Fifth, despite the number of changing factors affecting the methods of exchange, the method of business, etc., the quant.i.ty theory is a rule usable at any moment. These various factors change slowly, and the quant.i.ty theory answers the question, What change occurs in prices as a result of an increase or decrease of the money in a given community at a given moment? Like the law of gravitation, the law of projectiles, and the statement of the chemical reaction to be expected when adding some substance to a given compound, the theory must be interpreted with practical limitations. When the quant.i.ty theory is thus stated and understood, its negation is unthinkable, as is evidenced by the involuntary use made of it constantly by every one of its few critics in explaining the simplest monetary phenomena.

[Sidenote: Practical application of the quant.i.ty theory]

[Sidenote: Recent price changes]

5. _The quant.i.ty theory makes intelligible the great and rapid changes in price that have followed sudden changes in the money supply._ Inductive demonstration of broadly stated economic principles is difficult, but in no other economic problem is laboratory experiment so nearly possible as in that of money. Many inflations and contractions of the circulating medium have occurred, now in a single country, again in the entire world, and the local or general results have served to exemplify richly the working of the quant.i.ty principle. With the scanty yield of silver- and gold-mines in the Middle Ages, prices were low.

After the discovery of America, especially in the sixteenth century, quant.i.ties of silver flowed into Europe. The great rise of prices that occurred was explained by the keenest thinkers of that day along the essential lines of the quant.i.ty theory, though there were many monetary fallacies current at the time. The experience in England during the Napoleonic wars, when the money of England was inflated and prices rose above those of the Continent, led to the modern formulation of the theory by Ricardo and others. The discovery of gold in California and Australia, in 1848-50, increased the gold supply marvelously, and gold prices rose throughout the world. Between 1870 and 1890 the production of gold fell off greatly while its use as money increased and prices fell. A great increase of gold production has occurred in the period since 1890. In part the rising prices from 1897 to 1902 are explicable as the periodic upswing of confidence and credit, but in part doubtless they are due to the stimulus of increasing gold supplies. These are but a few of many instances in monetary history which, taken together, make an argument of probability in favor of the quant.i.ty theory so strong as to const.i.tute practically its inductive proof.

CHAPTER 46

TOKEN COINAGE AND GOVERNMENT PAPER MONEY

-- I. LIGHT-WEIGHT COINS

[Sidenote: Seigniorage and the value of coins]

[Sidenote: Saturation point for coinage]

1. _When the number of coins issued is limited properly, a seigniorage charge does not reduce their money value; they are worth more as money than as bullion._ The coinage thus far considered has been that of full-weight coins without seigniorage. The question now is, What is the effect of a seigniorage charge on the value of the coin as compared with the bullion that is in it? This is one of the most difficult phases of monetary theory. Two values must be thought of: one the value of the coin as money, the other the value of the bullion in it. When coinage is free and gratuitous, these two values are the same. How can they ever be different? The answer to the question is found in the theory of monopoly value. If the supply of coin is limited by the sole agency of issue, the value can be kept above the cost of production (_i.e._, in this case the bullion value), the seigniorage being the profit of the government. The limit within which the coinage must be kept is the number of coins that would circulate freely if they were made full weight without a seigniorage charge. This is the "saturation point" of the money demand of the country; it is a certain number of pieces of full-weight metal.

If more than that amount gets into circulation it becomes worth less as money than as bullion, and it is melted or exported.

[Sidenote: Example of seigniorage value in coins]

If this full supply of money at a given moment is 100,000 pieces or dollars, a seigniorage charge of ten per cent. could be made if the number of pieces were not increased above 100,000. The government alone having the right of coinage, the need of money would give the circulating medium a monopoly value. The value of the money would rise until the coin would buy one ninth more bullion than was in it, but if there were any further rise the citizens would begin to take coins to the mint. After the ten per cent. charge was taken out they would receive a coin which, though containing one tenth less bullion, would be worth very nearly the same as the metal taken to the mint. No considerable depreciation could take place unless the volume of business fell off so that less money was needed than at the old standard. In that case there would be no outlet for the excess of coins until they fell to their bullion value, _i.e._, till they lost the entire value of the seigniorage, the monopoly element in them. Melting or exporting them before that point was reached would cause the loss of whatever element of seigniorage value they contained.

[Sidenote: Example of excess and depreciation of coins]

a.s.suming that the volume of business, or sum of exchanges, remains unchanged, let us consider what will result if the government begins to issue "on its own account." The number of coins might be increased until at the bullion price the total money value were equal to the original 100,000 full-weight coins, at which point exportation would take place.

There being nine tenths as much precious metal as before, it would require ten ninths as many pieces, or 111,111 pieces, to have as great a value as the 100,000 had before. At this point there is no further profit to the government in issuing coins of that weight. To make a further profit it must again reduce the amount of pure metal in the coin.

[Sidenote: Medieval examples of depreciation]

This is essentially what occurred often throughout the Middle Ages. A ruler debased the quality or reduced the weight of money, but for a time the new coin, having the same money use, circulated as freely as the old coin. If, as so often happened, the ruler yielded to the temptation to issue more in order to get the profit, the older, heavier coins at once began to go abroad or into the melting-pot. Then occurred a fall in value, mystifying alike to the prince and the people. The reason is now perfectly plain: the number of pieces issued had not been kept within the proper limits, and the coins went down to their bullion value.

[Sidenote: Difficulties with full-weight subsidiary coins]

2. _Subsidiary coins of lighter weight than the standard, if properly limited, will remain in circulation at par._ Money to serve all of its purposes must be of different denominations. The amount required of each denomination is determined by the volume of exchanges for which each is most convenient. Each kind of money, as the penny, nickel, dime, has its own peculiar demand and its saturation point. For the smaller denominations the standard metal is not suitable. A gold dollar cannot well be cut into twenty or a hundred pieces. Thus copper, nickel, silver remain in restricted use. When these are issued at their bullion value, difficulties arise; not only are they too heavy, but as they vary in bullion value, some of them become worth more as bullion than as coin, and suddenly disappear from circulation.

[Sidenote: Adoption of light-weight minor coins]

[Sidenote: Theory of light-weight coins]

This happened often throughout the Middle Ages and until the nineteenth century. Gold and silver generally were coined at a ratio of weight corresponding exactly to their market ratio at a given moment, and every time the market conditions varied, one kind of the money went out of circulation, and the country was left either without the larger gold coins, or without subsidiary coin, or "small change." At length the plan was. .h.i.t upon of issuing a limited number of subsidiary coins of less than full bullion value, that is, as "token coins." By this plan there is given to the minor coins a value greater than that of the bullion in them. The small profit made by the government on every penny, nickel, or dime issued, is a seigniorage charge. These minor coins, in somewhat confusing variety, circulate side by side with full-weight money, their value depending on the monopoly principle. The result of a large issue of any one denomination would be a lowering of its value. In practice their issue is determined by the needs of business and by the requests of citizens for small coins in exchange for standard money. One needing "change" gets it at the bank; when the bank finds its supply falling short it gets more from the government mints. As business increased in 1898, the demand for nickels, dimes, and quarters became unprecedented, and the mints worked night and day to supply them.

[Sidenote: Gresham's law]

3. _Gresham's law of the circulation of coins of different bullion value is: bad money drives out good money._ This so-called "law" was stated in these circ.u.mstances: England had two kinds of metal money, silver and gold, which were coined at a fixed ratio in weight; and as the market value of the bullion changed, the new full-weight coins of the metal rising in value went out of circulation. The coining of the cheaper metal caused the melting or exporting of the one becoming dearer, and for those purposes the coins containing the most bullion were picked.

Likewise full-weight coins disappear whenever money of less bullion value (either because containing more alloy, or because made of a cheaper metal or of paper) is poured into the circulation in large quant.i.ties.

[Sidenote: Proper interpretation of Gresham's law]

Gresham's law needs some explanation, for it is frequently misunderstood. "Bad" money means money that has not the bullion value equal to its money value, money that is either debased in quality or light in weight. But not every piece of bad money will drive out every piece of good money. If that were so, a single bad penny would drive out of circulation all the gold. The law applies only under certain conditions. The "good" will leave the country only if the total amount of money in circulation is in excess of what would be needed if all were of full weight or best quality. Paradoxically speaking, if there is not too much of the bad money, it is just as good as the good money. The good money may not leave the country. It may be h.o.a.rded, or be picked out by banks and savings-inst.i.tutions to retain as their reserve, or it may be melted for use in the arts. Gresham's "law" is thus a practical precept: keep the amount of token or light-weight coin limited to the field of its peculiar use, or it will cause the other forms, the fuller weight money, to leave for a better market. That better market may be the melting-pot or it may be a foreign country.

-- II. PAPER MONEY EXPERIMENTS

[Sidenote: Nature of paper money]

[Sidenote: The legal-tender quality]

1. _Government paper money may be defined as money for which a seigniorage of one hundred per cent. is charged._ The order in the study of the money question is from seigniorage to paper money, because paper money embodies the principle of seigniorage in its extremest form. The issue of paper money grew out of the practice of debasing metal. The gain of seigniorage from paper money is greater and is just as easily secured. Government paper money is sometimes called "political money,"

in contrast with money whose value rests on the value of its material.

In this sense, however, all coins containing an element of seigniorage, or monopoly value, are to that degree "political" money. The typical paper money is irredeemable, that is, it cannot be turned into bullion money on demand. It was simply put into circulation with the legal-tender quality. The "legal-tender" quality is the declaration of the government that the paper money must be accepted by citizens as a legal discharge for debts due them. The object of this is to compel people to use it as money whether they will or not. The purpose of the government in thus employing its power over the circulating medium is usually to profit, that is, to secure the value of the seigniorage for public purposes. Paper money differs from bank-notes in that it does not depend for its redemption on the credit of the issuer. It differs from bonds in that its value is not based on the interest it yields, but solely on its money uses. The issue of paper money may save the government the payment of interest on an equal amount of bonds. The promise to receive paper money in payment for taxes or for public lands, may help to maintain the value of the notes by reducing their quant.i.ty, but nothing short of prompt exchange for standard coins makes them truly redeemable.

[Sidenote: Examples of paper money in the eighteenth century]

2. _The most notable examples of paper money in the eighteenth century were the American colonial currencies, the continental notes, and the French a.s.signats._ In all the American colonies before the Revolution notes or bills of credit were issued which were in most cases legal tender. Without exception they were issued in large amounts and without exception they depreciated. Parliament forbade the issues, but to no effect. The continental notes were issued by the Continental Congress in the first year of the war (1775), and for the next five years. The object at first was to antic.i.p.ate taxes, and it was expected that the states would redeem and destroy the notes, but this was not done. The notes pa.s.sed at par for a time, but depreciated rapidly as their number increased. The country had less than $10,000,000 of coin before the war, and when, in 1780, over $200,000,000 of notes were in circulation they were completely discredited; hence the phrase "not worth a continental."

Specie quickly came back into use. A few years later the leaders of the French Revolution, failing to learn the lesson of the American experience, issued, on the security of land, notes called a.s.signats in such enormous quant.i.ties that they became worth no more than the paper on which they were printed. In a figurative sense they may be said to have fallen to their "bullion" value.

[Sidenote: More recent examples of paper money]

3. _Notable examples of paper money in the nineteenth century were the English bank-notes in the years 1797-1820, and the American greenbacks, 1862-79._ There have been many other examples. During the Franco-Prussian War, France, through the medium of its great state bank, issued notes which only slightly depreciated. At the present time many countries--Russia, Austria, Portugal, Italy, all the South American republics--have depreciated paper currencies. But the English bank restriction of 1797-1820 is notable because it gave rise to the controversy which did most to develop the modern theory of the subject.

The Bank of England was forbidden to redeem its notes in coin because the government wished to borrow all the coin the bank had. The result was the issue of a large amount of bank money not subject to the ordinary rule of redemption on demand. It was virtually government paper money. The notes depreciated and drove gold out of circulation, and not until 1820 was there a return to specie payments.

[Sidenote: The greenbacks]

The United States under the const.i.tution did not try paper money till 1862 when paper notes (called greenbacks, because of the color of ink with which the reverse side was printed) were issued as a war measure to the amount of about $450,000,000. Other interest-bearing notes were issued with legal-tender quality and circulated as money to some extent.

Greenbacks depreciated in terms of gold, and gold rose in price until, in June, 1864, it sold at two hundred and eighty a hundred. Fourteen years elapsed after the war before these notes rose to par, in terms of gold.

[Sidenote: Evil effects of political money]

4. _Paper-money issues usually have had injurious effects on general industry._ The purpose of the issue of paper money is generally to relieve the financial necessities of the government. It is a costly expedient, resorted to only in desperate extremities. A result usually unintended is the derangement of business and of the existing distribution of incomes. The rapid and unpredictable changes in prices give opportunity for speculative profits, but most legitimate business is injured. This incidental effect on debts and industry becomes the main motive of some citizens in advocating the issue. It is peculiarly liable to be the subject of political intrigue and of popular misunderstanding.

-- III. THEORIES OF POLITICAL MONEY

[Sidenote: Commodity-money theory]

1. _The commodity-money theorists declare that government is powerless to influence value, or to impart value to paper by law._ There are two extreme views regarding the nature of paper money, and a third which endeavors to find the truth between these two. First is that of the commodity-money theorists, or the cost-of-production theorists, who will not admit that there is any other basis for the value of money than the cost of the material that is in it. Money made of paper, on a printing press, has a cost almost negligibly small, and, therefore, they say it can have no value. The fact that it does circulate, and is treated as if it had value, is explained by the commodity theorists as follows: While the paper note is a mere promise to pay, with no value in itself, it is accepted because of the hope of its redemption, just as is any private note. Depreciation in this view is due to loss of confidence; the rise toward par measures the hope of repayment. Such a view overlooks the feature in which paper money differs from ordinary credit paper. The value of one's promise to pay depends on his reputation and his resources; the resources const.i.tute the basis of value. Bonds have value because they yield interest and are payable at a definite time in standard money. But paper money, lacking this basis for its value, has another basis in its money use, in its power to buy goods. The money demand in connection with the monopoly power of government over the money supply, furnishes a satisfactory logical explanation of the value of paper money.

[Sidenote: Fiat-money theory]

2. _The fiat-money advocates a.s.sert that government has unlimited power to maintain the value of paper money by conferring upon it the legal-tender quality._ The meaning of fiat is "let there be," and the fiat-money advocates believe that the government has but to say, "let it be money," to invest paper with value. The typical fiat advocates in the United States were the "Greenbackers," those voters who wished to retain the paper money issued in the Civil War, and to increase its amount greatly. They saw in paper money an unlimited source of income to the government. They proposed the payment of the national debt, the support of the government without taxes, and the loan of unlimited money without interest to citizens. All might live in luxury if the extreme fiat-money theorists could realize their dream. There are still some survivors of this faith in the power of the government fiat. The depreciation that has taken place in every case where government notes have been issued, they declare to be due to a too mild enforcement of the law of legal tender. To them the fact that paper money may circulate for a time at par appears a reason why it always should. They do not admit that there is a saturation point in the use of money, and that its use is still further limited by the fear of larger issues. They do not see that the ultimate basis of the value of paper money is economic,--is in its money use, not in the fiat of the government.