The lender, on his part, would have to pay interest and repay the principal in a money that is to be obtained only in exchange for a larger sum of goods than that which could be bought with each dollar that he borrowed. This means that, with individual exceptions, creditors generally gain and debtors lose by falling prices.
But this is fully true only in respect to loans already made. For just to the extent that such a movement of prices comes to be more or less regularly in the same direction, both borrowers and lenders are able to take it into account, and as experience shows, do take it into account.[13] When prices fall men become more eager to sell wealth, to lend the proceeds, and more reluctant to borrow for investment at the prevailing rate of interest and at the prevailing prices. There is an incentive to divest one's self of ownership (e.g., by selling stocks) and to become a lender (e.g., by buying bonds). This whole situation is reversed in a period of rising prices. The result is that the rate of interest in any long continued period of falling prices (such as from 1873 to 1896) has a trend downward and in a period of rising prices (such as from 1897 to 1915) has a trend upward. This movement of readjustment would not go on indefinitely, even if the same trend of prices continued; for in the strict theory of the case the adjustment would be complete when the interest rate had changed by just the amount of the annual change in the level of prices. For example, if 5 per cent is the static normal rate of interest, then when prices are falling 1 per cent each year, the adjusted rate of interest would be 4 per cent; and when prices were rising 1 per cent each year, the adjusted rate of interest would be 6 per cent. Such adjustments serve to some extent to neutralize the effects of changes in the standard of deferred payments so far as concerns new loans made in view of just such a change and in expectation of its continuance.
But no one can foresee exactly, and most persons take little account of, such a change until it has continued for several years in the same direction. The adjustment is therefore never very prompt or very exact. In some years the general level of prices has risen more than 5 per cent, or more than enough to offset the entire interest received by most lenders. A man with dollars to invest would have been as well off if he had kept them buried during that period.[14]
-- 9. #Notable changes in prices#. In most cases the true effects of monetary changes escape recognition. In a few cases, however, the change has been so great as to cause an economic revolution. Such was the change in prices following the discovery of America, which occurred soon after the old feudal dues had come to be generally expressed in terms of money instead of labor services. In modern times, since the mass of debts has become greater than ever before, such changes bring even graver economic consequence. The increase in the output of gold in 1849-57,[15] caused what was the most rapid, if not the greatest money inflation that had occurred since the sixteenth century. The substitution of gold for silver by some countries at that time, by making a great additional market for gold, helped to check the fall in its value. Indeed, a considerable decline in the output of gold after 1870 combined with its widening use to cause in 1873 the beginning of a great fall of gold prices. The resulting increase in the burden of outstanding debts was felt by all debtors, but particularly by great numbers of the agricultural classes both in Europe and in America. Their tribulations were aggravated by the fact that at that time (especially from about 1873 to 1896) the prices of their products were falling much more rapidly than were general prices, as a result of the very rapid extension of the agricultural land supply.[16] There was complaint, agitation, and demand for relief on the part of many interests in France, Germany, England, and the United States. As a result, the money question became in this country a leading political issue and continued to be such between 1873 and 1900.
-- 10. #Nature and object of bimetallism.# First came "the greenback movement," which, lasted until after 1880.[17] This then gave way to an agitation for bimetallism. _Bimetallism_ is the plan of using two metals as standard moneys. Bimetallism is legally authorized when both metals are admitted to the mints for free coinage at an established ratio of weight. Bimetallism may be legally authorized, but not actually working, for, if the market-value long continues to vary appreciably from the legal ratio, only one of the metals may in fact be left in circulation. This situation is called _limping_ bimetallism (or the halting double standard), tho this is a contradiction of terms. National bimetallism is confined to a single country, as was the case in the United States before the Civil War, or in France before 1867. International bimetallism is that resulting from an agreement among several nations to use two metals on the same terms.
The theory of bimetallism is that the government can act on the value of the two metals through the principle of substitution. The metal tending to become dearer will not be coined, the other will be coined in greater quantities. The degree of influence that can thus be exerted on the value of the two metals depends on the size of the reservoir of the metal that is rising in value. When it all leaves circulation, the law on the statute book permitting it to be coined becomes a mere phrase. In such a case there is bimetallism _de jure,_ but monometallism _de facto._ The greater the league of states the greater is the likelihood that the plan will continue to work. The only notable historical instance of international bimetallism is that of the Latin Union, which united France, Belgium, Italy, and Switzerland in an agreement remaining actually in force from 1866 to 1874. A strong movement developed between 1878 and 1892 in favor of forming a great international bimetallic union of states.
One object of the movement was to put an end to the great fluctuations in the rates of exchange of money between the silver-using and gold-using countries, fluctuations which occasioned much uncertainty and loss to individuals engaged in foreign trade. The rise in the price of gold-exchange in the silver-using countries (notably India) meant also an increase in their burden of taxation. These countries collected their revenues in silver, but they had to pay their debts, principal and interest, in gold. Another object of this movement was to prevent the burden of individual debts from increasing by reason of the rise in the value of the single standard, gold. It was, indeed, hoped that by bringing silver much more into use, the value of gold would be reduced, thus bringing relief to the debtor classes. Still another object of the bimetallic movement was to aid the silver miners and silver-producing districts by creating a larger market for silver.
Several international conferences were held which were taken part in by some of the leading financiers of the world representing their respective governments. The United States was foremost in advocating the policy, France at first favored it, as did in large measure the British Indian administration, tho England was in the main opposed.
The movement came to nothing.
-- 11. #The movement for national bimetallism in America#. When all hope of international bimetallism failed, the efforts of many of its advocates were turned to the plan of legalizing national bimetallism in the United States at a ratio of 16 to 1. This was very different from the market ratio. Gold had become before 1860, in fact, the standard of our money system, and after 1873 it was the only metal admitted to free coinage. Silver, little by little, had been losing purchasing power in terms of gold, until from being worth, in 1873, one-sixteenth as much, ounce for ounce, it became, in 1896, worth but one-thirtieth as much as gold. The power of silver to purchase general commodities fell much less than the change in its ratio to gold would indicate, gold having risen in terms of most other goods as well as of silver. Nevertheless, the proposal to open the mints to the free coinage of silver at the ratio of 16 to 1 in the year 1896 threatened a sudden and marked cheapening of money.[18] Probably gold would have been entirely driven out as money and silver would have taken its place as the standard. In any event "free silver" would have accomplished the purpose of making the standard of deferred payments cheaper. It was at first a debtors' movement, but to succeed it had to enlist the support of other large classes of voters. And thus it developed into the more sweeping theory that wages, welfare, and prosperity were favored by a larger supply of money quite apart from the effect it would have upon debts.
In its extreme form the free-silver plan was a fiat scheme, for some of its supporters believed that by the mere passage of the law the two metals could be made to bear to each other any ratio desired. But its most intelligent advocates recognized that the force of the law was limited by economic conditions. The victory of the gold standard in the campaign of 1896 was, it would seem, due more to the well-founded fear that a sudden change of the money standard would cause a panic than to a popular understanding of the question.
The free-silver advocates got what they desired, a reversal of the movement of general prices, through an occurrence for which no political party could claim the credit. In 1883 the gold production of the world was less than $100,000,000. From that date, with the opening of newer gold-yielding territory in South Africa and in the Klondike, the annual output of gold had been increasing rapidly and almost steadily. The methods of extracting gold theretofore had still been in large part of a primitive sort. But intricate machinery was taking the place of crude tools, chemical processes had been introduced (notably, the cyanide process), and the principal product began to come from the regular and certain working of deep mines rather than from chance surface discoveries. In many parts of the world were enormous deposits of low-grade ores, before useless, that could be worked economically by the new methods.
The general price level fluctuated, but on the whole tended downward between 1884 and 1893 (the year of panic), and reached a minimum in the year 1895 in Germany, 1896 in England, and 1897 in America. It is noteworthy that the very year 1896, which marked the height of the political agitation to abandon the gold standard for silver, saw the gold production for the first time in all history surpass the two hundred million dollar mark. The gold output had caught up with, and began to surpass, the normal monetary demands of the world, meaning by that phrase, the amount of gold needed to maintain a stationary level of prices.
-- 12. #Rising prices after 1896#. The whole character of the monetary problem then changed. A period of rising prices set in, which has continued to the present time. By 1913 prices had risen just about 50 per cent above the low level of 1896. The rise has been, and still is, at the average rate of nearly 3 per cent each year. This caused a reversal of the former positions of advantage and disadvantage on the part of debtor and creditor respectively. The purchasing power of a 3 per cent annual interest on notes and bonds has been offset by the decrease in the purchasing power of the principal of the debt. The burden of the average debt began relatively to decrease. A wide field for enterpriser's profits was opened up by the rapid displacement of prevailing prices in all quarters of the industrial world. The price of manufacturer's products rose in advance of the rise of costs of many raw materials and especially of the labor costs of manufacture.
The average enterpriser's gain was the average wage-worker's loss.
Wages (and salaries), as nearly always in the case of a change of price levels, moved more slowly than did the prices of most of the commodities which are bought with wages, thus causing great hardship to large classes living on comparatively slowly moving incomes.[19]
Extremes meet, and these classes include both those living on passive investments, and those dependent on their daily labor for a livelihood.
Thus we escape the evils of a rising standard of deferred payments, only to meet those of a falling standard. And as long as we have so fluctuating a standard these difficulties must arise again and again, continually repeated, causing unmerited gains and losses to individuals. Let us conclude with a brief consideration of the fundamental principles involved in this problem.
-- 13. #Defectiveness of the gold standard#. Money is, in general, for both borrowers and lenders the most convenient standard of deferred payments. But from the usage of speaking of all things in terms of gold, arises the popular notion that the value of gold is always the same, while the value of other things changes. In truth, a fixed objective standard of value is not possible of attainment. Altho the value of gold is stable as compared with most things, it rests on the estimates made by men and is constantly changing with conditions. The current new supplies of gold are comparatively regular. For centuries at a time there was little change in the methods of mining gold and there were no radical changes in its output. The nature of the use of gold, likewise, is such as to made changes in the amount of it needed, under ordinary conditions, more stable than is that of most other goods. Moreover, the stock of gold in monetary uses is but slowly worn out; it is, therefore, a large reservoir into which flows a comparatively small stream of annual production; the existing stock is twenty or thirty times the annual output. Yet the value of gold expressed in other things is never quite stable, and sometimes several influences combine to affect it greatly and suddenly. Recent inventions, chemical and mechanical, moreover, have considerably altered the conditions of production. While, therefore, it is the best standard yet devised and put into actual practice, it is very imperfect. A standard better than a single metal, more stable than a single commodity, is desirable if it can be found.
-- 14. #Various ideal standards suggested.# It may, perhaps, be agreed that the ideal standard of deferred payments is one that would insure justice between borrower and lender. Yet different views may be and have been taken as to what constitutes justice in this matter. The suggestion is attractive that repayment should involve the return of enjoyment equal to that which could be purchased with the sum at the time of the loan. Such a standard is impossible of perfect realization in any general way, for men's circumstances are constantly changing.
To insure even to the average man the same amount of enjoyment is only roughly possible. The same goods do not afford the same enjoyment when conditions, either subjective or objective, have changed. Another suggestion is that the goods returned should represent the same sacrifice as those loaned. Here again the difficulty is in the lack of a standard applicable to all men. Whose sacrifice? That of the lender, who may be rich, or that of the borrower, who may be poor? Some have supposed that the condition of equal sacrifices was met by the labor standard, according to which the sum returned should purchase the same number of days of labor as when borrowed. But what kind of labor is to be taken, that of the lender or that of the borrower or that of some one else? Labor is of many different qualities, which can be exactly compared only through their objective value in terms of some one good.[20]
It must be recognized that any possible concrete standard of deferred payments will sometimes work hardship in individual cases. The best average results for justice and social welfare will be secured by measuring debts in some standard that will change least often, and least rapidly, in relation to the great majority of people of all classes in the community.
-- 15. #The tabular standard.# Apart from the difficulties of its practical operation, a standard better than a single metal and more stable than a single commodity would be a _tabular standard_, consisting of a number of leading commodities in fixed proportions, such as is used in calculating index numbers expressing the general scale of prices. Such a standard averages the fluctuations of particular goods and would give a fair approximation in practice to the ideals of equal sacrifice and equal enjoyment (on the average tho not in individual cases). While some natural materials are growing more scarce and call for more sacrifice, other products are by industrial progress becoming more plentiful. This kind of standard has been viewed with favor by many monetary authorities, and despite the administrative difficulties ways may yet be found for putting it into practice.
After determining the tabular standard, the actual regulation of the quantity of money to make prices conform to the standard might be accomplished in one of several ways. It might be done by letting the value of the gold dollar fluctuate as it does now, while requiring a greater or less number of dollars to be given in fulfilment of all outstanding contracts. For example, if prices by the tabular standard fell from 100 to 95 in the time between the origin of a debt of $100 and its payment, the debt would be discharged by paying $95; if prices rose to $110, the debt would be discharged only by the payment of $110.
By the plan of a "compensated gold dollar" the legal weight of the gold coins would be increased or decreased from time to time to conform with the tabular standard. Still a third method would be to regulate the issue of standard paper money, contracting and expanding its amount by issue and redemption, by deposit in and withdrawal from depository banks, at regular intervals to bring prices into conformity with the tabular standard. These are as yet but distant possibilities, and for some time to come gold will continue to serve as the standard money in the same manner as in the past.
[Footnote 1: The amount of silver is here expressed at its coining value; this is not the commercial value, but rather the number of silver dollars 371.25 fine grains weight that could be made out of the silver produced. Silver and gold of equal coining value are, therefore, as to weight always in the ratio of 16 to 1.]
[Footnote 2: See above, ch. 5, sec. 4.]
[Footnote 3: See Vol. I, p. 45 ff. See also above, ch. 4, sec. 8.]
[Footnote 4: Numerous tabular index numbers have been worked out for different countries and periods. The main results of the more recent ones have been brought together with critical comments, by Professor Wesley C. Mitchell, in Bulletin 173 of the U.S. Bureau of Labor Statistics, July, 1915, from which the figures here used are quoted.]
[Footnote 5: The price movements in the United States between 1860 and 1879 must be left out of consideration here, for the excessive issues of greenbacks drove gold out of circulation and made greenbacks the standard money, except in California and elsewhere on the Pacific Coast where, by public opinion, gold was retained as the circulating medium.]
[Footnote 6: This change was what later was referred to in political discussions as "the crime of '73." The dollar referred to was the _standard_ silver dollar; at the same time the coinage of a _trade_ dollar was authorized (intended to be used only in foreign trade), which, after 1876, was not legal tender in the United States.]
[Footnote 7: See Vol. I, p. 262.]
[Footnote 8: See Vol. I, p. 263, on credit transactions, and p. 302, on the interest contract.]
[Footnote 9: See Vol. I, p. 304.]
[Footnote 10: See Vol. I, p. 319.]
[Footnote 11: This could not be treated in connection with the interest-rate in Vol. I, Part IV, for the reason that even its elementary treatment must presuppose the fuller study of the nature of money and the study of changes in the level of prices, that has just been given in this and the three preceding chapters. The theory of interest in Vol. I, therefore, is a static theory in respect to the standard of deferred payments, and requires adjustment to apply to a condition of a changing price-level.]
[Footnote 12: See above, sec. 3.]
[Footnote 13: Mention was made in Vol. I of the prospect of profit as affecting the motives of commercial borrowers; e.g., pp. 298, 335, 348, 495.]
[Footnote 14: The modern explanation of this phenomenon was worked out in the period of falling prices before 1896 and hence was referred to as the theory of "appreciation and interest" (meaning the relation of the appreciating dollar to a falling rate of interest). More generally the theory is that of the relation of a changing standard of deferred payments and the rate of interest.]
[Footnote 15: See ch. 4, sec. 12, and above secs. 1, 2, 4, 5.]
[Footnote 16: See Vol. I, on agricultural leases, p. 159, wheat prices, p. 436, and changes in the land supply, p. 442.]
[Footnote 17: See ch. 5, sec. 11.]
[Footnote 18: The advocacy of this proposal was called "the free-silver movement" because it involved resuming the free coinage of silver at the legal ratio of 16 to 1.]
[Footnote 19: This happened to coincide with a relative increase of the price of food-products and of other necessities of daily life at a greater rate than general prices. This aspect of the much discussed rising cost of living must be carefully distinguished from that of the change of the _general_ price level, and also from that of the relatively slower change of wages. See Vol. I, pp. 437, 445-446 on population and food supply.]
[Footnote 20: See on the labor theory of value, Vol. I, pp. 210, 228-229, 502.]
PART III
BANKING AND INSURANCE
CHAPTER 7
THE FUNCTIONS OF BANKS