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Laws of a Heterogeneous Currency

( Originally Published Early 1900's )

IN our consideration of monetary operations we have hitherto not taken account of any distinction between the effects of the various kinds of currency which may be in circulation. We have supposed that every dollar which a man received was paid out by him as soon as he could satisfactorily spend it, and that he spent it in the same way whether it was a gold, silver, paper, or credit dollar. But there are certain cases in which these different kinds of dollars will not always be used in the same way, and will therefore not have the same economic effect.

Let us suppose that, in a country using gold only as money, the currency is expanded by the addition of irredeemable paper money. The first effect of this addition to the currency will be a general increase in the demand for goods. This demand will produce an increased activity in trade, to be followed by a general rise in prices. Since this rise of price is confined to the country in question, its citizens will be led to purchase goods abroad, and thus to export gold. It will also lead them to invest more money in watches, jewelry, picture-frames, and other things made of gold. The result will be a diminution in the quantity of gold in circulation. The equilibrium will be reached when the gold eliminated from the circulation is equal to the paper money which has been added. The scale of prices will then be the same as before, and the only effect of the change will be that paper has displaced a certain quantity of gold in the circulation, in the same way that a stone placed in a vase full of water will displace a volume of water equal to its own bulk.

Another similar addition to the currency will be followed in the same way by a disappearance of another portion of gold ; and if the increase be continued, the final result will be that all the gold will disappear from circulation. Besides being ex-ported and melted into jewelry, it will be hoarded up by individuals and banks according to a law now to be developed.

Gresham's Law. This law is : A cheaper or depreciated currency always tends to displace a more valuable one.

At first sight this statement may seem to contravene one of the admitted principles of economics by implying that the worse article is preferred to the better one. But it is really in strict accord with fundamental principles. For the special purpose of making an exchange bad money may answer as well as good money. Now, we always prefer for any purpose the cheapest article which will answer that purpose, unless some evil to the person using it attends its use. For example, we do not make our axes out of gold or silver, but prefer the cheapest metal, namely, steel, which will answer the purpose. If there were a community which had to make silver axes because it had no steel, we should find that when that community began to trade with the rest of the world, the silver axes would entirely disappear and be replaced by iron or steel ones. The case is exactly the same when gold is replaced by paper. As silver can be put to other uses than making axes, so gold has other uses than that of serving as money.

For a similar reason a slightly depreciated paper currency also tends to displace any other paper currency which is at par with gold, always provided that the depreciated paper is accepted in trade. The rule is that it will be so accepted within certain limits. If a bank-note in New York is worth 98 cents on the dollar, a retail dealer would rather accept it and pocket the loss than lose his bargain or run the risk of offending his customer. Then, since the latter can only get 98 cents for it at a bank, he will pay it out in preference to a good bill. The very same motive will prompt the dealer who receives the bill to pay it out in preference to other bills, and thus the depreciated money circulates with greater rapidity than any other. No more powerful stimulus can be given to trade than the feeling of everybody that it is for his interest to get rid of money as soon as he receives it. Moreover, if the depreciated currency is circulated in such quantities that everybody expects to receive it, then, instead of refusing it, the more gracious course on the part of the dealer is to raise the price of his goods. Thus, when the bulk of the currency will only bring 90 cents on the dollar, it is more to the interest of the trader to raise the price of his goods 10 per cent than it is to dispute with his customers about the money they offer him.

The most striking example of the operation of this law is seen when, owing to the depreciation of the currency, the metal in the minor coins becomes more valuable than the money in which larger payments are made. When, in the year 1862, our government began to issue paper money and, in consequence, a gold dollar became more valuable than a paper dollar, all the small silver coins disappeared from the circulation. The reason was that every man who paid four silver 25-cent pieces in change for a paper dollar gave more than the dollar was worth. Every man who paid out the 25-cent piece paid what was worth more than that amount. It might indeed seem scarcely credible that the whole community would put itself to great inconvenience for so insignificant a reason. But the result is nevertheless an historical fact of universal experience. It is probably to be explained, not by supposing that everybody hoards his small change in the case supposed, but that people here and there do so. If only one man out of ten, or even one out of fifty, keeps all the small change he receives, a scarcity very soon results.

Let us now return to the case of the infiltration of paper currency into a gold circulation. If it be continued, the gold will all be displaced. There will also be a slight, though not necessarily great or permanent, rise in the scale of prices. If, however, the addition of paper currency be continued, then, as already shown, prices will rise ; or, in other words, the currency will depreciate. There is no limit to the possible amount of this depreciation. If the paper money is accepted, which it must be if made a legal tender, every one will expect to be paid in paper, and will charge accordingly. The gold dollar having the same value as before, gold will be at a premium, the banks will refuse to part with it, and private individuals will hoard it. It will be bought and sold in the public markets like any other commodity, to be exported to foreign countries in payment of goods, or to be made into articles of utility.

The reader can now form in his mind a symbolic picture of the operation we have described. To make this picture correspond as nearly as possible to the actual case in our own country, let us suppose that our material currency is of three kinds, gold, silver, and paper. The gold in the gold dollar is more valuable than the silver in the silver dollar, while the paper in the paper dollar is worth much less than either. The order of absolute value is then paper, silver, gold. By Gresham's law, the silver tends to displace the gold, and the paper to displace both.

The question may now arise how, on the law in question, it is possible for the gold or silver to circulate at all, if the paper money is preferred to make payments with. But the law does not say that the two heterogeneous currencies cannot circulate together, but only that one tends to displace the other. The solution of the difficulty is found in the law al-ready laid down that, under given conditions of trade and industry, a certain volume of currency is absolutely necessary to carry on the trade of the country on a certain scale of prices. Our experience seems to show that if our material currency were exclusively of gold, we should need about fifteen dollars for each inhabitant, exclusive of the credit currency of the banks. If then we have a population of sixty millions of people, they will need nine hundred millions of dollars in gold to transact their business on a scale of gold prices. Since this amount is absolutely necessary to make the payments, it follows that if there is less than nine hundred millions in paper money, it is absolutely necessary to make use of silver or gold. If the silver and paper together are less than this amount, some gold must still be used ; otherwise prices would fall so low that a gold dollar would be worth less than a currency dollar, and this would lead to the importation of gold and thus remove all temptation to hoard it.

This condition that nine hundred millions is necessary may be represented to the mind by the contents of a vase which holds just nine hundred millions of any kind of dollars. The paper, silver, and gold currencies combined are then just sufficient to fill this vase when the scale of prices is on a gold basis. The fact that if we now infiltrate more paper into the currency gold will begin to pass out, is represented by supposing that if we now add more paper to the vase an equal quantity of gold will overflow. To make the comparison complete, we must suppose that the gold, though the heavier metal, tends to float to the top of the vase, the silver to float under it, and the paper to be at the bottom. Then if we continue to pour in paper money, the gold will soon have floated out in equal quantity. When the gold is all gone, the silver is at the top and be-gins to flow out. If so much paper is added as to fill the vase and displace all the silver, what will then happen ? If there is any place to which the paper can flow, then it will begin to flow out. For example, if the paper is redeemable in silver or gold, then, when its volume exceeds nine hundred millions, people will take it to the banks or Treasury for redemption. Thus it will be impossible to get more than the nine hundred millions in circulation.

If, however, it cannot be redeemed, this is the same thing as saying that the vase is so closed that the paper cannot flow out of it. Then prices will rise, so that not only will more than nine hundred millions of money be in circulation, but more will be necessary to the business operations of the country. We may represent this state of things by imagining our vase to be of some flexible material which will expand to any extent when we force paper money into it.

By thus forming a mental picture of the vase containing, from the bottom downwards, gold, silver, and paper money, and by imagining that as one or the other kind of money is added it displaces other money in the way described, or expands the vase when there is no other money to displace, we shall have an exact conception of the way in which different kinds of currency affect each other.

The law of expansion of price when the currency becomes too redundant explains a fact which frequently perplexes financiers who have experimented with paper money. It is that an issue of such money does not result in a lowering of the rate of interest, or indeed in any accumulation of money at the great centres of trade. The supply of money is apparently as scarce as ever or scarcer. The reason is that, on the higher scale of prices caused by the money, more dollars are required to carry on the exchanges of the community.


From the establishment of the United states mint to the year 1834 our gold dollar weighed 27 grains 916+ fine, and the monetary ratio for our coinage was 15 : 1. But the market ratio of value of the two metals was generally greater (cf. II. 68). The result was that very little gold was coined, and that little did not get into common circulation.

By the acts of June 28, 1834, and January 18, 1837, the weight and fineness of the gold dollar were changed to those stated in II. 68, making the ratio 16 : 1. The result was that gold came into circulation, and, after the gold discoveries of 1849, silver disappeared from circulation except as subsidiary coin. In 1853 the subsidiary coins also began to disappear, and, in order to keep them in circulation, Congress had to reduce their weight by seven per cent. This device worked until 1862. Then, when large volumes of notes irredeemable in coin were issued, gold soon disappeared from circulation, and began to command a premium. The subsidiary silver coin remained until the premium on gold began to approach ten per cent, and then it disappeared also, much of it going to Canada. It was replaced by postal notes. In 1873 occurred the great fall in the market-price of silver, which restored the small silver coins before the premium on gold fell to ten per cent.

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