The quantity theory of money and prices.
This is the so-called quantity theory of the relation between money, credit, and prices and it holds good in a general way although it does not work out as simply as it reads. The adjustment of supply and demand sometimes takes place very slowly. The volume of credit which can be built upon a given reserve of gold is not absolutely fixed, moreover; in some circumstances it may be more extensive than in others. |Defects of the quantity theory as shown by recent experience.| During the World War, for example, credit ran away from the gold reserve in all the European countries. Enormous amounts of paper money were issued with very little gold in reserve to protect them. Due to reduced production, the supply of ordinary goods sharply declined. A combination of these two things, inflation of credit (i. e., potential demand for goods) and decreased production, sent prices sky-high.[[209]] In the United States credit was also inflated during the war and prices went up, though not to the same extent as in Europe. Since 1920 the process of “deflating” credit has been going on. This process of deflation is guided by the federal reserve banks, which are able to contract the volume of credit by charging higher rates for rediscount.
The Advantages and Dangers of Credit.—It is probable that at least two-thirds of the buying and selling in the world is done on credit. Nearly all large transactions are put through by the use of credit for short or long terms. Credit affords many advantages to modern industry and commerce; without it, indeed, our whole economic system would break down. |Four functions which credit permits.| A few of these advantages may be mentioned: (a) It economizes the use of gold and silver, by doing away with the necessity of passing gold and silver coin from hand to hand at every transaction. (b) It enables large payments to be made at distant points without an actual shipment of metallic money. (c) It permits men to engage in business operations beyond their own means by borrowing capital and using it productively. (d) It enables people to invest their savings (by depositing in savings banks, lending money on mortgages, buying bonds or stocks, etc.) so as to secure a profitable rate of interest without great risk.
Credit may also harm.
But there are also some disadvantages. The credit system often encourages extravagance in that people are tempted to buy goods which they eventually find it hard to pay for; it tends to encourage speculation which frequently results in heavy losses; and it sometimes enables promoters to obtain capital when there is little or no chance of their being successful. By strict governmental supervision, however, the advantages can be retained and most of the dangers eliminated.
The Stock Exchange.—A word should be said about the place where instruments of credit are most commonly bought and sold, namely, the stock exchange. As its name implies, this is a market in which men buy and sell stocks, bonds, and other securities.[[210]] There is a stock exchange in every large city. The buying and selling is done through brokers, who are members of the exchange and who receive a small commission for their work, this commission being paid by the persons for whom they buy or sell. A broker, at your request, will buy or sell on the exchange any security that is listed there. The amount of the purchase may be paid in full, or, if the buyer desires, a partial payment of five, ten, or twenty per cent may be made. |Trading on margin.| This is called “buying on margin”. The current prices of all securities are kept posted on the exchange; they go up and down from day to day in keeping with market conditions. Shrewd investors try to buy when prices are low and to sell when prices are high, but in this they are not always successful. Many fortunes have been made—and lost—on the stock exchange.
General References
F. W. Taussig, Principles of Economics, Vol. I, pp. 227-235 (Coinage); 236-251 (Quantity of Money and Prices); 265-273 (Bimetallism); 348-359 (Banking Operations); 375-385 (The Banking System of the United States);
Isaac Lippincott, Economic Development of the United States, pp. 550-580;
H. R. Burch, American Economic Life, pp. 336-371;