|An inquiry Into The Currency Principle|
ON THE CONNECTION BETWEEN THE AMOUNT OF THE CURRENCY AND THE PRICES OF COMMODITIES.
A great part of the examination of witnesses by the Committee of the House of Commons on Banks of Issue in 1840 was directed to the eliciting of opinions as to the terms by which the various kinds of instruments of exchange should be designated and classified. The witnesses were severally called upon to define the sense in which they used the terms "money, currency, and circulation," and to say whether they included deposits in the Bank and bills of exchange under any or all these terms.
The importance which was attached to the attempt at settling those definitions seems to have arisen from an opinion which prevailed evidently among the members of the Committee,that, by arriving at a conclusion as to what part of the various forms of paper credit should be considered exclusively as money or currency, conferring a power of purchase, some criterion or test might be found of the influence of one of the principal elements upon which not only the state of trade and credit, but also general prices depend; it being assumed that commodities, although liable in each particular instance to be influenced by circumstances affecting the supply and demand, are more or less under a direct influence from variations in the quantity of money or currency. And the same assumption of a direct agency of the quantity of money, according to the assumed definition of it, on prices, will be found to be either expressed or implied in the vast majority of the numberless publications to which the currency question has given rise.
An increase or diminution of the amount of bank notes is evidently considered, not only by the professed adherents of the doctrine of the currency principle, but by a large proportion of the public who take an interest in the subject, to be analogous, in the effects on markets, to alterations in the quantity of a government compulsory paper; or, in other words, they consider that prices in such cases are under a direct influence from, and affected in the same manner by, variations in the amount of bank notes in circulation, which they designate indiscriminately as paper money.
This erroneous impression arises from a neglect of the consideration of the difference in the manner and purpose of the issue. I have not met with an instance in the inquiry by the committees, or in the numerous publications which have appeared on the subject of the currency, of any attention having been paid to this particular point. Indeed, the context in all of them seems to assume that there is no difference, and that therefore any attempt at explanation would be a work of supererogation. Thus, Mr. Porter who, in the chapter on Currency, in his highly valuable work "On the Progress of the Nation," attributes to the amount of the circulation great influence on prices, contents himself with observing, "It is not necessary to explain, at any length, in what manner excessive issues of currency tend to raise the general prices of goods." Now an explanation, however brief, of this point was exactly the thing wanted. And I cannot help thinking, that if he had suffered himself to pause and reflect upon it, he could hardly have failed to modify the opinion he has there expressed of the influence of the amount of the currency on prices, and he would possibly have been led to distrust the correctness of the view presented by the table which he has inserted in illustration of his opinion of that connection.
A moment's consideration will serve to show the importance of the distinction to which I have here alluded.
When a government issues paper money, inconvertible and compulsorily current, it is usually in payment for
1. The personal expenditure of the Sovereign or the governing power.
2. Public Works and Buildings.
3. Salaries of Civil Servants.
4. Maintenance of Military and Naval Establishments.
It is quite clear that paper created and so paid away by the Government, not being returnable to the issuer, will constitute a fresh source of demand, and must be forced into and permeate all the channels of circulation. Accordingly, every fresh issue, beyond the point at which former issues had settled in a certain rise of prices and of wages, and a fall of the exchanges, is soon followed by a further rise of commodities and wages, and a fall of the exchanges; the depreciation being in the ratio of the forcibly increased amount of the issues.
It will hence appear that the difference between paper money so issued and bank notes such as those of this country consists, not only in the limit pre- scribed by their convertibility to the amount of them, but in the mode of issue. The latter are issued to those only who, being entitled to demand gold, desire to have notes in preference; and it depends upon the particular purposes for which the notes are employed, whether a greater or less quantity is required. The quantity, therefore, is an effect, and not a cause of demand. A compulsory government paper, on the other hand, while it is in the course of augmentation, acts directly as an originating cause on prices and incomes, constituting a fresh source of demand in money, depreciated in value as compared with gold, but of the same nominal value as before.
In a convertible state of the currency, given the actual and contingent supply of commodities, the greater or less demand will depend, not upon the total quantity of money in circulation, but upon the quantity of money constituting the revenues, valued m gold, of the different orders of the state under the head of rents, profits, salaries, and wages, destined for current expenditure.
Dr. Adam Smith, in the passage which I have before quoted from him (at p. 34.) observes: "The value of the goods circulated between the different dealers never can exceed the value of those circulated between the dealers and the consumers; whatever is bought by the dealers being ultimately destined to be sold to the consumers." Assuredly, then, the prices at which the commodities have gone into consumption, the result of them constituting the return for the capital expended in the production, may be considered with greater propriety than any other description as general prices.
The cost of production will determine whether and to what extent the supply will be continued, but the extent of the effectual demand, in a given state of the supply, will be measured by the prices which the consumers may be able and willing to pay. Now, the power of purchase by the consumers depends upon their incomes; and the measure of the extent and of the exercise of such power is, as has just been observed, in that portion of their revenues which is destined for expenditure in objects of immediate consumption.
Of the revenues or incomes of the community devoted to immediate expenditure, by far the largest proportion consists of wages, from those of the skilled artizan, who gets his 5 l. a week or upwards, to those of the day labourers and common workmen, whose earnings with their families are from 20s. to 7s. a week. Any increase, accordingly, of incomes, of which wages constitute the largest part, will raise general prices, and a fall of wages will depress them, supposing no alteration in the cost of production, or in the actual and contingent supply.
If prices of one or more articles of consumption fall from diminished demand, and continue for any length of time below the cost of production, the supplies will fall off until, in consequence of the diminution of supply, the price rises, so as again to cover the cost. Or if the cost of production is raised by permanent causes, the means of the consumers being limited if the article is not a necessary of life, and if the supply fall off so as to raise the price, there will be a permanent falling off of the demand, and less of the article will be produced and consumed. But, given the cost of production, and, barring the effect of vicissitudes of the seasons, and other casualties affecting the supply, the quantity consumed, at certain prices, which is the test of effectual demand, will, as I have said, depend upon that portion of the incomes of the different orders of the community which may be destined for expenditure in immediate objects of consumption.
As an instance of the false practical conclusions to which the currency theory leads, in the view taken of the distinction between bills of exchange and bank notes, and in overlooking, as it does, the distinguishing features of credit, and capital, and currency, and between wholesale and retail dealings, I have to cite the following passage from Mr. Norman's Letter to Charles Wood, Esq. (page 43.) proposing to show, according to his view, the usual effect of bills of exchange on price:
"A buys cotton of B at 10 per cent in advance on the previous price, payable at three months, and gives his acceptance for the amount. At the close of this period, or after one or more renewals, the bill must be paid out of the currency in existence; and if there is not enough money to sustain such a price, a fall in prices must ensue, and B will suffer from his bargain. But further, if the advanced price has become general, a stimulus will be given to the importation of cotton, a check to its exportation, or to that of articles manufactured from it, and the final result will probably be a fall below the original price, commensurate with or perhaps greater than the original rise. This imaginary case may be taken as a fair representation of the usual effect of bills of exchange on price."
The bills of exchange are here supposed to have an effect on price, that is, to be a cause of price; whereas the very reverse is the fact. The bills of exchange, so far from being a cause, are the effect of price. The prospect of advantage supplies the motive, and the credit of the buyer constitutes the power of purchase, while the bill of exchange is a mere written evidence or acknowledgment of the debt, accompanied with a promise to pay the amount at some definite period. If A, the buyer at the advanced price, has not under-estimated the supply, or over-estimated the consumption, the manufacturer must give the advanced price, and, by his acceptance or cheque, enable A to discharge his acceptance at the time of its becoming due, with a profit, or, by the supposition, without loss. But if A has been mistaken in his view of the supply, actual and contingent, compared with the rate of consumption, the price will fall, and he will suffer from his bargain; and if he trades upon a large proportion of borrowed capital and the loss be heavy, he will fail.
So much of the results, in the alternative of the two suppositions, is clear enough according to the ordinary course of business. But, according to Mr. Norman's view, if I understand it rightly, the price would fall, not because the buyer had been mistaken in his view of facts and in his reasoning as to the supply relatively to the rate of consumption, but be- cause there was not enough money to sustain the advanced price.
Mr. Norman does not attempt to show that the quantity of money requisite to sustain the advanced price of cotton in the case supposed is necessarily dependent on the aggregate of coin and bank notes, which he considers as the currency in existence in the country, and out of which he states that the bill given by the buyer of the cotton must be paid. He seems not to be aware that the quantity of money applicable to the purchase of cotton and cotton goods from the raw material in the hands of the grower, to the finished article in the hands of the consumers, is dependent upon that portion of the money incomes of the consumers at home and abroad, which they are able and willing to expend in the satisfaction of their wants for cotton clothing and the other uses of cotton goods. All sales and purchases from those of raw cotton in the hands of the planters, till the finished goods find their way into the hands of the consumers, must in the aggregate reach that amount, and cannot but by miscalculation of employers of capital and labour, in the distribution and the manufacture through the intermediate stages, exceed that amount, whatever may be the multiplication of bills arising out of the intermediate transactions.
The principle of limitation, therefore, to the maintenance of an advanced price of any particular article, m consequence of actual or apprehended deficiency of supply, is not the quantity of money in existence in the country, but the quantity of money in the hands or pockets of the consumers destined for expenditure in that article. And the eventual fall of price will not be from deficiency of the quantity of currency in the country to sustain the advance, as supposed in the foregoing passage, but from the inability or unwillingness of the consumer to pay the advanced price, and from a restoration, actual or expected, of the usual or a greater supply.
But then follows a passage which shows that in that which I have just quoted, the effect ascribed to bills of exchange on prices is supposed to arise from the circumstance, not of their creation, but of their changing hands by indorsements: "A large proportion of bills are drawn and paid which have no effect on the currency whatever. Thus let A sell coffee to B at three months, and at a fair current price, draw for the amount, and keep the bill in his portfolio until due; it is clear that the result will be the same as if he had given a simple credit for the same period. The economy in the use of money will commence when he makes a payment to C by means of an indorsement, and will be repeated as often as the bill, by a repetition of this process, changes hands. Thus even purchases on credit, at advanced prices, against which bills are drawn, may be made without any new creation of money, and without the necessity of employing an economising expedient."
The advance in the price paid for cotton in the first of the hypothetical cases stated, and the fair price at which the coffee is in the second case supposed to have been sold, should seem upon the face of the statements to be essential conditions of the cases; but the two concluding sentences are calculated to remove that impression, and to lead to the inference that the prices paid have nothing to do with the question, how far bills of exchange do or do not answer the purposes of money in a supposed effect on prices.
The cases only prove what I have before endeavoured to show, that purchases and sales between dealers and dealers may be, and are in a great majority of cases, transacted through the medium of credit, of which bills of exchange are the written evidence; the successive indorsements adding to the credit of the original names on the bills, and serving the purpose of so many transfers of capital. And I have only referred to the cases stated by Mr. Norman as bearing on the question of the connection of the currency with prices, in order to point out the grave error of his doctrine, in ascribing to bills of exchange an effect on prices, instead of viewing them as an effect of prices.
The same error, being no less than that of substituting cause for effect, is observable in a still greater degree (because more importance is attached to it) in the `influence ascribed by the currency theory to the amount of the circulation, that is, of bank notes, on prices. It is an error which perverts the reasoning, and distorts the view of facts, in every attempt to apply the theory of the currency principle to the actual course of commercial affairs.