices. Money in the coffers of banks, or retained as a reserve, does not act on prices until drawn out to be expended for commodities.
It is also conceded that in fixing prices not only all the money actually available for use must be taken into consideration, but the rapidity of circulation must also be regarded; and due allowance must be made for the number of times commodities change hands before consumption.
The same dollar may, by passing from hand to hand, make a number of purchases, and the same goods may be sold repeatedly before consumption. It is, probably, correct to say, that the money available for use multiplied by the rapidity of circulation, or, as Mr. Mill expresses it, by its efficiency, equals the total money to be considered; and the commodities sold multiplied by the average number of sales equals the total commodities to be taken into consideration in fixing the general level of prices.
Are there any other elements that act on the general level of prices? Of course an abundant yield, or a short crop, or an over-production, so called, or under-consumption, of any particular commodity may depress or raise the price of that particular crop or commodity; but are there any elements other than those above enumerated that act on the general level of prices? I think there are none.
If, then, prices are controlled by the volume of money available for use; and if the general level of prices will rise as the volume of money is increased, and fall as the volume of money is diminished, and rise or fall in an exact ratio corresponding with the expansion or contraction of the volume of money, it becomes important to ascertain what money is, and also whether there is anything which can be used as a substitute for money in such a manner as to affect the general level of prices.
Senator John P. Jones, than whom there is no one better informed, says:
The money of a country is that thing, whatever it may be, which is commonly accepted in exchange for labor or property and in payment of debt, whether so accepted by force of law or by universal consent. Its value does not arise from the intrinsic qualities which the material of which it is made may possess, but depends entirely on extrinsic qualities which law or common consent may confer.