Amazing articles on just about every subject...


The Mechanism of Exchange of Money

( Originally Published Early 1900's )



THE necessity of exchange arises from the division of labor. If there were no such division, then every man would make all things necessary for human wants, and hence might supply all his own wants. He would then not need to exchange with other persons. But, in the actual state of society, each producer generally makes a large quantity of some one commodity, and in order to supply his wants he must exchange this commodity for a great number of other commodities.

We have already defined two possible systems on which this exchange might be effected, the one barter, the other sale. By the method of barter the exchange of one quantity for another would be made by a mutual transfer of the ownership of the commodities exchanged. . We have shown how impossible such a system would be in civilized society, and how by the introduction of a common medium of exchange, called money, the difficulties in the way of barter are avoided.

But to understand correctly the theory of exchange it must be remembered that its ultimate result is, after all, barter, in that commodities are ultimately exchanged for commodities. To show this, let us suppose the owner of a pair of shoes to sell them, and with the money to buy a barrel of flour. In doing this he has made two exchanges, selling the shoes for the money and buying the flour with the money. But so far as he is concerned, all he has done and all he wanted to do is to exchange his shoes for the flour. The money was only an intermediate agent which enabled him to effect this exchange. This is why money is called the medium of exchange.

The function of money in leading to what is equivalent to barter, and the nature of the exchanges which are actually made in the social organism, can be most clearly apprehended by referring to the communistic view of the operations of the organism which has been set forth in Chapter IX.

We there introduced the conception of each producer bringing his product to a central point, and depositing it in a common stock for the benefit of other men. In return for this he is permitted to take from the common stock such equivalent of the products of other men as he desires. We have shown how difficult and complex would be the problem of deciding how much of any commodity he should be allowed to take from the common stock in exchange for what he brought into it. By the use of money this requirement is fulfilled in a wonderful manner, and the most complex problem which could be presented to the central authority is solved at once without serious trouble to anybody. The benefit conferred by bringing wealth in and the evil caused by withdrawing it are measured by the money received and paid. For example, considering a shoemaker in his relations to society at large, that is, to all other individuals of the community, we see that when he sells a pair of shoes he puts them into the common stock for the benefit of other people. The measure of this benefit was the money that he received for them, and the possession of this money was his certificate that he had rendered the benefit. When he bought flour with the money he surrendered this certificate and took a barrel of flour from the common stock. His right to draw from the common stock on account of his shoes then terminated. In consideration of giving other people a pair of shoes other people gave him a barrel of flour.

Our next questions will be what commodities can be used as money; and what requirements these commodities must fulfil in order to perform the functions of money in the most advantageous manner.

Requirements of the Medium of Exchange. From what has already been said we see that all civilized communities are in need of some common commodity called money for which all other commodities shall be exchanged. We also call to mind that exchange consists in a mutual transfer of owner-ship, the ownership of the goods passing from the seller to the buyer, and that of the money in the reverse direction. We have now to examine what requirements money should fulfil.

FIRST REQUIREMENT. It must have value. To see the reason for this requirement, let us take the case of a man who agrees to work one month for the sum of $30. If his employer could agree beforehand that this $30 should purchase for him a certain amount of clothing, flour, and other necessaries, it would make little difference to him whether it had or had not value. But no such guarantee is possible. The employé can buy with his money only as much as it has the power to command from the dealer, the shoemaker, the grocer, and the other persons who are to supply his needs. Moreover, the commodities he can thus buy measure what his money is really worth to him. Let us suppose that he wants to have a pair of shoes made. It is very clear that if the shoemaker can get money without going to the trouble of making shoes, he is not going to make shoes for the laborer for the sake of the money. The same is true of every one who supplies the laborer's wants. Hence it is clear, if the latter is not to be deceived, that the money which he receives must be something which the grocer, the shoemaker, and the tailor cannot get except by working for it as he himself does. It must also be desired by them, because of course they will not work for what they do not desire.

Thus three necessary qualities of money are (1) that it must be desirable, (2) limited in supply, and (3) incapable of being commanded except by labor. These elements, as we shall. hereafter see, determine value. The somewhat vague yet excellent term purchasing power is applied to the power possessed by money to command commodities. We may then say that the purchasing power of money is the measure of its value to the person who possesses it.

SECONDLY. The value of money must be definite and permanent. If the commodity used as money is something of which either the desirability or the quantity at hand fluctuates widely from week to week, then the seller, laborer, or other receiver of money can never know beforehand what quantity of the necessaries of life the money which he is getting will purchase for him. It may possibly be weeks, months, or years before he will want to expend the money for the necessaries of life ; but he wants a reasonable assurance that when he does expend it it will buy as much as it would when he gets it. This constancy of purchasing power implies constancy of value, and therefore a general constancy in the conditions of supply.

THIRDLY. Money must possess durability. If it is liable to wear out or deteriorate as it passes from hand to hand, it speedily disappears and no person could with safety keep it for along time. To avoid this difficulty it must be something which is as durable as possible.

FOURTHLY. It must admit of convenient subdivision. Of the vast multitude of commodities or services necessary to sup-ply human wants, some have to be bought in small and others in large quantities. Thus payments of various amounts have to be made, which cannot be done unless the money by which they are made can be divided up to any extent.

FIFTHLY. It must be something which can readily be trans-ported from place to place, and thus be at convenient command of the owner. This needs neither illustration nor proof.

The commodities which most nearly fulfil all the preceding conditions are the precious metals, gold and silver. These metals have therefore long formed the universal medium of exchange among civilized nations, with some exceptions which will be considered from time to time. Yet it cannot be claimed that they absolutely fulfil any of the above requirements. All we can say is that they come nearer to the fulfilment than any other commodities with which we are acquainted.

Other commodities have been temporarily used by people who could not readily command the precious metals. Among tribes engaged principally in the chase, furs and skins have been employed as money. These formed the medium of exchange between the Hudson Bay Company and the Indians. Among pastoral tribes sheep and cattle have frequently been used. In the early history of the American colonists wampum was the medium of exchange with the Indian tribes. When the metals have come into use, it is not always gold or silver that is first employed. Platinum coins were once in use in Russia. The smallest coins of Europe are made of copper, although it is gradually giving way to the alloys of' nickel, out of which our small coins are made. We might not inappropriately include in this class an irregular kind of money, the paper notes sometimes issued by governments in dire distress. But although these notes are intended for use as money, they generally purport to be promises to pay money, and not the money itself. It will hereafter be shown how and under what conditions such promises can take the place and fulfil the functions of money.

Methods in which, the Precious Metals are utilized as Money. When one sells a commodity, it is essential that he shall know how much money he is getting in exchange; hence arises the necessity of measuring money. In the early stages of society the money is measured by its weight; men sell for so many pounds or ounces of gold or silver. This seems to have been the case in ancient times. We read of the pieces of silver with which Abraham bought land. So, after the gold discoveries in California, payments were made in mining communities by weighing gold-dust. But the weighing of all money paid is too troublesome in ordinary transactions, to say nothing of the difficulty of insuring the fineness or purity of the metal. Hence, from an early age of the world's history, governments have adopted the policy of coining the precious metals into pieces of definite weight. Such pieces of metal are now universally used in domestic transactions. Thus we have certain weights of gold in England, France, and America known respectively as pounds, francs, and dollars.

The way in which money gets into circulation is ordinarily this : When any possessor of gold or silver desires to use it in purchasing commodities he sends it to a mint. The mint is a kind of factory established by the government for purifying the precious metals and making them into coins. At the mint the government makes the gold and silver bullion brought to it into coins, and returns it to the owner in the form of money. Some governments coin all the bullion brought to them free of charge, while others demand a small percentage for the expense of the operation. As a general rule, however, the charge is so small as not to be a very important item in the value of the money.

The reason for governments undertaking the coinage of money is that, if the coinage is honestly executed, it affords the best assurance that the coin is what it professes to be. If individuals or corporations were allowed to issue money, the question would be constantly arising whether any particular coin did or did not contain the requisite amount of metal. But when a government coins, the weight and quality of the metal in the coin is fixed by law. Each nation determines for itself what amount of metal shall be contained in a given coin. If we compare the moneys of England, France, and America, we find the fundamental units to be entirely different. The English pound contains nearly as much gold as five American dollars, and one American dollar contains more than five francs. But it is essential that whatever coin is issued under a given name shall be as invariable as possible from generation to generation. Otherwise we have changes in the meaning of the word "pound," "dollar," or "franc," which would be intolerable.

When a government undertakes to coin money, its first step is to prescribe how much gold or silver shall be put into a coin, and to give that coin a name. The name should then indicate the quantity of the metal of which the coin consists. Some economists have objected to giving special names to the coins, be-cause these names impress the ignorant public with the idea that some element of value resides in the name itself. For ex-ample, all ignorant people who do not possess unusually good sense think that a dollar has some peculiar element of value which does not reside in twenty-six grains of ordinary gold. Hence it might have been better to designate coins simply by their weight, as so many grains or grams of gold or silver. But it is questionable whether the superstition would have been done away with by any system of naming. The English pound was not originally the name of the coin, but meant a pound of silver. But this did not prevent more than one king from making a coin which contained less than a pound of silver and calling it a pound. At the present time no one ever thinks of any relation between the pound sterling and the pound weight.

Legal-tender Quality of Money. As a general rule the great body of the coined money of each nation is a legal tender for all payments made under its laws. It is very essential to clearly understand how the necessity of making money legal tender arises. It arises because men must have some common understanding as to what shall be meant when one person agrees to pay another a specified sum of money. We can readily imagine that if there were no such understanding. disputes might arise as to what sort of dollars or cents or currency a party had agreed to pay. Such disputes would be especially liable to arise when, as is always the case, substitutes for the precious metals are used as money. They are avoided by a legal provision that when a person agrees to pay a sum of money within the jurisdiction of any country, the agreement shall be construed to refer to the coin issued from the established mints of that country. Money with which this right is associated is called a legal tender.

The legal tender of a given kind of coin may be limited or unlimited. It is limited when the legal understanding is that payments can be made by it only to a certain amount; unlimited when there is no such legal understanding. Some of our small silver coins, for example, are a legal tender to the amount of $1, and others to the amount of $5 or $10. The largest and most important coins are a legal tender to any amount. The effect of the limit is this: No creditor is compelled to accept payment and give the debtor a release if the coin is nota legal tender to the amount of the debt, but may require payment in coin which is a tender to the full amount.

The power of making particular kinds of money a legal tender is so easily abused that its nature and effect should be well understood. When properly used it has no other effect than that of establishing the meaning of words. As it is necessary that there should be a common understanding as to what; I shall be meant by "one foot," "one acre," or "one gallon," so 1 a similar understanding is necessary as to the meaning of "one dollar." As the law prescribes that " one pound" shall mean a particular weight, so it prescribes that the word "one dollar" shall meat a certain coin issued from some United States mint. During the Civil War, however, Congress went farther and enacted that certain paper notes issued by the government should be a legal tender. This was changing the meaning of words, because the word dollar, which before meant a piece of gold, now meant a piece of paper. Had this change applied only to agreements made after the law was enacted, it would not have been morally wrong. But some courts decided that it should apply to all previous contracts, in one case even to an expressed contract for the payment of gold coin. This decision was as wrong as if Congress had changed the size of the bushel measure and the courts had decided that old contracts for the delivery of wheat must be made in the new measure, and not in that understood by the parties when they made the contract.

The monometallic and Bimetallic Systems. In some cases only one of the precious metals is made into coins of unlimited tender. Thus in England and Germany all large payments can be required by the creditor to be made in gold coin. Among oriental nations, especially India, China, and Japan, silver has very generally been the only unlimited legal money.

The system of making but one of the precious metals an unlimited tender is called monometallism.

The system of making both gold and silver coins an unlimited tender under the same jurisdiction is called bimetallism.

Under the bimetallic system the debtor has the right to make his payment at choice in either of the two precious metals, no matter how great the amount may be. This system prevails with some modification among most European nations except England and Germany, but with certain limitations which will hereafter be discussed. In the United States sometimes one and sometimes the other system has prevailed. At the present time we have a modified form of bimetallism, which will be described subsequently.

The system of pure, or unlimited, bimetallism is as follows: The government first assumes that the values of equal weights of the two precious metals have a certain fixed ratio to each, other. During the first seventy years of the present century the value of an ounce of gold in the markets of the world was generally nearly equal to that of 15 1/2 ounces of silver. Only on rare occasions did it fall below 15 or rise above 16. Hence France chose 151 as her ratio. Since 1834 the ratio adopted by the United States has been 16. The number thus established is called the monetary ratio.

It must be understood that this does not mean the actual ratio in the markets of the world, but is an arbitrary number, chosen by the legislative authorities so as to be as near as possible to what they supposed would be the market ratio.

Having fixed the ratio, and prescribed the weight of pure metal in each coin in accordance with it, the mint coins all the bullion of either metal brought to it into coins of unlimited legal tender. At the present time the United States gold dollar contains 23.22 grains of pure gold, while the silver one contains 371.25 grains of pure silver. The coins, however, also contain ten per cent of alloy, so that the actual weights are :

The gold dollar 25.8 grains. The silver dollar 412.5 grains.

The three essential features of unlimited bimetallism are :

I. That the law recognizes no difference between the values of its gold and silver coins.

II. The mint must coin into dollars all of each kind of metal which is brought to it.

III. Each metal being an unlimited tender, a debtor may pay his debt in the one he chooses.

Difficulties have been found in making a scheme involving all these features work satisfactorily. Hence they have been modified in various ways.

Limited Bimetallism. Between the years 1873 and 1878 the ratio of the market value of gold to that of silver took an extraordinary rise, and has for several years past not differed much on the average from 18. The result has been to throw the monetary systems of those nations practising bimetallism into confusion. The system temporarily adopted by these nations is that of restricting the coinage of silver, while placing no limit upon that of gold. This restriction applies only to the quantity coined, and not to the legal-tender quality of the silver coins. That is, a debtor can pay a debt of any amount in silver coins if he can find them, but the mint will not coin them for him. At present the mints of the United States are required to coin not less than two millions nor more than four millions of silver dollars monthly. But, for reasons which cannot be well understood at present, the government does not coin these dollars for the owners of the bullion, but buys the bullion, coins it on its own account, and pays these coins out to the public creditors.

At the time of sending this book to press the whole question of coinage throughout the world is in an uncertain and confused state, owing principally to the extraordinary change in the relative market values of gold and silver which has just been described, and owing also to the increasing amount of money needed to transact the great volume of business to which modern production has given rise. The desirableness of an international system of coinage is widely recognized, but the people of no one nation are fully agreed as to what is the best system even for themselves, and of course an international arrangement involves yet greater difficulties.

Subsidiary Coinage. The system of monometallism does not imply that gold coin alone shall be used, but only that no other coin shall be an unlimited tender. Small payments must always be made in coins of other substances, because gold coins of small value would be so minute as to be liable to loss. Hence all governments issue coins of small value, which are made a limited legal tender, and are called subsidiary coins. The metals most used in these subsidiary coins are silver, nickel, and copper. To prevent them from being melted down as bullion, they contain less than their nominal value of metal. Thus our silver quarter dollar weighs only 96 grains instead of 103 grains, which last would be one fourth the weight of the silver dollar.

If the coinage of this subsidiary money were free, like that of gold, every one who got his silver coined into quarter dollars would receive in coined money a greater nominal value than that of the bullion from which the coin was made. Hence the practice is similar to that adopted in the case of our silver dollar : the government buys the silver bullion for its small coins, makes them into coins of the prescribed denominations, and offers these coins in exchange for those of unlimited legal tender at their face values. The result is that the public take what are wanted for small payments, and no more.

Volume of the Currency. By currency is ordinarily meant money or some substitute for money in actual circulation from hand to hand. One of the most important mathematical conceptions which enter into economics is that of the total volume of the currency. We may reach it in various ways which are nearly equivalent to each other. Assuming, as we may, that the quantity of coin more than fifty years old actually in circulation is insignificant in amount, we may add up the value of all the coins issued from the United States mint during the last half-century. We shall thus have a sum total from which all the coined money now in circulation must have come. If we subtract from this sum total all the coin that has been melted down, all that is now in foreign countries, and all that is lying idle in the vaults of the banks or of the Treasury, we shall have a balance showing the coin in circulation. This balance is the volume of the currency so far as coin is concerned.

But we may commence at the other end of the line by considering the money which is in every man's pocket. If we conld at midnight on any day demand and obtain from every individual and corporation in the country a statement of the amount of coin money in actual possession of such person, we should have a definite sum total. It is evident that this sum total would change very slowly from day to day, and even from year to year. The only effect of payments would be that one man would have a great deal more and another man a great deal less on different days. Only when money was melted down, sent out of the country, or stored away in vaults, or as new coin was issued, would there be changes in the sum total.



Home | More Articles | Email: info@oldandsold.com