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Effect of Diminution in the Flow of the Currency

( Originally Published Early 1900's )



OUR answer to the question what will happen in case of a withdrawal of currency from the regular flow, and a consequent diminution of that flow, depends upon principles which have already been developed in the preceding chapters. But it will conduce to clearness to combine these principles in a new form and apply the result to this special question. The immediate effect is very obvious, and is correctly apprehended by the business public. The ulterior effect is not so obvious, but is capable of being made clear to any mind capable of grasping the problem.

The immediate effect of the withdrawal must be a diminution of the industrial as well as of the monetary flow. Let us once more revert to the hypothesis of Fig. 7. The consumers A were there supposed to have been spending their money for clothes, thus causing an industrial flow along the lines d', c', b', and a' from sheep-raisers and wool-dealers, etc., through tailors terminating in the men A. It was shown in the last chapter how the change of A's expenditure from clothes to shoes now causes the industrial flow to pass along the veins d, c, b, a, but without causing any diminution in the demand for employment. Now it is very evident that if A does not spend his money in either of these directions, nor in any third direction which will cause a demand for the products of the community, that particular branch of the industrial flow shown on the diagram will entirely stop. This will be the case if he sends his money abroad, melts it into jewelry, or deposits it in a bank which does not loan it out to its customers. Hence the tailors, shoemakers, and producers of subsistence in general naturally oppose this policy on the part of A, and desire that he shall not only spend his money, but spend it at home.

Now if the money prices of all commodities or services were fixed by any law whatever, whether a legislative enactment or a provision of nature, then this diminution of the industrial flow would be not only the immediate but the permanent result of every diminution in the flow of the currency. But such is not the case. The ulterior effect is that the industrial flow is restored as soon as prices can accommodate themselves to the new state of things. To see this we must first remark that there is no law which prescribes how great a monetary flow is required to measure or equal the industrial flow. This depends altogether upon the scale of prices. When in the equation of the industrial flow, K X P= V X R, we have a diminution in V, it may at any time be compensated by a corresponding diminution in P, without changing the actual industrial flow K. Moreover, this operation of diminishing P, so as to keep up the equation, is nothing more than that of accommodating prices to demand, as we have already shown.

If then we suppose that the change of expenditure by A was equivalent to one per centum of the total expenditure of the entire community, it would follow that one per centum of the industrial population would be thrown out of employment so long as the scale of prices remained the same as before. If this one per centum were composed wholly of tailors, that class alone would be immediately affected. Finding this diminution in the demand for their labor, some of them would have to submit to a reduction of one per cent in their wages, while others would seek for other employments. This competition for work would cause a fall in prices, and the reduction in price would cause an increase of demand. Thus, as soon as the equilibrium was restored, everything would go on as before, except in the following points :

1. There would be fewer tailors in proportion to the rest of the community.

2. Wages would be one per cent lower.

3. Goods would be one per cent cheaper.

Thus everything would go on in its regular normal way, only on a scale of prices one per cent lower. No one except A would in reality be either better or worse off. We may assume that A would be a little better off, because he bought, instead of clothing, something which he must have wanted more than be did clothes.

In tracing this effect of the withdrawal of the circulation we have supposed the withdrawal to be permanent. But in most cases the circulation will be restored through the action of causes brought into play by the very act of withdrawal. For example, if a portion of the volume of currency is sent abroad, that very act, if it diminishes home and raises foreign prices, will lead to a demand for our goods from abroad, and thus result in sending back the money. The more money the owner deposits in a bank the more the bank will have to loan. Hence the general rule will be that the volume of currency cannot be so diminished by bank deposits as to cause a great rise of prices. When prices begin to fall, that very fact will cause men to seek for money in order to buy, and thus will arise a tendency on the part of the owners of bullion to get it coined into money, and on the part of business men to borrow from their banks.

The question may arise whether, after all, we are not here dealing with a general and serious evil in that we are supposing a change of occupation on the part of men and a change in prices of goods, neither of which can take place without loss and friction. This would be true if there were any system on which we could accurately adjust prices and demand, so that everybody should know exactly what occupation to engage in, and pursue that occupation all his life, and if the change consisted in a disturbance of this adjustment. But such is not the case. As a matter of fact, changes of the kind we have supposed are going on all the time as an inevitable result of the continual change in population and tastes, of old men dying off and -new ones coming on the stage, of new modes of production being discovered and new wants arising. Laborers of all classes are continually making changes by demanding higher wages or better terms of labor from their employers, and every change of this sort is necessarily accompanied by change of demand. Prices of every sort are therefore always varying so as to accommodate themselves to these changing circumstances. It is perfectly conceivable that the change made by A in his mode of expenditure would be compensated by a change in the opposite direction by some one else, or by tailors getting dissatisfied and going into other employments of their own accord before A changed his demand. In this case A's change, instead of resulting in the necessity of a new adjustment of prices and wages, might obviate the necessity of an adjustment due to same other cause.

Moreover, we have supposed A's cessation of demand to be for clothing alone, and thus thrown the whole burden of the change on the tailors. But this is an extreme case. The chances are that the demand falls off equally from nearly all classes of products, and that the compensation is effected without any material change of occupation.

The above conclusion is subject to one important temporary exception. Although the wholesale prices of commodities rapidly adjust themselves to variations in the monetary flow, there are certain classes of services in which the adjustment takes place very slowly and is impeded by various causes. The salaries of government officers can be changed only by legislation, and therefore do not respond to changes of demand. The salaries of employés generally are to a certain extent subject to the same rule. They are fixed by agreement or custom, and can be changed only after the pressure has become so serious as to derange the business of employers. The same thing is true of most retail prices. It has been shown in a preceding chapter why they do not respond rapidly to changes in the market. No one expects the prices of dishes on Delmonico's table to rise and fall with the market prices of cattle and flour. Although it is undoubtedly true that in the long-run a permanent change would produce its effect, even at Delmonico's, unless some other cause intervened to prevent it, yet this would not be true immediately.

This resistance to change modifies in an important degree the effect which we have described, and renders it much more injurious to certain classes. What we have conclusively shown is, firstly, that in the case of a diminution in the monetary flow this diminution tends to divide itself in equal proportions in all the channels of flow; secondly, that there is also a tendency to cause a uniform fall of prices; and thirdly, that* when these tendencies have full play, no one except debtors and creditors are either worse or better off.

But suppose that there are certain channels in which the sellers of services or commodities are able to demand the same price as before ; that is, to keep up the same monetary flow as before through the channels which lead to themselves. The inevitable result will be that the flow into other channels will be diminished in an undue proportion, and that other persons must in consequence suffer. To fix the ideas, let us suppose that the persons who can thus command a constant flow to themselves form one half of the community, and that there is a diminution in the total flow of 10 per cent. Let us call A the half of the community who possess this ability to keep up the flow, and B the other half. The result will be that class A will command the same prices for all their goods and services as before, while class B will find a diminution of 20 per cent in the flow to them. Then class A will actually gain, by being able to purchase more cheaply all the goods which class B have to furnish, while class B will lose to the same extent. In the present state of human nature, class B are not going to submit immediately to this discrimination against them; they therefore determine that they will remain idle rather than submit to selling their goods or services at so low a rate. The result will be that their prices as well as those of class A will be kept up, and thus there will be a diminished industrial flow from them corresponding to the diminished monetary flow to them. In short, to take the case just sup-posed, 20 per cent of them will be idle, or perhaps all of them will be idle 20 per cent of their time. Supposing the former case to occur, as it commonly will, the result will be that the 80 per cent of class B who remain at work will be in the same position as class A. Thus we shall have 90 per cent of the population at work on the old scale of prices, and 10 per cent idle, and looking fora living as best they can get it.

Such is the familiar case presented to us in what are commonly known as " liard times." The real trouble in such cases is that wages and prices are higher than they should be to correspond to the monetary flow. Were there any power which could by its own fiat diminish all prices ten per cent, that act would operate exactly like taking the load off a wheel when the driving force became insufficient to turn it. The wheel would immediately commence turning again.

In order that such a fiat should be effective it would have to include not only a scaling down of prices and wages, but of debts. The payment of a debt is an integral portion of the monetary flow ; but it is a portion which cannot be diminished in response to a general diminution in the flow, except through the disaster of bankruptcy on the part of the debtor. The result is that when the general flow of currency diminishes, the intensity of its effect is exaggerated, not only because there are such large classes of men who cannot command the same prices as before, but because in every mercantile community large payments of debts are always due. This is why a commercial panic is first felt at the monetary centres, where business is conducted- and debts are incurred on a large scale, and why in case of such a panic the obstruction to current business is proportionally greater than the diminution of the total monetary flow.

Since there is no power which can possibly issue or en-force such a fiat, or make any regulations respecting prices, it follows that the only available way of avoiding the evils just described would be to make the monetary flow correspond to the variations of price. Were this practicable, the method of doing it would belong to a, separate portion of the present work, since it would be a practical application of economical principles, and not a branch of the science. But we may dispose of the subject by showing what kind of difficulties surround it. What we want is an accordance between the two quantities, scale of prices and flow of currency. Now suppose that the government or banks of the country could, by the issue of credits or paper money, make the flow of currency what it pleased. If prices were fixed by law, there would then be no difficulty in keeping up the equation. But, as a matter of fact, every man is at liberty to set what price he pleases on his goods and services. It would therefore be impossible for the government to keep up the equality. The result of an at-tempt to do so would be a continuous increase in the volume of the currency to correspond to the continually increasing prices which everybody would be putting upon their contributions to the industrial flow.

In this connection it must be remarked that we have in all the preceding discussions supposed the disturbance to begin with a diminution of the monetary flow. But the student of the subject should never forget that the real evil is not merely this diminution of the flow, but the lack of correspondence between the flow and the scale of prices which thus arises. The very same trouble will arise if prices are made higher while the flow remains unaltered. Now, efforts to increase prices or wages are constantly being made on every hand, and no power can prevent them. Let us suppose all the operations of industry to be going on in the normal way already described, everybody being employed on terms which are satisfactory for the time being. As human nature is, we may be sure that this satisfaction will not continue. Some class of men, the builders of houses for example, will be sure to demand higher wages. Let us suppose that they command them; the result will be an increase in the flow of the currency to the builders of houses which must come out of the pockets of their employers. Hence there will be a less flow from these employers to other people. The success of the house-builders will encourage other classes of laborers to demand higher wages. This demand will come at the very moment when, in consequence of the success of the house-builders, there will be an inability on the part of the public to pay even the same wages as before. The probable result will be a more or less prolonged strike, which, even if it succeeds, will lead to some classes being left out of employment. That is, we shall have the very same effects as would have resulted from a withdrawal of currency.



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