# Variations in the Equation of Societary Circulation

( Originally Published Early 1900's )

IT is necessary at the outset that we have clearly in mind the results reached in the last two chapters. They may be summed up as follows :

I. There is a certain definite mass of money, notes, and credit in circulation, the amount of which, in dollars, we call the volume of currency, and represent by the symbol IT.

II. Each dollar of this mass circulates with greater or less rapidity. The average rapidity we represent by the symbol R. We conceive R to represent the average number of times which each dollar changes hands in the course of the year.

III. It is necessary to the well-being of a community, that a certain sum total of transfers of wealth and services should be made between its members. The total of these transfers during the unit of time, measured in dollars of absolute money, that is, on the unit scale of prices,—is represented by the symbol K.

IV. Representing by P the ratio of the actual scale of prices to the unit scale, the value of the absolute dollar measured on that scale will be equal to P. The amount of business expressed in the current scale of prices will then be K X P.

V. This being the case so long as all the processes of buying, selling, incurring debts and paying them go on at a regular and uniform rate, we have the equation VXR=KXP.

All four of the quantities V, R, P, and K are subject to change. Let us first consider the changes to which V, or the total volume of the currency, is subject. Were no money or credit ever introduced into or withdrawn from the circulation, no change could occur in its total volume. But in the actual case a circulating dollar may go out of the regular course of circulation in any of the following ways :

I. If it is a coin dollar, it may be withdrawn through being melted into bullion or exported to a foreign country. Since we are considering only the operations within a certain community, we regard money as outside the field of our circulation when it passes outside the community. If, as we might well do, we suppose our community to include the whole world, then there would be no diminution of the total volume of the currency by the export of coin. But there would still be a diminution when-ever coin was melted down.

II. Credit-money is withdrawn by the payment of debts to banks. If a merchant who has a note in bank pays it in coin, that coin goes into the vaults, and is out of circulation until it is loaned to somebody else. If he pays it in banknotes, the same thing is true. If he pays it by a bank cheque, he transfers to the bank a certain credit either on itself or on some other bank. In either case this credit is cancelled until a new loan is made, and thus the volume of credit-currency is diminished by the amount of the payment.

Of course the volume of currency is increased by the reverse operations. Every dollar of bullion which is coined adds one dollar to the money in circulation. Whenever a loan is made at a bank, the amount of the loan is added to the circulation, as already shown in the chapter on banks.

It may be remarked that neither the payment of ordinary commercial debts nor the deposit of money in a bank changes the volume of the currency. In the first. case we have only a transfer of money, which the receiver takes for the purpose of transferring it again as soon as he has occasion. The transfer is therefore simply an ordinary money payment. If the money is deposited in a bank, it is true that that particular money does for the time being pass out of circulation. But an addition equal to the deposit is made to the credit-currency by the depositor having the right to draw cheques on the bank, so that the total volume is the same as before.

Hence when the banks discount new notes in greater quantity than the old ones are being paid off, they increase the volume of the currency. The banks are then said to expand the circulation. When they demand payment of maturing notes to a greater extent than they discount new ones, they contract the circulation.

Changes in Rapidity of Circulation. Every cause which leads a man to hesitate before spending his money tends to diminish the rapidity of circulation. Every cause which tends to make him pass it off quickly tends to increase it. We now have to inquire whether there are any causes which may be from time to time operative upon a whole community, so as to make all or the general body of its members desirous of ex-changing their money more or less rapidly than usual. Business men almost universally believe in such changes. " Disturbance" and " stagnation" of business imply a diminution in R. " Briskness" implies that, so far as those who find business to be brisk are concerned, the circulation is rapid. Conclusions drawn from the experience of men of business in this particular case are, however, rather unreliable, and we must look at the matter more closely.

Money circulates with a normal rapidity, which we may regard as a healthy maximum, when every man who earns money can immediately pay it out with a result satisfactory to himself. Every cause which leads him to doubt what is the most satisfactory disposition to make of his money interferes with his expenditure, and leads him to keep his money longer than he otherwise would. The general rule will be that before he receives his money he forms more or less definite conclusions as to what he will do with it. If anything happens to disappoint the expectations on which those conclusions are based, he is likely to keep his money longer than he otherwise would. Let us see what examples of this we can find.

If in a manufacturing establishment an unexpected disagreement occurs between the employers and the operatives, the money which the former received in the course of business no longer goes to the payment of the latter, and remains for a longer period on their hands than it would otherwise have done. Thus every strike on the part of laborers tends to diminish the rapidity of circulation. If prices unexpectedly rise in consequence of the strike, purchasers will delay buying, and a still further block in the circulation may arise. In periods of uncertainty, investors of money, that is, purchasers of capital, be-come apprehensive, and their money lies on their hands longer than it would otherwise have done.

On the other hand, mere " hard times" does not necessarily imply any diminution in the circulation, though they may arise from that cause. When business of some one kind is very dull it may happen that the people who ordinarily spend their money in that particular business are spending it in some other way. It is therefore impossible to conclude with entire certainty whether the circulation is more or less rapid than usual; but we may suppose it true that, as a general rule, when business is dull in all its branches the circulation is less rapid than when it is brisk.

A very potent cause of increase in the rapidity of circulation is the issue of irredeemable money. Such an issue leads, as will hereafter be shown, to a rise in prices. The prospect that prices will rise makes a large number of people anxious to purchase as soon as possible, and thus to obtain all the money they can get. It therefore causes business to be very brisk for the time being. Conversely, the prospect that there will be a fall in prices leads people to postpone buying as long as possible, and thus tends to diminish the rapidity of circulation.

16. Next let us consider the changes in the product K X P. Remembering that this product signifies the entire exchange transactions of the community, measured in current dollars, we perceive that it may change from two causes :

I. The actual increase or diminution in the quantity of goods which change hands, represented by K.

II. A change in the general scale of prices at which the goods are sold. This scale is P.

For example, if exactly the same transactions should take place this year as last, but at double the price, then, although there would be no change in the actual transactions, yet since every sale was made for twice as many dollars, the numerical measure of K X P would be double that of last year. We must therefore carefully distinguish between these two causes as affecting the measure of the industrial circulation. As a general rule the actual exchanges will not vary rapidly so long as things go on in their regular way. It is of course to he expected that in a growing country they will increase from year to year as population increases and production improves. As already shown, there is a certain amount of these transactions which is most advantageous, and in which everything goes on as nearly as possible to every one's satisfaction. So long as this happens it makes no difference, except indirectly, what the scale of prices is. All our current wants would be as well satisfied on a scale of half-dollars as on one of two dollars, always provided that the change is carried through so as to include all services rendered. Practically, however, it is impossible to carry such a change uniformly through, and therefore it is to the best interest of society to have as little change as possible from month to month and from year to year.

Effect of Changes in the Volume of the Currency. In the social organism demand is exercised only through the instrumentality of the currency. Whoever purchases anything in market must have the money to pay for it, either in hand or in prospect. Since, then, his power of demanding is limited by his power of commanding money, we may consider money as in some sort the instrument of demand. We have now to consider the effect upon demand, price, and supply produced by changes in the amount of money in circulation, or the volume of the currency.

To make the state of the case as clear and simple as possible, suppose that a beneficent government or any other power should distribute five dollars in paper money or coin to every person within its sway: what would be the consequence ? Firstly, since a very great majority of the recipients would feel the want of something which the. money could buy, they would proceed to purchase the necessaries of life from the dealers. The latter would therefore find their stores unusually crowded, and would speedily have to send to their wholesale dealers for an increased stock. The latter, again, would call upon the producers for an additional supply of goods. The result of this increase of demand would, as shown in III. 17, 21, be a rise in price.

We might also expect an increase in the production, and therefore in the supply. This expectation, however, would probably be disappointed, because, by hypothesis, each and every producer has his five dollars and, for the time being, would be more anxious to buy something with it than to keep up his business. So long as everybody crowded to the stores to buy, everybody would have to leave off work, for a while at least ; and although the prospect of an increased price would be an inducement to produce more, yet, on the other hand, the feeling of increased wealth would lessen the stimulus to hard work, and would therefore counteract the action of that cause. We should therefore have two effects from this influx of money firstly, a general selling off of the store of products through the channels of business ; secondly, a general rise of prices.

This rise of prices would affect different classes differently according to their position. The man who promptly spent his money would be the richer; the man who did not spend it until after prices had risen would not be so well off. Nearly every one engaged in trade would profit by the increased prices, and be encouraged by the increase of his business. Workers for wages and men on salaries would find the week following that, owing to the rise in prices, they were unable to purchase as much as before. Possibly in one or two weeks they would find their whole gift absorbed in the increased prices they would have to pay, so that they would be worse off than before. They would therefore be compelled to demand an increase of wages which they might ultimately get after more or less suffering. The general selling off of goods would result in the scarcity of a great many things that people who did not buy them at the time would want, and this would have to be made up by increased work in some directions.

The final result would be that all prices and all current wages would rise in nearly the same proportion. Each individual would therefore be able to command no more of the necessaries and comforts of life than before he had received his five dollars. So far as current operations are concerned, neither harm nor good would on the whole be done. Some would gain and some would suffer.

The case is different when we consider future debts and payments. Every person who had loaned money would, when he received it, find that he could purchase less of the necessaries of life than before. Ho would therefore be a positive loser; the debtor would be able to command the money with less labor, and would therefore be a gainer.

The reverse effect would result if the volume of the currency were diminished by taking money from the community. There would be a falling off in the sales of all dealers, and hence a depression in trade generally. The falling off in demand would lead to a fall of prices, and wages would have to be lower or production would be temporarily stopped. Debtors would lose by having to work more, or sell more goods to command the money which they had agreed to pay; and creditors would gain by being able to purchase more with the proceeds of their debt.

Effect of Varying Indebtedness. In establishing the equation of the societary circulation, it was assumed that the payment of debts throughout the organism kept pace with their incurrence, so that the two balanced each other. Now this is not always the case. The history of commerce shows periods of great buoyancy of feeling and tendency to speculation, when men of business incur debts on a larger scale than usual. Since every debt is incurred on account of some transfer of goods or services, for which no money payment is made at the time, it follows that the whole mass of indebtedness represents that portion of the industrial circulation which has not yet been balanced by the monetary circulation. At the same time, as already remarked, if this mass of indebtedness is not increasing, the two circulations must still balance each other, because the unbalanced portion of the industrial circulation, for which indebtedness is being incurred, is then balanced by the equal payment of former debts.

But if the mass of indebtedness is increasing, there is then a portion of the industrial circulation which is not balanced by the monetary flow at all, and thus the equation is disturbed. How important the consequence of this is will be seen by reflecting that if people stopped paying off their old debts, and bought everything on credit, the monetary flow would for the moment entirely cease. This is of course an extreme case. But let us suppose as a possible case that one fourth the volume of current business is done on credit, while the old debts are left standing. The result will be that the industrial flow will be to the monetary flow in the ratio of 4 : 3. If before this state of things commenced the two flows balanced, then when the speculation begins there will be an apparent redundancy of the monetary flow, because the volume of currency suffices for the flow 4, while only the flow 3 is required. The result will be the saine as in the case of an increase of the volume of the currency ; that is, a universal demand for commodities of all kinds, with a tendency towards a rise of price.

When the indebtedness is to be paid off the reverse effect occurs. If the volume 4 of regular business is to continue, and a volume 1 of indebtedness is to be discharged, there will be a call for a monetary flow represented by the number 5. But, on the scale of prices established by the speculation, the actual volume of currency only suffices for the volume 3 of exchanges. Thus arises a state of things to be subsequently discussed.

Fundamental _Law of Value of the Total Volume of Currency. The law which would determine the amount of variation in wages and prices in every case, after things had been readjusted on the new basis, can be got at by considering that in the industrial circulation nothing would really be changed except the scale of prices. The quantities purchased being the same is before, K remains unchanged. In the equation K X P = V X R, R also would be unchanged; whence it follows that the rise in the price P would be proportional to the increase in the total volume V of the currency. For example, if in the beginning the total volume of the currency had averaged \$10 per capita, then a gift of \$5 to every person would add 50 per cent to the volume of currency. To re-store the equilibrium, the scale of prices, represented by P, would have to be increased 50 per cent also. If, instead of adding 50 per cent to the currency, it had been doubled, prices would double. After the equilibrium was restored every two dollars would do the same work which one dollar had done before. Leaving out the case of debtors and creditors, and the temporary disturbance before equilibrium was restored, everything would be readjusted on this basis of double prices.

Since the volume of currency and the prices would be in-creased in the same proportion, it follows that the quantity of goods whose value would equal the total volume of the currency would remain unchanged. We may express this result in the following form :

When the volume of the currency fluctuates, other conditions being equal, the purchasing power of each unit of money varies inversely as the whole number of units, so that the total absolute value of the whole volume of currency re-mains unaltered by changes in that volume.

The question now arises, What fixes this absolute value of the total volume of currency? To answer this let us return to the equation of societary circulation, V X R = K X P. Here R represents the number of times that a dollar changes hands in a year. If we divide the year by R, we shall have the average length of time that a dollar remains in one man's hands. If we take this period instead of one year as our unit of time, we shall have R = I. K will then be the total value of the exchanges during this period, measured on the unit scale for which P = 1. Thus the equation will become V = K. We conclude

The absolute value of the total volume of currency circulating in a social organism is equal to that of the total industrial circulation of the organism during the average time that apiece of money remains in one man's hands.

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