The Equation of Societary Circulation
( Originally Published Early 1900's )
IN the preceding chapter we considered the total payments of money from person to person in a social organism. Now, considering only the cases which come under economic principles, each of these payments was made in exchange for something transferred from the payee to the payer. This something may be either material wealth already in the possession of the payee, or it may be a service involving labor on the part of the payee. When one hires a laborer to work for him, he receives in return a service consisting of the results of the man's labor. If the buys a pound of tea at his grocer's, he receives the tea in exchange for his money. Hence, as already remarked, to every flow of currency from one person to another corresponds a reverse flow of wealth or services from the second person to the first. The total circulation consists, therefore, of two combined circulations equal and opposite to each other, the one of some form of current money, the other of some object of desire, the product of human labor. To distinguish these two we shall call the latter the industrial circulation.
The same diagram which represents the monetary circulation may also be considered to represent the industrial circulation, the latter flowing in the opposite direction from that of the arrows, but along the same veins.
We shall use the term societary circulation to designate these two opposite circulations.
We have shown that it is the industrial circulation alone which really supplies the wants of the community. Were it possible to keep up the industrial circulation without the use of money, men's wants would be supplied just as they are.
Since we cannot possibly keep up the industrial circulation without the other, it might seem idle to point out this fact, but the understanding of the fact is conducive to sound thinking on the subject. The public are prone to assume that the supply of their wants depends altogether on keeping up the monetary circulation, regardless of the industrial circulation, and bad policies are therefore urged upon governments. The lesson to be drawn from the fact is this : The 'influence of changes in the monetary circulation upon the well-being of the community is to be determined by their effects upon the industrial circulation.
Our first proposition concerning the industrial circulation defines its amount. If we include in this circulation every transfer of commodities or services for which money is paid, or to be paid, and no others, then its value will necessarily be equal to the flow of the currency, this flow having been defined as the sum total of money payments. But to preserve the equality we must exclude from the monetary flow all such transfers as loaning money, or depositing it in a bank, because these are not balanced by reverse transfers of wealth or services. Then, keeping the two flows in correspondence with each other, the flow of the currency must, in the long run, remain equal to the total value of the industrial circulation as measured in money.
Of course this measure is subject to the general laws of measurement already developed, according to which the numerical value of any fixed quantity varies inversely as the measuring unit. Hence, with every change in the absolute value, or " purchasing power," of the dollar, there will, all other conditions being equal, be an inverse change in the money measure of a fixed industrial circulation. This measure will therefore vary directly as the scale of prices. Hence, in accordance with the mathematical principle already illustrated, the money value of a fixed industrial circulation will be equal to some quantity multiplied into the scale of prices. The quantity to be multiplied is simply the value of the industrial circulation as it would be on the scale of prices which we assume as the unit of comparison. Thus in III. 11 we assumed the scale of prices in the year 1880 as the unit, and found certain other scales for other years. If then we put K for the industrial circulation on the scale of prices which we take as unity, and if we put P for the actual scale as found from the table of prices, then the money value of the total industrial circulation will be K X P.
From what has already been said, this product is the same as the flow of the currency ; hence, using the notation already given, in which that flow is V X R, we have the equation VXR=KXP, which may be called the equation of societary circulation.
This equation may be regarded as the fundamental one in the theory of exchanges. To the non-mathematical reader a further explanation of its significance may be needful. The first member, V X R, assumes the very obvious fact that the total money value of the exchanges which will be effected in a year by a number V of dollars is equal to V multiplied by the average number of times which a dollar changes hands during the year. The other member of the equation, K X P, implies that the total money value of the wealth and services which these payments balance increases with the scale of prices, and with the quantities of wealth exchanged ; so that when either of these factors increases, V X R must increase in the same proportion.
The next proposition is that the quantity K, which represents the industrial circulation as measured by the unit scale of prices, also represents, with some slight modifications, the sum total of the necessary operations of the social organism, so far as these operations consist in the transfer of goods and the rendering of services. To show how this is, and what it means, let us take some continuous series of those operations. Our old history of the coat will serve for this purpose. We wish to learn what flow of the currency was caused by the various processes of transportation and manufacture to which it was subject. Commencing with the sheep on the prairie, the first industrial operation was that of tending and shearing the sheep. The measure of this industrial operation was the money paid by the owner of the sheep to his employés for their work, which money payment counts as a part of the flow of the currency. The next industrial operation we may conceive to have been the transportation of the wool to Chicago by rail. This was balanced by a flow of the currency from the sheep-owner to the railway company. Arriving in Chicago, the ownership of the wool passed to the wool-merchant, and was balanced by a flow of the currency from the wool-merchant to the owner. By a succession of such operations the wool reached a factory, and each operation was balanced by a flow of currency. In the factory operatives rendered service in manufacturing the wool into cloth, which service was balanced by a flow from the owners of the factory to the operatives. As the ownership of the cloth passed successively to the wholesale dealer, to the tailor, and the owner of the coat, every transfer was balanced by a flow of currency between the same parties in the opposite direction. The same thing is evidently true of all industrial operations. For every such operation there is a corresponding flow of the currency.
We are mainly concerned with the converse proposition that, omitting exceptional cases to be considered presently, every money payment is made to facilitate the progress of goods or services from those who own or render them to those who want them. This follows from the general principle that no one pays out his money unless he receives an equivalent, and that he always pays it in such a manner as to get the greatest equivalent he can command. Hence, as a general rule, payments of money are made only for the services which they can most advantageously command, and every money payment is balanced by a corresponding transfer of services of some kind.
A third principle touching the industrial circulation is that there is a certain amount of that circulation which is most conducive to human well-being. To show what this maximum is, let us commence with a simple example. Here is a shoemaker who has a wife and two children to support. He can work a certain number of hours in the day, six or eight perhaps, with positive pleasure to himself. Work beyond these hours gradually becomes more and more irksome. The first additional hour he will think little of, the second he will have more aversion to, the third yet more, and so on. A point will at length be reached when he cannot work longer unless at the expense of his health.
Now, under the laws of demand and supply, lie can obtain a certain amount of sustenance with his eight hours of agreeable labor. If this sustenance is all his family want, the problem of his existence will be a very simple one. But we may be sure it is not all they want. If it suffices to give them cotton curtains to their windows, they will want lace; they will want the choice cuts of beef rather than the coarser ones; and the wife will want to hire a seamstress instead of mending the clothes herself. The man will therefore certainly work a little more than the number of hours agreeable to him. The limit of advantageous working is reached when the additional sustenance which he can obtain by additional work will not compensate for the irksomeness of the labor. At this point he will stop working of his own accord. For the number of hours up to this limit he can command a certain amount of money yearly. This amount will be, so far as he is concerned, the most advanta geous flow of the currency from his customers to him. If he works longer, the irksomeness of the labor will more than balance the benefit derived through the additional monetary flow.
What is true of this shoemaker is true of everybody. There is a certain maximum amount of labor which, whether applied to production or exchange, cannot be exceeded without disadvantage to the individual. Every man must be his own judge of, this maximum, because it depends upon his health, habits, the wants of his family, and his own desire for wealth. We may therefore regard the flow of the currency as measuring, in the normal state of society, that particular amount of industrial circulation which on the whole is most conducive to the enjoyment and well-being of the community.
It is true that this proposition runs counter to current notions. The popular opinion is that almost every man in the community wants more employment than he can get. Merchants are sorry when business is dull, and glad when it is so brisk that they have hard work to keep up with it. Laborers are often out of employment entirely, although they profess their willingness to work for even lower wages than the pro-ducts of their work ought to entitle them to command. But a fallacy underlies these conclusions. The fact is that the average man does not want to do any more work than he does. Many laborers desire laws to prevent them working more than eight hours a day. What everybody wants is, not to render more service, but to get more pay for that which he does render, which is a very different thing. That is to say, he does not wish to increase his part of the industrial circulation, but he does want to increase the flow of currency to him which should balance his contribution to the industrial circulation. In other words, he wants to establish a higher scale of prices for his services. The greater the demand the higher the price he can charge. Hence his desire for increased demand.
The wish for high prices being entertained by all men, there is a force akin to pressure tending to make the scale of prices as high as possible. Now, the very fact of this pressure reacts upon the circulation itself. Bearing in mind the proposition already reached, that every transfer must be balanced by a corresponding payment, it follows that there cannot be any greater industrial circulation than that measured by the flow of the currency. But the higher the scale of prices the less industrial circulation a given flow will measure. In other words, in our equation, if we suppose V X R to be fixed, then K X P must be fixed ; so that the larger we make P the smaller must be K. Hence the combined efforts of every man to command as high a price as he can for his services may result in himself or some one else not being able to contribute his normal amount to the industrial operations of the social organism.
Exceptions to the Equation of Societary Circulation. With every such general proposition of economics as this, we are to consider to what limitations and modifications it is subject. The first and most obvious limitation is that the act of incurring debts prevents it from being necessarily fulfilled at all times. When a debt is incurred, a transfer forming a part of the industrial circulation is made without any corresponding transfer of money in the other direction. If the debt is not paid during the year, we shall find in the sum total of the industrial circulation certain transfers which are not balanced by the societary circulation. But since, as a rule, the debt is paid at some time, it follows that in the long-run the balance will be made good. Moreover, taking each year by itself, the chances are that the excess of industrial circulation arising in this way towards the end of the year will be balanced by the payment of debts incurred during the year before.
It may be truly said that in cases of bankruptcy the payment is never made. If, then, we are to be quite strict, we should add to that side of the equation which represents the societary circulation a certain quantity indicating the loss from bankruptcy. The reader can do this, if he chooses, by writing the equation in the form K X P=V X R+B; B representing the loss by bankruptcy.
This modification would not materially affect the conclusions drawn from the equation, and therefore need not be further considered.
It may also happen that two persons, A and B, have made a direct exchange of goods and services, and that the only money that passes between them is a balance due from one to the other. Then there would be a portion of the industrial circulation not balanced by a flow of currency. As a general rule, however, money passes between any two parties only in one direction at any one time. That is, if A buys from B, and B from A, it will commonly happen that A pays B and B pays A separately. Practically the cases are too few to be of any importance, the flows of money between any two per-sons being generally in one way only, and of commodities the other way. To include this exceptional case we have only to draw two veins between the circles representing the persons.
The opposite result occurs in great speculative transactions. In the Chicago markets the ownership of large quantities of wheat may at various times pass back and forth between parties, either with or without corresponding direct payments. So also, in New York, speculative sales of railway and other shares are made on a large scale. For reasons which will be presently shown, such sales, and the payment made for them, should be excluded from our sums total.
Yet another disturbance of the equation arises when A purchases from B, and B from C, and A pays C directly, and thus cancels both debts with one payment. To represent all the transactions, such a payment should be counted as made from A to B and again from B to C, and the veins should be drawn accordingly.
Yet another partial exception to the equation occurs in the collection of government revenues. When government collects a tax from the people, there might appear to be no industrial flow back to the taxpayers to balance the monetary flow embodied in the tax. We may, however, consider the general benefit rendered by the government as such an industrial flow, and then the balance will hold good. But if government borrows money, there is no flow of services from the government to the borrower. When, year after year, the government slowly pays off the debt, there is no industrial flow from the bond-holder to the government. These cases constitute another general exception to the equation. The same exception arises whenever a flow of currency consists in borrowing money to be subsequently repaid.
For the most part these exceptional cases do not need to be treated in connection with the main principles of the subject. Our proper course is first to consider the action of cause and effect as it would be were the balance of the two flows always perfect, and afterwards to consider, so far as may be necessary, what disturbance or change is produced in the exceptional cases.
Illustrations of the Societary Circulation. In the graphic representation of the monetary flow already given, each separate person was separately represented. But in considering the action of economic causes upon classes of men, we cannot consider each individual separately, but have to treat whole classes together. For example, we may consider all the shoemakers in a city, in the country, or in the world, represent them by a circle, and then suppose a flow of money to them and another from them. The flow to them will consist of all the payments made for the purchase of shoes ; the flow from them will consist of their payments for leather and other capital, and for their own sustenance. We may also consider our class to include the whole body of men en-gaged in producing anything to be made into shoes—shoedealers, leather-makers, and even the raisers of the cattle whose hides went into the leather. If, however, we wish to consider the separate relations of these classes, we may sub-divide them to any extent, and have different classes for the shoemakers, the shoe-dealers, the tanners, and so forth.
On this system let us represent graphically the operation of levying a tax in order to pay off a debt due the public creditors. We draw one circle to represent the public treasury; another circle, which we call society, represents the totality of the taxpayers, bond-holders excepted ; a third circle represents the bond-holders or public creditors. We draw a vein from society to the public treasury, showing the flow of money from the people to the government, in payment of the tax.
We draw a second vein from the public treasury to the bond-holder, showing the payment to them to extinguish the debt. But the operation is not complete until the money gets back into the possession of society at large. If the bond-holders spent the money for miscellaneous purposes, it would go directly to society at large, and we should draw a third vein, when the circuit would be complete. This is shown in Fig. 2. FIG. 2.
But suppose the bond-holders spend the money in building a railway. Since railways are built only by certain special classes of people, we may consider their functions as separate from those of society in general. The circulation will then be as in Fig. 3. Here the stream subdivides. One branch goes directly or indirectly to the laborers who excavate the road.
Another portion goes to steel-makers who furnish the rails. A third goes to lumbermen who supply the ties. The fourth we may consider as going to unenumerated classes of people, a part of society at large. Thus we have four flows, a, b, e, d, going from the bond-holders which are together equal to the one flow from the public treasury. As represented in the diagram, two flows go from the steel-makers, one to society at large, and one to the owners of iron ore.
All the other flows we draw to society. Thus, taking the classification we have given, the single flow of money which went into the public treasury returns in five different streams. Of course, by subdividing the streams still further, we might have had a thousand or ten thousand return flows; but in any case their sum total would have been equal to the outflow of taxes, or, to speak more exactly, equal to the flow from society into the treasury of that portion of the tax used in paying off the bond-holders.
As another illustration, let us draw a diagram representing the flow of the rents paid to a landlord by his tenants, in case the landlord spends one portion of his rents for his own support and the remainder in building new houses. The tenants derive their income by rendering services to society at large, no matter what particular persons. The flow of those particular moneys paid for rents is represented by the vein from society to the tenants. That portion of the land-lord's income which he spends for his own sustenance is represented by the vein e drawn from him to society at large. But in building houses he employs bricklayers, carpenters, painters, lumbermen, and so forth. If we include the lumbermen with the carpenters, the brickmakers with the bricklayers, etc., which we do merely to simplify the diagram, we may consider three classes of men to whom go the three flows d, e, f. These three flows, together with the fourth one, c, going directly to society, are equal to the flow b to the landlord. All the classes of men who build the house draw their sustenance from society, so that we have the outflow from society to the tenants compensated by four inflows, thus completing the circuit.
As in the former case, we might have subdivided the flow among many hundreds or thousands of different classes, including the iron-founders, owners of iron ore, managers of saw-mills, land-owners, etc. The reader can do this to any extent he desires, when he finds it necessary to consider the effect of the operation upon any particular class of men. But this further subdivision does not change the total amount of the flow, but only splits it up among a greater number of classes.