# Stabilizing the Dollar/Chapter 2

CHAPTER II
THE CAUSES
1. False Scents
We have answered the first of the four questions and have seen that the price level is always changing, that is, that the dollar is not a constant unit of purchasing power or value in exchange.
We are now ready for the second of the questions, i.e. "Why is it not constant?"
In recent popular discussions a great variety of reasons have been assigned for the "high cost of living," e.g., "profiteering"; speculation; hoarding; the middleman; foreign demand; the war; labor unions; short hours of labor and limitation of output; trusts; patent monopolies; the tariff; cold storage; longer hauls on railroads; marketing by telephone; the free delivery system; the individual package; the enforcement of sanitary laws; the tuberculin testing of cattle; the destruction of tainted meat; sanitary milk; the elimination of renovated butter and of "rots" and "spots" in eggs; food adulteration; advertising; unscientific management; extravagance; higher standards of living; the increasing cost of government; the increasing cost of old-age pensions, and of better pauper institutions, hospitals, insane asylums, reformatories, jails and other public institutions; the increasing cost of insurance against accident and disease; the ​increasing burden of unemployment and crime; investments in public undertakings, such as railways, public works, etc.; the growing cost of military establishments, both before and during the Great War; the destruction of wealth by war; the withdrawal of labor to war; the concentration of population in cities; the high price of land; private ownership of land and other natural resources; impoverishment of the soil; the displacement of the near-by farmer as the chief source of food supply; the fact that farmers' wives no longer compete with large establishments in butter making or poultry raising; drought; hoarding by housewives; daily purchases by housewives and their abandonment of home storage in attic, smokeroom, and cold cellar.
I shall not discuss in detail this list of alleged explanations. While some of them are important factors in raising particular prices, none of them except the war has been important in raising the general scale of prices, and the war, of course, only recently. If other causes seem to the reader to deserve special discussion beyond the brief summary which follows, I would refer him to my previous writings and to the writings of others.
That none of the ingenious explanations enumerated go far to account for so general, or universal, a change of prices is fairly clear when we consider that the rise, before the war, applied to producers' prices as well as to consumers', to wholesalers' prices as well as to retailers', to prices of competitive goods as well as to ​those of trust-controlled and patented goods, to prices in free-trade countries as well as to those in countries having a protective tariff, to prices in countries without labor unions as well as to those in countries with them, to prices of necessities as well as to those of luxuries, to prices of unadvertised goods as well as to those of advertised goods, to prices in non-militaristic nations as well as to those in militaristic nations, to prices in the country as well as to those in the city, to prices where sanitary laws were absent as well as to those where they were present, to prices of bulk goods as well as to those of package goods.
I do not mean that the above suggested causes had no influence on prices. The prices in free-trade countries seem to rise (or fall)—or did before the war—somewhat less than in other countries; prices of proprietary breakfast cereals are far above the prices of the materials of which they are made; trade unions have added to costs in many industries; middlemen have sometimes combined to depress the prices of truck to farmers, while increasing the prices to consumers; trusts have sometimes raised prices above competitive levels, although they have sometimes reduced them and made their monopoly-profits by still further reducing costs through the economies of trust-organization; and war-time prices rose more in countries near the seat of war than in those remote. But interesting and important as are these facts, they do not go far in helping us understand the cause of high prices.
2. Profiteers, Speculators, and Middlemen
Much is said to-day of profiteering and of speculation in general. Speculation is always stimulated when prices are changing. It feeds on price movements. Thus when prices are expected to rise in the future, speculators buy goods and raise their prices in the present; and when, in the future, they sell their holdings, prices are kept below what they would otherwise have been. The normal effect of such, as of most, speculation is to reduce or "even-up" price fluctuations.
Occasionally speculation causes or aggravates fluctuations; but, in such cases, speculators usually come to grief as a consequence. This was true of the speculative rise in prices that occurred immediately at the outbreak of the war, in August, 1914, and was promptly followed by a fall. Speculators who thus try artificially to mark up prices when other causes are not about to produce a rise are like the comedian who said he could "command $1000 every night" but added, "the only trouble is it won't come!"
Similarly cold storage is a stabilizer of prices and, on the whole, has probably mitigated the rise of prices instead of aggravating it. Equally far from the truth is the popular idea that the rise of prices is due to "the middleman." It is true that the processes of distribution are often wasteful, but probably they have, on the whole, been growing less wasteful rather than more wasteful. Index numbers show that the average margins between wholesale and retail prices have, on the whole, actually diminished during most of the rise in ​prices since 1896, while they tended to increase when prices were falling before 1896. In other words, wholesale prices move faster, in either direction, than retail prices. Figure 4 illustrates this fact, and more
Showing: (1) that the two roughly correspond; (2) that, in general, wholesale prices have moved faster (whether down or up) than retail prices; and therefore (3) that "middlemen's profits" will not explain the rise from 1896 to 1907.
recent figures of the U. S. Bureau of Labor Statistics confirm it.
The common idea that "profiteers" are responsible for rising prices is, as will be more clearly seen in Chapter III, a reversal of the truth. Rising prices are responsible for profiteering.
3. Circular Reasoning
Obviously no explanation of a general rise of prices is sufficient which merely explains one price in terms of another price. To say that the cause of rising "prices" is rising "wages" is merely to say that the prices of commodities have risen because the price of labor has risen; and we might as well turn it about and say that the price of labor has risen because the prices of commodities have risen and so driven workmen to ​strike for higher wages. It is equally futile to say that finished products have risen because the raw materials have risen; or that the raw materials have risen because finished products have risen.
Such explanations are as unsatisfactory as the answer of the gardener who, when asked, "Where is the hoe?" replied, "It's with the rake," and when asked, "Where is the rake?" replied, "It's with the hoe." Such alleged explanations were shrewdly caricatured by the cartoon showing many persons standing in a circle, each accusing his neighbor: the consumer blaming the retailer; the retailer, the wholesaler; the wholesaler, the middleman; the middleman, the manufacturer; the manufacturer, the workman; the workman, the trust; while (to complete the circle) the trust blames the extravagant consumer.
It is true that individual prices do react on one another in thousands of ways. But the several pushes and pulls among individual prices are not what raises them as a group. Such forces within the group could not move the group itself any more than a man can raise himself from the ground by tugging at his bootstraps. We cannot explain the rise or fall of a raft on the ocean by observing how one log in the raft is linked to the others and is pulled up or down by them. It is true that some prices rise more promptly than others and give the proximate reason for raising the others. The whole raft of prices is bound together and its parts creak and groan to make the needed adjustments. But such readjustments between prices do not explain why the whole raft of prices has risen.
4. The Error of Selecting Special Cases
Nor will special causes working on selected commodities prove to be general enough to explain the concerted behavior of commodities. While "scarcity," for instance, will go far toward explaining the rise of certain selected prices, it will not help explain changes in the general scale or level of prices,—at least not before the Great War.
Thus, even if, for reasons of scarcity, wheat should rise, let us say, 20%, nevertheless, so unimportant is wheat relatively to the great mass of commodities in commerce, that the index number for 300 commodities, computed by the United States Bureau of Labor Statistics, would be affected only 1%. So also potatoes would have to rise 100% to raise the index number by 1%. And even these negligible figures exaggerate the effect on the general price level,—for several reasons, which need not be discussed here.
The truth is, most explanations of the general rise in prices are mere graspings at the first straw in sight that seems to offer any explanation. People unconsciously pick out some particular cases with which they happen to be familiar and drag them before the public. A middleman or a trust raises prices, a firm announces a rise because of the demands of labor unions, a crop failure raises the price of a cereal,—and immediately some one hails the event as a representative cause of the high cost of living. The newspapers, with impressive headlines, feature the stories about such cases; and the more unusual and unrepresentative the cases are, the more glaringly they are featured.
Only a general survey is of any real value, and such ​a general survey, as we shall see, fails to confirm many, if any, of the numerous popular impressions which have gone abroad.
5. The Argument from Probability
All those who have offered such explanations make one fatal mistake. They look at the wrong side of the market. They seek the causes wholly in the goods, the prices of which have changed, and not at all in the gold dollar, in terms of which those prices are expressed.
Which of these—goods in general, or the dollar in particular—is the more likely to vary? Is it credible that commodities should rise and fall so concertedly without some simple common cause? Is it not more probable that the dollar, which, as such a common cause, affects all the commodities it buys, should fall in value than that hundreds of individual changes in the values of other commodities should all happen to occur in concert? Are not the coincidences involved a little too remarkable? It is one of the accepted maxims of logic that a complicated multiple explanation is not to be presumed if a simple single explanation can be assumed.
Mere chance almost never plays onesidedly. If we throw nine coins in the air, it will not surprise us if four or five of them come up heads, but it will surprise us greatly if all come up heads. The chance of such a coincidence is exactly 1 in 512. The chance that eight would come up heads is less than 1 in 50 (exactly 10 in 512).
Now, of the nine groups of commodities included in the index number of the United States Bureau of Labor ​Statistics, only one group (house-furnishings) fell in price between 1896 and 1913, the year before the war. Assume that the nine groups, like the nine coins, are independent of one another,—for instance that "clothes and clothing," when they rise, do not prevent "drugs and chemicals" from falling; assume further that, for any one group among the nine, the chances of rise or fall are even; then the chances that eight out of the nine would rise coincidently would (as in the case of the coins) be exactly 10 in 512.
In actual fact the chances are less; for the assumption that a rise is as likely as a fall is not true of any ordinary commodity. A fall is really what we would, in most cases, expect because of improvements in methods of production. Taking this fact into consideration the chances that eight groups would rise coincidently are therefore less than 10 in 512—doubtless less than 1 in 100.
Of the 243 commodities recorded under the nine groups only 27 fell in price. It is true, of course, that not all of the 243 commodities are independent. Many commodities like bread and flour, or pig iron and iron products, move necessarily in sympathy with one another; but, even so, we may, I believe, safely put the chance of such an accidental rise simultaneously in 216 commodities out of 243 at less than one in a thousand.
This all corresponds with common sense. We seldom have world-feasts or world-famines. If the corn crop is short in some places, it is usually abundant in other places. If it is short in all places, the crop of wheat or barley or some other staple food is practically certain to be at least normal. If there is ​war in Japan, it is not likely that there will also be war in India. A world-war or even anything as near to a world-war as the recent conflict is a most—the most—unprecedented event in all history.
Our conclusion is that, so far as the argument from probability can help us, it is not likely that the simultaneous rises and falls of hundreds of commodities happen merely by coincidence. It is much more likely that there is one common cause or, at most, a very few common causes. We find two such common causes at hand, monetary depreciation and (since 1914) the war, which, as we shall see, has affected prices chiefly through monetary depreciation also. If these are not the common causes, what are they?
The same question arose concerning the general fall of prices between 1873 and 1896. Then there was another explanation besides the monetary one—the increased or cheaper production through invention. But while in the period from 1873 to 1896 this cause, cheaper production, worked with the trend, a downward price movement, from 1896 to 1913 it has worked against the trend. No common cause for the upward trend of prices between 1896 and 1913—except money—has ever been suggested or seems likely to be.
6. The Argument from Statistics
So much for the mere probabilities of the case. But we have several other lines of evidence. First there is the evidence of direct statistics, which evidence points to the same conclusion. These statistics show that, up to the outbreak of the war in 1914, there was no ​progressive scarcity of goods in general but rather an increased abundance and that this increased abundance probably continued in the United States even during the war.
Professor W. I. King, in his Wealth and Income of the People of the United States, shows that "real income' " (that is, income in terms of commodities instead of dollars) has risen every census year since 1850 (excepting only 1870, following the Civil War, when there was a slight diminution)! The volume of general trade in the United States has increased, on the average, faster than population. According to the statement of Nat. C. Murray of the Bureau of Statistics of the Department of Agriculture, the per capita production of the ten leading crops in the United States has increased during the last twenty years. Professor E. W. Kemmerer and the present writer find that the volume of trade has increased greatly and continuously during that time.
This was true even during the war. Professor Wesley Clair Mitchell has made a study, under the War Trade Board, on the production of raw materials which indicates that the raw materials used in the ​United States in 1918 were 16% more than in 1913 and 2% more than in 1917. The physical volume of trade in 1918 is estimated variously by my own fragmentary studies, published and unpublished, and by the studies of others to be from 22% to 41% above that in 1913 and 8% above that in 1917.
President Wilson, in his address to Congress, August 8, 1919, on the High Cost of Living gave other impressive examples as to foods, especially eggs, frozen fowls, creamery butter, salt beef, and canned corn, showing that there is no scarcity to account for high prices.
Aside from this argument as to the abundance of goods in belligerent countries, there is the additional ​evidence of high prices in areas not directly affected by the war.
Mr. O. P. Austin, Statistician of the National City Bank, says:
"Raw silk, for example, for which the war made no special demand. and which was produced on the side of the globe opposite that in which the hostilities were occurring, advanced from $3.00; per pound in the country of production in 1913 to $4.50 per pound in 1917, and over $6.00 per pound in the closing months of the war. Manila hemp, also produced on the opposite side of the globe and not a war requirement, advanced in the country of production from $180 per ton in 1915 to $437 per ton in 1918. Goat-skins from China, India, Mexico and South America advanced from 25 cents per pound in 1914 to over 50 cents per pound in 1918, and yet goat-skins were in no sense a special requirement of the war. Sisal grass produced in Yucatan advanced from $100 per ton in 1914 at the place of production to nearly $400 per ton in 1918, and Egyptian cotton, a high-priced product and thus not used for war purposes, jumped from 14 cents per pound in Egypt in 1914 to 35 cents per pound in 1918. Even the product of the diamond mines of South Africa advanced from 60 to 100 per cent in price per karat when compared with prices existing in the opening months of the war.
"The prices are in all cases those in the markets of the country in which the articles were produced and in most cases at points on the globe far distant from that in which the war was being waged. They are the product of countries having a plentiful supply of cheap labor and upon which there has been no demand for men for service in the war. The advance in the prices quoted is in no sense due to the high cost of ocean transportation, since they are those demanded and obtained in the markets of the country of production.
"Why is it that the product of the labor of women and children who care for silkworms in China and Japan, of the Filipino laborer who produces the Manila hemp, the Egyptian fellah who grows the high-grade cotton, the native workman in the diamond mines of South Africa, the Mexican peon in the sisal field of Yucatan, the Chinese coolie in the tin mines of Malaya, or the goat-herd on the ​plains of China, India, Mexico or South America has doubled in price during the war period?"
Lord D'Abernon found that in England those objects of luxury "which would seem to be influenced not at all or only very remotely and to a very small degree by increased cost of labor and materials," such as old books, prints and coins, had, nevertheless, advanced, roughly speaking, fifty per cent during the war.
There seems little doubt that the rise in prices during the war, even in Russia where scarcity of goods played a part, was, nevertheless, chiefly due to paper money depreciation; while in the United States, prices rose before America entered the war, not because of any general scarcity here, but because of gold depreciation brought about by huge imports of gold (a billion dollars) from Europe, in other words, gold "inflation." After we entered the war there has been added credit inflation.
7. Price Movements Vary with Monetary Systems
Thus far our argument has been one of elimination. We have excluded the probability of the commodity explanation for rising prices (except, to some extent, in war-time) and find ourselves almost forced to a monetary explanation.
But we have still more positive evidence of the great and constant influence of money and money substitutes on prices.
We find, in the first place, that countries having like monetary standards have like price movements. Thus​—to consider gold-standard countries—there is a remarkable family resemblance between the curves in Figure 3, tracing the index numbers of the United States and England. As long as the two countries were on or near a common gold basis, that is, in the entire period except when one or the other country was on a paper basis (because of the Napoleonic wars or the Civil War), English and American price movements have been strikingly parallel.
Showing how similar the ups and downs of prices have been. This similarity exists in spite of differences in methods of calculating the five index numbers.
For most other gold-standard countries the available statistics begin with 1890; and from that year until the outbreak of the war in 1914 there is a remarkable similarity among the price movements of these countries, namely, the United States, Canada, England, France, Germany, Austria, Italy, Switzerland, Russia, Sweden, Denmark, Holland, Belgium, and even, though less strikingly, far-away Australia, New Zealand, Japan, and India.
​The chief of these statistics are given in Figure 5. It is surprising how little any one gold-standard country departs from the average of all.
Affording an instance of differing price movements under differing monetary standards.
Again, countries which have the silver standard in common also have price movements in unison as, for instance, India and China from 1873 to 1893.
We find, in the second place, that countries of unlike monetary standards have unlike price movements. Thus we find a great contrast between the gold and silver countries as soon as gold and silver themselves separated. Speaking roughly, we may say that, ​between 1873 when gold and silver broke apart, and 1896, the price level in gold countries fell 25% and in silver countries rose 30%.
Again countries with exceptional monetary standards show exceptional price movements. When, during a paper money regime such as during the Civil War in the United States or the Napoleonic wars in England, the curve tracing an index number in terms of paper is compared with that in terms of gold, the former looks like a great blister upon the latter. Figure 6 illustrates this fact.
So also when a country shifts over from a gold to a silver standard and from a silver to a gold standard, as did India, its price movements shift likewise. Figure 7 illustrates this.
In the third place, not only do the price levels of various countries having different monetary standards differ from one another, but the degrees of difference correspond to the degrees of difference in their standards, that is, the variations in prices of goods correspond with the variations in the values of the two metals as measured each in terms of the other.
For instance, the divergence between prices of goods in gold countries and in silver countries corresponds roughly to the divergence between the prices of gold and silver. Thus, between 1873 and 1893 the price of silver in London fell 40%, while the price level of commodities in gold countries relatively to prices in silver countries fell about 40%.
The curves should be compared for three distinct periods: (1) 1861-1873, during which the English gold standard and the Indian silver standard were, to some extent, tied together (through bimetallism); (2) 1874-1893, during which there was no tie between the monetary standards of England and India; and (3) 1894-1912, during which the Indian rupee was again tied to the English pound (through the gold exchange standard).
It will be noted that, in the first and last of these three periods, there is some similarity between English and Indian price movements, but that in the middle period there is little similarity.
The chief exceptions to the above statements are the early years of the middle period (1871-1876) and the early years of the third period (1894-1899). In the former the two curves show similarity instead of the dissimilarity usual in the middle period; and in the latter the two curves show dissimilarity instead of the similarity usual in the third period.
It is interesting to observe that both exceptions are largely explainable—the former by the fact that, although bimetallic laws were abandoned in 1873. the ratio between gold and silver did not climate greatly until three to five years later; and the latter by the fact that, although the gold exchange standard (legally fixing the Indian rupee at 16d. in English money) was adopted in 1893. nevertheless (because of existing hoards of coined silver and the continued coinage by Indian petentates, etc.) it did not succeed in actually controlling Indian exchange until five years later.
For the period of the recent war the data are so meager that it is impossible to express the exact
Showing a fairly close similarity and throwing light on the contrasts of Figure 6. Thus, when, during 1861-1864, the currency, or greenbacks, which would buy a unit of gold rose rapidly (as shown by the lower curve), American prices in greenbacks also rose rapidly relatively to English prices in gold (as shown by the upper curve); and when, during 1864-1878, the former ratio fell, the latter ratio fell also.
relations in figures, but we can arrange the different countries in the approximate order in which their prices rose. As a result, we find that the order of the nations corresponds in general with the order in which the currency in these nations has been inflated by paper as well as with the order in which their monetary units have depreciated in the foreign exchange markets. This order—of ascending prices and roughly of expanding currency during the war—is: Australia, India, New Zealand, United States, Canada, Denmark, ​Holland, England, Switzerland, Italy, France, Norway, Sweden, Germany, Austria, Russia.
8. Price Movements Vary with the Money Supply
The ups and downs of prices roughly correspond with the ups and downs of the money supply. Throughout all history this has been so. For this general broad fact the evidence is sufficient even where we lack the index numbers by which to make accurate measurements. Whenever there have been rapid outpourings from mines, following discoveries of the precious metals used for money, prices have risen with corresponding rapidity. This was observed in the sixteenth century, after great quantities of the precious metals had been brought to Europe from the New World; and again in the nineteenth century, after the Californian and Australian gold mining of the fifties; and, still again, in the same century after the South African, Alaskan, and Cripple Creek mining of the nineties. Likewise when other causes than mining, such as paper money issues, produce violent changes in the quantity or quality of money, violent changes in the price level usually follow.
The war has furnished important examples of these points. In the United States the curve for the quantity of money in circulation, and the curve for the index number of prices run roughly parallel, the price-curve seeming to follow the money-curve after a lag of one to three months. It was in August, 1915, that the quantity of money in the United States began its rapid war-made increase. One month later, prices began to shoot upward. In February, 1916, money ​suddenly stopped increasing, and about two months later prices stopped likewise. Similar striking correspondences have continued to occur. Figure 9 shows these.
The same sort of correspondence (with a probable three months' lag) has been found by Nicholson for England and (by inference, at least) by Cassell for Russia.
9. Kinds of Inflation.
It is well known that a great increase, i.e., " inflation," of paper money raises prices. But there are two other forms of inflation which do so also, gold inflation and credit inflation.
War finance is the prolific source of inflation. The war has exemplified this in all three forms. Russia indulged in the simple crass inflation of paying Government bills by printing irredeemable paper. Before the Bolshevist régime the Russian Government printing presses turned out, according to reports, a million roubles an hour, day in and day out, for over a year at a stretch. Under Bolshevism the output has been even greater, a total of eighty billion dollars in nominal value having been issued, which is more than the money of all the rest of the world put together. It is reported also, on apparently good authority, that, under the Bolshevist regime, the Russian Bureau of Printing and Engraving has issued counterfeit Spanish paper money and used it in Spain for Bolshevist propaganda.
Showing a correspondence between the quantity of money and the level of prices. Since the middle of 1915, when the quantity of money in the United States began to be greatly affected by the war, the correspondence has been close, changes in the price level seeming usually to follow changes in the quantity of money one to three months later. (The apparent discrepancy between the upper and lower figures at the right is due to a change in the official method of computation adopted by the Federal Reserve Board.)
Germany allowed the people, when a new loan was asked, to deposit the bonds of the previous loans at certain banks which were authorized to issue paper money to the depositor who then lent this paper money to the Government. In the United States also, Liberty Bonds were to some extent used as collateral at banks which, in turn, deposited them with Federal Reserve Banks and received their notes.
During the war the neutral countries were flooded with gold. This gold did not add to real wealth. When, directly or indirectly, it found its way into the hands of an American munition maker, food producer, or other seller of goods, it acted simply as a requisition for goods by one American on another American. It was merely a yellow token, like a brass check, redeemable in our own goods. Such an increase in the number of such tokens, or counters, could only cause them to depreciate.
War finance brought us still another, the most modern, kind of inflation, due not to the increase of money proper but to the increased volume of bank deposits subject to check. Banks sometimes subscribed to Liberty Loans simply by writing deposits on their books to the credit of the Government, and individuals often lent to the Government by borrowing of the banks, the sums so borrowed being likewise created by the banks as deposits on their books. Deposits subject to check have increased greatly, and until the ​loans which gave them birth are paid off, these deposits stay in circulation like money, being transferred by check from the original bank customer to the Government (as his subscription to bonds); then from the Government to munition makers, etc.; then from them to steel producers, and so on, indefinitely.
Even gold inflation became transformed into credit inflation because the gold was used as bank reserves, the basis of bank deposits. During the war the people of all gold-using belligerents were asked to turn over their gold to the banks to become bank reserves. Thus gold was "mined out of the people's pockets" and intrusted to the banks where it had a multiplied effect; for every dollar of reserve can support several dollars of deposits.
It was failure of individuals to save the funds loaned to the Government which chiefly inflated deposits; they lent by borrowing. A Committee of the American Economic Association appointed to study the problem of the purchasing power of money in wartime reported: "The public should understand that lending by borrowing, though much better than nothing, is still a very unsatisfactory way to help the Government. By raising prices, such a procedure tends to shift the cost of the war to the poor who pay it in a higher cost of living."
In England it was found (as might have been expected) that the introduction of "continuous borrowing," advocated by Mr. Drummond Fraser, which absorbed savings as rapidly as they could be made, and before they had a chance to be dissipated in ​personal gratification, immediately reduced deposits or credit inflation.
In all cases where the amount subscribed is not saved, the Government creates or secures purchasing power without creating any equivalent goods to purchase. It either creates the purchasing power out of whole cloth, as in Russia, or authorizes banks to create it out of whole cloth, as in Germany, England, and, to a less extent, the United States. All of these methods of war finance, like the greenback method in the Civil War and the Continental paper money method of the Revolution, may be defended on the plea of military necessity, but they are inflation none the less, even when gold redemption has been nominally maintained, and they therefore tend to add to the cost of living. As Dr. A. C. Miller of the Federal Reserve Board has said, "Inflation is no less inflation when gilded with gold."
10. Extent of War Inflation
On the whole, the money in circulation in the United States rose from three and one third billions in 1913 to five and a half billions in 1918, and bank deposits from thirteen to twenty-five billions, both approximately corresponding to the rise in prices.
Taking a world-wide view, the money in circulation in the world outside of Russia increased during the war from fifteen billions to forty-five billions and the bank deposits in fifteen principal countries from twenty-seven billions to seventy-five billions. That is, both money and deposits have trebled; and prices, on the average, have perhaps trebled also.
​The increase of over thirty billions in the money of the world (outside of Russia) is, as Austin says, "more in its face value, than all the gold and all the silver turned out by all the mines of all the world in 427 years since the discovery of America."
It is a common impression that wars always raise prices. But a study of index numbers in the belligerent countries, during the Napoleonic wars, War of 1812, Mexican, Crimean, Civil, Franco-Prussian, Spanish-American, Boer, Russo-Japanese wars and the World War indicates that war seldom raises prices except when, and to the extent that, the costliness of the war forces recourse to inflation as a fiscal expedient of governments or their people.
The conclusion toward which the foregoing arguments (and others which might be added) lead is that, in the past, the chief disturber of the peace, so far as the purchasing power of money is concerned, has invariably, or at any rate almost invariably, been money itself, not the goods which money purchases.
11. Money Illusions
The attraction which inflation policies have for so many people grows, in part at least, out of what may be called the money illusions.
The general public finds it hard to admit that there can be too much money. Money, however abundant, always seems scarce. Each individual wants all the ​money he can get and naturally reasons that a country, like an individual, cannot have too much. If the reasoning were sound, it would justify counterfeiting. Counterfeiting does enrich the counterfeiter—but at the expense, of course, of others, even if the counterfeit is never detected. Inflation might almost be called legal counterfeiting.
After a rapid inflation once starts, the clamor for more money often grows louder and louder, just as when a dipsomaniac once gets under the influence of liquor he calls for more and more of that deceptive agent.
Of all the illusions which cluster about money, the one which most interests us here is the illusion that money is always fixed in value, that "a dollar is a dollar." If this were really true, the present book would not have been written. That so many people assume it to be true is the reason there is so little demand for a change. For why try to stabilize what is already supposed to be stable?
Money is so much an accepted convenience in practice that it has become a great stumbling block in theory. Since we talk always in terms of money and live in a money atmosphere, as it were, we become as unconscious of it as we do of the air we breathe.
To shake ourselves free of these illusions it would help greatly if, for the phrase "a general rise in prices," we should substitute the phrase, "a fall in the purchasing power of the dollar." Our attention would then be focused on the money, which is the chief controller and disturber of prices.
Even many well informed people bolster up the illusion that the dollar is a stable standard of value ​by reference to the fact that "the price of gold" never changes. Only recently a former Government officer asserted that the value of gold is evidently constant because its price is fixed!
I once asked a dentist if the "high cost of living" had affected the price of his materials.
Yes, of course," he replied.
"Of the gold you buy for fillings?" I ventured jokingly, expecting him to know that this could not be.
To my surprise, he answered, "I suppose so," and sent his assistant to look the matter up.
She returned presently and solemnly informed us that the price he was paying for his gold was substantially the same as it always had been.
"Isn't that surprising!" he exclaimed, "gold must be a very stable commodity."
"It's just as surprising," I replied, "as that the price of a quart of milk is always two pints of milk."
"I don't see the point."
"Well, what is a dollar?" I asked.
"I don't know,—what is it?"
That question is vital. The almost universal ignorance of the answer is chiefly responsible for the almost universal misunderstanding of the high cost of living and the ups and downs of the dollar's worth!
A dollar is defined by statute as 25.8 grains of "standard" gold (that is, of gold of which 900 parts out of 1000 are pure gold). Consequently the actual pure gold in a dollar is ${\tfrac {9}{10}}$ of 25.8 grains or 23.22 grains. Since an ounce is 480 grains, the number of dollars in an ounce of pure gold is ${\tfrac {480}{23.22}}$ or 20${\tfrac {67}{100}}$ dollars. In other words, any lump of gold containing one hundred ​ounces, taken by a gold miner to the Mint, can be cut up and coined into 2067 dollars and handed back to him. Thus, fixing the pure gold in the dollar at 23.22 grains necessarily fixes the price of pure gold at $20.67 an ounce. Naturally, then, the miner gets $20.67 an ounce and this "price" can never vary so long as the weight of the dollar does not vary. In short we may say, omitting fractions, that gold is always worth twenty dollars an ounce simply because a dollar is a twentieth of an ounce of gold, just as a quart of milk is always worth two pints of milk because a pint is half a quart. Gold is thus stable merely in terms of itself.
But, of course, the fixity of the dollar's weight (and therefore of the price of gold in terms of gold itself) does not fix its value in exchange for other commodities. It does not exempt gold from the effects of supply and demand. The value of the dollar, in the sense of its general purchasing power, is not stable but fluctuates with supply and demand as does the value in exchange, or purchasing power, of anything else. There is only this difference: since a descending value of gold cannot lower the price of gold it must raise the prices of other things in terms of gold; and since an ascending value of gold cannot raise the price of gold, it lowers the prices of other things in terms of gold.
Thus the supply and demand of gold (and of its paper and credit substitutes which also affect its value) cannot be thwarted. Since we deny to such supply and demand the normal outlet of raising or lowering the price of gold, they take their revenge, so to speak, by lowering or raising the prices of other things.
​If, instead of gold, we were to make milk the standard, or eggs,—that is, if we used these to purchase all other things,—they would acquire the same fixity of price—that is, price in terms of milk or eggs; and we would then fall victims to the same illusion of inherent fixity. If a dollar, instead of being 23.22 grains of gold, were, let us say, a dozen eggs, obviously the price of eggs would always be a dollar a dozen simply because a dollar is a dozen eggs. If the hens did not lay, the price of eggs would not rise (or vary at all) but, instead, the prices of other commodities in terms of eggs would fall; while, if eggs were a drug on the market, their price would not fall (or vary at all) but the prices of other commodities, in terms of eggs, would rise—and the mystified public would then be inquiring gravely "why this high cost of living?" The world's prices would then be at the mercy of hens just as now they are at the mercy of mines, as well as of banks and of governmental and private financiering.
In colonial days, in Virginia, tobacco was money. In those days a high price of wheat might have been attributed to scarcity of wheat when really due to abundance of tobacco, just as to-day we attribute the high prices of most things to a supposed scarcity of these things when it is really due to abundance of money.
12. The Instability of the Gold Standard as Compared with an Egg Standard and Others
In order to see what the purchasing power of a dollar is from time to time we need merely to invert the index number showing the general level of prices; ​for if this level doubles, the purchasing power of the dollar is halved, and vice versa.
Figure 10 shows both. The upper curve shows the variations in the price level and the lower curve
Since many commodities constitute a better standard of value than one commodity, the apparent fall and rise of commodities (upper curve) really means a rise and fall in gold (lower curve), while the mere constancy of the price of gold in terms of itself is shown by the middle (horizontal) line. The lower curve is the important one and, with others, is shown in the next diagram. Fig. 11.
shows the opposite variations in the purchasing power of the dollar. That is, the upper curve shows the changes of commodities expressed in terms of gold dollars and the lower curve shows the changes in the gold dollar expressed in terms of commodities; while the middle and horizontal line shows the constancy of the price of gold in terms of gold.
As the lower curve in Figure 10 shows, the purchasing power of the dollar over other things in general has fluctuated widely. If the war period were added, ​the fluctuations would be even more violent (as may be seen from Figure 3).
If we compare this lower curve of Figure 10 with similar curves calculated for other commodities, we may see whether gold is really any better standard than any one of these other commodities.
Figure 11 gives this comparison. In it I have plotted not only the purchasing power of gold, but also the purchasing power of pig iron, pig lead, cotton, silver, eggs, wheat, carpets, and brick. We see that, in terms of general purchasing power, gold is no more stable than eggs and considerably less stable than carpets!
It will also be of interest to see the relative stability of gold and the other articles combined. To paraphrase an old adage we may say that "in union there is stability." The curve representing the combined eight articles, pig iron, pig lead, copper, silver, eggs, wheat, carpets, and brick (which were originally selected at random, i.e. as representative articles and without thought of being combined), is also shown in Figure 11.
13. Seeing Ourselves as Others See Us
The curve for gold is the same as the lower curve of Fig. 10. It shows the rise and fall of a unit of gold as measured by its purchasing power over commodities in general. The curve for silver shows likewise the changes in the purchasing power of a unit of silver. The other curves show the purchasing power of pig iron, pig lead, copper, eggs, wheat, Brussels carpets, and brick.
It will be observed that gold, as a standard of general purchasing power, has been more stable than silver but less stable than eggs or carpets, which last proves to be the most stable standard of purchasing power during this period. As to wheat, its power to purchase commodities has fluctuated widely but has shown a general horizontal trend.
Sir David Barbour tells the following illuminating incident: "The late General Keatings, V. C., informed me that when he was Commissioner in Assam he had an interview with an Indian merchant and mentioned to him how serious the fall in the value of the rupee was. The merchant was surprised and said he heard from his agents in Calcutta every week and none of them had said anything about the fall in the value of the rupee. After a pause he added: 'But they mentioned the rise in the price of gold, and perhaps that may be what you are thinking of.'"
Both the Englishman and the Hindu assumed his own money fixed, as a matter of course. Each could see the aberration of the other's money but was blind to that of his own. The Hindu thought gold had gone up because he measured gold by silver, and the Englishman thought silver had gone down because he measured silver by gold. Each was nearer right about the other's country than about his own! Yet neither was as nearly right as he would have been if he had gauged the values of gold and silver alike in terms of other commodities. It is reasonable to assume that the general mass of commodities is stabler than the single commodity, silver, or the single commodity, gold.
This illusion, that our own money is immovable while everything else moves, is like the illusion we often experience when the railway train in which we are sitting passes another train standing on a switch, ​or like the illusion that the sun rises and sets instead of the earth revolving.
Thus we have been deceived by appearances in commerce just as we have been deceived by appearances in astronomy. The earth seems to be fixed and all the other heavenly bodies seem to move. It is true, of course, that these bodies do move; yet most of the motion which we are tempted to attribute to them is not theirs but the earth's. So money seems to be fixed and all the other commodities seem to move. And it is true that these commodities do move; yet most of the motion we are tempted to attribute to them is not of them but of money.
It took a long time to overcome the apparent evidence of our senses in regard to the actual rising and setting of the sun, moon, and stars. In fact, the first astronomers did not doubt this popular view but accepted it and succeeded, by numerous special and complicated assumptions (of "cycles" and "epicycles"), in explaining all observed movements, even those of the planets. This was the system of Ptolemy; and one of the greatest revolutions in human thought was the adoption of the later astronomical system of Copernicus. This revolution of thought in astronomy was based chiefly on the presumption that a simple explanation is more likely to be correct than a complicated one.
Sooner or later a similar revolution will be wrought in popular economics and we shall come to see that the course of prices is due chiefly to the movement of money and not to coincident movements of all or almost all other commodities at once. We now think only of the gold-value of goods; we shall then think also of the goods-value of gold.
14. A Visit of Santa Claus
Many people, after being forced to admit that an abundance or scarcity of money does, in some way, raise or lower the prices of other things, still remain somewhat mystified because they cannot trace the intermediate process by which money operates on the price of a given article. "How," they ask, "does the import of gold (or the issue of paper money or the creation of bank deposits) really affect the price my grocer charges me for butter? He has probably never even heard of this new gold (or paper or bank credit), much less seen it."
The answer is that more money in tills and pockets means more lavish spending, i.e. a greater demand for goods, without any greater supply.
To make the picture vivid, let us imagine a financial Santa Claus. Let us suppose that, before his visit, the average per capita amount of money in actual "circulation" in the United States, that is, all money except that of the United States Treasury, is about $40. On Christmas Day Santa Claus doubles this amount. Each individual person, firm, and bank suddenly has on hand twice as much as before.
Now, while the amount carried by any one individual necessarily fluctuates because of his expenditures and receipts, in a large group of people the average amount carried usually fluctuates but little. If, then, an addition to the total circulation is suddenly made so large as to put forty extra dollars per capita in the pockets of the people, the first thought of most people will be how to expend this extra sum instead of merely keeping it idle in their pockets. If they should be ​inclined to hoard it in stockings or safes or bury it in the earth or drop it into the sea, it would have no tendency to raise prices. Instead, however, they will seek to make some use of it either by expending it for goods or by depositing it in banks. In one or both of these two ways the surprised recipient of Santa Claus' bounty will, in most cases, have disposed of his surplus a few days after the supposed visit of Santa Claus. Let us assume that half is disposed of by expending and half by depositing.
The part expended will evidently tend to raise prices; for the sudden expenditure of $20 per capita will mean a spectacular rush upon the shops. Suppose, as is probably about the truth, that the average individual expended or turned over his per capita $40 in about two weeks. This is about three dollars a day, or $300,000,000 a day for the entire country. If within five days from his Christmas present the average person should expend half of the additional $40, i.e. $20, the result would be $4 additional per day per capita, or $400,000,000 per day for the nation, or more than the entire original daily expenditure of money. Such a sudden briskness in trade would astonish the shopkeepers and lead them promptly to raise their prices; otherwise, in many cases, their stocks of goods would be entirely depleted in a few days.
At first sight, it might seem that it would, according to this supposition, only require five days for every one to get rid of his extra money, so that the flurry in prices would be only temporary. Such reasoning is, however, fallacious, for the only way in which the individual can get rid of his money is by handing it ​over to somebody else. Society as a whole is not rid of it. If the shopkeepers, who, under our Santa Claus hypothesis, have already had their till-money multiplied by two, receive, in addition, the surplus cash of their customers, they will be doubly embarrassed with a surplus fund on hand and will, in turn, seek to make some use of it, either by investing it in goods for their business or by depositing it in banks. That is, the expending by each person of his surplus merely results in pushing it along from person to person. The average person still has more money to buy with; but nobody has more goods to sell. The effect on prices will be upward, and this effect will go on until prices have reached a sufficiently high level to stop the process.
Nor can this conclusion be avoided by supposing that most of the money is not expended, but deposited in banks. The bankers whose deposits are thus suddenly swollen will now be the ones with the surplus. Bankers do not wish to have idle reserves, and they will make the increase in the reserves the basis for an increase of business. Moreover, those who deposited the surplus money will draw checks against it in the effort to expend it rather than keep it idle, and these checks will likewise raise prices. And, as the prices rise, the banks' customers will have to keep pace with the rise by enlarging the scale of their operations, loans, and deposits. For instance, a merchant, in order to buy a certain stock in trade with money borrowed at the bank, will have to borrow more because the prices of the commodities he needs have gone up.
In the end, the doubling of society's money will mean ​an increase (1) of the money in actual circulation, (2) of the money in banks, (3) of the loans and deposits based on this money, and (4) of prices. Approximately all these will be doubled. For, as long as prices fail to double, the surpluses and the tendency to spend them will continue to exist. Individuals, tradesmen, and bankers will all be trying to make use of their surplus, and their efforts to do so must tend to raise prices. Only when prices have reached about double their original level will the large stock of ready money cease to be regarded by its possessors as a surplus. At that time, since $80 will buy only what $40 bought before, the additional $40 will no longer seem superfluous. People will find their wages or incomes doubled likewise. Thus, if formerly the average individual was accustomed to expend $1000 a year and to carry an average balance of $40, he will now expend $2000 and carry an average balance of $80, the $80 being exactly the same relatively to $2000 as the former $40 was relatively to $1000.
Needless to say, the imaginary case just described is highly theoretical. Many qualifications need to be made in practice, especially those due to the existence of debts. As will be emphasized in the next chapter, debts are fixed in terms of dollars and, unlike prices, could not change. The supposed prank of Santa Claus would therefore upset debts as well as disturb somewhat the exactly proportional changes just supposed. The essential fact that an increase of money tends to increase prices would, however, remain unaltered.
The imaginary example we have given represents roughly what happens when new gold is discovered. ​The mine owners convert their product into money, getting coin or "yellowbacks" (gold certificates) from the mint. They then find themselves in possession of money far beyond what is needed for pocket money. Suppose one of these men gets from the mint a thousand gold dollars while, for pocket money, $50 is sufficient; he is almost sure to get speedily rid of at least $950 by spending it for enjoyables, investing it in durables, or depositing it in the bank. In any case he and the hundreds of others in the same situation tend to raise prices in the community where they are expending their money, or where they and others draw checks on the banks in which it is deposited.
It was thus that prices rose in the mining camps of California a half dozen decades ago and in Colorado and the Klondike one or two decades ago. This local rise of prices soon communicated itself to other places; for the price level in one locality cannot greatly exceed that in a neighboring locality without causing an export of money from the former to the latter as a cheaper market to buy in. Thus, new money gradually finds its way into circulation throughout the world, raising prices as it flows from place to place, the process consisting, in all cases, of the effort on the part of somebody to make use of an otherwise idle surplus,—a surplus which cannot be dissipated by transferring it from hand to hand, but only by a rise of prices.
15. Tracing the Invisible Source of the Tide
This operation, by which an increase of money causes a rising tide of prices, is so subtle and pervasive that it seems to come from nowhere in particular and ​everywhere in general. The price of butter at the corner grocery is lifted on this tide without our being able to observe the connection of the rise with inflation, just as a fisherman's boat is lifted by the tides of the sea without his being able to connect the rise with the action of the moon.
To answer categorically, therefore, the question, How does inflation raise the price of butter at the corner grocer's, we may say: (1) partly because his customers have more money to spend, and (2) chiefly because the prices he pays to the wholesaler have been raised; and the wholesaler's prices have been raised for the same two reasons, i.e. (1) partly because his customers have more money (and purchasing power generally) to spend, and (2) chiefly because the prices he has to pay have been raised; and so on indefinitely. In this explanation at each stage the chief factor is the second—the rise of some other prices. But as we proceed to trace it back through other stages this second, apparently chief, factor is, at each stage, resolved partly into the first—the abundance of money. What is not thus resolved at the early stages of this tracing back becomes so in the end. When, therefore, all stages are considered, the second factor melts away, and the first factor which at any one stage was the lesser turns out to be "the whole thing."
In the literature on the high cost of living we sometimes find partial glimpses of the series of readjustments above described. Some newspapers have said that higher wages, by increasing costs, require higher prices of the goods produced and that, in turn, high prices in the form of the high cost of living require high wages, and so on in "a vicious circle." Others have called ​the raising of prices a game of ring-a-round-a-rosy and everybody following his neighbor. A book, "Keeping up with Lizzie," has been patterned on this idea. This notion that in the price-raising process prices influence each other in endless chains or circles is quite correct, but the notion that the initial step is arbitrary and that there is really no beginning or end of the process is incorrect. Prices do not lift themselves by their own bootstraps.
In short, the process by which inflation raises prices is misunderstood because, at any stage, it is almost invisible. The only big reason the grocer can give for raising his prices is that the wholesaler has raised his. The only big reason any expert on a particular price can give is that other prices have risen. But when one price thus boosts another it simply transmits the boosting power of the underlying inflation.
16. Other Causes than Money
The price level is affected not simply by the quantity of money in the strict sense but by a number of other factors. The price level may rise not only because of an increase of money (whether primary money like gold or secondary money like paper), but also because of an increase of deposit currency, "money I have in the bank," which is paid out in checks, or because of an increase in the rapidities of circulation of the money or deposits, or because of a decrease in the volume of ​trade. And back of these causes (gold money, paper currency, deposit currency, their respective velocities, and trade) lie innumerable other causes acting through one or more of them.
The relative importance of the several causes in affecting price levels varies with circumstances. Thus, in 1914 at the first shock of war, there were very complicated changes including a slowing-down of trade and of the velocities of money and of the deposit or check circulation and a temporary shift from credit to cash. But in almost all great and prolonged price movements the chief factor is the quantity of money. Seldom has the volume of trade been the chief factor; for statistics show a great steadiness in the growth of the volume of trade.
We may conclude, on the basis of all the evidence, that to monetary causes in general (money, deposits, and their velocities) we should ascribe the great bulk of almost all changes in the price level. In short the chief causes of the variations in the purchasing power of the dollar are to be found in the dollar itself.
* ↑ See, in particular, Why is the Dollar Shrinking? Macmillan, 1914; and The New Price Revolution, Department of Labor, Information and Education Service, March, 1919.
* ↑ Prof. Meade (in Journal of Political Economy, April, 1912), shows by index numbers that trust-made products have been more stable and, on the whole, have been less inclined to rise than competitive products.
* ↑ See Fabian Franklin, Cost of Living, p. 97.
* ↑ For further discussion of this point, see § 15 below and Chapter III. §§ 13 and 14.
* ↑ King's figures (in terms of the average purchasing power of the dollar in the years 1890-99) for the successive census years from 1850 to 1910 are 69, 79, 82, 111, 169, 232, 262 (p. 129).
* ↑ Monthly Crop Reports, U. S. Department of Agriculture, November, 1917.
* ↑ "Inflation," American Economic Review, Vol. VIII, No. 2, June, 1918.
* ↑ "Will the Present Upward Trend of World Prices Continue?" American Economic Review, Sept., 1912; "Equation of Exchange," American Economic Review, June, 1919; "The New Price Revolution," Department of Labor, Information and Education Service, March, 1919.
* ↑ The mistake has sometimes been made of thinking that the stream of goods absorbed by the war should be deducted from the total volume of trade and that only the remainder, used for civil consumption, should be considered for comparison with pre-war times. They say that this volume of goods was greatly reduced and so naturally bears a scarcity price. But, granted that the scarcity of goods for civil consumption enhanced these goods, as estimated subjectively, it must not be overlooked that it tended just as much to enhance money, as estimated subjectively. There is no need therefore of any change in price. Thus, suppose that, for whatever reason, the same price level were kept in the war as before it, but that the people were suffering from lack of food and clothing. These starving people might subjectively esteem bread and clothes ten times as highly as before, but, if they did, they would certainly esteem the money to buy these with also ten times as highly as before. Professor J. S. Nicholson in his War Finance writes: "The late Robertson Smith used to say that in the East great famines were often accompanied by no particular rise in prices. The people died of hunger, but their demand was not effective. They had no more money than usual." Prices do express the intensity of wants for goods, but only relatively not absolutely.
* ↑ "Prices, Yesterday, Today, and Tomorrow," address delivered before the Editorial Conference of the New York Business Publishers Association, April 11, 1919.
* ↑ A still greater agreement would be found if the statistics in the different countries were constructed by the same methods. Professor Wesley Clair Mitchell has shown this by reconstructing the statistics, in this way, in certain selected cases.
* ↑ J. Shield Nicholson, War Finance, p. 100.
* ↑ Gustav Cassel, "Present Situation of the Foreign Exchange," Economic Journal, March and September, 1916.
* ↑ See Professor H. S. Foxwell, Papers on Current Finance, London (Macmillan), 1919, pp. 241-244.
* ↑ See Appendix IV, § 1.
* ↑ Cf. Bullock's Monetary History of the United States, N. Y, (Macmillan), 1900, p. 38; see also Irving Fisher, "The 'Scarcity' of Gold," Cotton and Finance, New York City, February 15, 1913. The recent attempts of the gold-mining interests in England and the United States to secure a Government subsidy utilized this illusion.
* ↑ The figures for these curves were easily found by dividing the index number for any commodity, pig iron, for instance, by the index number for commodities in general.
* ↑ The Standard of Value, London (Macmillan), 1912, p. 20, n.
* ↑ There are still a few students of money who do not accept any form of the "quantity theory" of money. Fortunately, however, the proposal of this book, described in Chapter IV, is not bound up with this theory, even in the form stated in my Purchasing Power of Money. See below, Appendix II, §1, D, E.
* ↑ Irving Fisher, "Equation of Exchange for 1914, and the War," American Economic Review, June, 1915; see also same journal, author, and subject, June, 1919.