Value Theory and Business Cycles [First ed.] 0894990675

Table of contents :
Preface
Table of Contents
Chapter I Ricardo's Theory of Value
Chapter II Sismondi's Theory of Commercial Crises
Chapter III Karl Marx
Chapter IV Early Typed of Currency and Banking
Chapter V John Law
Chapter VI Proudhon
Chapter VII Robert Owen
Chapter VIII Kellogg and "Greenbackism"
Book II Commanded Value Theory in Relation to Business Cycles
Chapter IX Malthus and Commanded Value
Chapter X Tugan-Buranowsky
Chapter XI Aftalion and Voluntary Failure of Demand
Chapter XII Foster and Catchings -- Involuntary Failure of Demand
Chapter XIII Irving Fisher
Chapter XIV John Maynard Keynes
Chapter XV The Malthusian System of Economic Thought
Book III The Problem of Business Fluctuations
Chapter XVI The Problem of Business Equilibration
Chapter XVII Avoidable Causes of Instability
Chapter XVIII America Goes Off the Gold Standard
References Cited in Footnotes
Index

Citation preview

VALUE THEORY AND BUSINESS CYCLES

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ROBERT OWEI\'$ L\BOR TIME ;-';OTF;'I;llte . :--:0 one on st ud v Robert Owe n ' s Labor Time Nore of one hundred vc .irs ago " 'ithout recognizing at once thJr ir \\.".1; rhc origin.,1 "T'erh n r.crari: EI'g" so cnt hus iasrical lv proposed recently by Mr. SCali vnd h is T ec hnocr J tic col lc.>gucs .l ~ rhe molgic money that would sake t hc world 's economic ~t)d mone[.1ry problems, set the wo rld to wor l , elimin ate uncmplovm cnr , and bal ance production ,md consumption. H:ld [he, · been economists in,(e~d of engineers, rhcv wou ld h.ivc known tn :lt the ir experiment had been tried before, .1nd [he rcnsons for its fJilu re. (Sec" Tullf1')Cf(Jty Smolhei (he Price Svsrr»!" bv How.ir d Scott. Harper> M .,g.17.ine, .J~I\. 1933 )

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PREFACE The past t\VO decades have brought forth a vast number of books and articles on business cycles and price movements. I\10st of these treatises have dealt with description, quantitative measurement, causes and cures. The views presented have been highly divergent, and in many instances distinctly contradictory. A partial explanation of this situation would seem to lie in the fact that many have proceeded directly to an analysis and explanation of price movements and business cycles without recognizing that these phenomena are definite problems in applied economic theory, especially value theory. It is the purpose of the present study to show the vital relation between business cycle theory and value theory. In fact, the study is intended to contribute quite as definitely to the economics of value as of business cycles. Book I deals with embodied value theory and price movements. The analysis appears to show that no embodied value theorist can logically explain a business cycle. He either involves himself in a dual theory of value, a logical inconsistency, or explains nothing but a secular trend. The presentation is quite critical, since it deals, as we believe, withthe "false trails," based upon an erroneous theory of value, formulated by Ricardo, and utilized in a modified form by the Socialists, Anarchists, Greenbackers, and those affiicted with "Lawism." Book II deals with business cycles in relation to the marginal utility theory of value, as developed by the Austrian School. The "fore-runner" of this theory was T. R. Malthus, who coined the term "Commanded Value." Malthus serves as a logical starting poin t for the consideration of business cycles, first, because he stressed the importance of "short run" factors, and second, because his value approach was from the demand v

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PREFACE

side. Consistent with his theory of value, he held that business might be depressed, either by a voluntary failure of demand on the part of those who had the po\ver but not the will, or by an involuntary failure of demand by those who had the will but not the po\ver. The former is pursued much further by Aftalion in the light of the completed statement of the marjrinal utility theory of value by the Austrians. The latter is presented, though less successfully, we believe, by Foster and Catchings. Fisher and Keynes extend the argument still farther by showing how a failure of demand may result from unstable 1110ney and unsound banking policies. Book III deals directly with the problem of business equilibration, showing how certain forces contribute to instability, and suggesting \vays and means for the achievement of greater business stability. The positive argun1ent in this work nlay be followed quite successfully by reading the first chapter in Book I and then proceeding directly to Books II and III. Bankers and other business men who n1ay be interested primarily in the monetary sections, should be able to read with profit, chapters \,1 and "1 on "La\visn1" together with chapters XIV and XV, by Fisher and Keynes. Everyone interested in the general problem of business instability even though unfamiliar with economic literature and terminology, should be able to follow quite easily the argument in Book III as it is purposely written in non-technical language. The author is indebted to numerous friends and colleagues for helpful suggestions and criticisms. First of all I am obliged to Professor John R. Commons of the University of Wisconsin who was a helpful counsellor in the early stages of preparation, while I was a graduate student at Wisconsin, and who has made helpful suggestions at all stages. I am next indebted to Dr. W. E. Zeuch, who first developed the "Commanded Value" concept as given by Malthus, and placed before me the results of his labor. The Ricardian theory of value has been made clearer and more accurate by being privileged to "sit in" with

PREFACE

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Professor F. B. Garver of the University of Minnesota in his graduate seminar. Helpful suggestions have been received from my colleagues at the University of Minnesota, especially, Professors Alvin H. Hansen, Bruce D. Mudgett, Roy G. Blakey, Walter I~. Myers and Mr. Herbert Tout. At the University of Chicago) Professors Frank H. Knight and Garfield COX were of great assistance by \vay of cooperation and constructive criticism. Additional help came from Professor I~agnar Frisch of the University of Oslo. The monetary section dealing with Fisher and Keynes has benefited by valuable suggestions made by Irving Fisher, himself, after a careful reading of those chapters. For these kind favors, I am extremely grateful.

'T.

H. L. University of Minnesota Minneapolis.

l\1CCRACKEN

CONTENTS BOOK I Ef\,1BODIED VALUE THEORY IN ITS RELi\TION TO BUSINESS CYCLES PART I PRICE ftl0VEMENTS IN A PRECIOUS METALS ECOJ.lOMY CHAPTER

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Ricardo's Theory of Value .

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Ricardo and Mal thus in vital disagreement over value. Ricardo's theory of exchange value. Effect of demand and supply on value. Possibility of overproduction. Appraisal and cr iticism , Ricardo deals with "the long run," Malthus deals wi th "the short run." Alfrcd Marshall deals with both.

II

II I

Sismon dl's Theory of Commercial Crises The multiple causes of crises. (a) Industrial Revolution and the Factory System. (b) The "false calculus" of entreprencurs. (c) Freedom of competition. (d) The role of banks. (e) Government protection of industry. (f) Mieu» Value. The possibility of general over-production. J. B. Say, Ricardo and Sismondi, debate the "Law of Markets." Sismondi's theory of value, Appraisal and criticism. Errors and inconsistencies.

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Theory of value and price. Explanation of price level. S.urplus value and the business cycle. Appraisal and criticisrn.

PART II EMBODIED llALUE THEORY AND PRICE MOVEMENTS IN A PAPER ftl0NEY ECONOMY IV

Early Types of Currency and Banking . A. Paper money as commodity tickets. The Commodatum and Bailment period. B. Paper money as commodityix

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CONTENTS

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CHAPTER

value tickets. The Mutuum and Certificate of Deposit period. Banks of the "Currency Principle." Banks of emission on the basis of partial reserve, Unregulated, private, wild-cat banking. V

John Law

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"Lawisln"-Bank notes or legal tender notes issued on the basis of comrnodi ties of value other than the precious metals. Law's theory of 1110ney and banking. Experiments in "Lawism." (.1) The Mississippi Bubble. (b) The South Sea Bubble. (c) The Ayr Bank of Scotland. (d) The Bank of Norway at Drontheirn (1816). (e) The French Assignats, Final Criticism of Lawism,

VI Proud/Jon

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His Anarchistic theory of liberty and justice. Theory of value. Theory of nloner and prices. Banque du Peuple. Bank policy and price changcs. Chemical Thcory of Exchange. Appraisal and cr iticisrn.

VII

Robert OU en

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Experilnent at New Lanark, Scotl.md, The National Equitable Labor Exchange. Appraisal and criticism.

VIII

Kellogg and "Green/h1cliSJlt H

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The National Safety Fund. Legal tcnders to be issued against land and commodities. Abolition of interest except for cost of credit administration. Theory of value. Nature and properties of money. I~cLltion of interest rate to purchasing po\ver of money, Appraisal and cri ticism, Greenbackism and Populism. Note: The Ford-Edison Plan. Issue currency secured by Muscle Shoals, and less pcr ishablc commodities as cotton, wheat, wool and coal. John Stuart Mill's criticism of all "Lawistic" proposals.. BOOK II COMMANDED VALUE rrHEORY IN ITS RELATION TO BUSINESS CYCLES PART 1 PRODUCTION AND CONSUMPTION AS RELATED TO EFFECTIVE DEMAND

IX M a/thus and C o1Junanded Value

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The "short run view" of Malthus contrasted with the "long

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CONTEl'tlTS

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CHAPTER

run view' of Ricardo. Mcaning ;!.nd significance of "Cornmandcd Value." Volun tarv failurc of demand by thc rich who have the po\ver but not the w i 11. In \"01 un tary fail urc of demand by thc poor who ha \"C thc wil l but not the PO\\'cr. False trails. (a) [ncrcasc of population. (b) Saving and capi tal accumul ation , (c) I nvcntions and labor saving deyices. Truc causes of progrcss and weal th. LT uion of powers of production with thc means of distribution. (a) Division of landcd property. (b) Internal and external commerce. (c) L' nproductivc consumption. Summary appraisal. Anticipates marginal utili ty of Austrians and opportun ity cost of Davenport.

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TlIgan-Baratto:~:sl)',

The SignifiCtUbCe of a lvtolZey and Credit Econom» . . 137 Importance of a transition Irorn barter to :t money and credit econ0111Y. Contrasted with Karl Marx. How .1 partial depression develops into a general depression,

A'[talion and Volulttary Failure of Denzand .

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Demand and mnrg inal utility. Volun tary failure of demand by those who have thc pO\\'cr but not t 11C wi ll. Criticisrn of ]. B. Say's Law of Markets. 'The cause of crises. The causes of periodicity. (.1) Thc round-about process of capitalistic pro.luction. (b) Thc principle of d iminish irig utility. (c) Errors in j udglTICnt by entreprcneurs. Appraisal and criticism.

XII

Foster antl Catchings-Involuntary Failure of Denland 157 Invo1 untary fail ur e of demand because consumers have not thc povver, due to profits and saving. Unbalancing factors. (a) Money. (b) Profits. Thc Dil cmrnn of Thrift. The "Ten Minus One 'I'hcorcm." Supplying the deficiencies in consumer demand. (a) Planni ng Boards. (b) Pub] ic works. (c) Credit expansion. Appraisal and criticism.

PART II MONETARY INSTABILITY AND THE PROBLEM OF EFFECTIVE DEMAND XIII

Irving Fisher Money, thc maj or cause of business instabil] ty, Causes of monetary instability. (3) Quantity of n10ney. (b) Rate of interest. Statistical proof that unstable money gives unstable business. The problem of control and stabilization.

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(a) A tabular standard. (b) Open Market Operations. (c) Discount policy. Appraisal and criticism.

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] ohr: ]\1 aynard K e)'7zes . . 193 Poin ts in common \\'1th Mal th us and Fisher. Weaknesses in banking and currency control. (:1) Rigidity of gold reserves. (b) Banking irrcsponsibi lity. (c) Tardy interference and over-interference. (d) \V cakncss of gold as an international standar d of value, Remcdv through "]\;I.1naged Currcncv" and balance between i nvcstmcn t and savi ng. Hayek's cri ticism of currency management. General observa tions.

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The MaltlzlIsii.llt Sys/e/Jt of Economic Thougl!t . 210 Rela tion of theory to actu :11 i tv. I n adcquacv of Ricardian System of ECOn0111ic Thought. Four cardinal points in Mal th usi.ui Econom ics. (a) 'The Comma nded theory of value, explains \\-h:' supply docs not ncccssar ily generate demand. (b) The ro lc of 1110ncy and crcd it-e--expla ins why partial depressions yield general depressions. (c) The principle of dilnini~hing ut ilitv-c--givcs bJsis for explaining voluntary failur c of demand. (d) The role of unstable nl0ney -its relation to business instability.

BOOK III

'I'HE PROBLEM OF

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BUSI~ESS

EQUILIBRl\TION

The Problern. of Bnsiness E'luilibration . 219 'The static state. Requisites of frec competition and a perfcct market, LTna\"oicbbJc causes of business instability. Frozen pricc structures. RcJ cyancy of Proudhon's Chemical Theory of Exchange. Eff ccts of piece-meal price-fixing.

A voidable Causes of I JZstabil-it}' . (a) Tariffs. Bcaring upon the Law of Markets and problcm of effective demand. 'Tariffs, reparations and wardebts. Bearing of imports upon exports. (b) Unstable Money. Means of reducing monetary instability. (c) War and business instability. America Goes off the Gold Standard . 254The B;lnking Panic of March, 1933. Banks of nations close and specie is suspended. Three contributing causes. (I) A technical weakness in the gold standard. (2) An Intolerable Banking System. (3) The failure of liquidation to

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Iiquidate. The deflation spiral. By \yay of suggestion. (I) Government intervention to liquidate frozen price structures. (2) A 1110ne;: and ban king policy wh ich tcrminates forced sell ing, and the deflation spiral downward. (3) The substi tu tion of managed currency for the gold standard during the period of the depression.

References Cited ill F ootnotes Index

Book I v:MBODIED \TALLTE TI-iEOR1~ IN ITS RELATION TO BUSINESS CYCLES

P.L1RT 1

PRICE /\,10VE1\;1ENTS IN A PRECIOUS METALS ECONO/t)lY " . ~ -, ,

CHAPTER I

RIC..t\I~DO'S THEORY OF VALUE INTRODUCTION THE distinction made by Adam Smith between "Natural Value" and "Exchange Value' seerns to have given rise to two distinct theories of value. One is a commodity theory of value conveying the idea that value is intrinsic, embodied in a commodity and in its original statement was determined by the quantity of labor bestowed, The other is a demand and supply theory of value, arising out of transactions in the market, the earliest expression of which was that value consisted of "commanded labor." The signifIcance of this distinction is clearly revealed in a letter from l{icardo to Malthus, "1 sometimes think," wrote Ricardo, "that we do not attach the same meaning to the word demand. If corn rises in price, you perhaps attribute it to a greater demand. But demand cannot, I think, be said to increase if the quantity consumed be diminished, although much more Inoney may be required to purchase the smaller than the larger quantity." 1 Ricardo illustrated the point substantially as fol lows: 'If England imported 5000 pipes of wine one year at a cost of 5000 shillings and "the following year imported 4500 pipes at a cost of 9000 shillings, you (Malthus) would say that the demand for wine had risen because it commanded a greater sum of money in exchange. I (Ricardo ) would say that the demand had fallen because a smaller quantity had been purchased.'

1 Letters of Ricardo to Malt/JUS, p. 42) Aug. 30, 1814-- (Bonar's Edition.)

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.. .. The .Ilustration as given really fails to show whether de.. ~ · .-mana has risen or fallen. \\T e cannot tell whether the great ft. ~.... iTil.:r~,as.~ in price is evidence of an increase in demand or reveals ". i·;.6tlat~v~ly inelastic demand whereby a slight change in supply :' : ..' works a gr~at Ch,tllge in price. IT et the illustration does serve · ' ' to .show how vital "vas the difference between the Ricardian and Malthusian concepts of value. Ricardo, leaning strongly towards the embodied value concept approached the probleln of value from the supply side. Malthus, on the other hand, committed thoroughly to a commanded value analysis approached the problem of value from the demand side. Therefore, Ricardo contended that the demand for wine had fallen because a smaller supply was taken, while Malthus insisted that demand had risen because wine conimanded. more nl0ney in exchange. For the most part, Adam Smith held strongly to the ernbodied value concept for he took as his fundamental thesis that labor is the source of the Wealth of Nations and the Natural Value of a thing is determined by the amount of labor bestowed upon it. This was the view expanded by Ricardo, appropriated by Marx and championed by all those who are considered in Book I. The "Commanded Labor" theory of value was given its first clear statement and impetus by Malthus and will be treated in Book II. Yet Malthus, also, went back to Adam Smith and his catch phrase "the propensity to truck, barter and exchange." While Smith used this expression, primarily to explain the cause of division of labor and separation of occupations, one cannot help but observe that if the value of all goods "vas determined by the amount of labor embodied and things always exchanged at that ratio there would be little place for truck and barter. Thus we see, that while Smith presented both ideas he held the first to be fundamental and since his world of thought was one of free and unlimited competition among goods freely reproducible, he could logically maintain that in the long run exchange value, the price fixed by truck and barter, would be

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RICARDO'S THEORY OF VALUE

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determined quite definitely by natural value or labor cost. Such is the origin of the t\VO streams of thought which are to be traced in this study. Book I will deal with business cycle theory based upon an embodied value analysis. Book II will be g-ivcn to a consideration of business cycle theory based upon the Malthusian concept of "commanded value." If our analysis is correct, no embodied value theorist can logically explain a business cycle. He must stop with the explanation of a secular trend or arrive at an explanation of business cycles by a logical inconsistency or contradiction. On the other hand the constructive approach to business cycle theory proceeds from the commanded theory of value first formulated by Malthus, To Malthus goes the honor of being the first business cycle theorist.

})).. vn:

HJCARDO

As we begin our study of business cycle theory based upon an embodied value analysis it is logical and expedient to start with one of the greatest val ue economists, David Ricardo. \,T c at once recognize an apparent inconsistency. First of all, Ricardo forrnuJated no theory of business cycles-indeed in the hypothetical svstern which he presented, no cycle could possibly take place. In the second place, a careful study of his theory of value will reveal that he was not a "Simon-Pure" exponent of embodied value. Nevertheless, those who do accept an embodied value theory and build thereon a theory of business cycles have drawn so largely from Ricardo's labor theory of value that it is necessary to analyze his theory with care in order to have the proper background for those which are to follow. Theory of Exchange Value. First and foremost, it is necessary to state that Ricardo's theory of value is a "Labor Cost Theory." The first sentence in his Principles of Political Economy states that "The value of a commodity, or the quantity.. of any other commodity for which it will exchange, depends upon the relative quantity of labor which is necessary for its production." Utility was recognized as essential to value but it could not be used as the measure of value. Scarcity had a bearing

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VALUE THEORr AND BUSIJ.VESS CYCLES

upon value, particularly upon old and rare articles incapable of reproduction, but in the main sphere of economic life where goods were freely reproducible, and exempt from monopoly control, value would be determined by the quantity of labor invested. The background out of which grew the embodied labor theory of value is very interesting. It will be recalled that the Physiccrats had spoken of wealth as being due to the bounty of nature. When man labors along with nature, there is a Produit Net. Adam Smith, on the other hand, held that wealth, which had exchange value, was due, not to the bounty of nature but to the niggardliness of nature; that to get nature to produce there must be toil and effort. Hence it was only natural that the value of a thing should be determined by the labor expended in overcoming the niggardliness of nature. To show that this is where Ricardo went for the basis of his theory we note in the first section of his chapter 011 value that he quoted Adam Smith as [ollows: "The real price of everything, w hat everything rcall y costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What everything is really worth to the man who has acquired it and who wants to dispose of it, or exchange it for something else, is the toil and trou ble which it can save to himself, and which it can impose upon other people." "Labor was the first price, the original purchasemoney that was paid for all things." "It is natural that what is usually the produce of two days' or two hours' labor, should be worth double of what is usually the produce of one day's or one hour's labor." 2

But Ricardo was more definitely committed to the embodied labor theory of value than even Smith himself, for Ricardo went on to say that Smith who "was bound in consistency to maintain that all things became more or less valuable in proportion as more or less labour was bestowed upon their pro2 Adam Srnith's rVealtlt of Nations, Book I, ct. VI, p. 56, (First Edition, 1776). Ricardo's Works, p. t o, (McCulloch)s Edition) 1888).

RICARDO'S THEORY OF l'ALLIE

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duction, has himself erected another standard measure of val ue, and speaks of things being more or less valuable in proportion as they wil] exchange for more or less of this standard measure, Sometimes he speaks of C014n, at other times of labour, as a standard of measure: not the quantity of labour bestowed upon the production of any object, but the quantity which it can C01Jl1nanJ in the nrarkct: as if these were t\VO equivalent expressions, and as if because a man's labour had become doubly efficient and he could therefore produce twice the quantity of a commodity, he would necessari ly receive twice the former quantity in exchange for it.".3 But to this idea Ricardo did not agree and upbraided Smith for his error and inconsistency. There is a refinement, however, 111 I~icardo's Labor Cost theory of value which distinguished it somewhat froIn other labor theories, and shows how he veers off from an unconditional adherence to an "cn1boclied labor value" concept such as we find in Marx and Sismondi when they speak of "congealed labor-power. n Ricardo speaks of value as being in proporlion to "labour bestowed." The s.alu« of a given comrnoditv is governed by the quantity of labor bestowed upon it, but exc!7ange values are relaiivc rat los, determined by the rclati ve amounts of labor bestowed upon them. "The rule which determines how much of one (commodity) shall be given in exchange for another depends almost exclusively on the comparative quantity of labour expended on each." ,1 To make the point still clearer,

eel have not said, because one commodity has so much lahour bestowed upon it as will cost 1000£., and another so much as wili cost 2000£ that therefore one would be of the value of r ooo L, and the other of the value of 2000£.; but I have said that their values will be to each other as t\VO to one, and that in those proportions they will be exchanged. It is of no importance to the truth of this doctrine, whether one of these commodities sells for 1, 100£. and the other for 2,200£. or one for 1,500£. and the other for 3oooL.; into that question I do not at present enquire; I affirm only, that their relative 2

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Ricardo's ~·VorksJ Ch. I, p. Ibid., p. I O.

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VALUE TIIEORY AND BUS/J.,/ESS CYCLES

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values will he governed by the relative quantities of labour bestowed on their production." :>

. The above quotation must not be interpreted to mean, however, that Ricardo renounces all quantitative relationship between absolute value and labor cost, for in the foot note to the above quotation, he says "Malthus appears to think that it is a part of my doctrine that the cost and value of a thing should be the same; it is, if he means by cost (cost of production.' " By this Ricardo means capital costs as well as direct labor-costs. But since he looks upon capital as "stored-up labor," then capital costs are only indirect labor-costs. Therefore, while Ricardo's treatment of value is somewhat confused and an1biguous, a fair in. terpretation of his general theory of value is that value, both absolute and relative is determined by labor bestowed and in proportion to labor embodied.

Effect of DLl)ilanll anti Supply on Exchange Value. Ricardo's treatment of Dcn1and and Supply as factors in determining value and price was only a corollary of his labor theory of value. In his chapter on ((Dernand and Supply" he started with the statement ((It is the cost of production which must ultimately regulate the price of commodities, and not, as has been often said, the proportion between the supply and demand; the proportion between supply and demand may indeed, for a time, affect the market value of a commodity, until it is supplied in greater or less abundance, according as the demand may have increased or diminished but this effect will be only of temporary duration." Perhaps no point in Ricardo's whole theory has ever been attacked more vigorously than this, and no part did he defend! more vigorously. For instance, Lord Lauderdale had submitted [ four propositions: G I. A Commodity "would be subject to an Increase of its value from a diminution of its quantity. 1j

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Ricardo's Works, p. 3 o. Lauderdale, An Inquiry into tile Nature and Origin of Public Wealtlt,

p. 12. (1819')

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2. "To a diminution of its value, from an augmentation of its quantity. 3. "It might suffer an augmentation in its value from the circumstance of an increased demand. 4. "Its value might be diminished by a failure of demand."

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In reply, Ricardo admitted that such might be true of monopolized commodities, or rare articles of antiquity, but the price of commodities which were subject to competition, and were freely reproducible, so that the quantity might be expanded or contracted as the price varied, would ultimately depend, not on the state of demand and supply but on the increased or. diminished cost of their production. "Diminish the cost of production of hats, and their price will ultimately fall to their new natural price, although the demand should be doubled, trebled, or quadrupled. Diminish the cost of subsistence of men by diminishing the natural price of the food and clothing, by which Jife is sustained, and wages will ultimately fall, notwithstanding that the demand for laborers may very greatly increase." 7 T IJeory of Prices, On the basis of the above, we are now able to formulate Ricardo's theory of prices and its application to a theory of Crises. The value of money was determined as everything else, by the labor bestowed on specie. He was a bullionist to the core, hence commerce consisted of barter of physical commodities, in accordance with the amount of labor embodied. Money had its natural price, and its exchange value was based upon that. If the cost of mining, refining, and coining fell, prices would rise, for the natural price of gold had fallen. If by the introduction of new machinery, improved processes, etc., the natural price of commodities was reduced, i.e. the labor-cost required to overcome the niggardliness of nature became less while no similar improvements took place in the realm of precious metals, then the price of commodities would falL Ricardo's theory of prices was nothing more nor less than a logical deduction from the premises with which he started, and 7

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VALUE THEOR1' AND BUSINESS CYCLES

if the premises or assumptions be granted, the conclusions seem inevitable. Ricardo was a true disciple of Adam Smith as regards Competition and Laissez-Fairs. As a broker on the stock exchange, he knew it to be his function to make capital liquid so he assumed not only freedom of competition, but fluidity of capital and labor as well. With these assumptions, what was more obvious than that in the long run, natural value and exchange value should coincide? If, in any trade or business, the exchange value proved below natural value, competition and self interest would impel entrepreneurs to withdraw labor and capital from those enterprises to others where exchange value was in excess of natural value. In making the transition both would be restored to the level of natural value. He admitted temporary fluctuations due to "accidental and temporary" causes, but discrepancies were always slight, and constantly in process of correction. Movement of the General Price Level. \Vith Ricardo there could be no cycle, for natural value was determined by laborcost, and market value or price could vacillate but little above or below due to competition. Yet he predicted a secular trend of prices downward, for the reason that he expected more rapid progress in overcoming the resistance of nature in the production of other commodities than in the production of gold. Therefore, a given quantity of gold would gradually come to exchange for greater and still greater quantities of wares. The clearest representation of Ricardo's predicted price trend, is a river with its natural level at any particular point, about which the ripples rise and fall but with a general downward movement. Could there be a General Overproduction? To this question Ricardo's logic gives an emphatic "NO!" We have noted that his was a barter economy of physical commodities each of which had its natural value. Now, general overproduction assumes a general glut and uniform low prices, but according to Ricardo the only source of demand for goods consisted of a supply other goods. If everyone had an abundance of supply, then exchange would be easy, and society would revel in opulence. If

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RICARDO'S THEORr OF VALUE

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II

there were goods that could not be sold) it was because the people who wanted those goods did not have goods in exchange. A temporary maladjustment might be conceivable-a temporary shortage of certain goods-but never a general overp roduction . " But even that situation would be decidedly abnormal since competition and self interest would quickly correct it. For example, if the owners of cloth found a slow sale for their product and could not exchange it for its natural price, while food was scarce and exchanged for something above its natural price, then many of the cloth merchants would transfer their activities and capital to the profit-making corn industry thereby increasing the supply of corn and diminishing the supply of cloth . By no conceivable circumstance could all goods be overplenteous at th e same time. Neither could market prices in general be above or below th e level of natural values. Ricardo could not conceive total demand and total supply out of proportion. In fact he took little notice of demand. Wants were assumed, and demand was ever present when the subject possessed a supply of wares. He admitted the possibility of slight temporary maladjustment of suppl ies, yet such a situation was in process of constant adjustment. Fluctuations, for Ricardo, consisted in a continuous series of slight aberrati ons in market prices about "Natural Prices." A busin ess cycle positively could not happen in Ricardo's assumed economic world. APPRAISAL AND CRITICISM

Given the premises with which Ricardo started, his conclusions seem impregnable. These we must summarize in typical Ricardian sty Ie. Ricardo assumed a world of free competition, where monopolies were nonexistent or negligible, where governments practiced laissez-iairc, a world where capital, labor, and the entrepreneurial function had complete mobility; where the only medium of exchange was bullion; a world in which the value of all things was determined by the relative quantities of labor embodied. Supply was limited only by the resistance in nature which labor

12

VALUE THEORY Al-lD BUSIl\TESS CYCLES

had to overcome. Wants were insatiable, and demand was taken for granted when purchasing power, or control over supply was present. As a business man and stock broker he was keenly alive to all disturbances of the price structure due to temporary or accidental factors. But as a writer, formulating a system of economic principles, he rigorously ruled out all transient or disturbing factors. He applied his logic solely to a balanced system, operating under the conditions of free competition and a perfect market. Given these conditions, "in the long run" the values of all commodities will be governed by cost of production and the economic system will gravitate towards equilibrium. Economists and business men are still under a debt of gratitude to Ricardo for focusing attention upon the long-run forces. He was writing in the midst of a severe depression following the Napoleonic Wars, As usual under such conditions people were despondent, pessimistic, and fearful lest depression would be chronic and perpetual. In the midst of this gloom it was most refreshing and assuring to follow the keen analysis of Ricardo and be assured that for every industry operating at a loss, because market price was below cost of production or natural value, an overpowering force was incessantly operating to bring exchange values up to natural values, and profits to normal. While the above appraisal is complimentary and deserving it is neither adequate nor complete. Ricardo's strict adherence to the problem of normal value and the long-run forces is forced upon him by his concept of value and interpretation of demand. He studiously avoided being drawn into a discussion of market value and the short-run forces making for instability because there was involved a logical inconsistency. Let it be recalled that according to Ricardo, the source of / value is labor; that commodities take on value as labor is bestowed upon them; that the flow of value is from labor to the commodity. Therefore, value increases without limit as supply increases if the labor-cost remains constant. A supply of one million loaves of bread will possess one million times as much

I

I '(

I I

I

I

_j.

r,

,(

.' l

l

RICARDO'S THEORr OF VALUE

value as one loaf of bread, if a million times as much labor has been invested. Verily for Ricardo, value increases as supply increases, and in the same proportion. Such an analysis does not lead to a law of demand and supply but to "a law of two supplies." Goods exchange against goods in proportion to the ' quantity of labor invested. Since he assumed wants to be innumerable and insatiable, effective demand was always present when a supply was present, the market automatically clearing itself and maintaining equilibrium. Had Ricardo reversed the flow of value, so that labor was valuable only when bestowed upon goods of value; and that goods had value only when they would command other goods in a peaceful and voluntary exchange, regardless of cost; in other words, had his theory of value been subjective rather than objective, he would have recognized that value did not increase automatically as supply increased; that temporary forces might drive market values far from labor-cost or natural val uc , that the creation of a supply did not necessarily yield a proportionate demand. It was this commodity concept of value, which caused him to differ so radically from Malthus when he held that demand had fallen when 4,500 pipes of wine were imported instead of 5,000 even though the cost of the lesser amount had been 9,000 shillings instead of 5,000. Demand had fallen because a lesser quantity, or "fund of labor" had been imported even though it had commanded a great deal more in exchange. Ricardo, with his embodied theory of value, and approach to value from the supply side, was led to a consideration of the , long-run forces which make for stability. By so doing he becomes the pioneer in the study of equilibrium economics. Malthus, with his commanded theory of value, and approach to value from the demand side, was led to a consideration of the short-run forces which make for instability. By so doing he becomes the pioneer in the study of business cycles. The one concentrated on normal value and explained equilibrium. The other concentrated on market value and explained instability. Both

14

l'AL[JE THEOR}" AJ.\"D BUS/l-lESS C}"CLES

systems are tinged with error and incompleteness, yet in some degree the systems are complcmen tary rather than con tradictory." In the historical development of the theory of value, the Ricardian trail leads to the modern Neo-Classical school which approaches the problem of value from the supply side and gives ma j or consideration to "cost of production" including all costs. The Malthusian trail leads to the Austrian School which approaches the problem of value from the demand side and gives ma j or consideration to utility or subjective valuc, Both angles must be considered. After a century of discussion, the great Alfred Marshall cuts the Gordian Knot with these significant words, "As a general rule, the shorter the period which we are considering, the greater must be the share of our attention which is g-iven to the influence of demand on value; and the longer the period, the more important will be the influence of cost of production on value." !) Since the subject under consideration in this study deals with business cycles, which involves a rnaj or consideration of short time factors, vYC shall find our richest nuggets while follo\ving the Malthusian trail and pondering the problem of effective demand. s

]Ilote:

For the

t rcat mcnt

of \Ldthus, sec Ch. IX.

Alfred Marshal l, Prine] pIes of E conomics, p. 34-9. (MaClllilbn and COInpan)", Eighth Edition.) !)

rl

CHAPTER II

SISMONDI'S THEORY OF COMMERCIAL CRISES ONE of the greatest critics of Ricardo, and particularly of his contention that crises from overproduction were impossible, was Simonde de Sismondi. For this reason it may seem decidedly illogical to place him in the same category as Ricardo. Yet, his theory of value, while not so clearly formulated as that of Ricardo and Marx, seems to be in the main an embodied labore.theory. Since this is the basis for our classification, he may be treated at this point. As Sismondi is one of the earliest Socialists, and a champion critic of the modern capitalistic regime, it is expedient to consider his work quite fully as virtually all the arguments presented later by others, were set forth by this dynamic pioneer. \Ve shall first present his explanation of commercial crises. It will then be easier to interpret his theory of value and the logical relation between the two. THE MULTIPLE CAUSE S OF CRISES 1 THE

INDUSTRIAL REVOLUTION

AND

RIS E OF THE FACTORY

SYSTEM

Large-Scale industry, according to Sismondi, is fatal both to the entrepreneurs and to the workers. Crises of overproduction are constantly driving the former into bankruptcy, while the latter experience painful suffering and starvation. Yet overproduction, he said, is a recent phenomenon, and is an automatic byproduct of the new forms of production-a necessary consequence of large-scale industry and free competition. 1

Albert Aftalion, L'tEuore Ecouomique de Simonds de Slsmondi, pp . 87-

12 4 .

IS

t

16

VAL[]E

Tl/EOR)~

A;.\-D BUSIJ.\TESS CYCLES

In the patriarchal, primitive organization each family was self-sufficient and thus was able to regulate production to its own needs. But with the division of labor an10ng falnilies and individuals the problem of balance between production and consumption presented itself. Even in the handicraft stage the "offre" easily adjusted itself to demand, for the consumers created work by their consumption and the goods were made under the consumer's direction and immediately paid for when finished. The corporate organization of the old reginle was another obstacle to a glut of the market, There was no free competition between masters in the same craft. They were thorough 1y organized and all the legislative intervention of the middle of the last century (Eighteenth Century) was whol ly favorable to the producer. There was no price cutting and the number of apprentices per master was limited. Those who showed peculiar ability were given a certain preference by the buyers but all found work and all were sure of life. No overproduction was thinkable. Sismondi admitted that the old system was ((inconvenient" from the "chren1atistigue" (money nlaking) point of view and that the spirit of invention was somewhat paralyzed and progress retarded. y et "\V hcrever are found peasant proprietors are also found that ease, that securi ty, that independence, that confidence in the future, which assure at the same time happiness and virtue. The peasant who, with his children, does all the work on his little inheritance, who neither pays rent to anyone above him, nor wages to anyone below him, who regulates his production by his consumption, who eats his own corn, drinks his own wine, is clothed with his own flax and wool, cares little about knowing the price of the market; for he has little to sell and little to buy and is never ruined by the revolutions of commerce. Far from fearing for the future, it is embellished by his hopes." ~ Contrast with this the conditions resulting from the advent of the Industrial Revolution, These happy peasants had become dis-e-

2 Sismoridi, Etu.les sur les Sciences So ciales, Vol. II, pp. I09-jO, or Political E COJ/OJJIY and t h c PIJilosoplly of Go-ucrnmcut , arranged and translated by M. Mignet.

SISllJONDI'S TIIEORY OF

COj"!~1ERCIA.L

CRISES

17

propertied proletariat-servile laborers for the incoming capitalistic class. "The proletarii are cut ott from all the benefits of civilization; their food, their dwellings, their clothes are insalubrious; no relaxation, no pleasures except occasional excesses, interrupt their monotonous labours; the introduction of the wonders of mechanics into the arts, far from abridging their hours of labour, has prolonged them: no time is left for their own instruction or for the education of their children; no enjoyn1ent is secured to them in those family ties which reflect their suflering , it is almost wise in them to degrade and brutalize themselves to escape from the feeling of their misery; and that social order which threatens them with a worse condition for the future, is regarded by them as an ene1l1Y to combat and destroy. This is not all; whilst their own distress is increasing, they see society overcome, as it were, by the \veight of its material opulence; they are in want of everything, and on all sides their eyes are struck with what is everywhere superabounding." 3 THE "FALSE CALCULUS" OF Er-.;TREPRENEURS

With this revolution in industry, however, the problem of equilibrium between supply and demand arises and becomes very delicate. One manufactures for an extended market, for an entire country, for foreign countries. All production becomes a speculation. All entrepreneurs depend upon a "public metaphysique," a group invisible, unknown, whose needs they hope to satisfy and divine with their speaking. But the more importance manufacturing acquires, the more ignorant is the manufacturer of the consumers for whom he works, and the greater the risk of miscalculation. With the extension of the market it becomes impossible to conduct business upon exact calculations and crises of overproduction constantly menace the whole industrial group. It is necessary that the "previsions" of the entrepreneurs be exact for they are not able to conserve their merchandise and ~ Political

EC01l0JJ1Y,

Sismondi

err.

by M. Mignet }, p. 199. See also Chapter

"Des Manufactures,' Vol. II) Etudes sur L'Economie Politique, Sismoridi.

I

L

18

VALUE THEORY AND BUSIJ.\TESS crCLES

wait for better markets. I t is necessary that they sell their products at good prices in order to continue production, buy raw materials, pay wages, and reimburse creditors. The situation is the same for the merchants. Most men count on commerce for the satisfaction of their needs. In the partition of the social functions the merchants are made the administrators of the reserve fund of society. But the merchants lose profits on their goods if they hold them too long in their stores and they also fear the changes of taste and fashion. They are forced to sell the products as quickly as possible. With the establishment of the great stores in large cities, with the great facilities for modern transportation, goods circulate with lightning rapidity. Because of the widelv expanded market the danger of miscalculation is infinitely increased, while because of the accelerated rapidity of circulation a glut of the market suddenly blocking this circulation of goods is most catastrophic. FREEDOM OF COMPETITION

In conjunction with the false calculations of the entrepreneurs there has come the modern freedom of competition to increase the dangers of crises. Instead of being united as forrnerlv, producers are now rivals-the natural enemies of each other-each attempting to steal away the customers of his competitor. Each thinks only of his own personal interest and attempts to elevate his fortune on the ruins of a competitor. Among all manufacturers and merchants there is universal competition-a war to the death. In order to triumph in this struggle it is necessary to sell cheap. To this end one must use all his ingenuity to reduce the expenses of production, to employ the best processes of manufacture, and machines of mechanical perfection. The result is that victory goes to those that produce at the lowest price but it also means the bankruptcy of other manufacturers. Illustrative of this, Sismondi pointed to the progress in the manufacture of cotton in England and he insisted on presenting the bad features of this prosperity and the disasters that it entailed. The great factories developing from the inventions of Arkwright and

SlSIv/Ol\TDI'S THEORr OF COJfMERCIAL CRISES

19

others, magnificent factories though they were, had spelled death to the poor women of England. Thus it was with all new inventions. At the very time that they brought large profits to their authors or to those who exploited the invention, they ruined the existing industry and led to a perilous overproduction. This resulted in a vicious circle which ran as follows: "A surplus of products called for a new decrease in price which, in its turn, occasioned a new excess of fabrication. One follows this circle only to terrible ruin." To undersell and overtrade competitors-these were the two disastrous operations to which modern industry had constant recourse.' THE ROLE

c.

OF THE BANKS

The banks, principally the banks of emission, increased still more the danger of overproduction. True, credit creates no new wealth; the issuance of bank notes does not augment the wealth of a nation. Banks only retire from circulation the specie which they replace with paper. They add nothing to the riches of society but they increase the capital which enters into production.. This use of capital, formerly sterile, which people so often extol was, for Sismondi, a distinct evil. Like the machine, like the great industrial enterprises, the banks aided in the multiplication of merchandise, and helped to gorge the market. Speculators hurled themselves into excessive production on the basis of this credit, not in order to satisfy the demands of the consumers, whose needs were already satisfied, but in order to draw ~'_.--~ profits on fictitious capital. They entered business where there was no room for them and in order to attract customers they lowered the price. The other manufacturers were forced to meet the new competitors; production became accelerated, the pace became disorderly, men worked without rest, their labor was lost, and the crisis finally came with a crash. Thus we see how his opposition to liberty of bank note issue accorded with his general theory. He addressed to the banks the 4

Aftalion, L'(Euure Economique de Simonde de Slsmondi, p. 93.

20

VALUE THEORY AND BUSINESS CYCLES

same reproach as to the great modern productive process. They augmented the feverish instability of modern industrialism. Banks rendered crises more terrible still. GOVERNMENT PROTECTION OF INDUSTRIES

Sismondi was most vehement in his denunciation of governmental bounties and protective tariff systems. Despite all of the danger of crises which resulted from the industrial system or from the banks, even the state encouraged the expansion of manufacturing. The old mercantilist had done this 'because he had a false conception of riches but, in Sismondi's time he said the errors of Mercantilism had become well recognized. Yet governments still continued their pernicious policy of protection. On this point Sismondi was in substantial agreement with \,' Adam Smith. He presented in favor of free trade the classical arguments: the advantage that two parties draw from exchange; the benefits of buying the merchandise where the climate, the soil, the racial aptitudes enable one nation to produce a better product at a lower price; the territorial division of labor which permits each country to specialize in the production of those things for which it is peculiarly adapted; and he stressed the sacrifices which a system of protection imposed upon consumers. That which he reproached above all in Protection was the encouragement that it gave to the manufacturing ardor among modern people which was in no way in need of a stimulant.. Protection led not only to rivalry among individuals but to a contagious emulation among nations in order to dominate the markets of the world and secure possession of new outlets fot trade.. The "Guerre amort" was no longer circumscribed by the frontiers of the interior country but they extended far beyond . It had become universal, and commercial and mercantile speculation was given the honorable name "patriotic service." The goods of strangers came to be regarded as a calamity. The minds of statesmen seemed impervious to the idea that nations might be better served at times through foreign importation than by artificial stimulus to a handicapped productive process at home.

SISAJO~\?D1'S

THEORY OF COj\1J1ERCIAL CRISES

21

Then Sismondi asked the pertinent question aLes acheteurs sontils les tributaires ou au contraire les producteurs sont-ils les salaries de l'etranger?''' ;j But all efforts to check governn1ental protection were futile. Every conceivable device was used in order to extend markets and gain outlets for goods. The protectionist system or policy served onl y to multiply the crises of " overproduction, a condition towards which everything moves in the organization of modern econon1Y. 1\IIE1JX \T AL U E G

One of the maxims of the Chrematistic School was to produce at as low an expense as possible and lower the prices. To do this it was necessary to economize in every \vay possible, and the best of all places to economize was on ~Tages. Pressed by need, by hunger, incapable of struggling with success against those who employed them, the worker had been compelled to content himself with a very meager wage, a wage just sufficient to sustain himself and his family. The profits of the entrepreneur thus became very great. Thanks to the division of labor, thanks to the perfection of technique in manufacture, thanks to the development in machinery, the productivity of the worker had increased without ceasing. "A rnieu» -caluc (considerable) had come to increase the revenue of the capitalist." 7 The entrepreneur allowed the laborer just enough to sustain life and he reserved for himself all that the worker had produced over and above the value of his life (his living). The worker was compelled to restrict his demand to absolute necessities without which he would be unable to continue his labors, while the entrepreneur alone profited from all the increments in power of productivity which came from the division of labor, labor-saving machinery, etc. The worker was no longer interested in economic progress. No matter how much industry prospered his remuneration was ~ Sismondi, N o uccau x Principes D' Econo m ie Politique, Vol. I, p. 454, (2nd Ed. 1827)' G Aftal ion, L'(Ett,vrc i;COI/011Jiquc dc Simon.le d e Sisinon.ii, pp. I 18 ff. 7 Sismoridi, N ouoea ax Princit es D'Economle Polltique, I, p. 1°3.

rALUE THEORF Al\TD BUS/}lESS CYCLES

22

never increased and "the benefice of the entrepreneur "vas none other than a spoliation of the workers." 8 One could almost say that modern society lived at the expense of the proletariat, on the amount withheld from \\rages. "There has been spoliation, there has been robbery by the rich of the poor, when the rich receive a revenue which allows them to swim in opulence while those who have given birth to this revenue, who have bathed with their sweat all the products of which it (revenue) is composed, perish from hunger without being able to touch it." £) The rich "gain only because the poor lose, . . . the profits of commerce are none other than the diminution of wages." 10 But a nation enriches itself only when the mass of its revenue is augmented and not when the revenue of one class is usurped by another. I I In the discussion of Sismondi regarding "Mieux Value" we perceive the elements of the socialist theory of Surplus Value, so clearly treated by Marx and Rodbertus. But the original author was Sismondi, and in recent years, both Marx and Rodbertus have been accused of plagiarism because they gave no credit for the phrase "surplus value" to Sismondi who, vlriting in French called it "Micux Value." At this point it is important to note that Sismondi did not go so far as to deny to the capitalist remuneration for his capital. Capital cooperates in production, and in consequence should participate or receive a recompense. Sismondi found only that in modern, contemporary economy, this recon1pense was too large, while the reward for labor was far too small. He admitted the justice of remuneration for capital-of the principle of a profit. It was only exaggerated profits to which he objected. On this point, Sismondi separated himself clearly from the Scientific Socialists. Sismondi "vas also less absolute in his conclusions. It was only "sometimes" that there was profit in the spoliation of workers, Sismondi, Nouveaux Principes, Vol. I, p. 9 2 • Sismondi, Etudes sur L'Economie Politique, Vol. I) p. 35, pp. 274--5. 10 Sismondi, N ouocaux Princrp es, Vol. I, p. 379. 11 p. 37 8• 8

U

isu.,

SISMONDI'S THEORY' OF COl'JftlERCIAL CRISES

23

Reasonable profits were a necessary cost of production, but it was the "mieux profits" that came from too low \vages to which he objected. THE POSSIBILITY OF GENERAL OVERPRODUCTION

One of the most illuminating controversies in all economic theory was the heated discussion carried on among Ricardo;':' Say and Sismondi in regard to the possibility of crises due to overproduction. The view of Ricardo has already been given where he emphatically denied such a possibility. Sismondi, on the other hand, in the multiple causes of crises, which he developed, stressed particularI y the tremendous increase in the pO'Ner of production due to the industrial revolution, and insisted that a general overproduction was not only possible, but was actually occurring before their very eyes. Jean Baptiste Say, while much nearer to the views of Ricardo than those of Sismondi, admitted the possibility of a partial overproduction but scouted the idea of a general overproduction. In support of his views he maintained that no one produces solely to sell but all produce in order to buy after having sold. Products are bought, the one by the other. "Products exchange against products." 13 Obviously then, there could be no general engorgement of the market. If, in all the branches of industry, production was augmented proportionately and harmoniously, the manufacturers could sell more merchandise and in turn purchase more merchandise to the advantage of all. At such a time everyone would have more wealth and more enjoyment. The augmentation of production would be identical with the augmentation of demand. "If one is able to think," wrote J. B. Say in answer to Sismondi, "that any human society is able to produce of everything a quantity in excess of what it is able to consume, I shall demand how it happens that seven-eighths of the population lack a multitude of products regarded as necessaries." 14 12

13 14

Ricardo's l~l orks, Chapter XXX, p. 233. Say, J. B.) Traiti d'Econo1nie Politique, 5th Ed., pp. 184- ff. Say, J. B.) (Euores Dioerses, p. 252, (1848).

rAL[lE T1IEORY

24

Al\~D

BT.}SIJ.\-:ESS Ci"CLES

How, then, is to be explained the undeniable fact of crises? For Say, it consisted in partial ocrr-production-s-xs: excess of fabrication in certain peculiar industries. The "encunlbernlent" was due to the bad calculations of the entrepreneurs, who had not been able to perceive well the needs of the consumer, who had anticipated too large a demand for certain commodities, and too small a demand for others. The evil was not "too much products" but in not producing what was wanted. The remedy, then, was not in curtailment of production but in new developrnent of certain industries, in the more abundant manufacture of the articles which were lacking. It was only necessary that a part of the capitalists engaged in the industries which suffered from overproduction should abandon their ancient trade and start to produce the merchandise which existed in quantities insufficient to meet the demand. Now this remedy for crises acted spontaneously for Say. If the demand for a certain commodity surpassed the supply, then the price rose and the entrepreneurs who were hit by low prices ceased to manufacture the objects formerly produced which gorged the market and crossed over to those industries which had proved unable to meet the demand of the consumer. Enlightened self interest served to push them into that place where their capital would make the most profits. Crises then, were only transitory. Here, as everywhere, it sufficed to "lnisscr [airc," Liberty repairs itself. The inconvenience to which it has given birth, the troubles which result from extreme competition, competition itself, the free play of demand and supply, makes these troubles disappear. Let things take their normal course and production will proportion itself naturally to the needs or desires of the public.!" Say thus attempted to prove first, that the dangers of general crises were chimerical, that such crises were impossible, and second, that the crises of partial overproduction were momentary or transitional, and that equilibrium, broken at times between production and consumption, would soon reestablish itself. l

Hi

Say,

J. B.,

Traiti d'EconOJJlie Politique, Vo1. I, p. 9+.

SISA-I01\~DI'S

THEOR}Y OF COMMERCIAL CRISES

25

The answer of Sismondi to these critics constitutes one of the most illuminating arguments found in all socialist literature in support of a general overproduction theory of crises. He criticized the optimism of his opponent and was skeptical of the beneficial action of liberty. Says Sismondi, "If one reasons abstractly, it seems very natural that capitalists would quit one industry where profits were feeble and go across t'i industries which were more remunerative. But if, in place of a priori argument, one observes reality, this circulation of capital which runs wherever it is demanded, seems less lucid. A series of facts, of concrete causes become arrayed against that which one believes to be the natural order of things, to disturb harmony, F'or instance, there are other forces at work than the desire for profi ts. 'There arc such things as human sentiments in industry. \Ve forget the personal reasons why one is led to prefer this trade to that one. We neglect above all, the force of custom. Custom is a po\verful force which is difficult to calculate, and writers of economics frequently forget that men arc not machines." 16

r

Frequently, producers arc not disposed to enter into new Industries about which they know nothing. Accustomed for long years to a certain occupation, having acquired, little by little, the necessary knowledge, the necessary aptitude for their trade, they are not \villing to pass suddenly to a trade with which they are unfamiliar. And even more difficult than the shift of entrepreneurs is the transfer of fixed capital. Circulating capital can be moved easily from one industry to another, but there is another altogether different capital, quite fixed. Vast buildings have been constructed for a special type of production. Highly specialized tools have been acquired. The capitalist who has gone to such enormous expense is condemned to continue in the manufacture of those objects for which he has purchased so many instruments. To shut down his factory would mean for him disaster. He will never consent to it. He will prefer to reduce the amount of his profit rather than lose his capital entirely. He 16

r J

I

~'

Aftalion, p.

10].

26

IlALUE THEORr AJ./D BUSIJ./ESS CYCLES

will attribute the crisis to accidental and transitory causes. He will lower the price, seek to realize his profits by advantageous production, will redouble his activity, and the market will continue to be glutted. But this argument, presented by Sismondi, served only as an explanation of partial overproduction, or maladjusted production which his opponent, Say, readily granted. However, Sismondi sought to establish, also, the possibility of a general overproduction. He does not seem to have perceived at first the entire distinction between general overproduction and partial overproduction, but when his adversaries had showed him the necessity of making the separation he presented a series of arguments specifically treating crises of general overproduction. He recognized that such crises were more rare than the others, yet he insisted that a universal crisis could exist and in fact, did exist in his time. A cry of distress arose from all the manufacturing villages of the old world and all the countries of the new responded similarly. The supply was auglnented in all industries. But the demand never rose in the same proportion. This was due to the fact that demand dc pcndcii u-pon tsxo causes independent of production, (I) The needs of the buyers, and (2) their means of payn1ent. Sismondi recognized the limitations of the first cause, and recognized that in some lines "the needs and desires of man were without Iirnit." But this \vas an isolated statement that he almost forgot. The consumption of agricultural products were, according to him, naturally limited. The demand for the objects of manufacture were capable of increase, but only to a certain extent. Lower the price and undoubtedly your clientele would enlarge. But this hau ultimate limits. Sismondi recognized the prodigious increase in the past in the use of cotton goods, linen, etc., but as he viewed the future he said, "Today the consumption is scarcely susceptible of a new augmentation." On this point history has proved Sismondi entirely in error. Indeed, history has been most unkind to all opponents of

SISlvl01\lDI'S THEORr OF COll1lvlERCIAL CRISES

i

..

-I

I

27

progress, who have dwelt on the calamity of improved processes in production. "Humanity is still far distant from the day when merchandise will be in such abundance as to be more than needed," says the brilliant Aftalion. Our wants are insatiable, our desires are never completely satisfied. The development of production in our century has brought in its wake a vast expansion in consumption. The cotton industries and all other general industries have continued to expand since the time when Sismondi wrote, Yet it is true, as Sismondi well showed, that the desire for all, species of commodities will not expand with the same intensity. ' Ricardo and McCulloch reasoned a little too nimbly that if the supply of commodities which exchange with one another should double for example, their demand would expand in the same proportion. Sismondi showed the vice of these affirmations. If, for example, the supply of cloth and grain should be doubled it would not necessarily follow that they would still exchange for each other in the same proportion. This is due to the complexity and inequality of our needs. A slight increment in grain might suffice to satisfy our desires amply while double the amount of cloth might still not suffice to satisfy our desire for that. \\T e would have too much grain and not enough cloth. But even here, the adversaries of Sismondi were guilty only of imperfect reasoning. It sufficed to rectify slightly their argulnents to make them sound, and escape the objections of Sisrnondi. In order that development in all branches of industry should not give rise to crises it is only necessary that the increment be "proportional" or "harmonious" rather than arithematical. It might be double here and triple there, but a place there would be where equilibrium would be established between production and consumption. It would seem then, that Sisrnondi in dealing with the nature of human desires, failed to prove the case for general overproduction. In admitting that by doubling the production of grain and cloth, there might be too much grain and still not enough cloth, he played into the hands of his opponents and

28

FAL(]E THEORY' A ..\ ·D B[JSIJ.VESS crCLES

proved the case only against disproportionate production, which virtually all admitted. But the main argument presented to establish the possibility of a general overproduction was the lack of purchasing po\ver in the hands of the workers. .A . ccording to Sismondi most of the men engaged in production arc not able to exchange the products of their labor for those goods which they desire. The workers receive only a small portion of the selling price in exchange for their labor--a portion all too small to permit them to absorb the entire supply of merchandise. Modern industrial processes arc a menace not only to the entrepreneurs because of the danger of crises, but they have operated to the detriment of the workers and reduced their \vages. It is here that the second evil reacts on the first. The lowering of \vages, the diminution of the income of the family workers aggravate overproduction. While the manufacturers vie with each other in throwing upon the market a constantly increasing quantity of products, the capacity of the workers-iwho constitute the great bulk of the population-to acquire is diminished. Demand contracts to the degree that supply expands. This raised definitely the perplexing question: "DOES IT ~'I.:\KE ANY DIFFERENCE WHETHER THE WORKERS GET THE PCRCIIASING POWER

OR

THE

CAPITALISTS,

SO

LOKG

AS

THAT

PLiRCHASING

PO\VER IS SOME\VHERE?" And Sismondi definitely faced it. He says, "Some have held that if the workers receive only a modest fraction of the selling price of objects, nevertheless the price is paid entire. If it is not turned over to the workers it goes to the entrepreneur. What difference does it make whether it should be le chef d'atelier or the workers who receive the price of the products? In place of the workers, it will be the capitalist who will increase his capacity to acquire. The augmentation of his demand will be a sufficient equivalent to the augmentation of the supply of the categories of merchandise other than those which he produces. 'XliII not the crisis then be thwarted?" 17 17

Aftalio n, Op. Cii., p.

108.

SISJI0AT D I ' S THEORY OF COjtl.itlERCIAL CRISES

29

To these questions Sismondi replied, "It is because the objects of prime necessity, the chief objects of manufacture, are consumed to a very limited degree by the wealthy. The rich desire those expensive and rare things which single them out frorn among the crowd, i.e., objects of conspicuous consumption and conspicuous waste. They encourage the iniiustries d.c luxe, the industries which do not have a wide market and appeal to a restricted clientele. As soon as any article is produced in abundance and is found to be consumed by the ~v'ul gar, it is no longer dignified for them. Therefore the rich will not permit an excess of supply from the industries de luxe, industries which they call exceptionaL Hence, labor is always concentrated in those factories which create necessities for the masses, and overproduction results. "By an inherent contradiction in modern economic conditions, while their great wealth push the wealthy to build vast factories, their riches also exclude the products of these very great factories [rom the consumption of the rich. Those who receive the selling price of the merchandise, those who benefit from fabrication, are not the same as those who consume them. The production thus goes on accumulating while consumption is restrained. Overproduction is a fatal effect of contemporaneous economic organization." 18 Thus did Sisrnondi attempt to prove not only the possibility but the inevitability of economic crises which he linked definitely with the insufficient means of acquisition by the workers, due to capitalistic exploitation. Economic crises were an automatic byproduct of the Industrial Revolution and the Capitalistic System. THE MOVEMENT OF THE GENERAL PRICE I.JEVEL

According to Sismondi, crises come repeatedly to disturb commerce and industry. He held that they reproduce themselves every few weeks or months. "Le commerce semble un malade dans un etat de fievre ardente; on s'ctonne et 1'0n s'effraie de la 18 1\

ftalion , op. Cit., p. 1°9. See N ouoeaux Principes, Vol. 1, p. 36 I.

VALUE THEORY AND BUS/1'lESS CYCLES

3°

rapidite de ses pulsations." 19 In other words, the general price level is in process of constant violent fluctuation. The causes of this violent fluctuation were quite wholly in the realm of production, and were to be found in his multiple theory of crises. The immediate cause of the crises as explained above, was the glut in the market caused by overproduction. But the chief forces operating to guarantee the appearance and reappearance of the glut, were (I) increased production, whether due to inventions, improved processes, governmental stimulation, bank note issue, or longer hours for labor, (2) increased competition "Undersell and overtrade"-carrying with it reduced margins of profit for the employers and lower wages for the workers, and (3) "Mieux Value," which measured the degree of exploitation of labor and robbed it of ~ny possibility of purchasing all the products of industry. These forces caused the glut and the price-crash came as the result. The recovery and upward trend of the price level came because the crisis had bankrupted many employers and production virtually ceased, cutting off the supply. These entrepreneurs now reduced to poverty, had no wealth with which to purchase the products of the "industries de luxe," so confined their expenditures to necessities. The result was that the oversupply was gradually drained off and industry started up again. But with the recovery in prices and renewal of production, the same feverish competition broke out again carrying production to the limit, and profits to a minimum. The market was again glutted with commodities, prices crashed carrying the employers into bankruptcy and the poverty stricken laborers into unemployment. But a careful analysis of the movement of the price level must consider the order of events within the cycle. And according to Sismondi, they were about as follows: (I) Recovery and an upward swing of prices, (2) Expanded production and decrease of prices, (3) Overproduction carrying prices downward where profits were virtually eliminated, and wages reduced to a starvation level, (4) glutted market, crash of prices, bankruptcy 19

Sisrnondi, EtuLles sur! 'Economic Politique, II) p.

21

9.

SlS1~10J.\,.rDl'S

THEORr OF COll,11t1ENCIAL CRISES

31

and unemployment. Thus the causes of the crisis were diminishing profits, diminishing wages, and a decreasing price level, and the crisis was only a very abrupt fall of the general price level after a more or less extended period of previously falling prices. After more th.m a hundred years in which to observe and chart the course of the price level, we know that the course pictured by Sismondi does not fit the case. Most crises come at the end of a period of rapidly rising prices. In fact the typical Business Cycle has been characterized by Professor Mitchell as fellows: (I) Crisis, (2) Depression, (3 ) Recovery, (+) Expansion and Speculation, and crisis again. eo It is very true that some crises have occurred in connection with extreme depression as in 1884 and 1893, but the point we wish to make here is that if Sisrnondi's explanation is correct, the phases of the business cycle must come in the order he gives, and this we know is not the case. THEORY OF VALUE

According to Sismondi, the value of a good, in the days of the self-sufficing household economy, was determined by its utility, but the moment that commerce was introduced and the trades were separated, and each worked, not for himself but for the general market, the idea of utility as a measure of value gave place to exchange value. Before the introduction of commerce, when everyone provided for himself and family, an increase in the quantity of products was considered a direct augmentation of riches. It mattered little how much labor was required to produce these useful things. The father of the family considered himself twice as rich when his granaries were twice as full of grain, and the housewife felt twice as rich when she had twice as much linen regardless of whether it had been produced by a perfected process in half the time. For, after all, these things lost none of their utility because it took less labor to produce them. Grain and 20 Mitchell, W. C., Business Cycles, pp. 571-9. (1913.) University of California Press.

32

VALUE THEORY AJ../D Bf}SINESS crCLES

cloth were not less useful to their possessors even if they were found in the road or fell from the sky. "This is, without 'doubt, the true valuation of riches-utility and satisfaction. But the instant men cease to supply their own needs and begin to depend for their subsistence on the exchanges which they are able to make or on commerce, they become obliged to tie themselves to another method of valuation, to that of exchange value . . . . T'his exchange price, this price of the market, is of all the numerous abstract ideas which present themselves in the science of economics, the most abstract of alL In the determination of value which one has sought to measure by the institution of Inoney, the notion of utility has been put absolutely aside. It is the work, it is the effort necessary to procure the t/.1;'O things exchanged, the onc against the other, toliicl: has been alone considered. It is on this basis that is calculated the price of the seller as well as the offer of the buyer. rrhe first will affirm, perhaps, that the thing has cost ten days of labor. But if the other knows that it can be produced in the future with eight days of labor then competition will lead the two contracting parties to settle lipan eight days as the value and that will establish the price of the market. . . . (Of course the commodity must be uscful ) for without desire there could be no sale. But the fixation of the price has no relation to utility." :n

In passing over to competition, in the latter part of this quotation, one might think that Sismondi shifted from the theory of embodied labor to that of commanded labor but at this point he seems only to have anticipated Marx with his idea of "labor sociall y necessary." The value of money was determined in the same "vay as that of other commodities.. For Sismondi was at one with I~icardo in treating those precious metals used for money as only highly specialized commodities, and all purchases and sales were a species of barter, the value of the thing given and of the thing received being determined by the quantity of labor embodied. This would seem clear from the following quotation: "Before determining how m~ny units of grain one is able to obtain for a unit of gold, it is necessary to make intelligible the value of 21

Sismondi, Etudes sur L' Economic Politique, Tome deuxicmc, (18]8),

pp. ').66-7·

SISMOlvDI'S TliEORr OF

COi~lJIERCl_~L

CRISES

33

one unit of gold. Arid that task is not an easy one. However, we have come to see that the mercantile val uc is al wavs fixed in the last anal ysis by the quan tity of labor necessary to Pl:OCU rc the thing valued or evaluated. This is not the labor which it may actually have cost but that which it will cost in the future with the means perhaps perfected. (Here Sismondi clearly anticipated Marx and his expression 'Labor socially necessary.') And this quantity, however difficult it rna Y be to determine, is alwavs established with sufficient aCCllr:1CY by competition, It is thus that the value of a unit of gold VIlas found, and that it serves to measure all other things of value. The unit of gold represents the number of days of labor by means of which one was able to extract it from the mine and transport it to the place where it was exchanged. . . . One takes no account of the utility of gold . . . no more does one take into account the amount of work which had been formerly necessary to draw it from the mine (for it circulates perhaps for two or three hundred years) but only of the work which is necessary in order to draw an equal quantity today. All discoveries of mines more abundant or of processes more economical for the reduction of the minerals renders not onlv better markets for the gold newly produced but at the same time it causes to be lost a part of the value of all the gold previously existing." ~~

~

On the basis of this, it has been possible to establish a good standard of value and one which would represent to the imagination a particular quantity of labor embodied, This rather extended translation taken from one of Sismondi's latest works, presumably embodying his final and mature thought, seems to the writer to prove that, despite certain earlier statements more or less contradictory, we are justified in classifying Sismondi with Ricardo, holding that his theory of value is one of embodied labor and the price level is determined by the quantity of labor embodied in the unit of value, measured against that embodied in other commoditics.i" The exchange value of both goods and money, then, was determined by the effort required to overcome the resistance of nature and as progress and inventions came about and the re~~ Sismondi, Etudes} Op. Cit., pp. 267-8. 23 Corrobo rnring statements supporting this view are found in the introduction to his Eludes sur L'Economle Poiitique, p. 5, and in Part II of the same work, pp. 163-4.

34

VALUE THEORY AIVD BUSI1\TESS C}PCLES

sistance in industry became less and less so that the same effort yielded larger results, exchange value "vas proportionately reduced. It is true that in his early debate with Say and Ricardo he showed decided traces of a commanded labor theory, where value was determined by demand and supply quite independent of cost of production. For example, he cited the cases of the production of grain and of cloth. In this instance he showed that since the demand for grain was relatively inelastic, doubling the quantity by doubling the effort expended in its production, would not result in doubling its exchange value, because of the fact that a small increment in the quantity of grain would be sufficient to meet all needs. Whereas in the case of cloth, the demand for which "vas relatively much more elastic, doubling the quantity by doubling the labor embodied nlight more than double its exchange value as compared with grain. But his final statement in the Etudes, written in 1837 and 1838, would seem to indicate that he had completely lapsed into a fairly consistent embodied labor theory. It must be added, however, that it was a somewhat modified embodied labor theory. In fact, it is possible to see a difference in degree 'among the three men, Ricardo, Say and Sismondi. And this difference in their respective theories of value goes far in explaining the difference in their explanation of the movement of the price level. Ricardo, the absolutist, held that exchange value remained approximately identical with natural value or embodied labor. Hence, his theory permitted of no crises or material change in the price level at alL The aberrations about the natural price level were mere ripples on the surface. Say would permit the operation of demand and supply to interfere sufficiently with embodied labor value or cost of production to cause temporary maladjustment and brief, minor crises of partial overproduction. But simultaneously they were self corrective. The ripples about the surface of the price level had become large enough to be called waves. Sismondi, however, saw clearly that overproduction by entre-

SISM01'"'DI'S THEORr OF COMMERCIAL CRISES

35

preneurs and underconsumption by impoverished consumers might so glut the market as to permit the law of supply and demand to eclipse quite effectively, for the moment, the natural price set by the cost of production or effort embodied. But even for Sisrnondi, the discrepancy was little more than momentary, for, as quoted above, he said crises carne repeatedly to disturb commerce and industry, that crises reproduced themselves every few months or every few weeks, that commerce seemed possessed of a malady, in a state of ardent fever, astonishing and frightening one at the rapidity of the pulsations." In other words, the law of supply and demand had become strong enough with Sismondi to create the tremendous billows of a violent crisis. But the force of natural value or embodied labor was so strong as to compel frequent and rapid adjustment in case any other force had disturbed this equilibrium. APPRAISA"L AND CRITICISM

The last quarter of the Eighteenth Century had witnessed the meteoric advent of the French Revolution, when those electric words, Liberte, Egalite, Fraiernuc , caught the imagination of the masses and etched themselves, as it were, upon the tables of men's hearts. They spelled Political Ernancipation in the realm of government-the overthrow of tyrannical despotism. At the same time there broke forth the Economic Emancipation through the Industrial Revolution, wherein the ((niggardliness of nature" was to be overthrown by means of mechan.cal invention. A single generation was allowed to dream of political liberty and economic emancipation at one and the same time. The hopes of mankind rose to a height not approximated since the "CODling of the Savior." For a generation men had continued to live in this aDream World" while economic writers pictured in glowing terms the benefits to mankind of the new inventions and improved processes. But with the close of the Napoleonic Wars and the crisis and depression following, with its compulsory unemployment, dire poverty and misery, it was inevitable that some24

See above, p. 29.

L ..

36

v'

VALUE THEORY AJtlD BUSINESS CYCLES

one would become disillusioned, scrutinize more carefully this Dream Vl orld, and discover that all was not as pictured or anticipated. To Sismondi goes the honor for first making this discovery, and for presenting to the world a systematic explanation. While others wrote cheerfully of the value to mankind of new machinery, Sismondi took pains to show that this was not an unmitigated blessing, that the periods of transition with consequent displacement of workers, often wreaked terrible vengeance upon the craftsman who had lost out in the struggle with these new iron men. He showed that it was small comfort to tell a man fanlishing for food and shelter that his posterity would benefit by the change. Whereas society JJlay benefit "in tlze lon g run," nian must eat "in the short run." Again, Sismondi was among the first to show the evils inherent in the factory system where, for the first time, labor was divorced from the ownership of its tools and as a consequence labor found itself in a much less strategic position. "Classes" were arising and wealth was rapidly becoming concentrated to the detriment of the "proletariat." Here too, we find that the first outbreak against the system of economic thought built on a priori reasoning without reference to actual facts. Sismondi might be called the advance agent of the Historical School. He was much more interested in people and their economic status than in logical anal ysis. ERRORS AND INCONSISTENCIES

But this failure by Sismondi to analyze carefully and state his fundamental hypotheses, and to reason clearly regarding the possible deductions that might be made therefrom, and to define his terms properly, led him into gJaring inconsistencies and contradictions. \\7e have stated above ~;) that Sismondi failed to work out a definite theory of value, at least comparable to that of Ricardo or Marx, and hence we are left to judge his theory of value, largely by disconnected statements and inference. It is our con25

See above, p. 15.

SIS1'101\rDl'S

..

I

,\ I· I I

J

THEOR}~

OF COllfJJERCIAL CRISES

37

tention that it is impossible to give any adequate theory of crises without a working theory of value, either stated or implied. And it has seemed that in the main, at least in his later writings, Sismondi held to an embodied labor theory of value, similar to that of Ricardo, though slig-htly modified. But whether we have judged Sismondi's theory of value correctly or not, his "Multiple Theory of Crises" had undoubtedly placed him in a serious dilemma, namely, if his theory of value was embodied labor, it automatically precluded the possibility of a general overproduction theory of crises. If, on the other hand, his theory of value was a demand and supply theory, then he could not consistently argue the "Mieux Value" theory of crises, which meant that laborers embodied more value than they were given in return. One of the prime features of all physical, embodied labor theorists, is that they assume desire. Hence, there will be demand when there is purchasing- po\ver, and the only kind of purchasing po\ver possible is a physical supply of commodities, in the production of which labor has been embodied. It is in essence a barter economy, where the demand for one commodity is the supply of another. There is no law of supply and demand but a law of t\VO supplies, each representing the demand for the other. Obviously, then, there could be no general oversupply, for any visible surplus in one line would be due to a lack of supply in other lines given in exchange for it. Or, as Ricardo and Say both contended, "goods exchange against goods," and if ex- , change does not take place it does not indicate a general surplus but a shortage somewhere. Now, if all we had from Sismondi were his debates with Ricardo and Say, we would be thoroughly justified in saying that he did not hold to an embodied labor theory of value at all, but to commanded labor, or value determined by demand and supply, in which case he would with consistency argue for something approaching a general overproduction theory of crises. And yet it is exactly because he has an ambiguous or double theory of value that he runs into confusion, when insisting on

the possibility of general overproduction. For as shown earlier \vhell dealing with this point ~G he tried to establish this possibility upon three main arguments, first, the introduction of machinery and better processes, second, by the underpayment of labor, and lastly, because the "industries de luxe" were purposely limited so that their products would not become "vulgar" and con1n1011. '[his last admission seems to vitiate quite entirely Sismondi's whole contention for general overproduction and indicates that he is constantly in confusion as to the real difference between a partial overproduction, or maladjusted production and genuine overproduction. A careful reading would seem to show that, with all his endeavors, he never did successfully establish the possibility of general overproduction. But, admitting for the moment that he did establish his case, then it is prima facie evidence that at that time he was not operating on the basis of an embodied labor theory of value. But when he left the two arg"uments of increased productivity and lack of "industries de luxe" and argued in terms of "Mieux Value" there was no alternative nor basis for this argument other than the idea that labor embodied a certain amount of value in physical commodities but got back in \vages gold which had less labor embodied, the difference representing capitalist exploitation of labor or "~1ieux Value." Had he operated on the "commanded labor" theory here, he would have had the value of labor embodied determined by demand and supply-the result of bargaining between capitalists and labor and the value of the finished commodities determined by demand and supply. Even though there might have been a vast margin of profit, indicating miserably low \\'ages, much lower than should have been paid, or could have been paid by the entrepreneur, y'et never could it logically have been called "mieux value." It would have been nothing more than an exploitation of labor due to labors' bargaining handicap in a world where the value of everything was determined by the free interaction of the forces of demand and supply. And clearly, any careful study of Sismondi in the ~6 See above,

pp. 15 if.

.-(

SISM01\-DPS T1IEOR},' OF

COjl1l~IERCIAL

CRISES

39

various connections where this phrase was used will lead to the conclusion that he intended no such interpretation. Hence in attempting to establish the certainty of crises and pro\Te that they were inherent in our modern system of production and organization he was decidedly inconsistent and contradictory. "Too much was not enough." ..r\.. final criticism of Sismondi is with reference to the order of events in a business cycle, and the frequency of recurrence."? Here one has a right to expect much greater accuracy than is evident, for he chided Ricardo for his "a priori" reasoning about a world that did not exist and insisted on observing "the facts" as they appeared in the world about. ):0' et with Sismondi, the order was (I) rise of prices and business recovery, (2) increased competition, lower prices, (3) starvation \\Tages, margins gone, and markets choked, and (4) the crisis with accompaniments in bankruptcies, and general unemployment. So the forerunners of crises were diminishing profits, falling prices and lower wages. The crisis was only a very sudden fall of the price level, after a more or less extended period of previously falling prices. In regard to the frequency of crises, we recall that he pictured them as occurring every few weeks or months. We now know that crises are not comparable in frequency to the rapid pulsations of a fever patient. They do not occur every few weeks or months as he stated. Perhaps Sismondi should be forgiven for making such an error since he wrote one hundred years ago, thus lacking the privilege of observation over an extended period of time. He also lacked the advantage of modern statistical method for the reduction of observations to mathematical accuracy. Yet we cannot refrain from criticizing one who insisted on basing theory upon observation if his observation led him to picture the business cycle as a matter of weeks instead of years. In conclusion it might be said that Sismondi's logic was better than his observation. It is logical for those who hold to his theory of value and prices to have the crisis come at the end of 27

See above, p. 30.

40

VALUE THEORY Al"lD BUSll\,TESS

C}~CLES

a period of depression and falling prices, but since it does not often come then, does it not behoove us to investigate the field of credit which tends to raise prices, quite as carefully as we investigate the field of production which tends to lower prices? Someone may suggest that Sismondi took into account the role of banks, particularly the "banks of emission" which financed manufacturers through credit. It must be noted, however, that the only influence which he attributed to the banks was that it financed more entrepreneurs so that they could rush into the already overcrowded fields and further gorge the market. The only influence was the tendency to further increase the production of physical commodities. Not once does he suggest that the expansion of bank credit and currency might yield inflation and .. . rIslng prIces.

CI-L-\PTER III

KARL lVIARX IN many respects, Marx's explanation of value was almost identical with that of Ricardo. Money was considered as one of the many commodities, the value of which was determined by . labor embodied. ) . . et, with Marx, the concept of embodied value is absolute rather than relative. It is not necessary to compare t\VO commodities to discover relative ratios between the quantities of labor bestowed, as held by Ricardo, but value is "congealed labor-power," frozen, as it were, in a physical commodity. With Marx, the embodied labor theory of value becomes definite and unqualified. \\T e shall proceed at once to a consideration of his complete theory of value and prices. THEORY OF 'l:\LLTE

At the heart of Marx's theory of value and price was "t:rnbodied social labor-power." This he defined as "The labor tune socially necessary 10 pro{iuce an article under the normal condilions of production and rrL-.ith the average degree of skill and intensity prevalent at the time." 1 "Commodities in which equal quantities of labor are embodied or which can be produced in the same time have the same value. The value of one commodity is to the value of d.ny other as the lahar-time necessary for the production of the other. As tral urs; all co mrnoditics arc only r/f' finite m asscs of congealed labor time, '[he value of a commodity would, therefore, remain constant if the lahor-timc required for its production also remained constant. 13ut the latter changes with every variation in the productiveness of labor. This productiveness is determined hy various circumstances, amongst others, by the average amount of skill of the workman, the state of 1

[

Karl Marx, Capital, Vol. I, p. 46. (Kerr's Edition.) 41

~

42

VAL[IE

THEORr~

Al,rn BUSIJVESS CYCLES

science and the degree of its practical application, the social organization of production, the extent and capabilities of the means of production and by physical conditions. F'or example, the same amount of labor in favorable seasons is embodied in eight bushels of corn and in unfavorable only in four. The same labor extracts from rich mines more metal than frorn poor mines. . . . In general, the greater the productiveness of labor the less is the labor-time required for the production of an article, the less is the amount of labor crvstallize d in that article and the less is its value; and vice urrs a, the less the productiveness of labor the greater is the labor-time required for the production of an article and the greater is its value. The tmlu c of a co m moditv, thcrcfor(', varies directly as the quantity and uiurrsrlv as the producti,,)el1CSS of the labor incorporated in it." 2

In explaining how individual labor-time was reduced to abstract social labor-power or how skilled labor was measured in terms of unskilled labor so as to reduce his social labor-power to uniform units as of man-power-hours, Marx made the following statement: "It is the expenditure of simple labor-power, i.e., of the labor po\\'cr which on an averaf;e apart from an)' special dc vcloprucn t exists in the organi~l11 of evcry ordinary individual. Simple average labor, it is true varies in character in different countries and at different times, But in a particular socie-ty it is given. Skilled labor counts only as simple labor intensified or, rather, as multiplied simple labor, a given quantity of skilled being considered equal to a greater quantity of simple labor. Experience shows that this reduction is constantly being made. A commodity 111ay be the product of the most skilled labor but its value bv equating it to the product of simple unskilled labor represents a dcfinite quantity of the latter labor alone. The differcnt proportions in which different sorts of lahar are reduced to unskilled labor as their standards. are established hy a social proccss that goes on behind the backs of the producers, and consequently, appear to be fixed by custom. For SiJJI plicity's sake uic shall hctltcforth account every kind of labor to be unskilled sirnple labor j by this 'lor: do no more tluin save ourselves the troublc of rnakiilg the reduction." 3

Thus has Marx reduced value to embodied social labor-power 3 Marx, Capital, Vol. I, pr. 46-7. (Kerr's Edition.) Note: Unless otherwise stated, all references to Marx w ill be Kerr's English edition of Capital. 3 Marx) Capital) Vol. I, pp. 5 1 - 2 •

KARL ftlARJ:"

43

and social labor-power is reduced to uniform units as of unskilled labor expressed in what might be called "man-power-hours." Any thorough study of Marx would seem to prove beyond question, that he had a theory of physical embodied value. If so, the significant thing to keep in mind in connection with a discussion of price movements, is that value (and here he meant exchange value) increased as the physical volume of commodities increased. There could be no shrinkage of value, due to an unusually large supply of commodities. Value increased as supply increased not as supply decreased. THEORY OF l\JONEY AND PRICES

If commodities exchanged directly, as in a pure barter economy, there would be no need for money. But with the complex industrial organization as it had developed in the time of Marx, barter had long since proved virtually impossible and money had arisen for the !Jurpose of facilitating exchange. According to Marx "The first chicf function of money is to supply commodities with the material for the expression of their value or

I

•I

to represent their value as magnitudcs of the same dcnominntion qualitatively equal and quantitatively comparable. It thus serves as a universal measure of value. . Arid only by virtue of this function docs gold, the equivalent commodity par excellcnce, become money. "It 1S not money that re ndcrs commodities commensurable. Just the contrary. It is because all commodities, as values, are realized human labor, and therefore commensurable, that their values can be f,. measured by one and the same special commodity, and the latter bc converted into a common measure of their value, i.e., into money. Money as a measure of value, is the phcnomenal form that must, of necessity, be assumed by that measure of value which is immanent in commodities, labor-time." 4

In this connection it should be definitely stated that Marx, as the father of scientific socialism, stood foursquare for "sound money;" Like Ricardo, he was a bullionist to the core or, as one 4

L

Marx, Capital, VoL I, p.

106.

44

VALUE THEORY AJiD BUSINESS crCLES

might say, a "gold bug." In fact, it was essential that money, or the measure of value with Marx, should be specie. For that which gave value to money, the same as to all other commodities and made it capable of measuring the value of commodities was its common element, the social labor-power embodied. The value of money was determined by the amount of labor socially necessary to mine, smelt, refine, and coin the metal into money. Hence, this crystallized social labor-power was capable of entering into exchange as an equivalent or go-bet\veen in the exchange of commodities. EXPLANATION OF THE PRICE LEVEL

Since the value of gold was determined, like the value of '\./ everything else, by the amount of labor embodied, and also since embodied labor did not necessarily mean the amount of labor which may have been actually embodied in the past but what labor would be necessary to produce similar commodities today in the light of increased skill, improved processes and inventions, it naturally followed that the ratio between gold and commodities might change with time depending upon whether the greater improvements had occurred in the field of gold production or in the field of commodities in general. In support of this he says, "A genera] rise in the prices of commodities can result only, either from a rise in their values-the value of money remaining constantor from a fall in the value of money, the values of commodities remaining constant. On the other hand, a generJ.l fall in prices can result only, either from a fall in the value of commodities-c--the value of money remaining constant-or from a rise in the value of money, the values of commodities remaining constant. It therefore by no means follows, that a rise in the value of money necessarily implies a proportional fall in the prices of commodities; or that a fall in the value of money implies a proportional rise in prices. Such change of price holds good only in t he case of commodities whose val uc remains constant. With those for example whose value rises, simultaneously with, and proportionally to that of money, there is no alteration in price. And if their value rise, either slower or faster than that of

KARL

~IAR. Y

45

money the fall or rise in their prices will be determined by the difference between the change in their value and that of money." j

In other words, the movement of the price level was a resultant of two other trends. For any given moment the price level would be determined by the amount of labor embodied in a I.,-series of representative commodities (such as today might be taken in the construction of an index number) as compared with the amount of labor embodied in the standard monetary unit, which Marx conceived to be always gold. The movement of t he general price level after the moment considered would depend upon the relative progress made by labor in overcoming the resistance of nature in the realm of commodity production in general as compared with the progress made in the production of gold. That is, if less labor, relatively considered, was required to produce gold its exchange value would fall in terms of commodities and the price level would rise. But if greater progress should occur in the production of commodities then their exchange value would fall as compared with gold, since they contained a smaller quantity of embodied labor. As a matter of fact, Marx like Ricardo, predicted that the secular trend of the price level would be downward, since he anticipated more rapid progress in the production of commodities than in that of gold. This downward secular trend was made doubly certain, and accentuated by the changes in the relative importance of constant and variable capital. Since ((constant capital" consisted of machinery and raw materials, while ((variable capital" consisted of labor cost, controlled by the cost of maintenance, he predicted that constant capital costs should be reduced much, faster than labor-costs, hence there would be a constant tendency' of all entrepreneurs to substitute capital for labor. This would produce a double effect leading to a downward movement of prices, first because the value, or labor embodied would be less, thus reducing market value, or cost of creating supply; and sec5

."oiI

Marx, Capital, Vol. I, p.

I I I.

46

IT ALUE THEORY AJ.\TD

BUSl1v~ESS

CYCLES

ond, labor being used less would be able to buy back less, hence demand would drop off. (To this extent Marx departed from an embodied labor theory to that of demand and supply. In fact, embodied value theorists unwittingly pass over to a demand and supply analysis with more or less frequency.) THE BUSINESS CYCLE AND SURPLUS \'ALUE

,.1

Clearly for Marx, the secular trend was downward. But in addition to a secular trend, he sough t also to establish the fact of a constantly recurring business cycle. The theory of the cycle or of crises was based wholly upon his Surplus Value analysis. Surplus Value holds so important a place in the general theory of Marx that it is necessary to study it with care. In dealing with exchange or the metamorphosis of commodities, he first treated C-M-C (Commodity for Money for Commodity). Such an exchange he considered no different in principle from that of barter since the object of exchange was to transfer a commodity of little or no utility to its possessor for a different commodity of high utility, and money entered as a convenient medium to effect the transaction. This double transaction indicated no exploitation, for the assumption was that in each transaction there was an exchange of equivalent values, or quantities of embodied labor, so the final commodity had neither more nor less value than the original commodity, but had a higher utility for the recipient. Thus the metamorphosis /C-M-C represented an exchange of equivalent values and no exploitation. Marx admitted the possibility of variation in value, but such would be accidental and negligible and not inherent in the process. But the metamorphosis M-C-M' was fundamentally different. And it was in explaining this formula that Marx treated thoroughly the nature and source of surplus value. In this case the individual starts with money and ends with money. The only possible motive, then, for making the two exchanges was to end with more money than at the beginning. And the extent to which the second M or M' exceeds the first, is the measure of surplus

KARL MARX

47

value. However, surplus value "vas not created or gained in the circulation of commodities but in production. The first M represented the money paid to labor for wages. In return for the wages received labor created commodities C which belonged to the employer, the value being determined by the amount of labor-time or social labor-power incorporated. Then Marx, in the inimitable Marxian style, proceeded to show that, whereas there was an exchange of equivalents as between commodities, : yet with the concentration of capital and tools into the hands of capitalists and the rise of the proletariat, divorced from tools and compelled to seek employment of the capitalist, there arose a transaction between employer and laborer, a transaction involving the exchange of labor-power for subsistence, in which case there was no guarantee whatsoever that there would be an exchange of equivalents, but rather a predetermined certainty that labor would invest more social labor-power than would be l returned as \vages. Marx then turned directly to an analysis of the determination of wages, "\\T e must now examine more closely this peculiar commodity, labor-power. Like all others, it has its value. How is that value detcrminedi " Value of Labor-Poicer Determined by Cost of Subsistence and Perpetuation (Vfhe value of labor-power is determincd as in the case of cyery other commodity by the labor-time necessary for the production, and also for the reproduction of this special article. So far as it has value, it represents no more than a definite quantity of the average labor of society incorporated in it. Labor-power exists only as a capacity, or power of the living individual. Its production, consequent! y, presupposes his existence. Given the individual, the production of laborpower consists in his reproduction of himself or his maintenance, For his maintenance he required a given quantity of the means of subsistence. 'Therefore the labor-time requisite for the production of labor-power reduces itself to that necessary for thc production of those lTICanS of subsistcnce ; in other words the value of labor-pourer is the \ ,//' value of the means of subsistence necessary for the maintenance of the laborer. . • . His means of subsistence must therefore be sufficient

48

VALUE THEORY sv» BUS/J-iESS CrCLES

to maintain him in his normal state as a laboring individual. His natural wants such as food, clothing, fuel and housing vary according to the climatic, and other physical conditions of his country. On the other hand the numher and extent of his so-called necessary wants, as also the modes of satisfying them, are themselves the product of historical development, and depend therefore to a great extent on the degree of civilization of a country, more particularly on the condition under which, and consequently on the habits and degree of C0111fort in which, the class of free laborers has been formed. In contradistinction therefore to the case of other commodities, there enters into the determination of the value of labor-power a historical and 1110ral element. Nevertheless in a given country at a given periorl the a verage quantity of the means of subsistence necessary for the laborer is practically known. . . . rrhe value of labor-power resolves itself into the value of a definite quantity of the means of subsistence. It therefore varies with the value of the means or with the quantity of lahar requisite for their production." 6

Th us we are led to see that Marx held that the \vages of labor were determined, not by the amount of social labor-power which they invested in commodities for their employers, but by the cost of maintenance which tended to hover around the subsistence level, though it might be modified upwards slightly by the prevailing standard of living. It was by showing that labor actually did embody more labor-power in the commodity which it created for employers than was embodied in the money which it received as wages that employers found themselves the possessors of commodities more valuable than their cost. This represented surplus value created by labor, for which it received no equivalent. Returning to a final analysis of the formula M-C-M' the employer possessed a certain quantity of money, which represented so much embodied or crystallized social labor-power. With this he employed workmen who, in exchange, created for him the C of the equation or so n1any commodities in which was embodied a quantity of social labor-power, which, as we have already observed, might hold little or no relation to the value of money which he gave for its production and tended on the average to 6

Marx, Capital, Vol. I, pp. 18 9- 9 1.

II

,

4

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r I

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KJRL AfAR.¥.

be far in excess. This C of the equation was then sold on the market at its full value in exchange for a quantity of money of exactly equivalent value, i.e., embodying the same amount of crystallized social labor-power. By the extent to which the quantity and value of the second :!VI exceeded that of the first, by" so much had surplus value been created by labor. It also represented the exact extent to which labor had been exploited. As has been said, the wages of labor were determined, by the cost of subsistence, or of production and reproduction. The employer therefore paid him a sufficient money wage to guarantee that subsistence. But upon payment of that wage, the capitalist laid claim to the full productive capacity of the worker. To illustrate mathematically, if labor in six hours embodied value in commodities equivalent to that contained in the specie received as wages, but the employer withheld the specie until an additional six hours of labor-power had been embodied, then it is clear that labor has created six hours of surplus value for the employer for which no equivalent was paid. This represented accurately the degree of exploitation of labor, and Marx called. it "surplus value." 7 But exploitation has its limits and cannot go on indefinitely without producing serious maladjustments in the comrnodity field. All commodities produced must be exchanged (or virtually all in modern capitalistic economy) and the only effective demand -Is the supply of another commodity, the value of which is proportionate to the labor-power embodied. But the greatest group of buyers, or consumers is comprised of the laboring class which has been "robbed" of part of its purchasing po\ver, hence it cannot buy back the product of its labor. Commodities seek a market but can find none, or if they do, they must seek it at a market price much below the actual or market value. Then both entrepreneurs and labor lose, the former becomes bankrupt and the latter unemployed because factories close down and the world experiences a crisis. Indeed it comes at the time when the supply of commodities is the greatest. While the occasion for the crisis 7

i \

.L

49

Marx, Capital, VoL I, pp. 197-2 15.

50

VALUE THEORY AJ.\TD

BUSI~/ESS

CrCLES

was bankruptcy of entrepreneurs, the basic cause "vas in the exploitation of labor through employers' extortion of surplus value. If the cause of crises "vas to be found in underpayment of workers, with consequent lack of market for goods, a glut of the market and bankruptcy of employers, how was recovery to come about? The crisis was caused by too much goods, not only consumption goods, but also capital goods; in other words the po"vers of production had outrun the power of effective demand or consumption, and a bottomed market resulted. But all above the dire poverty line kept on consuming fairly normally even in time of depression. Ultimately the g-lut "vas worked off, because factories were closed down and production had ceased. Also, many bankrupt firms were unable to start again, machinery rusted a\vay, factories were abandoned, etc. In other words the function of depression was to scrap enough capital goods so that the po\vers of production no longer exceeded those of consumption, i.e., consumption goods became scarce, market price carne back to market value, which always contained a margin of profit, hence industries started up with a vim and the cycle started on its first phase again, but onl y to run the gamut of the previous cycle. Thus about the downward secular trend, there ran constantly this cyclical curve of prosperity, glut, bankruptcy, crisis, and depression; all based in the last anal ysis on "surplus value exploitation." Thus far, we have attempted to show how Marx explained the secular trend of the price level on the basis of ctnbodicii value) and the cyclical rnouemcnt of market prices on the basis of surplus value. Standing alone each explanation seems logical and complete. The difficulty arises when \VC attempt to reconcile the two, If the value of commodities vias determined by the amount of labor embodied, how could goods sell at times far below this value, as at the time of crisis, and at other times far above their value as in the period of prosperity? Marx noted the apparent contradiction and promised a reconciliation at a later time. This was eagerly looked for in the second

I

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I

1

I

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I j. i

KARL J.7tfAR}(

5I

volume of "Das Kapital" but strangely, it was conspicuous by its absence. However, before his death the attempt had been made and Engels found it among his manuscripts, and published it in Volume 111. 8 Stripped of its verbiage, numerous definitions and involved formulae, Marx held that t\VO sets of forces were operating in the determination of value and market price. The fundamental and primary force, was embodied social labor-power. This de->" . termined the value of all commodities. (Value here is used in exactly the same \vay in which Ricardo used "Nntural Value.") The natural value of commodities was determined by the quantity of labor embodied, and market price would never depart from this unless influenced by some disturbing factor. The disturbing factor was found in "Demand and Supply" which constituted a secondary force. But demand and su.pply had no effect so 1011 g as they tcerc in equilibriu.1n. Furthermore, demand would always equal supply if labor were not exploited. If it could buy back the full volume of its product the market would never become glutted and therefore market price would be held constantly at the natural value. But due to the exploitation of labor, the compulsory production of surplus value, supply exceeded demand and when dernand and supply were not in equilibrium, they did have an effect upon prices and compelled market price to depart from the curve of Natural Value. In the words of Marx: "If demand and supply balance, then they cease to have any effect, and for this very reason commodities are sold at their market values. If two forces exert themselves equally in opposite directions, they balance one another, they have no influence at all on the outside, and any phenomena taking place at the same time must be explained by other causes than the influence of these forces. If demand and supply balance one another, they cease to explain anything, they do not affect market values and therefore leave us . . . in the dark. ~ . . It is evident that the essential fundamental laws of production cannot be explained by the interaction of supply and demand . . . . For these laws cannot be observed in their pure state until the effects of 8

See Marx) Capital, Vol. III, Ch. X.

supply and demand are suspended, are balanced..As a matter of fact supply and demand never balance, or, if they do, it is by mere accident. It is scientifically rated at zero, it is considered as not happening. But political cconolny assumes that supply and demand balance one another. Why ~ For no other reason, primarily, than to be able to study phenomena in their fundamental relations, in that elementary form which corresponds to their conception, that is to say, to study them unhampered by thc disturbing interference of supply and demand. The other reason is to find thc actual tendencies of economic movements and to fix them, as it were . . . . The relation of dcm and and suppLy explains) therefore on the one hand onLy the deviations of m ark et prices froJJt mnrk ct cnlu c , and on the other the t e nd cnc» to lialaricc these d cinatio ns, in other words to suspend the effect of the relations of demand and supply." £)

Then Marx himself seems to drift into that circular reasoning of which Bohm-Bawcrk and others have so frequently accused him. The reason seems to be a desire on the part of Marx after making this excursion into the realm of competition, demand and supply, to return to his final analysis and prove that, after all, the ultimate explanation of market price and market value is his original value analysis with its accompanying statement of sur.. plus value. For he says, "If demand and supply determined the market price, so does the market price, and in the further analysis the market value determine demand and supply. 'This is obvious in the case of demand, which m?ves j~ opposition to price, rising when prices fall, and falling when pnces rrse. . • . This confusion of the determination of prices by demand and supply, and at the same time a determination of supply and demand by prices, is worse confounded by the determination of the supply by the demand, and the demand by supply, of the market by production, and of production by the market." 10

Having thus paid his respect to the demand and supply an .. alysis, he returns to his original thesis. HIn order that a commodity may be sold at its market value, that 9 Marx, Capital, Vol. III, pp) 223-+. 10

Marx, Capital, Vol. III, p.

225.

KARL .MAl?X

53

is to say, in proportion to the necessary social labor contained in it, the total quantity of social labor devoted to the total mass of this kind of commodities must correspond to the quantity of the social deBland for them, meaning the solvent social demand, C OU2 petition, the fl uctua tions of market prices w hic h correspond to the fl uctuations of de m and and supply, tend continually to reduce the total quantity of labor devoted to each kind of commodities to this scale."

Thus did Marx attempt to show that the fundamental force in the determination of the price level "vas embodied social labor po\\rer, and if demand and supply were in equilibrium-which would be the case were it not for exploitation and surplus value~ market price would coincide with market value. Also, since embodied labor was the dominant force, it established the point or center about which market price fluctuated and to which it must again and again return. In brief, Marx himself, finally admitted that his pure theory of embodied value could explain nothing but a secular trend,: and was forced to resort to ((competition" and ('denland and suppl y" to explain the business cycle. CRll~ICISM

l

...

It should now be clear that Marx went much farther in his attempt to give a scientific basis for crises than Sismondi. There is no guess about his theory of value. Neither is there the inconsistency of a ((Multiple Theory of Crises" for while many things might mitigate or accelerate crises, there was only one great overpowering cause and that was ((surplus value." In criticizing Marx, he seems to have left himself open to attack in at least three important connections. In the first place he was guilty of the fallacy of circular reasoning, in the second place he was inconsistent and contradictory, and finally, guilty of proving what was not true. In regard to the instance of circular reasoning, we remember that value was determined by the quantity of labor "socially necessary." But the determination of what was socially necessary was a most difficult task. Marx recognized that the value of similar

54

VALUE THEORY AND BUSINESS CYCLES

goods must be the same, no matter what the conditions were under which they were produced. Goods produced in marginal factories had no greater value than those produced in the best factories, even though much more labor had gone into them. He then explained that "market value" which determined the price set for the entire group, was established by ascertaining the quantity of labor expended in the representative plant, which he at first placed midway between the best and the poorest, but later modified the explanation, by choosing the modal plant where the "bulk of production" took place, and might be at the middle, or near the best plants or towards the poorer plants. At any rate, wherever the bulk of production took place, that fixed the market value. However it was essential for Marx's theory that goods exchange at their value. Hence the standard applied to test the value of the labor embodied in the representative plant, and determine the amount "socially necessary" was to take the commodity to the market and see what it would bring. But this is peculiar logic: first, to say that the value is determined by the amount of labor socially necessary for production, and the test of what is socially necessary is to take it to the market and see what it will bring. One is tempted to say "Would you like to go around again?" But this point has been treated so admirably by Bohm-Bawerk that it is useless to argue the point further .11 In the second place we have accused Marx of a gross inconsistency or contradiction. In the explanation of his theory of value he held strictly to an embodied value analysis. "Commodities in which equal quantities of labor are embodied or which can be produced in the same time have the same value" and enter into exchange as equivalents. The value of commodities \vas determined in a purely technological way; value was physical and intrinsic; and the greater the quantity the greater the value. Regardless of supply, the value of anyone unit remained constant. Had he held consistently to this analysis, he never could have 11 Bohrn-Bawcrk, Karl Marx, Ch. III) on "The Question of Contradiction." Note .. If the reader is unfamiliar with this classic criticism) it should be studied in this connection.

KARL MARX

55

spoken of a general overproduction, or a break in price because of oversupply, because the greater the supply, the greater the value, giving to the possessor added purchasing po\ver. Yet if others would not accept his supply in exchange, it was evident that he had produced the \vrong thing, giving mal-adjusted production, but never general overproduction. It cannot be made too ernphatic, that if value increases with quantity, then purchasing. po\ver increases with quantity, so there would always be demand if production were properly proportioned, and any evidence of lack of demand for any particular commodity gives automatic proof that demand exists for commodities that are not availabJ e. The theory of embodied value must stop with an explanation of partial overproduction and a secular trend of prices determined by the relative progress in the production of gold, and of commodities in generaL Marx must have unconsciously acknow ledged this when he passed from his explanation of value to that of surplus value. It is not necessary to repeat his theory of surplus value, but only to stress the use he made of this in explaining its relation to crises. Crises were due, he said, to the inability of labor to repurchase its products. This caused a glut of the market and a price crash. But that is to speak the language of "Demand and Supply." Under the embodied labor theory of value, labor would still have \vages sufficient for subsistence and reproduction, which was all that was possible under the Capitalistic Regime, and the more wares left in the hands of the employers the greater their wealth would be, so how could an increase in supply decrease the price? '[he inconsistency or contradiction may be stated somewhat as follows: Marx held that "as the quantity of goods increases, the value increases proportionately, since value is intrinsic, while as the quantity of goods increases, the market price diminishes due to the lack of demand on the part of labor." The conclusion is obvious. He explained value by an embodied labor analysis and got a secular trend. He explained market price. by demand and supply and got a business cycle. He could have got it in no other way. And to say finally that after all, embodied

56

VALUE THEORY AJ.lD BUSINESS crCLES

value was a more important and fundamental factor in the determination of price than demand and supply \vas only to admit his inconsistency. Our final criticism is similar to the one leveled against Sismondi. Even though Marx pictured a business cycle, the curve \,/ does not run as he said it did. Crises do not usually come after an extended period of depression, slow sales, low prices and a glutted market, reducing entrepreneurs to bankruptcy. They do not come after a long, gradual movement downward, but they tend to come after a rather prolonged period of violent expansion, speculation, and rising prices. In other words, Marx has the crisis come after a period of falling prices, whereas experience shows it to come at the end of a period of rising prices. So the final criticism of this group is that when consistent, they get no cycle at all, and even when by being inconsistent they do get a cycle, it is a very different cycle from the one that actually occurs.

P~1RT

II

E2\;lBODIED VAL[]E THEORY AND PRICE Jvl0VEMEJ\TTS IN A PAPER L1iONEY ECONOlvl1r

CHA.PTER IV

El\RLY TYPES OF CURRENCY AND BANKING INTRODUCTION

....

",'

...(

~".

As we pass from the group previously considered it is necessary to note a rather marked transition in the theory of value, money and prices. By 'ovay of review it will perhaps clarify the situation to note the variations thus far. Starting with Ricardo we found that he held to an embodied labor theory of value in which goods exchanged against goods typifying a barter economy. The result was no overproduction or underconsumption and no cycle. The secular trend of prices was forecasted as downward, due to more rapid improvements in the "state of the arts" than in the production of gold. The only disturbance of this secular trend consisted of minor variations due to accident, famine, etc. Marx represented a later period, when separation of occupa- .' tion and territorial division of Jabor had made the problem of exchange of products so complicated that it became necessary to stress to a far greater degree than had Ricardo, "the role of money" as a medium of exchange for the more complex world of trade. Yet even here there was no serious departure in principle. For Marx held rigidly to the embodied labor principle of value, and all exchanges whether of commodities for commodities or of commodities for gold, were exchanges of value equivalents. The principle of barter still obtained as money was restricted to specie, the value of which was determined as in all other instances by the social labor cost. The group we are now about to consider has a theory of intrinsic, or embodied value, but the source of value may be neglected. It may be embodied labor or not. The significant thing to 57

I

I

! ! III

58

VALlIE THEOR}· Al\TD BUSINESS CYCLES

recognize is that value is held to be inherent, resident in physical commodities. We should naturally expect them to hold not only that value increases as the physical volume of commodities increases, but also that the value (and by this they consciously or unconsciously mean exchange value) of a unit is constant, and therefore not affected by monetary experiments. But on the last point they are in utter confusion. The representatives of this group are legion, but we shall restrict ourselves to a treatment of a few outstanding and typical representatives which will introduce us to "La\vism," 1 Anarchism) Grecnbackism, Populism and current proposals. Like Marx they have noted the g-ro\ving complexity of the wor ld of exchange. But the physical volume of trade had become so large that barter had broken down completely, and exchange was severely handicapped, or slowed down because of an inadequate supply of the regular medium of exchange, gold-or precious metals. But the more necessitous gold became in the exchange process the more desirable was the ownership of it. But the supply of gold is limited by nature itself and the labor of acquisition. Hence, this group seems to have a feeling in common that Bankers and Banking Systems have arisen and gained a monopoly over this vital exchange essential, limiting the available supply more or less artificially and charging the producing and consuming public an extortionate "rental" in the form of "usurious" interest rates for its use. The remedies proposed are extremely varied as to details but throughout them all there runs a substantial agreement in basic principles. A. PAPER MONEY AS COM1vl0DITY TICKETS

In this chapter we are treating paper money, first, as commodity tickets and second, as commodity-value tickets. In the first instance paper money is nothing more nor less than a ware1 Note: The term "Lawism" was coined by the English Economist, Henry Dunning MacLeod, when treating the experiments of John Law and his followers. (See MacLeod's Theory and Practice of Banking, Vol. II, pp. 247 ff. Sixth Edition.)

EARLY TYPES OF CrJRRE}lCr A}lD BA1\!KI1VG

59

house receipt. The commodity is in the ware-house or on deposit and the ticket which represents the commodity enters into the world of commerce and exchange as a representative of cornmodities. In the second instance-paper money as a commodityvalue ticket-the ticket is transformed into a generalized warehouse receipt and no longer represents a specific commodity but any commodity of like kind and value. The origin of these terms and the distinction between them will become very clear as we briefly review the evolution of banking and currency. RISE OF BANKING AND CURRENCY

As shown in the preceding chapters, the first type of economy was a barter economy but with the rise of specialization in industry and more technical division of labor the problem of exchange became too complex for a barter economy. It was necessary to discover and set aside some commodity as a medium of exchange. After innumerable experiments precious metals came into general use as a medium of exchange, and this period we chose to call the precious metals economy. This situation made it necessary for almost every household to keep in stock a greater or smaller supply of precious metals, and since the hoarding of this money involved considerable risk, there gre\v up places of deposit where the money of the community could be kept in safety. In England the early keepers of the precious metals of the community were called Goldsmiths. It is in the history of the English Goldsmiths and the change in policy with regard to the money left with them on deposit that the transition is made from paper money as commodity tickets to paper money as commodityvalue tickets. TIlE COMMODATUM AND BAILMENT PERIOD

In the first stage the English Goldsmith received from his various patrons their bags and boxes of gold for safekeeping, issuing to the depositors in exchange ware-house receipts---eom.. modity tickets. This commodity ticket was the contract between

60

VALUE T1JEORY AND BUS/J./ESS ClrCLES

Goldsmith and depositor, and carried with it the unconditional promise of the Goldsmith to return to the depositor the identical gold deposited, while to the depositor himself, the ticket operated as a form of bailment, which, upon presentation at the shop of the Goldsmith, served to call forth the commodity previously deposited. The important things to note in this connection are that the property in the gold, or title to the deposit remained with the depositor and was merely bailed to the Goldsmith for safekeeping, to be returned in specie at the demand of the depositor or owner. For this service the Goldsmith charged a fee, but under no conditions was he allowed to trade with the goods on deposit for profit. He conducted a ware-house for storage solely. B. P.:\PER MONEY AS COl\1l\10DITY-\T.ALUE TICKETS THE MUTULTM AND CERTIFICATE OF DEPOSIT PERIOD

Following the Commodatum period of the English Goldsmiths they changed their policy to that of the Mutuum. In this period the Goldsmiths when receiving gold deposits from their customers issued in exchange, not a commodity ticket, promising to return upon its presentation the identical gold deposited, but a Comrnodity- V alue Ticket, i.e., a certificate of deposit in which the Goldsmith promised to return to the depositor or bearer of certificate an equal value in gold, or an equal weight of gold of similar fineness. In this case the property in the gold, or title to the deposit was transferred to the Goldsmith-it became his property-and he nlight do with it as he chose, so long as he kept his promises with depositors to return on demand gold of equal weight and similar fineness upon presentation of the tickets. In other words, the important thing to note here is that whereas in the first instance the ticket is a commodity ticket calling for the return of the thing in specie-the identical commodity-s-in the second case, that of the Mutuum, the ticket is a Commodity-Value Ticket, call-

EARLY" TYPES OF Cl1RREJ.lCY AJ.,TD BAJ.,TKll\iG

61

ing for the return of commodities in genere,'2 i.c., in commodities of the same quantity and quality. Now, the effect of the transition from a policy of Commodatum to that of l\1utuum by the Goldsmiths would have had no effect upon the quantity of the purchasing medium, so long as the total quantity of gold placed on deposit ,vas held in storage. But it was for the very purpose of avoiding this necessity that the change was made. So long as the property in the deposit remained with the depositor and the Goldsmith was required to return to each customer the identical property taken, it was impossible for him to trade with it and keep his agreement. But when he learned, after years of experience, that only a relatively small proportion of the gold on deposit was called for in anyone day, he longed for the privilege of gaining title to the deposits in order that he might return, upon presentation of the certificates, only gold of equivalent value. By so doing he could operate on a small reserve, trade with the remainder for personal profit, and still redeem his pledges. The opposition of the depositors was removed by abandoning the fee formerly charged and even offering a premium for the privilege of safekeeping, provided the depositor would agree ...: ' to accept a Commodity-Value Ticket----eertificate of deposit-redeemable in kind, instead of a commodity ticket-bailment-redeemable in the original deposit. This transition from Commodatum to Mutuum and from a 100% reserve to a partial reserve in the policy of the Goldsmiths leads up directly to the banking policies, and may be discussed best in that connection. BANKS OF THE "CURRENCY PRINCIPLE"

We now pass from Goldsmiths issuing ware-house receipts or certificates of deposit to "Banks of Issue," which gave in exchange for specie, not negotiable instruments, capable of passing in exchange by endorsement, but actual currency (Bank Notes) 2

Ely, R. T., Property and Contract, Vol. I, p.

12 I.

60

VALUE THEORY AND BUS!J./ESS crCLES

Goldsmith and depositor, and carried with it the unconditional promise of the Goldsmith to return to the depositor the identical gold deposited, while to the depositor himself, the ticket operated as a form of bailment, which, upon presentation at the shop of the Goldsmith, served to call forth the commodity previously deposited. The important things to note in this connection are that the property in the gold, or title to the deposit remained with the depositor and was merely bailed to the Goldsmith for safekeeping, to be returned in specie at the demand of the depositor or owner. For this service the Goldsmith charged a fee, but under no conditions was he allowed to trade with the goods on deposit for profit. He conducted a ware-house for storage solely. B. PAPER

IVIO~EY

AB

COl\1?vl0DI'I'~{-\7~-\LUE

TICKE'I'S

THE MUTUUM AND CERTIFICATE OF DEPOSIT PERIOD

Following the Commodatum period of the English Goldsmiths they changed their policy to that of the Mutuum. In this period the Goldsmiths when receiving gold deposits from their customers issued in exchange, not a commodity ticket, promising to return upon its presentation the identical gold deposited, but a C omrnodity- Value Ticket, i.e., a certificate of deposit in which the Goldsmith promised to return to the depositor or bearer of certificate an equal value in gold, or an equal weight of gold of similar fineness. In this case the property in the gold, or title to the deposit was transferred to the Goldsmith-it became his property-and he might do with it as he chose, so long as he kept his promises with depositors to return on demand gold of equal weight and similar fineness upon presentation of the tickets. In other words, the important thing to note here is that whereas in the first instance the ticket is a commodity ticket calJillg for the return of the thing in specie-the identical commodity-in the second case, that of the Mutuum, the ticket is a Commodity-Value Ticket, call-

EARLr TYPES OF ClJRREJ'.lCr' Al'lD BANKING

)

I i

{

61

ing for the return of commodities in genere, '2 i.e., in commodities of the same quantity and quality. Now, the effect of the transition from a policy of Commodatum to that of Mutuum by the Goldsmiths would have had no effect upon the quantity of the purchasing medium, so long as the total quantity of gold placed on deposit was held in storage. But it "vas for the very purpose of avoiding this necessity that the change was made. So long as the property in the deposit remained with the depositor and the Goldsmith was required to return to each customer the identical property taken, it \vas impossible for him to trade with it and keep his agreement. But when he learned, after years of experience, that only a relatively small proportion of the gold on deposit was called for in anyone day, he longed for the privilege of gaining title to the deposits in order that he might return, upon presentation of the certificates, only gold of equivalent value. By so doing he could operate on a small reserve, trade with the remainder for personal profit, and still redeem his pledges. The opposition of the depositors was removed by abandoning the fee formerly charged and even offering a premium for the privilege of safekeeping, provided the depositor would agree ..- .. to accept a Commodity-Value Ticket---eertificate of deposit-redeemable in kind, instead of a commodity ticket-bailment-redeemable in the original deposit. This transition from Commodatum to Mutuum and from a 100% reserve to a partial reserve in the policy of the Goldsmiths leads up directly to the banking policies, and may be discussed best in that connection. BANKS OF THE "CURRENCY PRINCIPLE"

We now pass from Goldsmiths issuing ware-house receipts or certificates of deposit to "Banks of Issue," which gave in exchange for specie, not negotiable instruments, capable of passing in exchange by endorsement, but actual currency (Bank Notes) 2

Ely, R. T., Property and Contract, Vol. I, p.

12 L

62

l'AL[JE THEORY

AJ.\~D BUSl~\~ESS

CYCLES

which passed freely from hand to hand without endorsement. The Early Banks of this type were those of Venice, Amsterdam, and Hamburg, They operated on the Mutuum principle of deposit, but unlike the Goldsmiths of that type they retained a IOOj~ reserve. . . // The sole function of these banks, operated on the "Currency Principle," was to exchange currency-bank notes-for coin and coin for currency. "\'{hen the notes were paid in, the money came out: when the bills came out the n10ney went in: The Inoney was the mother, the note was the son." 3 The banks named above, being in centers of great commerce where all sorts of coin appeared in use, accepted the coins by weight (standard fineness) and paid for them in currency equal to the exact bullion content, or value of the coins taken in.. They then melted down the coins of the promiscuous denominations of the various countries, and recoined them into standard units. These banks made no profit by their business. No bank conducted on the "Currency Principle" ever did or could by any possibility" make profit.. Merchants who kept accounts there paid fees to defray the cxpenses of the establishment. Since Banks of the Currency Principle did not promise to redeem currcncy with the same specie against which it was first issued, these bank notes were Commodity-Value Tickets. Yet there was provided no means of expanding the quantity of purchasing medium. The n10ney could never be irredeemable and it could be retired in toto without affecting in the least the quantity of purchasing medium. This principle was resorted to in China in 1309, when after centuries of experience with depreciated bank currencies they desired to get on to a firIn basis. I t is the principle of all those living today who hold that banking "to be really sound and on the square" should be allowed to issue currency equal only to the amount of bullion displaced. It is the principle back of the idea that the Greenbacks should be secured by a 100% gold reserve, and that banks should keep 10010 of their deposits on reserve. S

Macl.cod, H. D.) T lieory and Practice of Banking, Vol. I, pp. 321-4-

,I

) ~

I

1

EARLr T}·PES OF

Cr]RRE.L'~C}·

A.L'PD

BA..L'~KIJ.\·G

63

The Currency Principle of Banking would unquestionably give us sound money, but it is unnecessarily expensive. It operates on the hypothesis that there is a possibility that all money might be demanded the same day, and therefore safety requires that all of the money remain in the bank. But banking experience has taught us that demand for bank deposits follows the "Law of Statistical Regularity" and its corollary, the "Inertia of large numbers," i.c., the ratio of demand to deposits tends to remain fairly constant. In short, banks are no longer pure depositories, but rather "Insurance Companies," and as such they insure customers against all reasonable probabilities, but not the worst possibilities. It is conceivable that all should die of some epidemic in one year, or that a conflagration should wipe out cities by the score, but insurance rates are not pushed to the point sufficient to cover such contingencies. So in banking, it is practically possible that a banker may be called upon to pay all his liabilities in the form of deposits in a single day, which has been literally true in periods of fear, as revealed by "runs" on the banks. But just as insurance companies do not anticipate pestilence and wholesale conflagration, so do bankers not anticipate wholesale financial calamity. And even though all of these things have actually happened and may happen again to some extent, the losses do not justify running any of them on the annual calamity basis. Therefore, we do not follow the 1000/0 reserve, or Currency Principle in Banking~ The expense of running on the annual calamity basis, in the long run, would prove far more costly to depositors-since this would involve return to the" old fee system of deposit-than the modern plan with its comparatively thin margin of reserve. BANKS OF EMISSION ON BASIS OF PARTIAL I(ESERVE

The Bank of England, established in 1694 was the natural fruitage of the evolutionary process that had been going on under the English Goldsmiths. It was also able to profit by the long experience of the Continental Banks operated on the "Currency Principle" which had clearly proved that at a 100% re-

I

64

rALUE THEORY AND BUSiNESS CYCLES

serve was not necessary in order to carry out the promises to depositors to return specie in exchange for Bank Notes upon demand. Under the Act of 1694 the Bank of England was started as a ~ -Bank of Discount and Deposit, with privilege of issuing bank notes in exchange for commercial bills, the notes to be redeemable in specie upon demand, but only a partial reserve was required for that purpose. On this basis the Bank was organized, received the people's money, agreeing to pay a rate of interest or bonus for the privilege, instead of charging a fee for storage. The deposit was of the mutuum type, as the bank when accepting a deposit promised to return upon demand equivalent value, but not the specific deposit. The Bank Notes issued were clearly then, "Commodity-Value Tickets" and not "Commodity Tickets." The Bank then proceeded to loan out or trade with a considerable portion of the deposits, since they were of the mutuum form, in which the title to the property was transferred to the bank with the deposit. The importance of this transition from the currency principle to that of the partial reserve can scarcely be over-estimated. The supply of money or exchange media was vastly increased since Bullion when deposited in the bank gave rise to much more currency than the specie displaced." The t\VO things most vital for consideration at this point are, first, the extent to which they could go on a partial reserve and still keep their promises to depositors, and second, the effect of this increase in the quantity of the exchange medium on the price level. The consideration of the first point leads to a consideration of "Wild-Cat Banking." UNREGULATED, PRIVATE AND WILD-CAT BANKING

When once departure from the Currency Principle was made there seemed no limit to the amount of currency and credit that might be issued or extended against deposits in gold. Banks of partial reserve have ever found themselves caught between two 4 Note: For the effects of this change in reserve policy on business and the price level, see MacLeod, Theory and Practice of Banking, Vol. I, p. 4-52.

EARLY TrPES OF CURREJ.\"'Cr AJ.\TD BAJ.\rKIl\'G

65

forces. The lure of profits leads them to operate on as small a reserve as possible, while the promise to meet the demands of depositors c3.11s for a substantial reserve. The golden mean between profits and safety could be discovered only by a long period of experimentation, of trial and error, in which period errors seem to have been decidedly dominant. It is needless to recount here the painful experiences both in Europe and in America suffered from these experiments. Banking carne to be, in the eyes of many, a reservoir of specie on the basis of which almost limitless issues of currency and credit might be extended. Anyone could start a bank, take his neighbor's nloney as brought to him and proceed to trade with it as he saw fit. Feverish expansion, speculation, panics and bankruptcies resulted. Depreciated currency and inflation of prices ending in complete irredeemability and business collapses became common occurrences. Of course there was in many cases the element of deliberate fraud, but aside from that this period was the natural and logical culmination of an experiment with Bank Notes based on a partial gold reserve. Out of this disastrous experience came the modern regulated banking policy with required legal reserves and rigid, periodic inspection. The second point to be considered in connection with Bank Note issues on the basis of a partial gold reserve, is the effect upon prices. On this point there is remarkable disagreement. All agree that there could be no change in the price level due to monetary causes under the Currency Principle of Banking. Also there is substantial agreement that prices are bound to rise when Lcurrency becomes irredeemable or quoted at a discount. The price level expressed in terms of gold may remain about constant, but rises in terms of paper to the extent at least to which the paper goes to a discount. The crux of the question comes when banks operate safely on the basis of a partial reserve, and fulfill their agreement to redeem currency on demand in specie. Could such a situation effect a rise G~ th~ price level? This question has been heatedly discussed by numerous econo-

66

V'ALUE

THEOR}~

AJ.'·D

Bl.JSIJ.\~ESS

CYCLES

n1ists, but the view taken here is that if the volume of purchasing media were increased, without a similar increase in production and commerce, there would be a tendency for prices to rise, unless counteracted by some opposing factor. By \yay of summary, we wish to stress the importance of the departure, first from the Commodatum form of deposit to the Mutuum in which the depositor received in the first instance a "Commodity Ticket" calling for the identical commodity deposited, while in the second instance he received a "CommodityValue Ticket" which called for a similar good of equal value. But this change was only a means to an end. The most significant thing for this study is, that having changed to the mutuum deposit the ware-house man or Banker, now being the owner of his deposits, with temporary title to the same, proceeded to trade ,,?i th part of his wares and issued more tickets than he kept wares. 1\1 oney was no longer, as with Marx, a thing of value in itself, nor is it definitely linked to a specific commodity of value, but was a mere generalized representative of value, and furthermore, there were more representatives outstanding than there were commodities for redemption. The recognition of this peculiar situation has given rise to one of the grayest fallacies in regard to money and banking in all history. Macl.eod called it "La\vism," its first popular author being John La w." [j

See MacLcod, T'licory and Practice of Banking, Vol. II, Chapter XIV.

CH~-\PTER

JOHN L~-\\VIS~I-B~-\~I~

B~-\SIS

OF

v

t.xw :

KOTES OR LEG.-\L TEKDER ISSLTED ON THE VA.LC'E OTHER TH~-\N GOLD

CO~\\'L\10DITIES OF

LA\V (1671-1729) was a Scotchman, born in Edinburgh, and was the son of a rich Goldsmith. His father died leaving him the magnificent estate of Lauriston when the boy was scarcely in his "teens." For several years the rich youth squandered much of his wealth and was noted as a gambler and sport. .t\t the age of twenty-three (169-+) he departed for London where, as a handsome person with an easy and insinuating address, he gained admittance to the most exclusive social circles and drew the nickname of "Beau Law." A quarrel soon arose between him and a certain Beau Wilson in connection with a merry London widow which ended in a duel and the death of Wilson. Law, in order to escape trial- and possible imprisonment, fled to France. On the continent Law led the same gay, daring, social life but his knowledge of money and banking gained from his father-a shrewd Scotch Goldsmith-led him to make a careful study of the financial conditions and banking systems both in France and in Holland. He was particularly impressed with the ease of money or apparent large volume of currency and the low interest rate existing in Holland, and soon returned to Scotland to make proposals on the basis of his former knowledge and recent observations. The primary object of Law was to furnish the rapidly developing world of commerce with an adequate volume of currency or exchange media. In fact this entire group seem possessed of JOHN

1

Wiston-Glynn, A. W.) Lolm Law of Lauriston. See also Irving, Washington,

"The Great Mississippi Bubble," [rom WoLfert's Roost,

67

pp~ 174--2 1 4- .

f.

68

VALUE THEORY AND BUSINESS CYCLES

the idea that the successful and rapid exchange of commodities depends upon the maintenance of a sort of numerical ratio between goods and money, and that all depressions are due to an insufficient quantity of money to enable goods to exchange freely at their "real embodied value." Law seemed particularly convinced, upon his return to Scotland, that the financial difficulties of the government and the industrial depression of the people were due to a lack of money.. His direct object, then, was to increase the quantity of money in circulation. The method proposed by Law was unique in that day, but has a very familiar sound today because his followers have become legion. Briefly, his method was the issuance of currency on the basis of physical commodities of value) particularly land. The origin of his scheme is not difficult to discover. In fact, it represents the next logical step after banks of issue emitting currency on the basis of a partial reserve. We have just noted that the Bank of England established in 1694, about the time Law left for France, was established on this principle. And Law had observed that it had issued a quantity of paper money considerably in excess of the value of the gold kept in reserve.. He noted the same condition in Holland and even the Bank of Scotland he found to have issued over four times as much currency as it had bullion or specie to support it. As he revolved this situation in his mind it seems to have occurred to him that money was unique in the world of commerce and trade. Its value was no longer determined by the labor embodied as Marx later held, nor was its value determined by the fact that it was a ware-house receipt representing some specific commodity in storage. Money was not a commodity ticket but a commodity-value ticket. But the strange thing about the situation was that while money no longer possessed intrinsic worth and only represented commodities of intrinsic worth, banks had been allowed to issue more represen tatives ( Bank Notes) than they had things to represent (gold). The quantity of paper money or of value tickets had been made capable of increase by resort to a partial reserve.. But there was a limit to the quantity of money

#"

l

JOHN LAlV

that could be issued on the basis of the gold reserve if bankers were to keep their pledges of redeeming the bank notes or value tickets at par on demand. If, then, the quantity of money could not be sufficiently increased by this policy because of the limited supply of gold or precious metals, why not seek out some other . comnlodity, permanent in nature, v.)itJl value embodied, and let (..it be represented in the world of exchange by commodity-value tickets? Why 110t issue value tickets against commodities of value other than gold? This Law proposed to do. Summarizing, the object of Law was to ((increase the quantity of money." His method was "the issuance of bank notes against commodities other than precious metals." His theory "vas "Money represents commodities and hence paper currency Inay: be based upon commodities" and observing what he thought to' be a scarcity of money in Scotland, he said, ((It remains to be considered whether any other goods than precious metals can be made money with the same safety and convenience." 2 And further, since money is only a representative of commodities of value, "it is evident that any other goods which have the qualities necessary in money Jnay be made tnoney equal to their value with safety and convenience." Stated baldly he held that bank notes only represent property and therefore may be multiplied to the extent of the value of any existing property without depreciation. In accordance with this principle he proposed to the people of Scotland that they establish a land bank and issue bank currency on the basis of the value of land. His arguments were clear and forceful and he showed a thorough grasp of many of the principles and problems of finance. But the wily, conservative Scotch, while they could not discover his fallacies, were fearful of his proposal and the plan was rejected. He then risked a return to London since England was then involved in financial troubles and was seriously considering a similar proposal from Chamberlain, a member of Parliament. 2 MacLeod, n. D.) The Theory and Practice of Banking, Vol. II, Chapter XIV, pp. 247-51.

7°

VALUE THEORY Al'/D BfJSllVESS CY'CLES

Perhaps at this point it would be well to digress for a moment to review some of the earlier proposals, different in method and principle but with the view of accomplishing the same end, namely, increase the quantity of the circulating media. The policies of Mercantilism are well understood and have been ably defended by some on the grounds that in this early period of economic development when specialization of industry and division of labor were making exchange more complex and difficult, the g-reatest need of every country was an increased quantity of purchasing media and to this end many devices were invented for the purpose of acquiring or increasing the supply of precious metal. \\:e need only to recall the stress laid upon a "favorable balance of trade" and the means used to bring this about, such as tariff barriers against imports, prohibitions and duties on exports of gold and bounties given for the importation of gold. The whole philosophy and policy of Mcrcantilism was built on the theory that successful commerce and exchange rested upon the maintenance of the numerical ratio between goods and money and that depressions were linked with a shortage of money. In harmony with this general view that prosperity was linked with an abundance of money and depression with a shortage of money, Chamberlain of England had come forward with a policy similar in principle to that of Law but differing somewhat in detail. In order to increase the quantity of purchasing medium Chamberlain proposed to Parliament that land owners be permitted to mortgage their land to the state for one hundred years at one hundred times its annual rent value. Then the state with the mortgage as security could proceed to issue government notes to the full value of the mortgage or one hundred times the annual value of the land. The notes were to be declared of equal value with silver and made legal tender for their face value. Strange to say, Law severely criticized this scheme and proceeded to show that jf this could be done, then why not mortgage for a million years and issue in government notes a million times the annual value of land or "\vhat need of stopping there?

JOHl\T LAlV

71

"Thy not pledge it to all eternity? and every inch might be covered with paper notes and they might be piled high enough to reach the moon where the deviser of this scheme might find his lost wits." 3 L.~ \V'S

THEORY'

Law as well as Chamberlain proposed to issue government legal tender notes as representatives of the value inherent in land. But he proposed to calculate the value of the fee simple of the land at twenty years' purchase, to coin notes to the value of that amount and advance them to the owner of the land. He proposed that the value of all the lands should be estimated at twenty years' purchase and that a Parliamentary Commission should be appointed with po\ver to issue an inconvertible paper currency equal to that amount. "The paper money will be equal to silver for it will have a value in land pledged equal to the same sum of silver money that it is given out for. . . . This paper money will not fall in value as silver money has fallen or may fall." Thus he was not an advocate of an unlimited inconvertible paper currency. All that was necessary was that it represent some article of value. This throws peculiar light upon Law's theory of value. Being the son of a Goldsmith and a banker rather than an economist, he took little pains to state the theory of value on which his proposal was based. But when he reveals to us his basis for currency it is evident that he possessed a commodity theory of value. True, he did not say, as did Marx and Ricardo, that the 'value of commodities is due to labor embodied or is measured in terms of social labor-power, but he does show that he held value to be intrinsic, embodied in a commodity regard-' less of its source. There is no indication in his writings that the value, or price of the commodity on which his currency was to be based might rise as the quantity of the currency issued increased. While the proposal of Law was much less radical than that of 3

MacLeod, H. D.) TIle Theory and Practice of Banking, Vol.

II~

p. 24-8.

72

VALUE THEORY AlvD BCJSINESS CYCLES

Chamberlain, it was not accepted by the British Parliament so he turned again to France. But before considering his work in France it is perhaps well to say that the proposition he laid before the English Parliament seems to represent his true views on the subject of money and banking and was doubtless proposed in good faith. EXPERIMENTS IN LAWISM THE MISSISSIPPI COMPANY

When Law came to France the second time in the year 1715, the time was most propitious for such a visitor. It was near the time of the death of Louis XIV and he found the country with a luxurious court burdened with taxes, its currency depreciated and the government on the verge of bankruptcy. Government offices were being created and sold to the highest bidder for the sake of revenue. Law came forward and proposed a paper currency based on the security of landed property and the royal revenue, but was refused. He then secured permission to start a bank of his own which proved most successfuL The notes of his bank soon were at a 15%' premium while the government notes were at a heavy discount. In the meantime this social genius had worked his \vay into the good graces of I~egent D'Orleans who established a "Royal Bank" and made John Law Director GeneraL Situated in this strategic position, Law made ready to carry out his theory to its absolute and ultimate limit. He proposed now, not only to issue paper on the basis of land values, but on virtually all commodities of value. To this end the famous "Louisiana Company" was formed. Notes were then issued on the value of the entire holdings of the Louisiana Company which meant the entire Mississippi Valley in America. But from this point the acts of Law would seem to be prompted more by the love of gain and a policy of deliberate fraud than by a conscientious attempt to try out his theory and system of banking, for the holdings of the

JOHN LAlV

73

Louisiana Company were advertised as containing mountains of gold far richer than the discoveries of Cortez in Mexico and Peru. Hence the currency that could be issued as representative of this vast country of wealth could be almost limitless. But even this was too small a basis for currency issue for the ambitious and unscrupulous Law. Under his direction the Louisiana Company absorbed the Canada Company; then the tobacco monopoly; also the great East India Company, the China Company, the African Company, and the Senegal Company. His bank then undertook the management of the mint. Even the tax collection for the government was farmed out to the bank so that it could use the royal revenue also as a basis for currency issue. Having acquired all of these extensive corporations and their entire property the bank proceeded to set afloat currency to an amount which imagination might conceive as equivalent to the intrinsic value of the entire property controlled. Notes by the million were issued. A mania of speculation broke out and the peak was reached in November, 1719 when six shares of stock in the royal bank were sold for 10,000 livres each, and the current rate of interest was as low as 2.%. But the mania of speculation and the concurrent sky-rocketing of the price level characterized as the "Great Mississippi Bubble" is too familiar to need treatment here. Suffice to say that the first blow was struck by the Prince De Conti who sent an enormous quantity of paper to be redeemed in metaL Three wagons were required to remove the metal, Soon others Followed. Speciepayment was suspended and the bubble burst. Law was compelled to flee the country. In the month of September, 1720, for a single mark of gold I 800 livres in bank notes were given which ten months before were valued at 160,000 livres in specie." 4 THE SOUTH SEA BUBBLE

The South Sea Bubble (1720) was the English counterpart to the Mississippi Bubble in France, and it is most interesting to 4

Francis, John, History of the Bank of England, Vol. I, Ch. VII, p.

114.

74

VALUE THEORY Al\ID BUS//tt/ESS CYCLES

note that the people of London observed the wild activity of the uParisian Mob" with a mingled feeling of glee and disdain, only to find themselves reproducing the "Play" in its entirety scarcely two years later. The occasion that gave rise to the experiment was in the nature of a recommendation from the King to the House of Commons "that they consider proper means for lessening the public debt." The scheme "vas then projected by Sir John Blunt, who explained it to Mr. Aislabie, Chancellor of the Exchequer, together with others of financial influence. Without attempting to give an historical account of this familiar incident, the earmarks of "Lawistn" are clearly evident. The South Sea Company agreed to assume the public debt for the privilege of issuing legal tender currency on the basis of their holdings. And since the physical property held by this vast corporation was of almost limitless extent, little pains were taken to appraise its value and issu ~ a definite fraction of this value in currency. To that extent it was not strictly in accordance with Law's original theory, but the important items to be noted are that money was considered a representative of commodities, and there need be no fear of over issue so long as the currency issued was not in excess of the value of the property on which it was based. The value was inherent in the physical property and the currency was a Commodity-Value Ticket issued as a representative. THE AYR BANK IN SCOTLAND

About the middle of the Eighteenth Century the proprietors of the Ayr Bank were immensely wealthy, and the bank considered a veritable Gibralter of Finance, so the Directors conceived the idea of capitalizing their reputation for riches, by issuing bank notes on the basis of their possessions. But when they had advanced to people 800,000 English pounds sterling, and issued bank notes to the extent of 200,000, people's faith in the bank was shaken and the institution collapsed. It represents another experiment in Lawism in which a group thought it to be

7S sound finance to issue paper money as Commodity-Value Tickets to the full value of the commodities possessed. THE BANK OF NOR\VAY

(1816)

AT DRONTHEIM 5

The capital for this bank was originally raised by a forced loan or tax upon all land property, and the landholders became shareholders according to the amounts of their respective payments. The bank was especially designed to benefit agriculture. Its principal business consisted in advancing its own notes upon first Inortgages on land to any amount not exceeding two-thirds of the value of the land, according to a general assessment valuation taken in 1812. The Borrower was required to pay at the rate of 47c per annum, semi-annually, and pay 5 % of the principal annually, thus extinguishing the debt in twenty years. Sound as the scheme appeared to be, the notes of the bank fell to a discount of 455~ in six years and were gradually brought back to par, only by u'-illfully contracting the issues. This experiment would seem to indicate the essential danger of issuing bank notes on the basis of land values. THE FRENCH ASSIGNATS

In spite of the catastrophic ending of Lawism in France in the early part of the Century, Law's "Money and Trade Considered" was translated into French in 1789, and served as the basis for a new experiment in connection with the French Revolution of that time. It will be remembered that the National Assembly had confiscated the property of the Church, but soon found that, instead of yielding a ·revenue, it cost the nation 2,000,000 pounds a year more than it produced and in a few years had increased the public debt by 7,000,000 pounds. The property seized was worth about 80,000,000 pounds, so because of the embarrassing financial condition the new government was favorable to its sale. The municipalities finally agreed to purchase a considerable porr;

MacLeod)

Ope

cu;

p. 26 3.

76

Y

VALUE THEORi AND BUSIJ.VESS CrCLES

tion of the property, but soon discovered that "there was not enough money----eirculating media-to take care of exchanges on such a large scale.. " The problem then seemed to be that of increasing the amount of lnoney. Here Lawism carne to the rescue. The Assembly in the spring of 1790 authorized the issue of 16,000,000 pounds of assignats on the security of the Church Lands. In September, further issues to the amount of 32,000,000 were authorized." At this time much objection arose to the method, the chief opponent being the wily Talleyrand.. But Mirabeau triumphed over all opposition, in a classic defense of the plan, which we reproduce in part, because it has been repeated in one form or another thousands of times since, with the fervor of a crusader, but perhaps never in a more concise and convincing presentation.. Denying the possibility of depreciation of assignats based upon property of such sound values, he said, "It is vain to assimilate (compare) assignats secured on the solid basis of these domains, to an ordinary paper currency, possessing a forced circulation. They represent real property, the most secure of all possessions the land on which we tread . Why is a metallic circulation solid? Because it is based upon subjects of real and durable value, as the land which is direct! y, or indirectly the source of all wealth. Paper money, we are told, will become superahun dan t; it will drive out metallic money from circulation. Of what paper do we speak? If of a paper without a solid basis, undouhtcdly; if one based upon the firm foundation of landed property, never. . . . There cannot be a greater error than the terror so generally prevalent as to the overissue of assignats.. It is thus alone that you will pay your debts, pay your troops, advance the revolution. Re-absorbed progressively, in the purchase of the national domains, this paper money can never become redundant, any more than the humidity of the atmosphere can become excessive, which descends in rills, finds the river, and is at length lost in the mighty ocean." 7

Thus the process continued, issue following issue until the assignats amounted to forty-five milliards, or about 2,000,000,o 7

MacLeod, 'I'Iieory and Practice of Banking, Vol. II, p. 255. MacLeod, Theory and Practice of Banking) Vol. II, p. 256.

JOHN LAW

77

pounds' and the paper money had fallen to one thousandth part of its nominal value. To improve the situation the government decided to issue territorial rnandats at the rate of thirty assignats to one mandat, which were to be exchangeable directly for land, at the will of the holder, on demand. This act sent the mandats and assignats up temporarily, only to be followed by another huge issue which sent them down to such a depreciation that a mandat was worth no more than an assignat had been previously. At length the whole system broke down and a decree was published on July 16, 1796, stating that everyone might transact business in the money of his choice, that mandats should be taken only at their current value, quotations of which would be published daily by the Treasury. This destroyed the legal tender quality of the paper money, and specie soon made its appearance, showing concretely how worthless the assignats and mandats had become as compared with specie, even though backed by something as durable and valuable as land. 000

j ( ~

-".

...

l

"Such is a plain statement . . . of the results of the greatest experiment the world ever saw of issuing a paper currency secured upon commodities or property-the most complete example of Lawism . . • . Even though the experiment was not carried out to its fullest extent, the value of the paper assignat sank to one 3o,000th part of its value in silver! There were 2,400 millions of promises of mandats issued against property valued at 3,785 millions, and yet in July, 1796, the note for 100 livres was only five centimes! Such was the inevitable consequence of basing a paper currency upon property or securities, and such it must ever be, because, if such issues are once begun, there is no legitimate conclusion whatever, until all the property in the country is coined into notes. Pass the legitimate limits of a circulating medium by one hair's breadth, and there is no logical conclusion but in the Frenc.h assignats." 8 SUMMARY ANALYSIS AND CRITICISM OF LAWISM

~,.

I f

I

1

I . Theory of Value. I t is no insult to the intelligence of John Law, who lived two hundred years ago to say that he had a theory of physical value, that he considered value as intrinsic, embodied 8

Macl.eod, Theory and Practice of Banking, Vol. III, p. 263.

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VALUE THEORY AND BUSINESS CYCLES

in commodities. It was the accepted theory of his time, so he merely represented the thought of his day. 2. Theory of Money and Prices. Law found himself at the junction point or culmination of two previous policies, namely, Mercantilism and Bank Note issue on the basis of a partial reserve. According to Mercantilism, the surnmurn bonum was an enormous and ever increasing supply of precious metals as a medium of exchange. The greater the supply, the greater the possible increase in manufacturing and commerce. Prosperity and business activity were indissolubly linked with an "adequate supply of money." Although much of the Mercantilist philosophy had been exploded by the beginning of the Eighteenth Century, yet men's minds were still directed to the problem of expanding the volume of money_ In this connection we have spoken of the policy of the Goldsmiths, and the shift from Commodatum to Mutuum ; and later in Banking circles, the shift from the Currency Principle to the Partial Reserve, all directed to the one end of increasing the quantity of the circulating medium. N O\V the object of Law was identical with that of Mercantilism, but the method "vas s~ggested by the Partial Reserve Policy of Banking. Under Mercantilism with its precious metals economy, exchange was looked upon as an exchange of commodities of equivalent value, the value being considered as physically embodied in the goods exchanged, the most common good being gold or silver. In other words, a precious metals economy is only a modified form of barter economy as shown above. But the precious metals remained so "precious" and limited in quantity, that men began to despair of supplying the rapidly expanding world of commerce and trade with enough precious metals to expedite exchange with quickness and dispatch. Itt this point the idea of the partial reserve, permitting many times the value of the specie to be released in the form of paper currency which, while recognized as having little or no intrinsic value, yet being Commodity-Value Tickets, or representative of things of value} and redeemable upon demand in

JOHN LAlV

i

a commodity of value, was readily acceptable in trade in place of the precious metals. And in order to guarantee their general acceptibility they were made legal tender. As soon as money was made a representative of a thing of value, a mere value ticket, it was only natural and logical that someone, as Law, should have said, "It is evident tliat any other goods which have the qualities necessary ill n~oney n~ay be made n10ney equal to their -oalue 1J..;...i th safety and conuenience:" And this was Lawism. The fallacy of Lawism is to be found in his misconception of value. If value were constant and inherent in commodities, then obviously the issuance of currency would not affect their value. The quantity of currency issued would reach an automatic limit as their nominal 'value approximated or equaled the fixed value embodied in commodities such as land. The reason why the policy of issuing bank notes or legal tender on the basis of land or other commodity values is so catastrophic in its consequences, is because value is not intrinsic, embodied in physical commodities, but is affected by demand, and to furnish demanders with a large supply of new legal tenders, particularly at a low rate of interest (which is almost always a part of the scheme) inevitably produces a rise in the general price level including the commodity serving as a basis of issue. Hence by the time the first issue has been absorbed the value of the commodity back of the notes has so increased that it can serve as the basis for another issue, with a consequent rise and another issue, and so on ad ill [miturn, Lawism carried to its logical limit gives a secular trend of the price level skyward to catastrophe. The end is national bankruptcy. It is truly represented by the expansion of a bubble till it bursts. There is no cycle. Crises occur if and whenever the experiment is tried anew.

1/

CHAPTER "\1'1

PROUDHON THE foregoing extended treatment of Lawism has been given because of the light it throws upon the theories of the anarchists. In fact, the monetary and banking proposals of Proudhon and his followers remain quite unintelligible unless prefaced by an account of the earlier experiments carried on by John Law. However, it must be remembered that Proudhon was an anarchist and had a whole philosophy of life, government, and education in addition to his economic system. Liberty and Justice. First of all, Proudhon would abolish the state for it is tyranny institutionalized and prevents any degree of liberty. "Liberty," he remarks, "is the sum total of my system -liberty of conscience, freedom ?f the press, freedom of labor, of commerce, and of teaching, the free disposal of the products of labor and industry-liberty, infinite, absolute, everywhere and forever." 1 The state must be abolished in order to do away with two other great evils which depend upon government for enforcement, namely, property and enforcement of contracts. Without government the only property remaining would be that which each one could personally use, for without compulsion no one would work for another, hence there would be neither landlords and tenants, nor employers and employees. Property would be restricted to private property for personal use. Injustice was due, not only to large property holdings and landlords, but to state enforcement of contracts. The chief contracts involving injustice were those regarding "escheat" which was a general term covering rents, interest and discounts, "Of all forms of capital \v hich allow of a right of escheat to the 1

Gide and Rist, History of Economic Doctrines, p. 297.

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81

product of the worker, whether in the form of rent, of interest or of discount, the most important is money, for it is only in the form of money that these dues are actually paid. If we could suppress the right of escheat in the case of this universal form of capital-in other words, if interest were abolished-the right of escheat in every other case would soon disappear." ~ "The suppression of Inoney interest would enable the worker to borrow capital gratuitously, and would give him immediate control over all useful capital, instead of renting it. All attempts to hold back capital for the sake of receiving interest without labor would thus be frustrated. The right of property would be reduced to mere possession. Exchange would be reciprocal, and the worker would secure all the products of his labor without having to share it with others, in short, economic justice would be secured." 3 Thus the goal of Proudhon is ~4:liberty and justice" and the method is that of the elimination of the state, and with it would \,p' " go all property other than possession, and the aboli tion of interest. \Vith this goal in mind, his means of attainment become more intelligible. His whole banking scheme is designed for the purpose of eliminatinp interest and making loans free to all. THEORY OF Vi\LUE

Proudhon's theory of value is one of "embodied labor" but of a very unique type, and rather difficult to understand. It might be contrasted with the theory of Marx by saying that while Marx determined value by the "social labor-power" embodied, or labor socially necessary, Proudhon determined value by "individual labor time" and contended that "every day's labor is worth another day's labor." -t There is no qualitative difference, but the labor of one man is worth as much as the labor of another. Where Marx reduced the unit of labor to aliquot parts of a total social labor-power, Proud hori's idea of justice made the 2 3

4

Gide and Rist, History of Economic Doctrines, p. 308. GiJc and Risr, History of E conomic Doctrines, p. 309. Marx) Ti,e Poverty of PhiLosoplty, pp. 53-4-.

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labor-power of every individual exactly equaL He labeled his theory "Constituted Value." In developing his idea of value he begins by saying, "Value is the corner stone of the economic edifice," "yet it presents two faces." G The one is called use value or value "en soi," and the other excllange value, or "d'opinion." From this it might be judged that he held use value to be intrinsic or embodied, while exchange value was determined by demand and supply, with a psychological explanation. But when we learn the basis of this cCopinion" it seems clear that his theory of constituted value is an embodied value concept, even with reference to exchange value. In analyzing value, Proudhon immediately discovers an inherent contradiction. A thing must possess utility to have exchange, yet the more useful the things one produces the less exchange value they have. The two are inseparably linked, yet run in opposite directions. "Three years of fertility in certain provinces of Russia creates a public calamity just as in our country (France) three years of abundance becomes a calamity for the vine growers." (I Here is a serious contradiction that a satisfactory definition of value must explain. He then starts in quest of such a definition. In attempting to discover the unit of measurement for value, Proudhon held that there were two types of measurement, one a measurement as of length or weight, where the unit was of the same nature as the commodity measured, the other was similar to a thermometer, entirely different in nature from the thing measured, heat, yet indicating accurately changes in the thing measured. Value he held to be analogous to heat. The exact nature of heat had never been discovered, yet the Physicist had invented a unit and instrument of accurate measurement. It therefore devolved upon the Economist to perfect a measure of value, even though the nature of value remain unknown and inexplicable. Proudhon accepted his own challenge and defi5 Proudhon, Contradictions Economiques, Vol. I, Ch. II, p. 65) Dcuxierne Edition, Paris, 185 o. p. 73.

«iu«,

PROUDHON

nitely set for himself the task of discovering or inventing a unit of measurement for value. After years of study he pronounced his labors a success and proclaimed to the world his unit of..l measurement as "individual labor time." Hence it may be a slight distortion of fact to say that value, for Proudhon, was embodied labor, yet because value was always present to the degree that labor had been embodied, we tnay for all practical purposes of analysis speak of his as an embodied value theory. PR01JDHON'S CHEMICAL THEORY OF EXCHANGE

But the law on which value is based, and which explains the possibility of value, said Proudhon, is "rhe law of propor-: tionality.JJ Before there can be value, there must be a proper proportion. Commodities of value he likened to chemicals in the laboratory. Water is formed from Hydrogen and Oxygen, but only when these elements are in proper proportion,,! for if one chemical exists in excess, then only a part of it it( useful "and combines, while the remainder is left over and is useless until more of the other chemical is added. So with commodities. They have value when produced in proportion, but if not, then a part is left over and is useless. "The excess which remains over is non valeur and until the accession of a certain quantity of another element, it will not combine. There is no exchange." 7 But all lack of proportion leaves some laborers unrewarded, resulting in poverty and misery. The first essential in production then, is "proportionality." Under the present regime Proudhon found complete lack of proportionality in production. But that was due to the evils of government and property. Leave men absolutely free and they will distribute their work with the wisdom of a god, in fact, the society of his visions, he calls "Prometheus." "Let us call Society Prometheus." 8 In this new Proudhon, Contradictions Economiques, VoL I, pp. 82-3. Proudhon, o». cu; I, page 84. Note: In this connection, it would seem advisable to point out that his chemical analogy was not we ll chosen, for while it is true that in chemistry, the element in excess enters in no wise into the combination and therefore is a non use, yet in the field of commodities of value, an excess does not result in 7

8

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society, Prometheus gives to labor ten hours a day, to repose seven, and the remainder of the day to pleasure. In order to draw from his exercise the most fruitful yields, Prometheus (Society) takes note of the pain and of the time which each object of consumption costs him. Nothing except experience is able to instruct him in this, and this experience will be built out of life itself, with its fatigue, pain and pleasure. While thus engaged, Prometheus makes an innumerable quantity of calculations, but in the final analysis he arrives at an apportionment of his labor so that he gains the maximum of vvell-being at a minimum of cost or labor. On the basis of this experience Prometheus constructs a table of values, based upon the labor-time which he put into each unit or commodity. He knows that such a commodity cost him an hour of labor, another a day, another a week or a year. All are listed in order of labor-cost. The total value comprises his riches. Also this table Vol hen once constructed is not final, but is always changing. If a commodity, due to improved processes or discoveries comes to cost less labor it moves down the list and is exchanged for less than previously. But at any given moment its value is known. Thus does Proudhon lift Prometheus, the omnipotent and omniscient god out of the fable and stands him up to represent Society. And just as Prometheus could catalogue his products accurately in the order of the effort which he had to put forth to produce them, so Society when set free to work out its own interests without restriction or compulsion, will know quite as accurately the labor-cost of its various products. The values will change from time to time but for any given moment they will be known and recognized. Society (if government be ousted) established a law of Proportionality which determines value. certain goous remaining out of exchange. The great difficulty is that they do enter into exchange and operate to bring down the value of all. Here again also we find convincing proof that his theory of value was an embodied one. In that case, a surplus could in no wise affect the exchange of units. Therefore only a sufficient quantity of these fixed values would be needed in exchange for others and the remainder would be left over.

PRO [}DIIOJ.\T

But in addition to proportion there must also be quantity and variety. Abundance, ~variety, ani] proportion in products are the three terms which determine riches, or "constituted value." Again, he says, ",talue, conceived as the proportionality of products, otherwise called constu utcd value supposes necessarily and in an equal degree tttility and venallt», indivisibly and harmoniously united. Without utility it would be incxchangeablc, and hence not a part of riches. It presupposes venality (salability) since if it were not always acceptable in exchange for a determined price, it would be a non -calue, it would be nothing." 9 W e are now ready for his final definition of ((Constituted Value." It is individ~al labor correctly constituted or propor- i tioned in free society as by a Prometheus. "The constituted value of a product is simply the value which is constituted by the labor time embodied in it. . . . i\. given quantity of labor equals the product created by the same quantity of labor." 10 ·f

THEORY OF IvIONEY AND PRICES

~

((Every product is a sig-n representing so much labor. . . . Gold, as all other merchandise is a sign representative of labor. Therefore it has po\ver to serve as a common evaluator and as an intermediary in exchange." 11 The use of gold as money is purely conventional, Other commodities might be used as well, or at least as accurately, since it is only a representative, the real measure of value being labor-time. In actual practice, however, the use of gold has justified itself as convenient, and according to Proudhon, it was the first commodity, the value of which was "constituted," that is, it was the first commodity which Prometheus was able to list accurately in his table, as a definite representative of so much labor-time. Marx, in his criticism, severely condemned the idea that gold was the first commodity the value of which became constituted or recorded. However, Proudhon frankly stated that there was nothing sacred about the use of o Proudhon, o« cii., VoL I, p. 91. Marx) TIle PoverLy of Plulosoph y; p. 53. 11 Proudhori, oi, CiL., Vol. I, pp. 94-5. 10

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gold and silver as money and their constituted value was subject to change as everything else, if the labor-cost of production changed. From this it is clearly evident that as long as Proudhon thought in terms of a precious metals economy, prices 'Yvere determined by the relative amounts of labor embodied in the commodity and in the specie units. But in order to explain prices under his money economy, it is necessary, first to consider his "Banque du

Peuple." B,;-1.NQUE DU PElJPLE

As was pointed out at the beginning, Proudhon was intensely interested in establishing justice and liberty. On the basis of his theory of value, the more regularly labor worked the better off it would be. I-Ie held further that labor always yielded a surplus, though his explanation "vas far different from that of Sismondi and Marx, According to him the surplus was due to social cooperation. All the excess product due to improvements and organization, over and above what men would produce if working isolated and alone, constituted a social surplus. In a world ~~ of freedom this would go to labor. But in the world of governments, property, and interest changes, labor was kept in misery while many idle people enjoyed extravagant luxury. He would eliminate the state to get rid of coercion and property J and his bank was for the purpose of abolishing interest and thereby liberate laborers from the necessity of working for others. Each could borrow and produce for himself. The chief features of the bank were: (I) All loans were to be \" made without interest charge; (2) The Bank was to issue "circulating notes" (not legal tender, for there would be no government to force acceptance) which represented commercial goods, or other securities and loans on land; (3) The price of all commodities was to be determined freely between buyer and seller and the "trade acceptance" or certificate of sale could be discounted at par at the bank. The chief points to note, and those which seem clearly to justify linking his system with "Lawism"

PRO [JDH01V

are, that paper money was to be issued on the basis of commodities, and also that his theory of value was an embodied one. A more concrete idea of the bank and its working may be gained from a brief analysis of a supplementary sheet published in connection with his News Paper "Le Peuple" about Feb. 5, I 849. According to this the bank had for its end "The democratic organization of credit, and the making possible of more goods at lower prices." It further proclaimed that everything furnished by nature was gratuitous, and those not so furnished were the products of labor. Capital was unproductive. The bank was to issue bills or paper money in exchange for specie, two-name paper, and for securities such as stocks and bonds. Since this bank operated under the French Government, he had to suggest certain provisions against fraud, which provisions would probably have been omitted had his bank been established in connection with a purely anarchistic state. At any ra ' ~ in this bank there was to be a "Committee of Discount," Jrhose duty it was to pass on all loans. If loaning on real estate they were to determine its value. If on securities they examined the titles, and no discounts of two-name paper or paper connected with commercial transactions were to be made until "vised" by the Committee of Discount. EFFECT UPON THE PRICE LEVEL

As said above, one of the objects in establishing such a bank was to make possible "more goods at lower prices," but since its organization was a part of the liberal program connected with the Revolution of 1848, it perished in its inception and was never allowed to function. For this reason we have no such concrete proof of its influence upon the price level as in the case of the Mississippi Bubble.. We must therefore arrive at our conclusions deductively. Since the bank was to be discounting constantly paper arising out of exchange and commerce, and issuing paper money for full value as agreed upon by the buyer and seller and O.K.'d by the Board of Discount, it is clear that the price level would have

L-

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been quite wholly determined by the "opinion" of the buyer and seller, ratified or modified by the "opinion" of the Board. The judgment of the Board as to how much nloney should be exchanged for any certain commodity in the final analysis would determine the price of that good, and hence of all goods. Had the board been furnished with a Modern Index Number, it might have held to it rigidly, but since that was unknown to them, all was "opinion." But it is clear from the general viewpoint of Proudhon that he would not allow too much arbitrary power to a Bank Board. It Inay be assumed that the expectation was that the Board would perform its function quite automatically and ratify, not n10dify) the opinion of the traders.!" Granting, then, that in the bank as established, the price level could have been determined arbitrarily by a Board, and lnight have remained constant, gone upward or downward, how would the price level tend to move in connection with the idealized anarchistic bank where the "opinion" of buyers and sellers were ratified automatically, and money exchanged at the figure agreed upon by the traders? It is clear that Proudhon expected prices to fall or at least there would be no rise. For free credit and universal entrepreneurship would stimulate production, and hasten new processes to such a degree that goods would become so abundant, and the sacrifice necessary for labor to overcome the resistance in nature would be so lessened that exchange value of goods would fall, because less labor was embodied. But we must analyze very carefully his use of the word "opinion" since the opinion agreed upon between buyer and seller is the determining factor in the price leveL It must be remembered that in Proudhon's world no one was to get an income but laborers. Landlords and capitalists would be abolished. Idlers would starve, for he said that to give money to idlers would be like throwing it into the flames of Aetna. "Prometheus (symbolical of society as a whole) is always a la12 It is we'll to note that there was no provision for a Board of Discount in Proudhon's "Banque d'Exchang-e" which was his theoretical idea set forth as a part of a true anarchistic regime.

PROTJDHO.L\T borer, whether a vinczrower, breadrnaker, or blacksmith, Whatever trade he chooses he works for himself. He purchases what he consumes with one and the same money (his products). But the metric unit is necessarily his day of labor. It is true that work, even for him is susceptible to variation: Prometheus is not always equally disposed, from one moment to another his ardor, his productivity waxes and wanes. But like everything else which is subject to variation, labor has its average (moyenne), and this warrants us in saying, finally, the da)· of labor pays the day of labor. Nothing more or less. It is indeed true that if we compare the products of a certain epoch of life with that of another, the 100 millionth day of human kind will give a result, incomparably greater than the first (day). But that is only to say the life of the collective being, as well as that of the individual, cannot be divided, that if their days do not resemble each other they are indissolubly united and that in the totality of existence pain and pleasure are common to them. If the tailor, for rendering the value of a day's work consumes ten times the day's work of the blacksmith it is as if the blacksmith had given ten days of his life for a day of the life of the tailor. 'This is precisely what happens when a peasant ~ays 12 franks to a notary for writing a document that cost an hot} and this inequality in exchange is the most powerful cause of misery which the Socialists have discovered." 13

Proudhon did not admit of a hierarchy of capacity. Men were created equaL On account of governments and injustice some had developed their capacities more than others yet he held that men were still potentially equal and in an anarchistic state all would be equally capable and all would be laborers. In that case "Every day's labor is worth another day's labor; i.e., in equal quantity the labor of one is worth the labor of another: there is no qualitative difference. Given an equal quantity of labor the product of one will exchange for the product of another. All men are wage workers and equal wages pay for an equal time of labor. Perfect equality presides over the exchange." 14 Again he says, "Equality alone is our rule as it is also our ideal." 1,j From this we seem compelled to infer that the standard of 13

11 15

Proudhon, C ontra.lictions Economlques, Vol. I, pp. 106-7. Marx, The Poverty of Philoso-p/iy, p. 53. Proudhon, Contradictions Economiques, Vol. I, p. 115.

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value for Proudhon was individual labor-time and that the labor of one man was automatically equal to the labor of another man. When t\VO men enter into exchange, being laborers, they bargain on the basis of their knowledge of sacrifice embodied, and their opinion crystallized in an agreement determines the value of the commodity in exchange. Because of this Proudhon had no fear that the lending of unlimited quantities of paper money without interest could in any \vay affect the exchange value of commodities, since money had no relation as he thought to the value of commodities for value was embodied human effort. In a barter or precious metals economy Proudhon would not have needed to consider price level for exchange value would have remained on the labor-time or sacrifice basis. The labor-time embodied in one commodity would have been automatically equated against the labor-time in the other. But when commodities in which human sacrifice has been embodied are equated against paper money unlimited in supply, involving virtually no labor-cost of production there is no assurance that the equation between commodities and paper money would have given a constant price level. In fact, a constant price level is unthinkable with an unlimited supply of paper money, especially when the paper money was to be loaned without interest to the full value set by the parties in exchange. One seems compelled to visualize a concerted marking up of prices as if by conspiracy. Such a practice would allow individuals to gain control of additional purchasing power without interest and would not impose additional sacrifice when exchanging commodities against commodities. In the latter case equality of sacrifice might still govern but when one side of the equation in exchange represents virtually no sacrifice it is impossible to forecast the limits of an upward movement of the price level. It would seem that Proudhan, as well as Law, invented a theoretical scheme which would have guaranteed a secular trend of the price level skyward and ending in catastrophe.

PRO[]DHON

91

APPRAISAL AND CRITICISlVI

The basic fallacy in the system of Proudhon, as wel! as of others which we have treated, was in his theory of embodied, value. Were this a sound theory his paper lTIOney scheme undoubtedly would have little or no influence upon the movement of the price level. The value of the commodity being fixed and inherent would always and everywhere callout a definite quantity of paper money in exchange. But it is for the specific reason that exchange value is not embodied but varies with demand that a banking system which loaned freely without interest would give rise to a continuously expanding demand in the form of loans, and therefore a continuous rise in prices. Proudhon's system would seem to end in that same vicious circle as noted in connection with John Law, A second r -iticism applies to his attempt to abolish interest. \\Te have cCJne to think of interest, not as an indication of exploitation btt as inherent in the psychology of the human race. As Bohm-Bawcrk has well shown, "Present goods are of greater value than future goods of like kind and number." Normal beings subjectively value present goods higher than future goods. Therefore any system which would increase purchasing po\ver in ' the present through bank loans without a penalty or sacrifice in the form of interest would lead the human race into a mania of speculation and extravagance culminating in certain disaster. Proudhon had little to say about commercial crises, and there is no evidence to show that he had any concept of cyclical movements in business, as set forth by Sismondi and Marx. What he seemed to recognize was a tendency towards chronic depression. In his system of thought, designed to meet this situation we find four basic ideas. First, he begins with an embodied value con-v-:" cept. Second, he develops and presents his unique and original "Chemical Theory of Exchange." Third, he stands as one of the representatives of "La\vism" since he advocated the issuance of

92

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paper money secured by commodities other than the precious metals. Last of all, he advocated the elimination of interest as an indirect means of overthrowing the Capitalistic System, and emancipatinjr the proletarii.

ROBERT O\\TEN life, character, and pristine idealism of Robert Owen will never cease to be an inspiration to all who interest themselves in and struggle for a better day. The striking success with which he mingled humanitarianism and efficiency in the cotton mills of New Lanark, Scotland, and the noble aspirations culminating in the New Harnlony, Indiana experiment will ever continue to be fascinating chapters in human history. ) et striking as is the life story of this heroic social reformer, we must restrict ourselves to a consideration of his system of ex,' Lange and distribution in its relation to lnoney and prices. ~I THE

-s-

COOPER:\TI\,rE COl\I~vlUNITlES AND THE NL-\TIONL-\L EQUITABLE LABOR EXCH~-\l\GF

Owen began the organization of Cooperative Communities about 1830 as "the voluntary union of the industrious or productive classes in such numbers as to afford a market to each other for the mutual supply, directly by themselves of all their most indispensable wants.' After a year or more of preliminary work the proponents of the idea held the first Cooperative Congress at Manchester in May, 183 I. At this Congress the following resolution was unanimously adopted: "Resolved that this Congress considers it highly desirable that a community on the principles of Mutual Cooperation, United Possessions, and Equality of Exertion and of the Means of Fin joyment shall be established in England as soon as possible." As a result of the impetus given here several Cooperative 1

Frank Podmore, Robert Onoen, Chapter XVII, p. 39 8. 93

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B[JSll\~ESS

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Communities were organized and put into operation. Soon the problem of surplus goods arose which they met temporarily by sales to the outside public, in a more or less promiscuous fashion followed by the inauguration of Exchange Bazaars. These were formed as a direct means of exchange between producers and consumers in order to eliminate the "exorbitant and parasitic toll of the middlemen." This system gave rise immediately to the problem of value and price. To solve the problem they reverted to a labor-time standard which might be characterized as a hybrid cross between Marx's "Social Labor-Power" and Proudhon's "Individual Labor-Time." They followed the standard logic of Socialism, beginning with the major proposition that "Labor is the only source of wealth' and ending with its corollary "the natural standard of value is human labor." Therefore, the unit of value must be labor-time. The difficulties resident in such a system of labor-time, and the value of the daily output of every other man was so many units more or less than this, depending upon the degree to which his output was greater or less than that of the typical average. Upon depositing his products with the exchange store' the laborer would receive a labor exchange note for the proper hours of labor-time when reduced to the average. To illustrate, we n1ay consider the case of a tailor whose labor in the open market was paid for at the rate of a shilling an hour. If he brought a suit to the Labor Exchange Store to have it valued, its price in labor-hours would be computed as follows :-first, the value of the raw materials would be set down in "vulgar pounds, shillings and pence"; then the value of the labor would be added in the same base medium; the whole sum would then be divided by 6d., and the quotient would represent the number of hours of labor-time to be entered on the labor note." While the method is most ingenious, one immediately recognizes the same fatal inconsistency and circular reasoning pointed 2

See frontispiece.

ROBERT orVEN

95

out in connection with Karl Marx's "social labor-power" and "labor socially necessary" when he said that the \vay to find out what was socially necessary was to take the article to the market to see what it would bring. 3 The difference is that Marx took his article to the market at the last to see how much socially necessary labor had been embodied, while Owen, by learning i.: beforehand, a man's outside rate of \vages and the value of raw materials, could very accurately find out the number of hours of labor-time embodied by dividing these externally determined values by six pence, which was the customary wage per hour for the average man. Of course, this is circular reasoning of the most vicious sort. Instead of inventing a wholly new scheme of value within the rcalm of labor-time, the new value unit has been reduced from the current value units by a mere mathematical process not altogether different from that experienced in changing pounds and shillings to dollars or francs. How can "vulgar pounds and shillings" be refined into pristine units of labortime by a mathematical process of division? Again, labor differs, not only in speed but quality. And it was in this connection that the Labor Exchange Store experienced its greatest difficulties. For example, an instance is given of a tailor who received a labor-exchange note for full time value in payn1ent for a "coat and pair of trousers which were misfits and unsalable elsewhere." Unless care is taken to discount inferior work and misdirected labor, or to place a premium on superior work embodied in commodities, the value in labortime granted to the producer would have little relation to the value placed upon the article by a consumer. But any corrective method of this sort would be inconsistent with the embodied " labor theory of value and there is little evidence to show that Owen and his associates resorted to the Marxian refinement for qualitative measurement. After experirnentinp for some time with Labor Bazaars and having perfected, as they thought, a universal medium of exchange and stable measure of value, the time seemed ripe to I...,.,...'

3

See above, p. 54.

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VALLTE THEORY »v» BUSINESS crCLES

launch their system in a much larger and more comprehensive \vay. They secured a huge building from William Bromley near King's Cross and the "NATIONAL EQUITABLE LABOUR ExCHANGE" opened auspiciously on September 17, 183~. The deposits in commodities were enormous during the first few days, and they were compelled to close the store to the public for a time in order to arrange the stock. The store did an enormous business for over a year, and the labor-notes became a very common medium of exchange, accepted at theaters, and by merchants wholly outside the system. Then the business began to wane, reached negligible proportions early in 1834 and soon closed down." While the reasons usually offered to explain the failure were religious differences, lack of governn1ental protection against fraud, and the desire of the women to "shop-around," it is generally conceded that the most vital reason was connected with the fundamental error in value and price standards. It has already been stated that each article was priced in labor-time hours, with little or no consideration given to the problem of misdirected or poorly applied labor. The result was that the best work was priced lower than in most stores, while the poorer work was overvalued according to the judgment of the consumer. But since each consumer was at liberty to look at the price and choose the best article that could be obtained in exchange for his own labor-time notes the result was that the quality of the stock gradually deteriorated by the draining off of the better articJes until finally the stock looked like that of a second-hand store composed chiefly of "seconds, thirds, and discards." l\PPH.AISAL AND CH.rrICISM

We have already noted how Owen's embodied labor value concept differed from that of Marx and Proudhon, and while it di ffered in details, there seems to be little need for further 4

Frank Podrnorc's Robert Dnoen, Vol. II, pp. 4 0 8 if.

97

l ,..

Il

analysis and criticism. The point of major interest in connection with this study is the precise nature of the Iabor-time notes and their possible effect in the wa y of secular trends and business cycles, if the system were made universal. In this connection it is well to recall what was given above in regard to cominodu y tickets and conimoditv-ualue tickets. 3 In the latter case we find notes issued as represcntatiues of -calue, thus permitting an expansion on the basis of a partial reserve. But in the former case the note is simply a ware-house receipt definitely connected with the commodity and permits in no \vay of inflation or expansion except to the degree that the quantity of commodities expands. Now, the labor-time notes of Robert Owen, issued in connection with the "National Equitable Labor Exchange" were issued only to the actual producer of a commodity at the time it "vas deposited with the Exchange Store, and goods were sold only in exchange for these same labor-time notes. It "vas therefore impossible for the quantity of outstanding labor notes to be in excess of the marked value of the commodities on sale in the store. Notes went out as commodities carne in and commodities went out as notes came in. N a currency inflation was possible to produce a business cycle. The principle involved here is identical with that used in connection with the issuance of bank notes when banks operated on the currency principle with a one hundred per cent reserve. The commodity is the visual embodiment of labor time, and the L labor note is the visual evidence of that embodiment. This sheds a great deal of light upon the objectives of Owen as contrasted with those of John Law and Proudhon, Owen had little to say about a shortage of money, or usurious rates of interest. He sought chiefly, the overthrow of middlemen and the ~....__ elimination of their burdensome toll inserted between producer and consumer. He desired a system wherein the only path to consumption was by means of labor. Conspicuous consumption could be gained only by conspicuous production. In his auto5

See above, pp. 5 8 :if.

98

TlALUE THEORY Al\TD BUSI.L\TESS C}·CLES

biography, he says "I would effect the change by superceding existing evil conditions by good ones." 6 To this end he sought to establish communal ownership of property, and distribution of goods within the community according to the quantity of labor-time embodied, With the merits or demerits of the Owen type of Communism this volume is not concerned. But certainly, his monetary policy carried with it no such evil consequences or dangers as were involved in the inflationary schemes of Law and Proudhon. It may have been inequitable in individual instances, but a general confiscation of property by means of a fluctuating standard of value "vas impossible. Before concluding this section, it is interesting to see how the labor-time note was destined to bring the exchange store to a disastrous end, by the inevitable clash between t\VO systelns of value. As producers, who exchanged their products for labortime notes, the system operated under an embodied, commodity value theory. But as consumers, each individual was allowed the privilege of choice. Quite naturally each one selected the commodities which carried the greatest "bargains" for the notes expended. In other words, as producers value "vas objective and embodied, while as consumers value, automatically and unconsciously, consisted of a mental appraisal, and was subjective or volitional. This dualism in the operation of t\VO value systems constantly drained away the better bargains while the store became glutted with the "misfits" and undesirable products of misdirected labor or the overpriced products of the less skilled or inefficient workmen. The experiment could not have ended otherwise because of the fundamental clash in value systems. Thus it is, that while the labor-time notes of Owen did not lead to inflation and an unstable money yielding either a secular trend or a business cycle, it is true that the fundamental weakness in the whole communistic experiment of Owen and his associates lay in the erroneous and untenable theory of embodied labor value which stood as the corner stone of the whole system. (J

Life of Robert Onoen, written by HiITISclf, Vol. I, P: 89.

ROBERT orVEN

99

Those who have pointed to these experiments as conclusive proof that successful communities cannot be built upon a system of common property have usually given insufficient attention to the role played by a dual system of value unconsciously, yet automatically operating.

CHAPTER

vrn

KELLOGG AND "GREENBACKISM"

\

EDWARD KELLOGG, a merchant of New York City, made three improvements upon the scheme of Proudhon, namely, a method of retiring paper when money was not needed, a method of governmental banking in place of private banking, and the requirement of mortgages on specific property which could be held for redemption of the notes. But his theory of value was identical with that of Proudhon-a theory of value embodied in commodities and land. Kellogg has been called the "F'ather of Greenbackism" although his life ended before the active days of the Greenback period. His ideas were first published in I 849,1 popularized by A. Campbell, presented to the National Labor Party in 1,867) and became the platform of that party in 1872. As a Christian gcntlemJJl with a keen conscience Kellogg became ITIOre and more convinced that labor was exploited, that the spectacle of men of leisure living in conspicuous luxury while hard-working men were in poverty was unquestionably wrong, He felt it to be his task to discover and propose the remedy. His observation and study ultimately led him to believe that the root of the difficulty was to be found in the system of interest-taking by private banks. As a means of correcting this situation he proposed "T'he National Safety Fund." ~

TI-IE NI-\rrIONi\L Sl\FE"fV FUND

The object of Kellogg "vas to expand the quantity of Inoney 1 Kel1og-g, Edward, Labor and Ot hcr Capital (1 ~49). The cd irions of 1801 and later were called ((A New M oneiarv Systent." 'These we re cclitcd by KeIIogg's daughter, whil« a popularized aclaptat ion was published by ..'\.. CarnpbeII under the title T he True Greenback (1868). 2 Note: He held banks and hankers in such ill repute that he omitted the word «bank" from his proposed system.

roo

101

and at the same time reduce the interest rate. Like Law and the Mercantilists he felt that prosperity depended upon the maintenance of a sort of numerical ratio between the volume of commodities and the quantity of Inoney; that depressions were due largely to a shortage of money and credit. His tnethod also "vas fundamentally that of Law, Money itself had no value. It merely entered into exchange as a representative of commodities of value and the shortage of money was due to the fact that the government had arbitrarily lirnited the issuance of paper currency to gold and silver certificates or "representatives." This shortage could easily be met by the issuance of paper currency representing property other than the 1-··· precious metals. He declared that deeds and lllortgages were allowed to stand as representatives of property of value and therefore there was no logical reason why paper money should not also represent commodities other than gold and silver. For instance, he says, "I)aper made to represent landed property instead of specie and endowed with legal po\ver to accumulate, measure and exchange property would answer every purpose of 11loney and would be money." ;~ T he Plan. The plan which he proposed would require the general government to establish an institution with one or more branches in each state. "It may appropriately be called the c..N attonal Safety F Ulld," first, because the money of this institution will constitute a legal tender of uniform value for the whole people and wil l always be safe , second, because of the interest being fixed at a just rate it will secure the respective rights of labor and capital; and third, the supply of money being commensurate with the wants of business it will effectually protect the nation from financial revulsion.! Basis of Issue. (I) The Safety Fund must issue its money only in exchange for mortgages secured by double the value of the land mortgaged. In other words paper Inoney might be issued to the extent of fifty percent of the land value in the ~ 4

Kellogg, N es» Monetary System; p. Kellogg, tiu., 274--5.

272.

102

(Jnited States. (2) Notes could not be issued on perishable property nor on the credit of individuals because such property might be destroyed and individuals might go bankrupt. (3) The interest rate was to be legally established at one percent per annum and paid out of the annual income. (4) The Safety Fund will issue its money bearing no interest in exchange for mortgages bearing one percent interest. (5) This would provide a means of funding debts, and for contraction as wel] as expansion of currency, for the individual would be led to turn in his money to payoff the n10rtgage and get rid of interest. Thus the Safety Fund would issue t\VO types of instruments, the one without interest being called nloney', and the other with interest called a Safety Fund N ate. The distinction will be noted in the forms printed below. IVI0NEY No. - -

Date - - - - - -

$5 0 0 .

$5 0 0 .

The United States will pay to the bearer $500 in a Safety Fund Note on demand at the Safety Fund Office in the City of - - - SAFETY FUND NOTE No. - -

$5 00 .

Date - - - - - -

$5 00 .

One rear from the first day of J\;1ay next, or at any time thereafter, the IJ nitcd States will pay to A. B. or order, in the City of fi ve hundred dollars; and until such payment is made will pay interest thereon on the first day of IVlay of each year at the rate of one percent per annum.

It will be noted from the above that the money would bear no interest but it might always be exchanged for Safety Fund Notes which would bear interest. Those who did not wish to purchase property themselves could always loan money to the government for a Safety Fund Note bearing one percent interest. Therefore the money would be good for it would be a legal tender for debts and property and could always be in-

KELLOGG

A.L\~D

"GREEl-lBACKISltI"

1°3

vested to produce an income. An additional provision was made to induce people to loan to each other instead of lending to the government, for the private commercial rate was to be legally fixed at one and one-tenth percent. Under no circumstances could the interest rate be in excess of that amount. In defense of the low rate of legal interest he said "As money is designed for public use and is not in itself a produc-

ins power we think the rate on n10ney should not only be sufficicnt to pay for the necessary material and labor to manufacture the money but also for the necessary labor of loaning it, as well as for the safekeeping of any money that might remain on hand unused. . . . A just rate of interest would be one that would supply the money and keep the Safety Fund in operation. Thus the Safety Fund would be a self-supporting institution. No good reason can be shown why the interest should be greater than is necessary to furnish the money and keep in operation the means of supplying it." 5

Organization and J\-lanage1nent. He proposed that the "Principal Institution" be located at \Vashington with one or more branches in each state. The branches should be required to make weekly reports to the Principal Institution both as to loans and n10ney returned to be funded. The Principal Institution should report periodically the quantity of money in circulation. The manajrement of the Principal Institution was to be vested in a Board of Directors, one appointed by each state and one by the Federal Government. The officers of the Branches were to be elected either by the state or by the congressional districts. All directors were to receive salaries and were prohibited from borrowing from the Institution or from being interested personally in any of its loans. The tenure of office was to be during good behavior or until a certain age. All money loaned could be paid at the option of the borrower after one year, and interest must be paid regularly. In case of failure to pay interest when due the directors were em5

Kellogg, Op.

cu., pp.

28 4- 5.

104

powered to advertise the property covered by the n10rtgage and sell it at public auction, giving the debtor due notice of such advertised sale. Kellogg suggested that currency be issued in twenty-one denominations ranging from three cents to five thousand dollars. To prevent counterfeiting by change of figures he proposed that the size of the paper increase with the denomination. THEORY OF \'ALUE

Having presented the mechanism under which Kellogg proposed to operate we are now ready to consider his theory of value upon which it was based. He stated that there are t\VO kinds of value-actual and legal. "Actual value belongs to anything that inherently possesses the means of affording food or which can be employed for clothing, shelter or some other useful purpose ornamental or otherwise without being exchanged for anything." n "Legal value belongs to anything which represents actual value or capital. The worth of things of legal value depends upon their capability to be exchanged for things of actual value." 7 To illustrate the difference between actual value and legal value he showed the relation of a country to its government bonds. The government bonds constitute legal value. Burn them and the country would be as rich as before. It would result only in the change of ownership in property. But burn a similar amount of actual value as in houses, factories, machinery, grain, etc., and the country would be prostrated. In the same way money is like government bonds. It has no actual value, whether specie or paper, but it has power in exchange because by action of government it has been made a legal representative of actual value. THE

NA~rURE

A.ND PROPERTIES OF MONEY

According to Kellogg TI10ney is the national medium of exchange for property and products. It must be instituted and its 6

1

Kellogg , New M oneiary System, p.

Ju«, 4- 2 •

4-2.

10 5

value fixed by the laws of the nation in order to make it a public tender in payment of debts." Money, he maintained, possesses four properties or po\vers. I. Power to represent value. Real value, he said, resides in . property and products. Money is only the legal medium by which this value is represented and by which exchanges are made. It possesses no inherent quality which makes it equivalent to products or labor. It serves as a medium of exchange only because its legal tender quality makes it a lien on all the property 0 f the country. He maintained that it was entirely erroneous to hold that the value of money depended upon its material content or the value of the material from which it was made. For instance, t\VO laborers may work for a week, To one the employer gives a gold eagle and to the other a ten dollar bank note. Each can go to the market and buy the same necessities as the other yet no one would say that the paper note was as val uable as the gold. The value of both is in their legal tender quality and not in the material. At this point Kellogg apparently failed to recognize that the exchangeability of the ten dollar note at par with gold was due primarily to the fact that the government stood ready constantly to redeem the note in gold, and that the value of the gold in the coin was determined by the value of gold bullion in the market. It is true that the po\ver of the government was involved in the circulation of the note at par but that power was something different from and in addition to the legal tender quality given by the government. Both reading and experience might have taught him that legal tender quality alone apart from redeemability in specie had not uniformity given to paper money the same value in exchange as to specie. ~. Poiocr to Measure Value. According to Kellogg, standards • of measure are definite quantities of length, weight, bulk, or value, by means of which the amount of length, \veight, bulk or value of any substance is defined or ascertained. All is in8

Kellogg)

ap. cu., p.

45.

106

VALUE THEOR'i' AND BUSl.L\rESS CYCLES

definite unless there is a standard of measurement and money serves to measure the value of other commodities. 3. Power of Money to Accumulaic Value by Interest. Accu- mulative po\ver is essential to the existence of money, he held, for no one would exchange productive property for money if it were a non-productive thing. "The law making gold and silver coins a public tender imparts to dead masses of metal as it were, life and energy . . . one piece of gold receives a legal capability to earn for its owner in a given time another piece of gold as large as itself." !) It thereby compels the borrower to procure by the sale of labor and products another piece of gold in a certain time and return it together with the original sum to the lender, the time varying with the interest rate. At six per cent semi-annually the additional piece of gold must be returned in less than twelve years; at three per cent in less than twentyfour years; while if only one per cent were paid the additional piece would not need to be returned before seventy years. Thus money is popularly said to be a producer of value but such an expression conveys a false idea. Money possesses no po\ver to produce. It merely has po\\'er to represent actual value and to accumulate interest. As to the effect of demand and supply upon the value of money he held that they had no more effect than these forces have in fixing the length of the yard or weight of the pound. The value of the monetary unit is fixed by law, the same as the length of the yard. It is difficult to know what Kellogg's meaning is at this point. It is true that the government fixes the quantity of metal in coin but he has admitted that that did not determine its value. It is probable that he referred to the fixation of the value of money by government through the establishment of legal rates of interest, for according to him it is the rate of interest which fixes the value of money and nothing else. But while governments do establish lawful rates of interest they do not fix uniform rates, but rather maximum rates, leaving the actual rate quite variable. Therefore, whether he is thinking in terms of 9

Ibid.) p. 60.

KELLOGG AJ.\TD "GREEJ.,iBACKISM"

r J ~

.

1°7

the metal content of money or of the interest rate, in either case it seems erroneous to say that the government fixes the value of 1· money by law, 4. Power of Money to Exchange Value. "vVhen money is made the public representative of value and the interest rate is fixed at a just rate, it is fitted to perform the duty of money which is the equitable exchange of property. . . . The object of money is to facilitate the exchange of commodities and this it could never do unless it were possessed of as much legal value as the thing for which it is to be exchanged possesses actual value." 10 Quantity of Money Needed. On this point Kellogg leaves no room for doubt. At the head of one of his chapters he places in bold type "THE AMOUNT OF A CURRENCY SHOULD BE LIMITED ONLY nv THE \\TANTS OF BUSINESS." 11 The present difficulty, he said, lies in the fact that standard money is made of a metal very limited in supply. This makes it possible for people to withdraw at times a part of this supply from use. No government can deny them this right. But in withholding money from use the business world runs short. Obligations remain unpaid, foreclosures and sheriffs' sales set in. Then these with-holders come out and buy at the bargain rates. It is exactly what they expected and deliberately attempted to bring about, and this practice is perfectly possible if the quantity of money is limited by making it from a scarce and precious metal. Instead, money should be regulated to the needs of business by the issuance of legal tenders. Effect Upon Prices. Kellogg pondered this question with care for he admitted that many had argued that an increase in the supply of money would diminish the purchasing power of each unit, causing a proportionate rise in prices. This he categorically denied, for, according to his theory neither the material con- '. tent nor the quantity in circulation had anything to do with the value of money. He was neither a bullionist nor a quantity 10 11

Kellogg, New Monetary System, pp. 68-9. Ibid., pp. 254 ft.

108

VAL[}E THEORY Al\TD BUSINESS

G~}rCLES

theorist. For him, the value of money was determined by its rapidity of accumulation or the interest rate. Hence, if the government would establish a permanent interest rate at one percent, it would at the same time stabilize money and the general price level. .AIJPRliISA"L

i~.ND

CH.lTICISIVl

Since Kellog formulated most of his theory before the middle of the Nineteenth Century he deserves commendation for focusing public attention so definitely upon the importance of the interest rate. \\7 e are only now beginning to recognize the role of interest rates, not only as they affect the rate of wealth concentration but more especially the po\ver of discount rates to affect the purchasing po-vver of Inoney and the movement of the business cycle. Kellogg is also to be commended for the precautions advocated to guard against the evils of a depreciated and irredeemable currency. It will be recalled that he soug-ht to protect his legal tender currency by limiting the issues to fifty percent of the value of land. He also sought to correct the fundamental weakness in the French Assignats. These he believed to have depreciated because they were issued against property in general and not pieces of land in particular. Therefore, he proposed that definite mortgages be taken by the government on specific sections of land. If interest and principal were not paid when due, the government could foreclose on the specific property. It must be admitted that this was a wise and cautious provision. The fatal error in Kellogg's system comes from his use of an embodied theory of value and a chemical theory of exchange. 1 2 He held value to be intrinsic yet he admitted that a scarcity of money might cause depression because it was impossible to sell commodities "at their value." By increasing the monetary rep1~ Kellogg- does not usc the ph rase "Clu-m ira l Theory of Exchange" and

t hcrc is no conclusive evidence that ht~ was farniliar with the writ inj-s of

Proudhon. However, his explanation of depression and the rtmcdv proposed for its elimination is identical in principle vvith Proudhon's "Chemica 1 Theory of Exchange."

f

1°9

resentatives depression would be relieved because the comrnodities could enter freely into exchange at their intrinsic worth. It never occurred to him that if a shortage of money might cause products to sell belen» their value, a greatly increased quantity of money might cause them to sell "above" their value. There are two reasons for this apparent inconsistency. On the basis of an embodied value concept, he contended that there was no possible way of making goods exchange above their intrinsic value no matter how great the supply of money. An increase in legal tender representatives would cause prices to rise out of depression levels and come to "real value," then continue at that level. But in addition to his embodied value concept, he, consciously or unconsciously, falls into the grip of Proudhon's chemical theory of exchange. I 3 Just as Hydrogen and Oxygen combine in a certain ratio and the element in excess remains free and uncombined, so it is with goods and money. If there are more goods than monetary representatives, goods cannot ex-./ change but are left unsold and create depression. Such a situation is tragic because labor has been expended in the production of goods, a part of which are unsalable. But a surplus of nloney -in case legal tenders have been issued to excess--ereated no such a tragedy. All the commodities entered into exchange while the surplus money was left over. But since the issuance of paper representatives (currency) cost virtually no labor, i.e., had no labor embodied in them, a free surplus created no difficulty or depression. Should we grant the validity of an embodied value theory and the chemical exchange theory, then Kellogg would appear to be right, and "Greenbackism" would be the ideal remedy for all depressions. But the theory fails to fit the facts. We know that when money becomes excessive or freely accessible at a low rate of interest, it does not result in easy exchange of goods at a constant price level with part of the money remaining out of use because there are more representatives than commodities, but at all times virtually all commodities and all money avail13

See above, p.

119.

'>,J

able enter into circulation at some ratio and the greater the quantity of n10ney, the less the purchasing po\ver of any unit and the hig-her the general price leveL For this reason the issuance of paper currency to the extent of fifty percent of the value of all land, loaned to the people at one percent interest would create such a reservoir on which demanders might draw as to give rise to a speculative mania similar to that of the Mississippi Bubble. The results would be precisely those portrayed under "La\vism." By the time legal tender notes had been issued to fifty percent of the value of land, the price of the land in terms of legal tender would have made a spectacular rise in price, rnaking possible another vast issue, and so on ad infinitunz. The system of Kellogg- would give a secular trend skyward and an inevitable crisis or panic. In regard to the suggested interest rate of one percent it seems certain that this would furnish no basis for stability or equilibrium. For interest measures the rate of time preference. It is human impatience crystalized into a market rate and serves to balance the dernand for money and capital with supply, because present goods are of more 'value than future goods of like kind and number. Therefore, a legal rate of interest, definitely fixed below the normal rate of time preference, linked with an unlimited supply of legal tenders would invite a wild orgy of speculation culminating in the usual tragic catastrophe, of panic and depression. GREENBACKISM AND POPULISM

It is not our purpose here to deal with political propaganda or the numerous conflicting ideas prevailing in the minds of the more or less ignorant and misinformed populace during the stirring days of the 70's, 80'S and 90's. But in its origin it shows distinctly the ear marks of Kellogg's system and for very good and sufficient reasons. Greenbackism seems to have been ushered in largely through the vigorous efforts of Mr. A. CampbelL His tactics were those of the agitator and his speeches and writings are filled with reus-

KELLOGG A1.\"D "GREENBACKISM"

I, I

I

~

; \

I II

ing statements. But his theory of n10ney and banking is in virtual agreement with Kellogg. In fact his article on "Greenbacks" written in 186+ contained profuse quotations from Kellogg's book, "The l"C\V Monetary System," while he claimed to have arrived at the same conclusions by independent judgment, he freely quoted Kellogg's theory of money and value as representative of his own. Because of this virtual identity it may be well to treat this period by an enumeration of ideas and principles involved rather than by discussion since there is so little that is new, I. The depression was due to a Lack of Money, The "crime of '73" or demonetization of silver further accentuated this L/ shortage. Since specie was inadequate either in itself or as a basis for note issue, resort should be made to the issuance of legal tender .notes. 2. The "value was there" i.e., intrinsic in the commodities, but they could not be sold at their value because of a lack of money. 3. These t\VO points give us the old idea that prosperity is dependent upon a numerical ratio between quantity of money and quantity of commodities. 4. Bankers and the creditor class were deliberately curtailing the quantity of purchasing media in order to exploit the debtor class and rob labor of much of the products of its industry. 5. The Re1nedy was an increase in the quantity of money based upon things of value other than specie. 6. A Low Interest Rate. While it \vas a most dynamic period from the standpoint of politics, there seems to be little that is new after a careful treatmerit of Lawisrn and Kellogg. J.\T ole: 0 nc of the most recent examples of Green hackisrn, involving a resurrection of "Lawism" is the monetary proposal made by Henry Ford. 'The plan was first proposed in 192 I as a means of getting rid of the depression following the crisis of 1920. His idea Was set forth quite clearly in the Dearborn Independent, from which the following quotation is taken:

112

VALUE TIIEORY Al\TD BUSINESS CrCLES

"\Vhat is wrong? This is wrong: tha t a broad gauge industrial system is held up and cannot move because of our narrow gauge money system. \Vealth In ust slow down to pass through the narrower gates of money because there is more wealth than there is money to move it. And money itself must slow down to pass through the still narrower neck of gold, because there is more money than there is gold to validate it." 14 As a means of expanding this narrow monetary base, thereby furnishing the world of commerce and trade with an adequate supply of money, Ford ad voca ted the issuance of pape r currencv in connection with the I\·Iuscle Shoals project. He also championed the construction of concrete ware- houses for the rurpose of storing the less perishable commodities, including wheat, wool, coal, etc. These goods were to be insu rcd and Federal Reserve K otcs issued up to 5 0 ~{: of their aye rage value during the previous twe n ty-fi ve years. In this war the commodity market would be relieved of stagn:1tion because physical commodities of value could be furnished with monct.rrv representatives sufficient to move them, Depressions would be avoidcd because there would always be enough nl0ney to InO\'C the nation's goods. A similar proposal has been made b~' l\lr. Ford as a means of terminating the depression of 1932. It is obvious, however, that we have here, only another example of "La\visln," the idea being that real value is inherent in physical commodities, while 1110ncy consists of lcg:l1 n:presen ta tivcs of commodities, Hence, he coucl udes that the re can bc no infia tion or over-issue unless the representatives are in excess of the value of the commodities represented. FIN.A.L CRITICISIVI OF "LA.\VISM"

Let us now proceed to a final appraisal and criticism of Lawism in its entirety. One of the best criticisms of such proposals was made over three-quarters of a century ago, by John Stuart Mill, who was known to be a thorough advocate of sound money. "In order to give to currency that stability of value so essential to all forms of money it has become the practice of securing currency by those commodities most durable and least liable to vary in value, i.e., precious metals. And no paper currency should exist that does not conform in value to the monetary 14

Dearborn l n.iepen.icni, Jan. 28, 19 2

2•

KELLOGG AJ.\TD "GREEJ.lBACK1SM"

~

I I

3

metal. This idea is fundamental and generally accepted. But there are ever dissentients with luring proposals. To be able to payoff the national debt, defray the expenses of government without taxation, and in fine to make the fortune of the w hole community, is a brilliant prospect when once a man is capable of believing that printing a few characters on bits of paper will do it. The philosopher's stone could not be expected to do more." 13 Mill further stated that some have said "A paper currency cannot be issued to excess so long as every note issued represents property or has a [oundatlon of actual property to rest on." In reply, he says, '(If the property cannot be claimed in exchange for the notes it is difficult to divine in what manner its mere existence can serve to uphold their value. . . . I'" et, on this theory there have been nlany schemes for coining the whole land of the country into money," i o e.g. French Assignats. Of course Kellogg would object that the French Assignats were not a fair test because currency was issued against land in general an d not against a particular piece of land on a n10rtgage. I n the latter case nloney could call specific land in for redemption. According to ~lill such an arrangement would only mitigate the evil but not destroy it. Land must not only have value but, have quick and universal salability. If it is to serve as a redemption fund for paper n10ney and if huge quantities of land were to be suddenly thrown on the market for redemption purposes, exchange value might be almost totally destroyed. Again Mill pointed to a second error championed by the noted historian Hume in his essay on money, in which he even supported the thesis that "inconvertible currency quickens industry." Mill, however, noted that such a situation would undoubtedly bring a rise in prices with its simultaneous stimulus to production. But that method of quickening industry gives rise to the secular trend upward that goes on and on to cat as15 John Stuart I\'1ill) Principles of Political ECOllOJJZY, Vol. II, p. 61, (De Luxe Edition). 16 Principles of Political E(0110111)', Vol. II) pp. (j t-2. (De Luxe Edition.)

114

VALUE THEORY AJ.\:D BUSIJ.\'ESS CrCLES

trophe. It follows a vicious circle of delusion for both producer and consumer, and a robbery of creditors by debtors. It creates a bubble that must burst, scattering misery and calamity everywhere. For that time-before the days of index numbers-it would be hard to improve upon Mill's criticism of Lawism (though he himself specified no author). To begin the issuance of legal tenders on the basis of physical commodities of value is to start on an unknown sea without chart or compass. There seems to be no logical stopping place until the entire value of the commodities or a specified fraction thereof has been coined into 1110ney. Also, because the value is not intrinsic, but varies with demand, an increase in the quantity of the purchasing medium results in an increase in price or exchange value. Hence by the time 1110ney has been issued equivalent to the original base the base has expanded sufficiently to justify a new issue, with the result that society enters that vicious circle of increased representatives again. The price trend moves sharply upward as it did both in Russia and in Germany during the war. There seems to be no logical stopping point short of national bankruptcy. However, in these days of index numbers, it is quite conceivable that a nation could issue paper money as representatives of land and non-perishable commodities and still maintain a relatively stable price level. For with index numbers, a nation is not at sea without chart or compass. The index number might be used as an indicator to determine whether the governmental and banking policy should be one of expansion or contraction. Yet, granting the modern chart and compass, in the form of index numbers, any argument for "Lawism" resolves itself into a dilemma. If a more stable price level is desired, the Central Banking Systems as now constituted could furnish the world with all the monetary media required. Reserves reach the danger point only after a prolonged period of rising prices. Or, if it is "prosperity" that this group desires, and prosperity for them consists of a constantly rising price level, we grant that a rising price level could be maintained longer with a physical

I

I I

/

5

commodity basis than a precious metals basis. But in such a case the chart and COIn pass (index numbers ) is discarded and the business world finds itself lost in a dizzy whir l of speculation) expansion, and extravagance. It is the dance of death. It is the secular trend skyward to catastrophe. The conclusion is, then, that if the monetary policy is directed towards stabilization and a relatively constant index number, Lawism is not needed. If index numbers are forgotten, then Lawism leads to a South Sea Bubble and ultimate bankruptcy. \\T ere value e,nbotiietl and intrinsic then overexpansion of currency would not affect the price. Surplus monetary representatives would be left over as in a chemical exchange. It is because value is COJJl JJlaJided that an .incrcase of nloney serves to increase demand and thereby creates an increase in prices.

Book II COl\lMANDED VALUE rrHEORY IN ITS I~ELATION TO BUSINESS CY~CLES

l\CKNOWLEDGMENT T'he author wishes to acknowledge special Professor John R. COrTIlnOnS and Dr. Williarn preparation of Book II. The latter gave liberal "Commanded Value Theory" of Malthus and Managed Currency in his Doctor's Dissertation University of Wisconsin in 1925.

assistance from E. Zcuch in the treatment to the the Problem of submitted to the

PRODLlCl~IOlV

.AND CONSU]\1PTIOl\T

.AS RELilTED TO EFFECTIVE DEA1l1ND CH~\PTER

IX

NIALTHlTS i\.ND COl\1l\JANDED

'li\I~UE

IN Book I we followed the Ricardian trail of embodied value which served to explain long time secular trends in price I110Vemerits, Book II follows the Malthusian trail of "commanded value" in explanation of cyclical price movements and short term oscillations. It is no particular reflection upon the work of Ricardo to say that he explained only secular trends and failed to explain cyclical price movements, He frankly admitted that his statemcnt of economic principles was desig-ned to explain natural price and account for the long-run forces and these alone! 1 It has been shown how certain writers of a later period attempted to use his value theory and other premises and build thereon a theory of business cycles, but became hopelessly involved in economic contradictions and logical inconsistencies. As we take up the Malthusian trail of commanded value it is important to note at the outset that Malthus is prirnar ilv concerned with the short-run forces and the explanation of market prices." Quite naturally, it is only through a consideration of 1

Note: "Since these (tclllpor~ry and ace;dc'tHal ca uscs ] are equally opera-

t ivc in all stJg-cs of society, wr will lc.i vc rhcm cn r i rc lv out of our considera-

tion, whilst we arc t rcut int; of the laws which regulak natural prices, natural \\'J.g~s and natural profits) effL'cts totally independent of thL'sc accidental causes. In ~pL'aking then of the exchangeable val uc of conunodit irs . . . I mean al\vays thl' va lue it would possess if not disturbed by any temporary or accidental cause) and wh ich is its natural pr icc." Ricardo's Works, p. 49 (Mc-

Cullorh's Edition). ~ In the last paragraph of his Princi pl cs of Political EL'OJlOJJIY he says on this point "T'hvo rct ica l writers (indirect 1y refL>rrinr~' to Ricardo) are too apt, in their ca lcul a tio ns to overlook these int c r vals , but eight or ten years) recurring not unfrcqucnt ly, arc serious spaces in }H1l11an life. 'I'hey amount to a serious sum of happiness or misery, according- as they arc prosperous or adverse."

IH)

VAL[JE THEORY AND B[]SINESS CYCLES

120

current forces and short-run-factors in their bearing upon and detern1ination of market prices that we come to grips with the real problem of price oscillations and business cycles. Not only did Ricardo and Malthus differ in their objectives but they also differed in their method, Concentrating upon natural value and the long-run forces, Ricardo restricted his system to a few rna j or factors and basic hypotheses or assumptions which he treated deductively. These led to a few simple generalizations. Malthus, on the other hand, concentrating on market value, was driven to a consideration of a multitude of factors, some transient, others permanent, and the total ever in process of flux and change. This made for great complexity in method and called for a degree of quantitative measurement, incessant observation and use of the inductive method. This difference in objective and method led Malthus to state in the introduction to his Principles that "The principal cause 0 f error, and of the differences which prevail at present among the scientific writers on Political Economy appear to me to be, a precipitate attempt to simplify and generalize" and "an unwillingness to acknowledge the operation of more causes than one in the production of particular effects." 3 But the major difference between Ricardian Principles of Economics and Malthusian Principles centered in their divergent theory of value. At first thought, it seems inexplicable that these coritemporary thinkers, who met in frequent conferences) corresponded voluminously and went to the same sources for economic and philosophic background could remain so diametrically opposite in their theory of value. The answer to the riddle is explained by their divergent objectives as set forth above. Ricardo's embodied labor theory of value served reasonably well as a point of vantage from which to treat normal value and average prices in the long run. It was quite logical to contend that the cost of production, including normal labor-costs, T. R. Malthus, Principles of Political E conomy, p. 4°3 (Boston Edition, 1821). 3

Malthus, Principles of Political Economy, p. 5 (Boston Ed.).

AIALTH[/S

A1.\~D

COll,ljl1AJ.\TDED FALUE

121

normal capital costs and normal profits, would ever serve as a pivot about which market values would fluctuate and ever tend to return. Yet, Malthus was most concerned with those very fluctuations and the forces which made market values depart from normal val ue. This quest for an adequate explanation of market value dealing with the transient forces which operate to influence and change exchange value quite naturally leads along the trail which economists must travel if they are ever to understand and explain business cycles and short time, non-periodic price fluctuations. From this source must also come the valid suggestions for business stabilization since the forces which work for instability and maladjustlnent are the short-run) complex forces rather than the more simple and long-run forces portrayed by Ricardo. It is perhaps not an exaggeration to state that Ricardian Economics has made its full contribution both to economic theory and business practice. As Simon N. Patten stated many years ago "Econon1ic Science must develop beyond the simple world in which Ricardo lived into the complex world, the laws of which Malthus tried to elucidate." 4 There are three cardinal points in Malthusian economics. First, is his command theory of value, involving an approach to value through the demand side rather than the supply side. Second, the qualitative definition of demand, revealing intensity of demand in its relation to effective demand, and finally the union of "power of production" with "means of dis- ., tribution," or the principle of balance and proportion as the sine qua non of wealth and exchange value. I. Aleaning and significance of "Commanded Value." With Malthus value meant exchange value and every commodity got its value from its power to command other goods or services in exchange. The po\ver in exchange possessed by any commodity was determined by demand and supply. Demand and supply 4 "Malthus and Ricardo," by Patten. (Publications of the American Economic Association, Vol. IV, NO.5) pp. 9-3+.) (1889.)

FALrJE TJIEOR}" AJ.\TD BUSI1'lESS CrCLES

122

were synonomous with consumption and production. Demand was the tcill combined with the pov.)er to purchase, and supply consisted of the production of commodities combined with the intention to sell them. ((In this state of things the relative values of commodities are determined by the relative demand for them, compared with the supply of them." j 2. Effective demand. and intensity of de/nand. It will be recalled that Ricardo assumed demand, stating that due to the insatiable nature of human wants, demand was always present when the individual possessed a supply. ((1 go much further than you in ascribing effects to the wants and tastes of mankind; give men but the means of purchasing and their wants are insatiable. Mr. Mills theory is built on this assumption." G Malthus, on the other hand, was careful to point out that such was not the case. Exchange value might decrease even though supply increased, due to a failure in demand. And demand nlight fail either because of a voluntary failure of demand on the part of the rich who n1ight prefer s:lving to spending, or from an involuntary failure of demand on the part of the poor who had keen wants but not purchasing povver. To create exchange value or increase wealth there must be an increase in effectivc demand as well as in supply. In regard to intensity of demand, he stated that it might all be very well to speak as Ricardo did of the insatiability of human wants which was very true. But demand is a psychic thing and is qualitative. Therefore a person might wish for more castles or servants, yet either because of his "love of indolence" or the desire to save, he may find the desire to save more intense than the desire to spend. If so, effective demand is not present, unless at a very low price. 3· Union of power of production with means of distribution. Malthus saw very clearly that increase in volume frequently operated to depress exchange value and price. To stimulate 5 Malthus, Principles of Political Erono m y, p. 51. (T 82 T.) 6

James Bonar, Letters of Da7.,i.l Ricardo to T/IOJnaS Rober! Malt/Ilts, p. 49. (Clarendon Press) 1887')

182 3,

1810-

MALTHlfS

AJ.\~D

CO/\.fft1AJ.\'DED 'VALlTE

12 3

production regardless of distribution, to add to supply without regard for demand was to invite economic chaos. Therefore effective demand is quite as vital to an increase of wealth and exchange value as an increase in physical volume. There must be "proportion" between production and distribution and the proper proportion does not come automatically from individual self interest, laisscz-i aire, or planless production. \\7 e are now ready to see how Malthus utilized these basic ideas in the last chapter of his Principles where he deals with "The Immediate Causes of the Progress of \\Tealth." He first considers the false trails, then the true trails. F:\LSE l'!{_-\ILS CONSIDERED I. I ncreasc of Population. Malthus stated that a permanent increase in population was a powerful and necessary element in increasing demand. But mere increase which resulted only in greater pressure of the population upon the means of subsistence was not an ejjt!cti1..-,t> stimulus to increased wealth. There must be increased purchasing po\yer to create effective demand and increased wealth. j\ m ulti plication of n umbers and wan ts wil] not do it. 2. Sat"L,'ing and accumulation of capital. Smith and Ricardo placed great stress upon the importance of capital, and the necessity of adding to stock. The emphasis was well placed for that day. Y et from this tenet developed the classical doctrine that "capital sets labor in motion" therefore if there are sufficient profits for the capitalists and enterprisers, to enable them to save and add to stock, the demand for labor will increase proportionately pari passu. The idea fitted in neatly with the embodied theory of value, according to which wea lth increased as' supply increased, and increased capital added to the power to expand supply. Through this doctrine, saving and thrift, almost to the point of parsimony became a virtue par excellence, because when followed rigorously by everyone, people produced more than they consumed, saved the difference and added to capital stock.

124

VAL[TE THEORY AJ./D BUS]l-lESS CYCLES

The Malthusian theory of commanded value, with its approach to value from the demand side gave him a distinct advantage in anticipating the modern difficulties of finding a market for surplus goods. Holding tenaciously to the all important factor of effective demand, Malthus definitely raised the query as to how the goods could be sold, if everyone produced more than he consumed and saved the difference. There would result a general failure of demand, a fall in price or exchange value below cost of production, with all the ear marks of a general glut and severe depression." Malthus continued his illuminating, and for modern times, relevant observations as follows: "It has been thought by some very able writers, that although there may easily be a glut of particular commodities, there cannot possibly be a glut of commodities in general; because, according to their view of the subject, commodities heing always exchanged for commodities, one half will furnish a market for the other half, and production being the sole source of demand, an excess in the supply of one article merely proves a deficiency in the supply of some other, and a general excess is impossible." 8

To this view Malthus replied, "It is by no means true . . . that commodities are always exchanged for commodities. The great mass of commodities is exchanged directly for lahar, either productive or unproductive; and it is quite obvious that this mass of commodities, compared with the labor with which it is to he exchanged may fall in value from a glut, just as :lny one commodity falls in value from an excess of supply." 9

In this connection M. Say, ]. S. Mill and Ricardo have fallen into some fundamental errors, says Malthus, because ((they have considered commodities as if they were so many mathematical figures, or arithmetical characters, the relations of which were to be compared, instead of articles of consumption, which must of course be referred to the numbers and wants of the consumers." 10 Malthus, Op_ Cit., p. 274. Ibid., p. 274. 9 iu«, p. 275. ID Ibid., p. 275.

7

8

J.~lALT}J[}S

A.i.\-D

CO.ll-ll~!A.l\-DED

V'ALUE

125

Here we find ourselves again in the midst of the old, yet ever new, question regarding the possibility of a general overproduction, or only partial overproduction. Both logic and experience would seem to award the verdict to Malthus. In the short run, the exchange value of goods is not determined by embodied labor or cost of production, but by what they will com- C mand in the market in the light of effective demand. Push saving and capital accumulation too fast and far and effective demand will be inadequate to meet the supply, yielding a general price fall below the expenses of production and a glutted market. l\lalthus readily granted that saving and accumulation were essential to progress but never admitted that the greater the saving and the more rapid the accumulation of wealth, the richer the nation would become, Effective demand from consumers is as essential as adequate supply from producers. The maintenance of demand and large spending is quite as vital for dynamic business as accumulation and the maintenance of an adequate supply. 3. Inventions and labor sa~Jillg deuiccs-s-Meclnner», Malthus was a great champion of invention, and the use of machinery. I-Ie recognized many instances where the use of machinery had made possible such reductions in cost and price as to extend the demand quite as rapidly as the supply with no semblance of overproduction or glut. He further observed that because of the greater demand at the lower price, it was not uncommon to find an expansion in the quantity of labor used in the industry beyond what it was before the machinery was introduced. l-Ie cited the cotton machinery as a striking example. Indeed, he says "when the introduction of machinery has this effect, it is not easy to appreciate its enriching povver, or its tendency to increase both the value and quantity of domestic and foreign commodities." 11 Such a condition applied to a commodity the demand for which was very elastic. If however, "the commodity to which machinery is applied is not of such nature, that its consumption can extend with its cheapness, the increase of wealth 11

Ibid., p. 3 12.

I

26

l~AL[IE

THEORY AJVD BUS]J-./ESS c'rCLES

derived from it is neither so great nor so certain." Undoubtedly this is a wise reservation regarding the general benefit to be derived from the introduction of machinery. It is a point to be considered by the captains of industry and factory Inanagers when deciding upon the speed with which machinery and laborsaving devices are to be introduced. For it must not be forgotten that effective demand is as essential to prosperity as cheap and efficient production. TRlTF C_-\lTSFS OF l'HE }lROGRESS

or

\\-E_-\L'TH

Having explored rather carefully some of the "false trails" as Ma lthus conceived them, he turns to other trails better adapted to lead to the desired goal. In the first place, of course, adequate supply is necessary. And the three factors most productive of a large supply are (I) Accumulation of capital. (.2) Fertility of soil. (3) Inventions to save labor. ) . . et they will not lead to prosperity when traversed alone to the neglect of other trails. "They all act in the same direction; and as they all tend to facilitate supply, without reference to demand, it is not probable that they should either separately or conjointly afford an adequate stimulus to the continued increase of wealth, which can only be kept up by a continued increase of the demand for commodities." 1:l But for continuous prosperity there must be C~ION OF TIlE PO\VERS OF PRODUCTION \VITH

TIlE

rvI.EAN'S OF

DISTRIBUTION.

"'~Te have seen," says Malthus, "that the pO'Ners of production-

are not alone sufficient to secure the creation of a proportionate degree of wealth, Something else seems to be necessary to call these po\vers fully into action; and this is, such a distribution of produce, and such an adaptation of this produce to the wants of those who are to consume it, as constantly to increase the exchangeable value of the whole mass." 1 ~ "Production and distribution are the t\VO grand elements of wealth, which, combined in their due proportions, are capable of c Malthus, op. lO/bid.) p. 3 2 0 .

i

cn., pp.

3 [9-20.

]t,;/ALTH[}S

Al\~D

COlt-l},IA.l\-DED J!ALLTE

127

carrying the riches and population of the earth in no great length of time to the utmost [imits of its possible resources; but which taken separately', or combined in undue proportions, produce only, after the lapse of many thousand years, the scanty riches and scanty population, which are at present scattered over the face of the globe." 14 Assuming then that the factors increasing productivity are yielding adequate supply, a continuous increase of wealth requires that they be counterbalanced by three other distributive factors, namely, (I) Division of landed property. ('2) Internal and external commerce. (3) The maintenance of unproductive consumers. I. Division of landed property. The need for a proper division of property with many small land owners rather than one large baron surrounded with peasants is solely for the purpose of giving effective demand. Thirty small land owners with incomes of three thousand dollars a year would create a much larger effective demand for bread, meat and manufactured products than one large proprietor possessing a hundred thousand dollars a year. It is not at all inconceivable that as much or more might be produced under the concentrated management of the large land holder, but through failure of demand because of inadequate or fortuitous distribution, exchange values would fall and that means less wealth. It is even conceivable that total demand might be as great with large land-holders and many peasants, but "Practicallv it has alioavs been found that the excessive wealth of the few is in no respect equivalent) with. regard to effective ./ demand; to the moderate u.:ealth of the manv," is Malthus is neither a Socialist nor a Communist. In fact he definitely recognizes that land might be distributed too widely and be held in such small tracts as to make effective production impossible. "There is a certain elevation at which the projectile will go the farthest; but if it be directed either higher or lower, 14

uu., p.

15

Ibid., p. 333.

330.

t

128

VALUE THEORY AND BUSINESS CYCLES

it will fall short." So it is in the distribution of landed property. Place too much land in the hands of a few rich landed proprietors and the power to supply will outrun the will to consume and the progress of wealth will be checked by the lack of effective'demand. On the other hand if all land and capital were held by a vast number of small proprietors, all great enterprises and vast improvements lending themselves to the advantages of division of labor would be impossible. The progress of wealth would be checked by a failure in the powers of supply. Thus he concludes that all true progress in wealth depends upon proportions. 1 6 2. Internal and External Commerce. The second great factor which operated to create balance between production and distribution, or supply and effective demand, resulting in greater exchange value or wealth, was commerce, both internal and external. Ricardo and the embodied value economists quite logically held that commerce created no value for there were no more goods (value) after the exchange than before, hence no increase in wealth."? Malthus, thinking ever in terms of commanded value and effective demand, recognized that in every exchange, each party came into possession of that which held for him greater utility, and indeed greater exchange value than before. The only logical and defensible reason why goods in Glasgow are exchanged for goods in London is because these same goods will have greater exchange value after trade than before. If this were not true, London and Glasgow merchants would not find it profitable to trade with each other. The Ricardian theory explained quite satisfactorily exchanges between two conIbid., p. 334. Note: "No extension of foreign trade will immediately increase the amount of value in a country, although it will very powerfully contribute to increase the III ass of commodities and therefore the sum of enjoyments. As the value of all foreign goods is measured by the quantity of prod uce of Iand and labor, which is given in excha.ngc for them, we should have no greater value . . . if we obtained double the quantity of foreign goods in excha.nge for a given quantity of ours." Ricardo's Works, Ch. VII, "On Foreign Trade." IG

17

MALTHlJS Al\./D COA1JIA!\lDED VALUE

129

sumers who were willing to exchange equal values for different utilities, but it was whol ly inadequate in its explanation of the inducements which kept merchants in business. By transporting a good from a community or market where the demand was low to another corrmunity or market where the demand was high, the value if' .reased. Assuming a commanded theory of value, even in a straight barter transaction, values may be increased and the wealth of the nation or community augn1ented by exchanges of commodities. Ricardo and Malthus both agreed upon the distinct advantage which would accrue to laborers and the countries in general through an increase in volume of consumable goods from the same labor. They did not agree that value would remain the same. On this point Malthus would seem to have the best of the argument and from this he is able to show that all commerce, foreign and domestic, greatly contribute to the enhancement of exchange value and the progress of wealth. Ricardo held foreign trade in high favor because it furnished a means of getting goods at a cheaper price-more goods for the same value. Malthus insisted that there were more goods for more value. At the bottom of every act of barter, whether foreign or domestic, there is increased value resulting from "exchanging what is wanted less for what is wanted more." "Taking therefore a very different view . . . from Ricardo, I should bring forward the extension of markets as being, in its general tendency, pre-eminently favorable to that increase of value and wealth which arises from distribution." 18 3. Unproductive Consumption. The third great cause presented by Malthus, for increasing value and wealth, and maintaining proportion between production and distribution, was the crnployment of unproductive labor, or the maintenance of unproductive consumers. I-Ie held that the stimulus of private property coupled with fertile soil and rapid introduction of machinery had resulted in such an increase of supply that value 18l\lalthus) Principles of Political

EC01101lZY,

p. 357. (1821.)

VALL:E T1IEORr Al\-D BLTS!j.\-ESS CY'CLES

130

and wealth might fall and society experience a definite loss, rather than a gain, unless this increased po\vcr of productivity be offset by increased leisure or the maintenance of unproductive consumers. To what extent unproductive consumption should be fostered is difficult to determine. It depends upon the po\ver to produce and the wil lingness of capitalists to spend. If the soil is sufficiently fertile and mechanical improvements rapidly accelerate production, "an ingenious people cannot only support a considerable proportion of unproductive consumers without injury, but may absolutely require such a body of demanders, in order to give effect to their po\vers of production." ID Malthus here seems to have anticipated nlany of the current writers who speak of "dro\vning ourselves with our own products and starving to death in the midst of plenty." Certainly he was pondering a vital question when exploring the trail of effective demand. The second factor which made it difficult to determine the extent to which unproductive consumption was needed was the degree of consumption prevalent among the producers themselves. Obviously, there would be no need for unproductive consumption if the producers themselves regularly created enough effecti"ve demand to maintain exchange values, thus preventing any glut that might depress prices and general wealth. "\\Tith regard to the capi talists w ho are so engaged, they have certainly the pov)er (italics mine) of consuming their profits, or the revenue which they make by the employment of their capitals; and if they were to consume it, with the exception of what could be beneficially added to their capitals, so as to provide in the best way both for an increased production and increased consumption, there might be little occasion for unproductive consumers. But such consumption is not consistent with the actual habits of the generality of capitalists. The great object of their lives is to save a fortune, both because it is their duty to make a provision for their families, and because they cannot spend an income with so much comfort to themselves, »

tsu.,

p. 359.

l~IJ.LTHrJS

Ai\·D COltlJIAJ.\WDED 'VAL[IE

13 1

while they are obliged perhaps to attend a counting-house for seven or eigh t hours a day." co Adam Smith and Ricardo had virtually defined effective demand as desire plus purchasing power; wherever purchasing powe, existed, desire was present and therefore demand was always. commensurate with po\ver. It mattered not who had the pO\Vel, demand would be the same, regardless of its personal distribution. Malthus insisted that there were three requisites to effective demand, namely, desire, purchasing po\ver and in- . clination to use it. He did not dispute the contention that wants are insatiable; that people always have a multitude of unsatisfied wants, which more extravagant expenditures would tend to satiate, but along with the desire to consume is the desire to save. Due to the diminishing intensity of desire, as more and more desires are met, rnany capitalists and landlords with large incomes, find the desire to save transcends the desire to spend. On the other hand, the poor desire to spend but lack sufficient purchasing po\ver. It appears then, said l\lalthus, that "in the ordinary state of society, the master producers and capitalists, tllough they Iiai:« the po·v.)er have not the toill to consume to the necessary extent. And with regard to their workmen, it Blust be allowed that, if they possessed the v...ill, tlley have not the pou:er. (Italics mine ). ~l Thus, production and distribution get out of balance, goods glut the market, exchange values and national wealth decline, because of the voluntary failure of demand on the part of the rich) and the in·voluntary failure of demand on the part of the poor. There is no usc to lament the fact or accuse the landlords and capitalists of being parsimonious. They are normal beings animated by their desires, so we must take them as they are. But if the consumption of producers when left alone runs short and brings on depressed prices and a reduction of wealth, then the shortage of effective demand must be supplied by unproductive consumption. ~o

tu«, p.

359.

~l l\lalthus, Principles of Political £CO"0111Y, p. 164-.

(1821.)

13 2

IrA-LUE THEOR'l

A-.'9n

BfJSIJ.lESS crCLES

An alternative to unproductive consumption might be suggested, such as adding to the \vages of the laborers. If they have the will but not the power, gi,re them the po\ver ~ That would create the balance of proportion desired. Y et l\lalthus recognized that it was profits which induced the capitalists and industrialists to engage in industry, and if high \vages robbed them of profits, then the stimulus to produce would decline and society would suffer from reduced production rather than from inadequate demand. He therefore felt driven to fall back upon unproductive consumption to furnish the balance between production and distribution, demand and supply, and retain prosperity. T}7hat constitutes unproductn:c labor?' 1\1uch of the skepticism regarding the efficacy of Malthus's remedy is removed when we learn his meaning of "unproductive labor" and consumption. Concretely, he lists them as menial servants supported by individuals, public servants, as statesmen, soldiers, judges, lawyers, clergymen, teachers, etc. Such a classification by Malthus is due to his definition of wealth, which he defines as "those Ina/erial objects which are necessary, useful, or agreeable to mankind." ~~ \\'1' ealth is everything which gratifies the wants of man by means of material objects. And productive labor is every kind of labor which is directly productive of wealth. Unproductive labor might then be defined as all effort or labor which does not directly result in the creation of material wealth. This definition exempts Malthus from resort to the "makework" fallacy, just to get goods consumed and make demand equal supply. Y et his definition of wealth is not altogether consistent with his theory of value. He upbraids Smith and Ricardo for their embodied theory of value, yet he accepts the definition of wealth given by Adam Smith, with its materialistic concept with scarcely a hint of revision. While this is interesting from the standpoint of value theory, the main point remains, that a considerable share of the national income must be distributed 22

Ma Ithus,

Qp. Cit., p.

23.

ftlALTH[}S

~iJ.\TD COl'rJ~'JA;.\-DED

VALUE

133

to these "unproductive laborers" if effective demand is to equal actual supply. At this roint l\lalthus again anticipates a modern economic problem a~d discusses the possibility of capital becoming redundant. ~ Ie recognized that capitalists might create an estate for their families in t\VO \vays, either in pure saving, in which they spent less than they made and banked the difference, or they might add to the estate or legacy by reinvesting the savings in more capital g'oods. \\T e have already showed \\Thy the first kind of saving ran into definite [imitations. l~ et, if they practiced the latter type of saving, the productive machine might soon get top-heavy and create a still greater maladjustmcnt between the po\ver to produce and the means of distribution. Saving of the first type created an early excess of supply and shortage of effective demand, while the latter postponed the day of surplus and inadequate demand but created a worse situation when it came. Therefore, capital demand cannot be depended upon permanent ly to keep the balance. Capital will become redundant. The balance wheel and evener Blust be "unproductive COllSUIl1Ption." Vv e readily recognize that the creation of a large army of unproductive laborers as defined by Malthus, calls for decidedly large increases in taxation, because most of the members of the group arc governll1cntal employees. While modern economists would not count these unproductive at all and the number involved would be determined by the utilitarian problem of need for this particular service, yet there is still need for careful consideration of the problem as Malthus stated it. If industry is highly productive of physical, materia] commodities, and private consumption and demand tend to bring forth a surplus, is there a definite need for the creation of a considerable public fund through taxation, to be used in supplying services which yield no material commodity, or for unproductive capital such as roads, schools, parks, etc.? Malthus answered definitely in the affirmative. "In our endeavors to assist the working classes T

134

VALUE THEORr A}·lD BUSI1VESS CYCLES

in a period like the present (depression), it is desirable to employ them in unproductive labor, or at least in labor, the results of which do not come for sale into the market, such as roads and public works." aa To what extent then is taxation and governmental demand needed to supply the deficiency in private demand in order to maintain that proportion between effective demand and supply which is necessary to permit volume of production to proceed without curtailment and without experiencing a fall in exchange value or total wealth? This is not the same query presented by socialists in which they advocate the use of the taxing po\ver to socialize wealth and provide more even or «equitable" distribution. I t is the practical question, highly relevant at the present time, as to how heavy taxes should be, and how much money should be spent through public channels to supply the effective demand necessary to yield proportion and progress of wealth. Malthus spoke with no finality on the question, but did indicate that a considerable amount of taxation, might be highly essential to sustained prosperity. Concluding his discussion on "The Immediate Causes of the Progress of \\T ealth," he says "It has been repeatedly conceded, that all productive classes have the power of consuming all they produce; and if this po\ver were adequately exercised, there might be no occasion, with a view to wealth, for unproductive consumers. But it is found by experience, that, though there may be the po\ver, there is not the will; and it is to supply this will that a body of unproductive consumers is necessary. Their specific use in encouraging wealth is to maintain such a balance between produce and consumption as to give the greatest exchangeable value to the results of the national industry." 24 ~3 Mal thus, Op. Ctt., p. 395. Note: So La as the wr iter is aware, this is the first time this idea a.ppears in economic literature. We, therefore, gi,-e credit to Malthus for first stating it so clca r lv. ::!4, Ibid" p. 37 8.

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135

SU1\1IvIARY APPRA.lSAL

The major feature of Malthus's Principles of Political Economy \Ya~ his concentration upon the "short-run forces"-their importar-re in the creation of wealth and the continuity of prosperity. ".l~his led to the consideration of a great variety of forces and factors which had no bearing upon the science, if concerned only with long time trends. He desired to treat the wor ld of business as he found it with all its dynamics, flux and change. He knowingly, made no assumptions contrary to fact and was not interested in an hypothetical society, greatly simplified, operating under one or two overpowering forces. He upbraided his contemporaries for "oversimplification." He was one of the first to challenge the doctrine that production automatically financed consumption; that with adequate supply, demand would care for itself. He was among the first to advance the "overproduction theory of crises," maintaining that there might be a voluntary failure of effective demand on the part of the rich, who had the "power but not the will" or: an involuntary failure of demand on the part of the poor who had the "will but not the power." I t is amazing to observe the extent to which he anticipated much of the current business cycle theory of the Twentieth Century, especially the work of Aftalion. His theory of commanded value anticipates the marginal utility theory of value as developed by the Austrian School and suggests the idea of "opportunity cost" as developed by Davenport. His recommendations for the alleviation of depression have an amazing similarity to those presented for the depressions following the crises of 1920 and 1929. His suggestion that public works be used as an evener to keep business running on an evener keel is quite to the point. I-Ie definitely suggests the peculiar advantage to be derived from expenditures for public works that throw back no increased supplies upon the market.

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This comprises an important contribution for a writer in the early years of the Nineteenth Century. It is a bit unfortunate that both theory and practice followed so generally the Ricardian trail of increased productivity and supply regardless of demand. Ricardian economics in practice have given long run progress but far too much of instability, recurring crises and periodic s\vings of the business cycle. This instability having become the major economic problem of the Twentieth Century, the time is ripe for a renaissance of Malthusian Economics with its ernphasis on effective demand and the maintenance of proportions.

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CHAPTER X

TUGAN-BARilNO\\TSKy'" Tl-IE

I~'1PORTf\NCE

OF THE TI~ANSITI01\T FROl\1 A B.ARTER TO A. PRECIOUS l'vlE1--A.LS ECONOl\.JY LTKDEH. A COl\1l\ilANDED 1~HEORY OF \l:\LUE

ECO~OIVIY

\\T E have just contrasted the embodied value theory of Ricardo with the commanded value theory of Malthus, \Ve now wish to contrast Tugan-Baranowsky with Karl Marx. Marx explained commercial crises and price movements by assuming an embodied value theory functioning through a precious metals economy. Tugan-Baranowsky assumes a commanded value theory and shows the significance of the transition from a barter economy to a precious metals or money economy. By comparing the systems of thought of these two men we discover how vital is value theory in the explanation of commercial crises and depressions. Marx attempted to show how crises might come from general over-production and failed. Tugan-Baranovvsky at- . tempted to show how a partial depression might lead to a general depression, and succeeded. In Chapter III of Book I, we showed how Marx, with his embodied labor theory of value was driven to circular reasoning, logical inconsistencies, and contradictions in order to reconcile his theory with facts which were undeniable. Without a logical inconsistency, he never could have explained, either a commercial crises or a business cycle. Let us now turn to the clear and simple analysis by TuganBaranowsky, as he shows how a general depression may result from partial depression in a precious metals economy through . . . the operation of the forces of supply and demand.' In commenting first, upon barter economy, which he called 1 Tugan-Baranowsky, Studien zur T'Iieorie und Geschiclite der Handelskrisen in England, Ch. I. 137

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"Natural Exchange," he said there could be no general rise or fall of exchange values and no general depression. This is because goods exchange directly against goods. To illustrate the operation of exchange in a barter economy he cited as an example producers of grain and cloth. If, for some reason, the supply of grain was unusually large and that of cloth normal, then the producers of cloth would find their product relatively more valuable as compared with grain, while farmers would find grain relatively less valuable as compared with cloth. But there would be no general rise or fall. The relative rise in the exchange value of one product would be exactly counterbalanced by the relative fall in the exchange value of the other. Passing over to the precious metals economy, TuganBaranowsky found the situation quite different. In the Natural Exchange, products exchange immediately with products. But in a "geld" economy the exchange process is broken into t\VO parts: ware-geld and geld-\vare, the sale and the purchase. "The geld, which plays the rfilc of a medium of exchange cannot throughout be placed equally with the other commodities. It is indeed still a commodity, yet one wholly peculiar, which serves a special function in the process of commodity circulation. 'The commodity ccgeld}} wins a distinction from all other wares. . . . The ownership of gold, as a universal means of purchase and circulation, becomes the ob ject of a universal and limitless demand, while the demand of all other commodities can of necessity be only a limited one. That postulates a vast distinction hetween the two halves of the exchange process: the act of selling wins in the process of metamorphosis the ware of vast! y greate r importance t han that of purchase. By selling the ware, the seller received the object of a limitless and not dubious demand in exchange for an object for which the demand is both dubious and limited. The purchase is consummated under normal market conditions without any difficulty; on the other hand the sale of the commodity is always a hazardous moment in the metamorphosis of wares. "Although the first act of this metamorphosis-the sale-presupposes the second-the purchase-the moment and the place in which this second act will happen is not predetermined hy the first act. The sale of the ware can take place in the one market hut the purchase can take place in another, the purchase need not follow immediately

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139

on the sale, butjt can be postponed an indefinite time. Indeed, it is possible that no purchase will follow the sale at all. The seller can break up the process of commodity circulation, in that he holds back the gold 'n his hands as in a vise. It is known that by this means in the land nf the distant orient, namely, India, enormous quantities of silver are always held out of circulation. "The COIl version of the Natural Exchange process-by immediate exchange of products-to a complicated two sided process of purchase and sale is in no wise a mere formal variation, which does not affect the character of the exchange process. Rather, through the introduction of money as a medium of exchange, the exchange process is completely revolutionizcd ," ::!

In the first place, since the exchange value of commodities has come to be expressed in terms of gold, there may be either a general rise or a general fall of prices, due to the relative worth of gold as compared with that of commodities. But such a change would be largely nominal. The vital change in price is due to a variation in the realm of commodities in general. For example, to return to the illustration of grain and cloth, we found that in natural exchange, a fall in the exchange value of one automatically expressed a rise in the exchang-e value of the other. Now, if into this barter of grain and cloth there is interjected a purchasing medium, gold, the results would be very different. For if the supply of one of the commodities, grain, should exceed the demand, then the price of grain in terms of gold, would materially fall, and the gold received with which to purchase' cloth would be materially diminished. The result is that the cloth-makers have been able to purchase their grain at a much lower price; but when they come to sell their cloth they find the grain growers with a small supply of: gold with which to purchase cloth. Hence to sell their cloth they must lower the price. So a fall in the price of grain brings in its wake a fall in the price of cloth. As Tugan-Baranowsky concludes: "If the supply of one of the two wares-grain-exceeds the demand, then there follows from it, a fall in the monetary price, not 2

Tugan-Baranowsky, Op. Cit., pp. 7-8. (Free translation.)

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only of g-raln, but even of cloth. The price of the two wares vary, not in opposite directions, as was the case ill l'latural Exchange but in , one and the same direction." "Let us now follow this case a little further. If in the supply of cloth no variation has entered then cloth has not been produced overnburidan tly, neve rthcless its price, just as that of the ove rabundantly produced ware-grain-has fallen. Both cornruod ities have fallen in price. The grain producers as well as the producers of cloth have experienced loss-their monetary receipts have been dirninished." "If grain exchanges, not only with cloth, but also with other wares, then there would follow a fall in the price of grain, a fall in the price of all these wares. The decline in the price of commodities would be universal." 3

If instead of restricting the illustration to grain and cloth we make it general, the principle still holds. If any considerable group of producers find their purchasing power curtailed, due to the small quantity of gold they receive for their commodities, the producers of all other commodities will be unable to sell their normal quantity of goods without reducing the price. And unless some factor outside the precious metals economy enters-such as credit-enabling them to wait-the majority will have to sell their products for what they will bring in the face of diminished general demand, and the prices will be lowered. In conclusion, then, Tugan-Baranowsky held that under a precious metals economy a surplus of goods in one field and a low price, which reduced the effective demand of any significant' group, made it impossible for others to sell commodities at normal prices where only normal production had taken place, and therefore the market became glutted, betraying all the evidence of a general overproduction with a general fall of prices. "The overproduction of one ware under a money economy transforms itself into an overproduction of all wares. And the market struggles against this general overproduction by means of a general diminution of production." 4 3

4

Ibid., pp. 9- 1 0 • Ibid., pp. 10-1 I.

T[]GAN-BARA]\,TOl'T7SKY

By \vay of final comment, it might be said, that such depressions would tend to be infrequent, of short duration, and of a miJd type. Yet the possibility of a generally depressed market, and a fall of the price level would seem to be possible, even in a pure precious metals economy. It could not be explained, however, if value were taken to be embodied or intrinsic, and increased as quantity increased.

CHAPTER xt Y

AFT.L"-LION AND \lOLUNTARi FAILURE OF DEMl\ND DE!vl:\KD A1'\D l\L-\RGIN:-\L U1'ILrr'i'

'..

ADAM SMITH, consistent with his embodied labor theory of value, sought prosperity and increased wealth through continuous increase in physical productivity and expansion of supply. The greatest improvement in the productive po\ver of labor carne through more minute and technical division of labor. But division of labor called for vast expansion in capital "additions to stock." Capital sets labor in motion, therefore the higher the degree of saying and the greater the capital fund, the more effectively would labor be employed. Therefore "in all thy getting get capital." It is the sine qua non of prosperity. Thrift is the habit .surnrnuni bonu m, Prodigality is the vice SUillJJ1,Uln bouurn, The same idea was stressed by Ricardo, reiterated by John Stuart Mill and even crystali zed by him into the noted wage fund theory. Lord Lauderdale, writing in I 804- was perhaps the first to challenge strenuously this doctrine. His chapter on "Parsimony" continues to remain a classic in economic literature. He disagrees with Smith and Ricardo at two points. First, if saving goes too far, it greatly reduces consumer demand while enhancing production so that the mass of goods cannot be sold at a remunerative price. Second, while capital may set labor i11 motion it may also suppla.nt labor. When carried beyond a certain point capital may compete with laborers and displace them rather than furnish increased employment. In fact, Lauderdale referred to parsimony as the "baneful

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VOLLTJ.\TTARlP FAiLURE OF DE},JAJ·lD

1.4-3

passion of accumulation." However, Lauderdale was not an extremest but felt certain that it was as important to consider effective demand as physical supply. In this connection Professor Haney pays him this glo\ving tribute. "Lauderdale's emphasis of consumption and demand, and his shrewd observations on the effects of varying distribution of wealth, are remarkable. He was far in advance of his contemporaries in these matters." 1 Thus we see that Malthus and Lauderdale stood quite together on the problem of effective demand, because they thought in terms of commanded value instead of embodied value and feared the short-run evils which might come from maladjusted production and consumption. Following Lauderdale and Malthus, the commanded value idea with its emphasis on demand, seems to have gone into eclipse for almost half a century, until it was resurrected in a new form by the Economists of the Austrian SchooL Meanwhile the Principles of Politica-l Economy by John Stuart Mill dominated the field, and the prevalence of the \\T age Fund Theory furnished a closed case for prosperity based upon thrift and capital accumulation. The doctrine permeated economic science, mercantile practice, and furnished the cue for legislative acts of parliaments and congresses. It yielded quite definitely a "filtration theory of prosperity" which held that if only capitalists are made prosperous, they will employ labor and buy raw materials and their prosperity will filter down to the classes below and prosperity will be general. No sooner do we think of the Austrian School than immediately there comes to our minds the names of J evons, Wieser, Walras, Menger, and Bohm-Bawerk and the principle of mar-.. ginal utility. The development of the marginal utility theory of value marks very definitely a return in economic theory to the Malthusian trail of Commanded Value, with its approach to value in exchange from the demand side. Embodied value theory seems to be finally exploded and buried beyond recalL Cost of production is still used as a dominant cause of normal value, 1

L. H. Haney, History of Economic Thought, p. 350. (19 2 0 . )

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VALUE THEORY AND BUSINESS CYCLES

but cost is used to mean "Opportunity Cost" or po~rer in exchange-\vhat it will command-rather than actual embodied costs as interpreted by Ricardo. The Marginal Utility theory of value is perfectly familiar to all who will peruse this book, therefore an elaborate statement is superfluous. Yet, the significance of this shift in value theory has not been fully comprehended. Certain economic principles and doctrines, the validity of which rested upon embodied value theory, continue to remain current after the major and supporting premise has been exploded. For example, ernbodied value theory gave rise to the axioms "value increases as supply increases"; "goods exchange against goods"; "production automatical1 y finances consumption"; each one would be true if value were objective and intrinsic. 1""et, each one demands a rigorous reconsideration under a marginal utility analysis, or subjective theory of value. Let us observe how the brilliant French Economist, Albert '" Aftalion, proceeds with this re-appraisal of economic doctrines in the light of "Commanded Value" as distinguished from "Embodied Value," or in the light of the Marginal Utility theory of value, as developed by the Austrian School. THE \lOLUNTARY F.AJLIJRE OF DEI\1AND BY THOSE WI-IO Ht\ VE ~rHE IlO\\lFR ntrr :NOl' 1'I-IE WILL

The "Law of Markets" was first clearly formulated by J. B. Say, was ably defended by Ricardo and james Mill, and remains as one of the basic doctrines of Classical Political Economy. In its briefest terms it may be stated about as follows: Goods exchange ag;tlnst goods. rrhe power to demand increases as supply increases, pari passu and in the same proportion. 3. The 1.vill to demand (buy) is always present when the p07ver is present because of the insatiability of human wants. 4. Therefore, total supply can never exceed total demand and general over-production is impossible, I.

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145

W e have already observed how Malthus and Lord Lauderdale attempted to overthrow the la w of markets, but their success was only partially complete. Sismondi and Marx, also, trained their guns upon this classic edifice, but since they lived in a "House of Embodied Value," as well as Say and Ricardo, every shell dropping into the court of the enemy, reacted with equal violence upon their O\VI1. Therefore, the battle ended with the "La\v of Markets" still standing. But the Austr ian School, with Jevans, w alras, \\Tieser, l\1enger and Bohrn-Bawcrk as architects, builded the castle of Marginal Utility or Subj ective Value. Into this fortress a few years' later, the brilliant ..Aftalion stepped, trained his artillery upon the "Classic Law of Markets" and left it, as he thought, utterly demolished." Let us proceed to this method of attack. T /;e Cause of Crises, Aftalion recognizes that the point at issue is whether the phenomenon of production and consumption may yield general over-production or only partial over-: production. His thesis is well developed in a series of articles written for the Reuue .l'Econoini» Polutqu» in I gog on the subject "La I{calite des Surproductions Generales." 3 He considers, first, the doctrine of the insatiability of human wants and readily admits the point. It is perfectly true, he says, that humanity has many wants which are virtually insatiable. 1\ evertheless, these wants are not all of equal importance or intensity. Psychological observation reveals the existence of a long scale of desires, but desires of diminishing intensity. When / the first are satisfied, there surges up others less vivacious, and then others still less intense. The intensity of desire diminishes as we increase our po\ver to satisfy the lesser needs. "Thus, the :.! N ote: To a certain extent) the cr it icisms of Afta l ion are not wcl l founded. Say assumed free compct it ion and a perfect marker, wh ile :\ft~dion took the wo rl d as he fo uncl it. S.1 v also guarded the la w by the lll:llifi('~tion "in the long run)') w hr-rca s, l\ft;lion, as a Business Cycle theo: ~t concentrated on "thc short run." Sl.-'C bel ow , Chapter XVI, on "The Pro'\lclH of Business

Eq LIi 1ibrn t io n ." is given in a t\VO vol urne work Crises Periodiques de Sur-prod uction,

:::.:\ lTIOl'C extended trea tmcnt

19 I 3 on

LL'S

publ ished

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FALUE THEORY Al\'D B[TSIJ.\,7ESS crCLES

decreasing utility of goods is in perfect harmony with the insatiability of human wants." -1 Yet this increasing quantity of goods and decreasing intensity of desire cannot go on together without serious perturbations, unless at the same time there is a reduction in effort and the cost of production. Thanks to inventions and other means of industrial progress, it has happened that much of the time a diminution in the intensity of desire has been paralleled by diminished effort and cost of production with accompanying decrease in price so that over-production was averted. But if, with the fall in the intensity of desire there does not coincide a reduction in effort, the crisis comes. The principle of the insatiability of human wants is thus of little import, Our capacity to absorb ever more and 1110re products, necessitates the employment of these products in the satisfaction of lesser desires. \'l e will appreciate them less and less for these later needs. Their desirability will flee a\vay, and with it will flee their value and their price. Then comes the crisis for the entrepreneurs, not because they wil l not be able to find enough people to consume their merchandise, but because they cannot find cnough folks to purchase their wares at a price that will pay. The insatiability of wants is not an obstacle to a crisis of general over-production if we comprehend a general diminution in the intensity of desire for merchandise products." Aftalion next directs his attention to the classic doctrine that goods exchange against goods, creating a law of t\\TO supplies, making impossible a general over-production. The most that could happen would be maladjusted production or partial overproduction. In reply, Aftalion says it is of little import to say that one's pO\\1er to acquire increases proportionately with his production. "Intensity of desire for goods is not identificd with the po\ver of acquisition. It may be that my ability to buy cloth depends upon how much wheat I produce. But the strength of my desire for cloth 4 Aftalion, "La Rea.lite des Surproductions Gen~rall's," Reinie d't!conollzie politique. (1909.) Vol. XXIII, pp. 86-7. 5 Ibid., p. 87.

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l/OL[]l\-TARY FAILURE OF DEilIAlt/D

147

is not a function of my wealth of wheat. It diminishes with the increased abundance of cloth, since this abundance will permit onl y of the satisfaction of a lesser need. Wheat and cloth may be mutually exchangeable but if production is carried to the point where increased consumption satisfies a less intense desire then , the value of both will fall. Thus it is with the total ensemble of products. If supplies are increased quite generally, they meet on the demand side a diminished intensity of desire. But as general intensity of desire flees away, so does value. Prices will no longer cover cost of production. \\T e still have general overproduction, even if consumers have the po\ver to clear the market ~ but because of diminished intensity of desire refuse to do so. Then Aftalion trains his argumentative artillery upon the last defense of the Ricardian Classicists, who are not yet ready to capitulate and grant the possibility of a crisis from general overproduction.. They admit that one want might be carried to the point of satiation; that the desire for more cloth and wheat might become very feeble; indeed that goods, when considered seriatim, might, one after another be carried near the point of satiety. "Yet the human being always carries within him a per- " petual insatisfaction (italics mine) -an eternal capacity to desire more riches than can ever be attained or possessed." In meeting this contention, Aftalion readily grants the existence and persistence of unsatisfied desires. Yet, just as desire diminishes as additional units of a certain good are consumed or acquired, in the same way desire diminishes as consumers climb down the scale of needs from the more necessitous to the less necessitous. There is experienced a gradual transfer to goods, the desire for which is "less violent." Thus does Aftalion establish the "logical possibility of a general fall of value in use" by rigorous application of the principle of diminishing utility." It may be well before completing the argument to show a bit more clearly how the principle of din ~nishing utility applied to an increasing supply, registers itself i~ a decrease in value in exchange, or price. In clarifying the point, Aftalion definitely 6

Ibid., p. 89.

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VALUE THEORY AND BuS/}lESS CYCLES

rejects the Ricardian theory of embodied value and JOIns the Malthusian group and Austrian School of 4:4:commanded value." He quotes Wagner who says "Exchange value is not an intrinsic property in things, but is a property which is acquired when man takes cognizance of the relation between the good and his wants." 7 Thus we observe that as the intensity of desire diminishes, men assign to goods a less importance. At one and the same time they are willing to give less in exchange for them. The good will exchange for only what it will C011'z.1J~and of other goods when functioning through the human mind as in intermediary appraiser. These individual appraisals of an innumerable number of goods by innumerable persons results in a generalized comparison which establishes a social value in use and indirectly establishes the exchange value or price which goods will command. Thus, through a general expansion in production unaccompanied by a decreased cost of production there comes about a general fall of exchange values or of the general price level and the crisis is upon us, betraying all the ear marks of a general over-production because the supply is so great it cannot be sold at a price sufficient to cover the expenses of production. Rather than operate at a loss many factories are closed down creating unemployment, surplus raw materials and all the familiar accompaniments of a general crisis." 7 \V~gner, Les [ondements de Peconomie politique, Trad. fr., I, p. 4 8 5. Aftalion, Ope p. 90. t!.l\ critical review of Aftalion's Les Crises Periodiques de Sur-production appea rs in the Economic J ournal in 19 14, written by Robertson. Professor Robertson dissents most vigorously from Aftaliori's view that crises are caused by the operation of the principle of diminishing utility by which principle, the desire for additional units of a good is too feeble to induce the prospective buyer to p~y a price high enough to cover the expenses of production. Robinson holds that the principle of diminishing utility applies equally strong in the case of money. The more wealth one has, the less utility does one dollar possess, therefore, the utility of rnoney will fall as fast as the utility of goods, therefore the exchange values of goods from this source wili remain constant. In that case price would still cover costs and no depression could be caused by this principle. He states that it is apparently the view of Aftalion that the In~rgin~l utility of money is more nearly constant than for other commodities.

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VOLL,"'iVTARY FJILURE OF

DEMA.i\~D

14-9

But Robertson insists that since In01WY is o nlv the "chicle' for the exchans-c of conunodities, the ma rgina l utility ·of 1l10ll~'Y w il l a.lwavs 1IlO\T w it h g'cnel"alized average of couunodities. 'Therefore, if goods lose part of their value by an inr rcase of quautitv, the same dim inut iou in the value of 1110ney would take place, leaving- exc/lll.l/ge calucs at tlu: same le'"cl as before. T'he issue raised by Robertson is a vital one. If his position is correct, then all attell1pb by A.ftalion or anyone e lsc, to explain rouuuerr in l crises as due to the vo luntarv [a ilu re of cleruand by those who have the po\\'er but not the wil l, due to the operation of the principle of dimi nishing utility, are futile. Indeed one lllight go so far as to say that the personal distr ibution of wea lth-e-indi vidual courcutration of wealth and i I1Co111c-has no bearing upon the problem of effectin:' demand, or the maintenance of cquil ilnium between prod uction aud consum ption. Cf. Robe rtson 's Review of _'\ftalion's Work, E eono m ic Journal} 191+, p. 86, The whole point at issue between A.ftalion and Robertson is in reg-anI to the slope of the curve of d iruiriish int; utility for nIoHey. How rn pidl y does the I1larginal utility of uloncy fall when till' vo luinc of goods produced is rapidly increasing, due to technolog-ical changes and a 1110rl' capitalistic or roundabout process of production? Is the lliarginal utility of nloney climin ishi ng according to a generaliz~d ave rage> of the ensemble of goods, or does the Ina rginal utility of llloney tend to diminish in unison with the couuuoditv or g-rollp of cornniodit ies, the ma rg ino l utility of which tenus to fall the 1110st 510\\' lv ~ In "'rl'sponsc to these questions the w r itcr 1S inrl ined to agrl'l' with Aftalion. l\Ionl'Y is the most versatile of all couunod it ies. The a ltcrnar ivc opportunities for the use of IllOney ill cXChJ.l1gl' is gre;lter than for any orhe r connnodity, since, bL'ing 1non~y, it is the one rouuuodity in exchange w hich has general acceptability. 'Therefore the inference must be that the marg iual utility curve for IllOnl'y would approx imutc much more nearly to a ho rizorital line than the J. \'L>rag-C 1I1L'an of all comrnoclitv curves. Viewing- the matter realistically for a n101J1ent, let us suppose that the supply of apples lias been quadr uplcr! due to the cxpausion of orchards, a nc] more scicut itic pruning and spraying. The utility of the rua rtr ina l apple would be grl'J. tho diminished, but wo ulcl the increase ill till' wcn lth of apples cause the l..ltility· of the ma rjrina! dollar to decline ill such a parallel fashion that the exchange value of apples would not falP We think not. There Inig-ht easily a ris.: depression in the apple industry) even thoug-h stimulated by an improvemcnt in technological methods of production, because of a voluntary failure of demand at a price that would cover costs of production, due to the greatly clim inishcd utility of the 111arg-inal apple. If Aftu lion has succeeded in establishing the possibility of a voluntary fJ.ilure of demand by those who have purchasing power but insufficient keenness of desire when facing expanded production under the influellce of tlu. principle of dirninishinjr utility, then it constitutes one of the greatest contributions to economic theory in a generation. Say's Las» of Jl.larA>erl ) according to which production financed consumpt ion arul supply gen~rated adequate dCllland is in sr:rious need of Inoclification. In other wo rc!s a law formulated in harmony with Ricardo's embodied value theory, loses a measure of val i.lity when tcsted by the Inarginal utility theory of va l ue with its approach to value f roiu the delI1and side. Moreover, it furnishes a basis for explaining disequilibrium as well as equilibrium.

the {'

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THE CAUSES OF PERIODICITY

9

T he Cycle of Business.. Having first treated the problem of crises, Aftalion next turns to the rhythm of business and the problem of periodicity. No attempt is made to explain the cause of business instability. Looking at the business world as he finds it he discovers flux, change, continuous instability. "For every industry, observation reveals a perpetual oscillation about a state of equilibrium." Thus, finding a mechanism in motion he restricts his analysis to a treatment of the forces which move it from one phase of the cycle to the next, without attempting to deal with origins. In other words he shows how this oscillating mechanism is self propelling and never comes to rest. Just as the old classical economics pointed to market values fluctuating about normal values determined by cost of production, so the modern economics show how prices at the moment depend upon final utility but gravitate toward a point of equilibrium as determined by marginal cost. The three cardinal points in Aftalion's theory of business periodicity are ( I) the round-a-bout process of capitalistic production, (2) the principle of marginal utility, and (3) errors in judgment on the part of entrepreneurs or the directors of business enterprise. Let us observe how he utilizes these factors to explain the rhythm and amplitude of business fluctuations. There is probably no inclination on the part of anyone to dissent from the old economic principle, that if the demand for some particular commodity is very keen and the price high, then production of that commodity will be stimulated until the supply enlarges and the price gravitates towards the cost of production. Now, if the process of production is very simple with little capital involved, then the limitation in supply may soon be met, the oscillation in price above or below cost very minor, the 9 For a concise and admirable statement of this part of Aftalion's work, see Professor Hansen's volume on Business Cycle T lteor y, pp. 1°4-1 1. For original source consult Aftalion, "Causes de Ia survcnance et de Ia periodieite des crises de surproduction gcnerale," Revue d'economie politique, Vol. XXIII, pp. 200-2 9 _

VOL[ll'/TARY FAILURE OF DEj}fAND

15 1

period of adjustment very short. But if the method of production is very indirect and large quantities of expensive and complex capital machinery are involved, then maladjustments are corrected much less quickly and the departures from the point of equilibrium much greater. Aftalion, therefore, invites us to consider "L'allongement du proces de production capitaliste cornrne facteur determinant des crises periodiques modernes." 10 Not only is the lengthening of the capitalistic or round-a-bout process of production «one oj tlze [actors." but the pri;nary and" basic factor in the creation of business cycles. \\Te may start the analysis with the prosperity phase of the cycle. It is characterized by a shortage of consumer's goods, active demand and market price above the marginal cost of production entailing large profits. But high prices and high profits act as a powerful stimulus to production. Y---et, in this elongated "round-a-bout process of production," it is necessary to expand the factory before much can be done to increase consumption goods. Thus while goods are still scarce and prices high, entrepreneurs enter the market on the demand side as purchasers of capital goods and raw materials. This double demand in a scarce supply market raises prices still higher while for a time nothing is being added to the usual supply of consumers' goods. This is the prosperity phase of the cycle and in .the last stage reveals ferverish demand from both producers and consumers. Ultimately there arrives the second phase which is the crisis. The new capital and expanded factories begin to turn out consumers' goods in quantities never approximated before. To this I increased supply of consumption goods, the principle of diminish- .ing utility begins to apply. There is first a decrease in utility or value in use, and by consequence a decrease in exchange value which consumers will pay. This consumer behavior is communicated to entrepreneurs all along the line, notifying them in no uncertain terms that their capital equipment or expansion has gone far enough. Producers therefore drop out of the market for 10

Ibid., p.

203.

;

15 2

rJL[fE THEORr A ..\~D BUSIJ.\·ESS crCLES

production goods at the same time that consumer demand is \veakening. This double blow to demand creates the crisis, revealing the crash in prices, the fall of the whole price level and the phenomenon of general over-production. Virtually all prices being driven below the costs of production, the economic order experiences extreme depression. N or is this state of oyer-production, low prices and depression quickly remedied, for the over-production of extensive and expensive capital equipment with high overhead in fixed charges makes it inadvisable to close down and leave the capital unemployed. Depression continues because of the over-production of an overcapitalized round-a-bout capitalism. y.. . et even depression is not permanent, because no new capital is being added when there is obviously already too much. 1'"et, through ordinary "wear and tear" capital depreciates, a certain percent is junked, so productive po,Yer is lessened. At the same time, even with diminished utility expressing itself 2nlong consumers, the fall in price tends to augtnent the phvsical volume of goods consumed. Demand and supply tend toward the point of equilibrium again, but the depreciating capital equipment results in inadequate production, the price rises and the cyclical rhythm moves through its cycle again. Such is the explanation of the rhythm of business as set forth by Aftalion. "L'allongelnent capitaliste du proces de production collectif est done le grand fait moderne qui determine 1'ampleur des oscillations autour de l' equilibrc, la durec de la prosperite et de la depression." 11 When we scrutinize the theory of Aftalion in the light of effective demand, we realize that the cycle is primarily a cycle of producers' demand. Consumer demand is relatively constant, but the demand for capital goods waxes and wanes, revealing wide variations, Furthermore, the more indirect the productive process becomes, the longer will the phases of prosperity and depression continue and the greater the amplitude of variation. 11

Ibct., p.

~oG.

,,

I

j

VOLUNTAR}" FAILURE OF DEMA.l\iD

153

This is due to the probability of greater errors in judgment on the part of entrepreneurs. The more direct the process of production, and the sooner an increased consumer demand can be met with little adjustment in capital outlay, the milder the oscillation, and the sooner would the point of equilibrium be reached. To make the point extremely clear Aftalion illustrates the problem of errors in judgment for entrepreneurs who attempt to guess when to add more capital and when to desist, by referring to the problem of heating a house. The fireman finding the house cold, begins to stoke the furnace with coal. At frequent intervals he adds fuel until the thermometer registers the desired mark. But the fire has gained so much momentum and the supply of fuel in the furnace is so great that the house has become overheated and the thermometer registers extremely high. Whether the fireman (the director of the furnace) senses the temperature of the room or looks at the thermometer, he will keep on stoking after he should have desisted. In like manner if he waits to apply fuel and draft until the house feels cool again, the temperature will fall still further before the new fuel can affect the temperature. Of course if the fireman were wise enough to do the right thing to the right degree in advance of the signal for change, the temperature could be held much more nearly constant. So it is with business cycles and the entrepreneurs. The major fluctuations are due to "overstoking" and "understoking" capital> equipment.. Were they collectively wise enough to check the capital increments soon enough and begin the capital increments early enough, the oscillations would be much less severe. Yet the continuous lengthening of the round-a-bout process, the continuous "revolution" in the capitalistic process, serve to make the most wise appear frequently very foolish, and all attempts at forecasting future demand, either in the specific or the general, a grave speculation. In conclusion, Aftalion holds that the business cycle is an inherent by-product of capitalistic production, with both peri-

154-

VALUE THEORY AloiD BUSINESS CYCLES

odicity and amplitude determined by the average period of incubation for hatching out the new capital needed to meet an excess demand for consumption goods. APPRAISAL AND CRITICISM

Aftalion has merited careful attention in this study, first because his value analysis is completely in line with the concept of "commanded value" as set forth by Malthus, and wholly antithetical to the embodied concept of Ricardo. Second, because of the skill with which he deals with the problem of inadequate demand on the part of those who ((ha~\e the p01JJer but not the scill" to buy because of the principle of diminishing utility. After almost a century of heated discussion over the classical doctrine of markets and the possibility of crises from general over-production, it remained for Aftalion to grasp the significance of a subjective "commanded value" theory, in its relation to the problem of effective demand. Aftalion belongs quite definitely to that group of economists, which finds the cause and explanation of business cycles exclusively in the realm of production and consumption. The manner in which he explains the failure of consumer demand by linking together the principle of diminishing utility and the fluctuations in the demand for producers' capital, thus yielding a business cycle, is an analysis at once plausible and captivating. There is a negative part of Aftalion's work, not treated in this study, where he attempts to prove that the business cycle is not, and cannot be, caused by forces and factors in the realm of money and credit.!" It is inexpedient to pause here for a criticism of this view since we have not yet presented the exponents of the monetary explanation. Aftalion's cycle theory, however, does appear to be vulnerable in at least two points. He observes, or assumes instability and oscillations rather than equilibrium. There can be no quarrel with that view. However, the type of instability which he as12

u,

crises periodigues de sur-production, Vol. II, Ch. VI. (19 I 3.)

VOLUJlTARY FAIL[}RE OF DEft-lAND

( I

, t,

,

155

sumes, or observes, is one where the prices of virtually all corn-. modities are, at one and the same time, above marginal costs of production, calling forth a dynamic period of prosperity, then another period when virtually all commodities are selling at one and the same time below the marginal cost of production, revealing the period of depression. He does not submit sufficient proof for a general rise or fall of the price level from the point of equilibrium under the influence of factors wholly in the realm of production and consumption. It is quite true that he assumed as a starting point a type of equilibrium in which the prices of all goods were "off center" on the same side at the same time. He then showed how the factors considered moved the average back and forth. But in so doing his theory is open to the weakness of many other cycle theorists. They beg part of the question in the assumptions, He explained how the cycle propels itself but not how it generates itself. Furthermore, the "round-a-bout capitalistic process," does not clarify the matter. The incubation period necessary to hatch out capital goods available to increase consumption goods is as variable as the incubation period for the eggs of robins, hens, geese and ostriches. Apart from a fluctuating monetary unit, which in and of itself is capable of yielding a general rise or fall of the price level, there seems to be no logical grounds for the assumption that virtually all industries become undercapitalized or overcapitalized 13 at the same time or in the same period. Granting the varying periods required for capital augmentation in the various industries, it appears doubtful if there is any logical reason in the realm of production and consumption why capital equipment cycles for the various industries do not cancel out and offset each other, rather than move together in concert. \Ve also doubt if it is a satisfactory answer to the query to say that by observation we found them moving in concert and the factors set forth are sufficient to keep them in concert. The champion 13 Used in the literal sense of having an over- or under-supply of capital equipment.

156

VALUE THEORY AND BUSINESS crCLES

of a money and credit theory of business cycles might rightfully say that we started out on a quest of ((causation" to discover whether the basic cause of business cycles resided in the realm of money and credits, or in the realm of production and consumption, but the quest ended in description, not causation. On the other hand if there were factors at work to make money appreciate or depreciate in value, giving- a general fall or rise in the price level, then all goods would tend to rise or fall in price at the same time attended by a feverish scramble for capital equipment by all industries at the same time, followed by a general moratoriurn on capital installations when the price level began to descend. Aftalion's "over-production-under-consumption" theory of crises and his capitalistic theory of business cycles shall ever remain to challenge the thought and consideration of the most ardent monetary cycle theorist. However. it appears to the writer, that he pushed his case too far when he said that for the purpose of explaining the periodicity of the business cycle we might assume a stable monetary unit, and conclude that the business cycle is caused by the forces of production and consumption alone.":' 14 Aftalion, Les crises periodiques de sur-pro.Luction, Vol. II, Ch. VI, pp. 296 if..Aftal iori, "Lcs Causes des Crises Pc riodiques," Recu« D'Economie Politique, Vol. XXIII) pp. 206 if.

CHAPTER XII

FOSTER AND

CATCHINGS-IN'70LUNT.A.R)~

FAIL~lJRE

Fl1.ILURE OF EFFECTIVE

OF DEl\JIAND

DE~\1~-\I\D

BEC.ALTSE CONSLTI\,IERS

HA.VE NO'!' ]'HE POvV"ER

\\T E have just shown how Aftalion developed the Malthusian tenet regarding the voluntary failure of demand on the part of those who had "the po\ver but not the will." \\1 e shall now turn to Foster and Catchings, who address themselves to the involuntaryfailure of demand because consumers have not the po\\'er. T J2e Problcin Statc~d. :\.ccording to these writers, the great economic aim is that of keeping our industrial mechanism operating at capacity in order that society may enjoy as comfortable a standard of living as the economic mechanism is capable of yielding. \\7 e observe, however, "First, that there is no possibility of attaining the economic aim upon which all are agreed unless consumers somehow obtain the money, year in and year out, to buy the goods about as readily as they are produced; second, the present money and profit econOlny does not enable consumers long to obtain the required money; third, there is consequently no possibility of sustained economic progress, and extreme alternations of prosperity and depression are inevitable." 1 There was a time when production regulated consumption, but now, "since it is always possible to produce far more than we consume, consum-ption regulates production. . . . There could .: not possibly be a serious setback of business in general if consumption regularly kept pace with production. Sustained business depression accompanied by adequate consumer-demand is no more possible than drought accompanied by heavy rains. 1

Foster and Catchings, Profits, p. 23 L (IIoughton Mifflin Co.) 157

158

VALUE THEORY AJ.VD BUSIJ.'lESS C}"CLES

" "Thy do we ever curtail production in general-reduce crop acreage, bank furnaces, shut down mills, throw men out of work? For one reason and one only. Because we cannot get our products consumed, which means that we cannot sell them to the people who want to use them, at prices that make continued production possible." 2 "The one thing needed above all others to sustain a forward movement of business is adequate consumer purchasing power." "Sunshine campaigns may start business, but only consumers' dollars can sustain it." 3 ".It\. \villing buyer does not have to wait long, but a "'Tilling seller may have to wait forever." "Adequate consumer-demand would do more than any other means now within human control towards increasing wealth, abolishing poverty, maintaining employment, solving labor problems, increasing good will among men generally, and maintaining the peace of the world." 4 THE

UNB~.\L~t\NCING

FACTORS

I. Money. The significance of the transition [rom a barter econ01ny to a tnoney ecol1otny. The first great factor operating to unbalance demand and supply, or production and consumption, is money. The authors present substantially the same argument regarding the significance of the transition from barter as that made by Tugan-Baranowsky.5 Yet, their treatment of money is deserving of very careful considerations because the implications are wide and far reaching. A great deal has been written regarding the superiority of money over barter in the convenience of exchange. But that is of very minor significance. "The one meaningful characteristic of trade by barter is that demand for goods always equals the supply of goods. . . . Where goods are exchanged only for goods, there can be no addition to the effective demand without 3

Foster and Catchings, "The Dilemma of Thrift)" pp. 10-1 I. (Reprinted

from the Atlantic M onthl y; April) 1926.) 3 Foster and Catchings, Profits, Ch. XXI, p. 239. 4 5

Foster and Catchings, "The Dilemma of Thrift,)) p. 23. See above, pp. 137-4-1.

IJ.\TVOLUJlTARY FAILURE OF DEMAl'lD

159

an exactly equivalent addition to the supply." 6 Under barter econonlY there is perfect balance, but in a money economy there is an unbalancing of supply and demand because money intro- ' duces three options which do not enter into barter. Money is suspended purchasing po\ver. The man with money is free to choose the time, and the place where he will spend his lnoney and the goods he will accept for his n1oney. Such liberty does not attend barter. Of these three the most important is the choice of time. All who sell for n10ney without immediately buying register temporarily on the supply side but not on the demand side, therefore making for unbalance. The delay may be only a few months or it may be years. The Automatic Production-Consumption Fconomists who insisted that supply created its own demand, that goods exchanged against goods and that a n10ney economy \vas only refined and convenient indirect barter missed the significance of lnoney econolny entirely. Neither was their position materially strengthened by adding that "in the long run" the t\VO balance. "To keep business free from extreme fluctuations, production and consumption must balance within a sufficiently short period of time." "Time is the essence of the problem." 7 What boots it, according to them, for production and consumption to balance "in the long run" if "in the short run" production has exceeded consumption, creating a major crisis and depression, with millions of unemployed, thousands of idle factories and paralysis in production until they come back to a balance again. According to these writers, the classic law of markets, invented for a barter economy, has been carried over into a money and credit economy where it does not fit. It is obsolete and fallacious. 2. Profits-The Dilemma of Thrift. The second factor operating to unbalance demand and supply is profit. "What a mess we get into ! We work hard to pile our shelves high with 6

19 2 7

Foster and Catchings, Money, Ch. XII, pp.

3.) Foster and Catchings) Profits, p. 24 8•

212-13.

(Houghton MifHin,

160

VALUE THEORr AJ.VD BuS1J.\TESS Ci.'CLES

what we most desire, and then we have to stop working because we are unable to take these things off the shelf and enjoy them." 8 The logical explanation of this predicament, say Foster and Catchings, is about as follows: Crises and de prcssions COIne from under-consumption. under-consume, because they have not purchasing power. 3. Consumers are weak in purchasing pc)\ver or effective demand to the extent that corporations and individuals save-to the extent that they make profits. 4. 'Therefore pro fits lie at the root of crises and periodic depressions. Yet both producers and consumers lTIUSt save, the former to remain in business, the Iatte r to a void dependency. I.

2. Consumers

This is the dilemma of thrift. Both producers and consumers must save, but jf they save, over-production, crisis and depression result throug-h lack of consumer demand. The thesis submitted here is defended by a chapter on "The Circuit Flow of Money" accompanied by a comprehensive and intricate chart." The essence of the argument, however has been condensed to a paragraph in the article on "The Dilemma of Thrift." ((Consulners have no source of income except industry; and industry has no source of income except consumers, I f therefore, industry handed over to consumers all the money it received from consumers, without using part of this money to enlarge production, and consumers spent all this money, industry could continue indefinitely. . . . There would be an even flow fron1 consumers to producers, and a corresponding uninterrupted flow of goods. The balance would be perfect. Demand in dollars would exactly equal the supply of goods at current prices. "This could happen-let us note carefully-only if consumers spent all the n10ney they received. Every dollar they saved would cause a dollar of deficit in consumer buying, unless the deficit were made up in some way." 10 They presume that no ~ The Di lcmma of Thr ifr," pp. 5-6. (Rcprintcd frorn the Atlantic Monthly, Apri], 19 26.) tI Foster and Catchings) Profits) Ch, XXIII. Foster J,nd Ca-tchings) Money; Ch. XVIII. 10 "The Dilemma of Thrift," pp. 17-18.

INVOLUNTARY FAIL[IRE OF DEMA1VD

161

one would dissent from this view if savings were hoarded. "But what if savings are invested?" We are told that money invested is spent; that it makes no difference in dollar demand whether an individual spc?nds his income or invests his income. To this contention Foster and Catchings vigorously object. In fact the validity of their general thesis depends upon their ability to answer this query. Their answer is given in t\VO chapters in "Money" on "The Circuit Flow of Money" and "The Annual ProductionConsumption Equation." 11 Consulting their chart on "The Circuit Flow of Money" we find at the top the reservoir containing the Consumers' Fund, fed by the pipe streams which come from production. The consumers' fund finances production and production finances consumption.. If there are no leakages in the circuit flow and each returns pr01}'1 ptly to the other the entire fund, there is balance between production and consumption, demand equals supply, with no crisis, depression or business cycle. On the other hand, "production must slacken, and thus render increased consumption impossible, unless products find their way to consumers about as rapidly as they are produced. This condition prevails, obviously as long as there is close and continuous correspondence between the dollar-sales of consumers' goods and the output of these goods measured in dollars at prevailing prices." If no saving or investing takes place dynamic consumption generates dynamic production and all is well. But if individuals save, dollars do not readily return to the consumer-fund and there is unbalance. A much worse situation develops when producers save and reinvest their savings in production. "lVloney that is used once to bring about the production of goods is again used to bring about the production of goods, before it is used to' bring about the consumption of goods. In other words it is used twice in succession to create supply." 12 The circuit flo\v of money 11 Foster and Catchings, Money, Chap. XVIII and XIX. Recapitulated in condensed form in Profits, Ch. XXIII. 12 Foster and Catchings) Profits, p. 279.

i

162

VALUE THEORY' Al\TD Bl.lSIJ.\iESS CYCLES

is broken, the consumers'-fund is short while production is being expanded and unbalance in the form of over-production results. The argument is pushed still further by the use of the "Ten lVlinus One Theorem." 13 For instance, if producers produce ten thousand dollars worth of goods, but "plow one tenth of their income back into the business" as an investment, then the circuit How into the consumer-fund is diminished by that amount, thereby reducing effective consumer demand while at the same time guaranteeing an enlarged supply in the not too distant future. If ten units are produced, and demand is to equal supply, then consumers must receive ten units and not ten minus one. It is a closed circuit and there is no \vay to make ten minus one equal ten. This is the crux of the whole problem. Savings and profits create a deficiency in consumer demand, and unless this deficiency is made up from some outside source, over-production must result and a crisis appear. In the twelve hypothetical cases in profits, the authors indicatea few ¥lays in which savings may be effected without creating a deficiency in consumer demand, but the cases are relatively insignificant, while in the important cases "Income was used twice in production before returning to consumption" therefore overproduction was inevitable unless the deficiencies were made up in some other way_ In Profits, the Dilemma of Thrift was left unsolved. But in the latter work, T l1e Road to Plenty, the authors attempt to point out some of these "other ways" in which the deficiency in consumer demand resulting from Profits and savings may be made up. Mi\.KING UP DEFICIENCIES IN CONSUMER-DEMAND ARISING FROM PROFITS AND SA"INGS I. Appointtnent of a Federal Commission on "The State of Business." Assuming that the "Business Man's" "Road to Plenty" represents the program of Foster and Catchings for 13

Foster and Catchings) TIle Road to Plenty, p. 89.

INVOLU}{TARY FAIL[JRE OF DEMAJ../D

I

I

,. I

t j.

163

meeting the deficiencies in consumer-demand arising from profits, then the first step would be the appointment of a Federal Fact Finding Committee to investigate and report on the state of business and the relation between supply and demand. By making this information available to business men the business leaders would be able to forecast the future with greater accuracy and would be less apt to reinvest earnings and profits in such a \vay as to increase supply where demand was becoming deficient. It would tend to correct some of the "errors in judgment" which Aftalion pointed out as a cause of crises. 2. Public ~v arks. The Commission would advise the government also, with the result that the national government, states and municipalities would tend to keep a,vay from the demand side when private consumer-demand was adequate to meet supply, then register heavily as demanders in the market when business became depressed by surplus goods and a tendency towards falling prices. 3. Credit Expansion. V\T e must not interpret their recommendations on this point as "credit control," but rather as a continuous policy of credit expansion, for the main source of deficiency in consumer-demand comes from the profits of producers who reinvest their funds in capital goods to create more goods. Unless this deficiency is made up in some other \vay unbalance and underconsumption are inevitable, and to the exact extent to which this is done dollar for dollar. This deficiency may be met by an expansion of baftk: credit, or by the sale of government / bonds. Such devices would have the double effect, first, of matching the expansion of wealth with an expansion of money and credit to maintain the price level, and second, of furnishing the consumers with additional money with which to purchase the larger volume of goods.

}

APPRAISAL AND CRITICISM

I

Two services seem to have been admirably performed by Foster and Catchings. While there is wide diversity as to solutions, their statement of the economic problem may be regarded

164

r '

rAL[]E TIJEORY Al\iD BUS/J./ESS CYCLES

as excellent. It would appear that in the industrially advanced sections of the world, the economic struggle is 110 longer, primarily, for a precarious means of subsistence but is largely a quest for markets. Leading industrialists and business men would doubtless agree with Foster and Catchings when they say that tIle economic probl em is that of keeping our industrial mechanism operating at capacity in order that we n1:1Y enjoy as high a standard of comfort as the mechanism is capable of yielding. They have also presented in an illuminating \vay the significance of the transition from a barter economy to a money and credit economy. To be able to register on the supply! side without at one and the same time registering on the demand side, is to introduce an entirely new situation into the realm of business, not known to the barter economy. Of course they are not the original discoverers of this idea as is shown in earlier chapters of this volume, yet few have been able to develop the argulnent more vividly than these facile writers. However, a final appraisal of the work of these t\VO writers must involve a major consideration of their entire argunlent with respect to profits, as they themselves have made profits almost the sale cause of commercial crises and the business cycle. I. TIle Consumers' Fund and the Ten Minus One Theorem, \\T e shall first turn to an appraisal of their argument in connection with the "Consulners' Fund" idea. No one would question the fact that in the long run production must finance consumption. It is not so clear that censumers alone, must finance producers. T 0 some extent the answer turns upon a definition of terms, and Foster and Catchings have defined production in a very limited and unusual \vay. It seems desirable to reproduce it at this point. "\Vhat, then, do we mean by production r For our purposes, we mean the turning-out of things which are ready for final use; not lathes, and harvesters, and spindles, \\7 hich are used up in the process of making other things, but chairs, and bread, and shirts-the things in general, for which incomes are spent. These are called consumers'

goods; and consumption is, of course, the proccss of using them

up."

14

This is a very unique definition as it eliminates from production the creation of capital goods entirely. If production consists only in the creation of final consumption goods, then obviously, the entire income from production must go to consumers if consumption is to equal production. But such a definition begs the question by circular reasoning at the outset.!" The allimportant question at issue is whether or not balance can be maintained between production and consumption, or demand and supply, if some of the products arc turned back into production channels and "used twice" before returning to consumption. Frorn the mere statement of the problem, we must infer that production nlay yield either production goods or consumption goods. It is then, and only then, that we can consider intelligently whether or not adequate consumer-demand can be sustained if profits are utilized for the purchase of production goods. When th us considered, there are four things which production must do. First, it must replace what is lost by "wear and tear." Second, it must supply final consumption goods; third, it must finance government works and public services; and fourth, it must supply the means for progress, whether in the form of business expansion or improvements in the "state of the arts." , In other words, production 111USt finance, not only consumers and the government but refinance producers, and provide the additional equipment necessary for progress in a dynamic society. Th is would consti tute total supply, \Y hilc total demand would not come from consumers alone, but also from producers and the government. So long as the combined demand kept pace with Foster and Catching-s, "The DilclJ1m~ of 'fhrift," p. to, Note: A careful 1"c~dinR of the IJlOn~ cxtrn decl t rcat nrc nt given in the bonk) ProfitJ, would lead one to think that their concept of production is not so strictly conceived throughout most of the arglll11ent. Yrr , it is not improbable ~hat an .unbiguous usc of the term Iics at the root of SOllW of the logical l-t LJ

lI1consistL'ncil.\s.

166

rJL(lE THEOR}"

AJ.\~D

BUS/J.lESS CY'CLES

total supply there could be no general over-production or general under-consumption. It is impossible to tell, for example, when looking at a pile of brick, whether they are to be used in final consumption to build a home, or as capital goods to build a factory. Furtherrnore, there is no failure of demand for brick whether purchased for one purpose or the other or both. Of course, partial overproduction will result if factories are built that are not needed, and for the reason stated by Aftalion."" But Foster and Catchings insist that there is immediate unbalance between demand and supply because a "dollar "vas invested instead of spent," thereby robbing the consumer-fund of a dollar essential to keep demand adequate. If the pipes leading back to the consumerfund fronl the productive process permitted any escape whatsoever, in the form of profits, for investment in capital goods, then there is involved the dilemma of a "Ten Minus Onc Theorem" in which nine is expected to equal ten and does not do it. Yet, if production is to be so defined as to consist in the creation of both consumption goods and production goods, then it is not necessary for "Ten minus one to equal ten." It is only necessary that nine plus one should equal ten which invol ves no serious mathematical dif11culty. 2. Profits and Dvrmrnics. The diagram of "The Circuit Flow of Monev" featuring the "Consumers' Fund," 1 7 around w hich is built the dilemma of thrift and the theory of unbalance due to profits, is a study in economic statics. There is portrayed a closed circuit in perfect equilibrium. If no "leaks" occur, equilibrium continues indefinitely, but if saving takes place and profits are utilized for expansions or improved processes, the circuit flow is broken and consumption falls short of production. To what extent, then, is the Foster and Catchings theory of statics invalid or inadequate for the dynamic world of reality in which we find ourselves? 3. Dynamics and the Dilemma of T lzrift. In attempting to Hl 17

See above, p. 15 0 ft. See Profits, p. 255.

l.~\.illOLU.lVTA.Rr

FAILfJRE OF

DEl,IA]~/D

167

criticize the thesis that profits invested in the business robs the consumer, resulting in unbalance between demand and supply, it is important to disting-uish between linear expansion and -ocrricnl cxpansion.l" Under linear expansion, profits are invested in such a ,val' as merely to enlarge the plant by.. expanding the wa lls and increasing the quantity of machinery and laborers, but involving no change, whatsoever, in the state of the arts. The capitalistic process is no 1110re round-a-bout, costs of production are not decreased, and prices to consumers are not reduced. The chief reliance upon the po\ver to find a market for the increased output is in higher sales pressure. If competition is keen, and the major competitors, in an atmosphere of business optimism all engage in factory expansions of the linear type, then it would readily be granted that concerted reinvestment of profits in the given field of business would place more goods on the market than consumers would buy at the price, or at any price high enough to cover expenses of production by the given technique. But such a failure of demand could not be labeled overproduction through a robbery of the "consumer-fund." It is adequately explained by Aftalion's phrase "errors in judgment" on the part of enterpreneurs. If each and every competitor in a given field is afflicted with megalomania, or a superiority complex, to the extent that he believes that he can organize a sales force capable of winning the major portion of the market from his competitors, and proceeds to organize his business on a scale sufficient to supply the anticipated market, then obviously, when these exaggerated supplies reach the market, we may be sure that "consumer-demand" will be lacking, but not because of a "Ten Minus One Theorem." Unbalance would occur whether expansions came from investment of profits, or an extension of bank credit. A vertical expansion is fundamentally different. This involves a change in the technique of production, usually by introducing 18 See F. A. Hayek's article in E conomica, May, 193 I) on "The Paradox of Saving"- A criticism of Foster and Catchings "Dilemma of Thrift."

more intermediary stages in the productive process. It is a more round-a-bout process involVing relatively more capital equipment, but makes possible lower production costs and lower prices to COnSU1TIers. Furthermore, this resort to more capitalistic methods of production-this increase in the number of intermediary stages in production-"makes it necessary" as Hayek well sa:'s, "that, henceforward, a greater proportion of the existing means of production should be permanently devoted to the production of capital goods and a smaller part to finishing consumption goods; and this shift in the immediate utilization of means of production must, under the conditions prevailing in the modern economic system, conform with a change in the relative amount of money expended in the various stages of production." 19 Thus, the reinvestment of profits for purposes of lower cost production by vertical expansion, instead of reducing consumption, may yield a substantial increase by lower price. Of course, if reduced costs are not passed on in reduced prices because of monopoly control, then it would follow that an improved state of the arts, turning out more goods., without price reduction would tend to create unbalance between demand and supply. But the cause would be what Professor Hansen has chosen to call an "Institutional Friction" and not because of the diversion of profits from the consumer-fund to capital expansion. Unquestionably, there are instances of monopoly profits based upon a price structure above the market clearing point which creates unbalance between supply and demand. But if profits are plowed back into the business only fast enough to care for the dynamics of progress-only fast enough to finance the new and needed intermediary processes for more efficient productionthen there is no a priori reason for saying that profits per se, regardless of amounts or ratios automatically create a deficiency of consumer-demand, yielding crises, depressions and a business cycle. In attempting to prove too much they have proved too little. H) For a fuller development of this a rg ument see Hayek, 0 p. Cit., pp. 162-9, or his other work Prices and Production, Ch. II.

PART II l\.fONETARY INSTABILITY AND THE PROBLEM OF EFFECTIVE DEMAND CH_-\PTER XIII

IRVING FISHER

Vl E have thus far explored the Malthusian Trail through the realm of production and consumption in quest of a causal explanation of business cycles. The trail quickly led to the field of commercial crises and business depressions revealing a large and definite lack of adequate demand. There was voluntary failure on the part of those who had the po\ver but not the will. There was involuntary failure of demand on the part of those who had the will but not the power. \\7 e are now ready to follow the trail through the realm of money and credit in quest of an explanation of cycles or business instability. In like manner the trail quickly leads to the field of inadequate demand, both voluntary and involuntary. The failure is voluntary on the part of those who refuse to exchange money for goods on a falling price level when money is appreciating in value and goods are depreciating in value. The failure is involuntary on the part of those who are the victims of heavy losses attendant upon a falling price level, which wipes out profits, reduces capital assets, closes factories, creates unemployment and destroys the market for raw materials. Malthus had little to say regarding money in its relation to "the progress of wealth," although he recognized that the purchasing power of gold coins varied with conditions. Yet his theory of commanded value, his emphasis of the "short-runforces" and the necessity of considering "all the factors," disdaining "oversimplification" makes imperative the extension of the trail into the field of money and credit. \Ve are electing Irving Fisher for major consideration in this connection, since he is an outstanding exponent of monetary causation for business instability.

169

170

llALUE THEORY AND BUSI1../ ESS CYCLES

MONEY THE l\/IA]OR CA·USE OF BUSINESS INSTABILITY

"Business staggers because the dollar staggers," 1 says Fisher. The dollar staggers because governments, in adopting the gold standard, fixed the 7.veigl1t instead of the value. By so doing they guaranteed that the measure of value would fluctuate. Yet, people have viewed the dollar as a measure of value in the same way that they have viewed the yardstick as a measure of length. Furthermore, since prices are quoted in dollars it has always appeared that goods rise and fall in value-s-which they do to some extent-s-while the dollars appeared to remain constant. This has created "The l\loney Illusion" which makes it difficult to understand price movements and the fundamental cause of business fluctuations. Yet, through the development and wide use of index numbers, the fact of monetary instability with wide variations in the purchasing po\yer of nloney is coming to be recognized. But if the dollar is not of fixed value, then its value changes. '\Then it changes it must do one of t\VO things. It must appreciate in value or it must depreciate in value. It has performed many demonstrations of both. But when the monetary unit depreciates in value, prices (the general price level) must rise. Conversely, when the unit of value appreciates prices must fall. Experience also teaches that a falling price level yields depression and a rising price level yields prosperity. The crisis is at the end of a rising price level, when the unit of value ceases to depreciate and begins to appreciate. The whole business cycle in all its phases is little more than "the dance of the dollar." The Causes of Monetary Instability. All those who attempt to explain business cycles and general price movements in terms of production and consumption make one fatal mistake, says Fisher. "They look at the wrong side of the market. They seek the causes wholly in the goods, the prices of which have cnanged, and not at all in the gold dollar, in terms of which those prices are expressed. Which of these-goods in general, or the dollar in 1

Irving Fisher) Stabilizing the Dollar, p. 66, (1920) Macmillan Company.

particular-is the more likely to vary? Is it credible that commodities should rise and fall so concertedly without some simple common cause? Is it not more probable that the dollar, which, as such a common cause, affects all the commodities it buys, should fall in value, than that hundreds of individual changes in the values of other commodities should all happen to occur in concert? Are not the coincidences involved a little too remarkabler It is one of the accepted maxims of logic that a complicated multiple explanation is not to be presumed if a single simple explanation can be assumed. Mere chance almost never plays onesidedly. If we throw nine coins in the air, it will not surprise us greatly if four or five of them come up heads, but it will surprise us greatly if all come up heads. The chance of such a coincidence is exactly I in 5 12. The chances that eight would come up heads is less than I in 50." 2 Our conclusion is that in so far as the argument from probability can help us, it is not likely that the simultaneous rises and falls of hundreds of commodities happen merely by coincidence. It is much more likely that there is one common cause or at most, a very few common causes. The major cause of the fall of prices between 1873 and 1896 was monetary. The t\VO common causes for the general rise of prices from 1914 to 1920 were the war and monetary depreciation. No common cause for the upward trend of prices between 1896 and I913---except money -has ever been suggested. Truly, business staggers because the dollar staggers. But why does the dollar stagger? The answer to this query is given at length in Fisher's notable work, "The Purchasing Power of Money." The two major arguments are developed under (r) Quantity of Money, and (2) Rate of Interest. I. The Quantity of Monev, The quantity of money is made up of specie, currency and bank credit. The purchasing power of money is determined by the ratio of the quantity of money to the quantity of goods or the volume of business. In other words we Inay say that there are t\VO streams constituting the ((flow of 2

Irving Fisher, Stabilizing the Dollar, pp.

17- 1 9 .

172

VALlIE TlfEORY

Al\~D

BUSINESS CYCLES

goods" and the "flow of money." "If these t\VO opposite Ilows, namely the circulation of goods, and the circulation of n10ney . . . should keep going on at the same even pace, year after year, there would be no inflation and no deflation-and there could be no change in the general level of prices. Nor could there be any change in the general level of prices if these two streams were both to gro\v greater at the Sa1JZ8 rate, nor if they were to gro\v less at the sarne rate." 3 When money and goods "run along together," where the ebb and Bow are alike, the situation is normal and the price level constant. But if the two circulations do not keep pace the price level is not constant. If more Inoney pays for the same goods their prices must fall. Of course in the world as we observe it neither current or Ilow is constant. The vital principle to discern is that in so far as the price level is concerned, it is determined by the relation between these two circulations. "If the circulation of money increases relatruclv to the circulation of goods, the price level will rise. If, on the contrary, it decreases ralaiiucl», the price level will fall. . . . In the first case there is relative inflation; in the second, rclatiuc deflation." -i In this ",'ay does Fisher present in non-technical language the ('Quantity Theory of Money" and its relation to the general price level." In order to clarify his analysis as given above we must be sure of the rneaninp he gives to words. By "inflation" Fisher has no reference to the creation of paper currency, irredeemable at par. He merely means the expansion of money, including specie, currency and bank credit at such a rate as to yield a rising price level. In similar fashion "deflation" is a relative decrease in the total quantity of money such as to cause a fall in the general price level. His theory involves a vital disagreement with many economists, particularJy those who belong to the "Bullionist School" of monetary theory. The commonly accepted view of the pur;; Irving Fisher, Tlte Money Illusion, p. 33 (1928). Ibid., p. 35. Ii Note: For a technical t reatmcnr and explanation of the formula MV M'V' PT see Chapters 2) 3) and 4, in Purchasing PO~J.)er of Money. 1

+

==

173

chasing power of money under the gold standard is that the value of gold coin is determined by the law of demand and supply in the industrial arts, and in the long run governed by the cost of production. The value of paper 1110ney and credit instruments gain their value from gold so long as redeemable at par. The volume of currency and credit has little or no effect upon the purchasing po\ver of standard money, so long as redeemability is maintained. Contrary to this view Fisher holds that it is the quantity of secondary money that determines the purchasing po\~/er of standard money and not the reverse. "IJ nder modern conditions, with our vast credit structure, the old theory of an automatic gold standard, beyond the reach of any voluntary control, has ceased to have much relation to reality. According to that theory, gold was supposed to derive its value chiefly from its use in the arts, and any credit currencies, such as paper Inoney or deposits sub jcct to check, redeemable in gold, were assured the same val ue as the gold itsel f. An r reaction w hic h these 'secon dary' sorts of Inoney might have on the value of gold itself was ncgligible. But today this very reaction is the main factor. Credit currency has gro\'\/n to he a la;ger part of our money than the gold stock into which it is redeemable. In England and America, the proportion of credit currency to gold is about seven to one; the tail now wags the dog. Today, then, instead of saying that the p~pcr dollar derives its value from the gold dollar into which it is convertible it would he truer to say that the gold dollar derives its value from the credit dollar into which it is convertible. And since the volume of circulating credit is controllable and controlled, we have already a managed currency in spite of ourselves. If we insure scientific management in place of hit-or-miss management, we shall thereby attain stahiliza-

tion ,"

6

This is probably one of the most significant statements made by Professor Fisher in all his writings upon monetary theory and business cycles. Granted the Quantity Theory of Money and the forces which determine the purchasing po\ver of money as stated here, it leads quite definitely to some major conclusions, chief of which are (I) The major cause of business cycles and 6

Gp. Cit., pp. 128-9.

174

VALUE THEORY AlvorD BUSINESS CYCLES

changes in the general price level are monetary not industriaL (2) Business cycles and industrial instability are not automatic and inherent by-products of a capitalistic-round-a-bout process of J production, or results of the exploitation of labor by capital, but are the by-products of an unstable dollar, made so by a hit-andmiss credit policy. (3) The price level is controllable, and business stability is possible by scientific management of credit and currency, or the adjustment of the flow of money to the flow of goods. 2. The Role of Interest. The primary cause of business fluctuations is "Quantity of Money." The secondary factor is the "rate of interest," says Fisher. The quantity of money in its relation to the volume of business determines the price level, while the relative rate of change in this ratio explains the movement of the price level upwards or downward, The rate of interest, on the other hand, accounts for the transitions from rising to falling price levels, and vice vorsa. "Indeed, the chief object of this chapter 7 is to show that the peculiar behavior of the rate of interest during transition periods is largely responsible for the crises and depressions in which price movements end." The cycle of events may be traced about as follows. First, we may assume some initial disturbance such as an increase in the quantity of gold, which operates to create a rise in prices. Second, profits and interest rates will rise but interest rates will lag behind profits. Third, the increased profits lead to increased borrowings and an expansion of bank credit. But increased bank credit adds to the volume of money thus serving to accelerate still further the rise of prices. Fourth, a rise in prices not only calls forth an increase in the volume of money, but accelerates its velocity, which also leads to an increase in prices. "We all hasten to get rid of any commodity, which, like ripe fruit, is spoiling on our hands. Money is no exception; when it is depreciating (as in a time of rising prices) holders will get rid of it as fast as possible. As they view it, their motive is to buy goods 7

Chapter IV, in Pure/lasing Power of Money. See p. 56.

i

f

I

IRr/J.,/C FISIJER

175

which appreciate in terms of money in order to profit by the rise in their value." 8 Thus we see that "a slight initial rise of prices sets in motion a train of events which tends to repeat itself. Rise of prices generates rise of prices, and continues to do so as long as the rate of interest lags behitul its normal figure." 9 It is evident, however, that this expansion and rising price level cannot proceed forever. It must ultimately spend itself. "The check upon its continued operation lies in the rate of interest. It was the tardiness of the rise of the interest rate which was responsible for the abnormal condition. But the rise in interest, though belated, is progressive, and, as soon as it overtakes the rate of rise in prices the whole situation is changed. If prices are rising at the rate of 2.j~ per annum, the boom \\,i11 continue only until interest becomes 2;~ higher. It then offsets the rate of rise in prices. The banks are forced in self defense to raise interest because they cannot stand so abnormal an expansion of loans relative to reserves. 1\.S soon as the rate becomes adjusted, borrowers can no longer hope to make great profits, and the demand for loans ceases to expand." 10 Th us it is that as soon as the lag in the interest rate is corrected-or more specifically, when the stem-total of rises in the interest rate above normal is greater than the annual rate of rise in the price level-the price level ceases to rise and begins the descent downward. But this point of transition yields a COInplete set of new phenomena. At the higher rates of interest, loans and bank credit contract in volume, prices fall, bankers call for additional collateral-in many cases can get nonebusiness men fail, banks get "shaky" and experience "runs,'·' interest rates rise to a panic figure, prices fall still further making necessary forced liquidation on a falling price level and the crisis IS on. 8jbi.I.) p. 63. Ibid.) p. 60. lOOp. p. 64-. 9

cn.,

VALUE THEORr

AJ.\~D

BUS/l\-ESS CYCLES

Everyone seems to be aware that collapse of bank credit and loss of confidence are an essen tial part of e,~ery crisis. ,,\\rhat is not generally recognized . . . is that this loss of confidence (in the typical commercial crisis here described) is a consequence of a belated ad justment of the interest rate." "Borrowers unable to get easy loans, blame the high rate of interest for conditions which were really due to the fact that the previous rate was not high enough. Had the previous rate been high enough, the borrowers never would have over-invested." 11 In this \\"ay does Irving Fisher develop his theory of business fluctu::ttions and commercial crises. The explanation is almost \\~holly monetary with no reference, whatsoever to maladjustrneut of production and consumption, other than to say that there 1l1ay be 1l0nn10nltary causes of crises but "the monetary causes arc the most important r..~'llet! talcen ill connection ~L'itI2 the ina]adjuJt il/Cit /J in the rate of interest." 1 ~ '\T e also get a suggestion from the last sentence of the previous paragraph regarding an approach to control. The stresses and strains of a rising price level which lead to the crisis are possible because of the lag in the interest rate under a passive policy on the part of bankers. "Had the previous rate been hio-h enouvh" (rnade so bv~ volib b tional and concerted action of bankers) "the borrowers never would have over-invested." Before terminating our treatment of "the rate of interest" it seems expedient to digress long enough to indicate that Fisher made a revision in the statement of his interest theory in an article of rather recent date, the title of which was, "Our Unstable Dollar and the So-called Business Cycle." It involves the problems of "r\pprcciation and Interest" and the extent to which the rate of appreciation and depreciation registers itself in the nominal rate charged. His earlier view was stated as follows:

I

\

"The inf ucnce of monetary appreciation or depreciation on the rate of interest will be diffc re n t according to w hether or not that appreciation or depreciation is foreseen. If ~it is not foreseen, the ap]1

12

Ibid., pp. 66-7. Ibid.) p. 66.

I

j

177 preclatlon of money necessarily injures the debtor. . . . If the appreciation is foresee n any increased burden in the principal may be offset hv a reduction in the rate of interest." "In ~ctual fact future appreciation or depreciation is neither entirely foreseen nor entirely unforeseen ....:\.11 intermediate condition is usually maintained. When prices are rising, the rate of interest is usually high but not as high as it should be to compensate for the rise, and when prices are falling, the rate of interest is usually low, but not as low as it should be to compensate for the fall." 18 In fact he goes on to say that all those who have given attention to this subject agree "that the appreciation or depreciation of money actually does inf uc nce the rate of interest." 1--1

This statement "vas made in 1907 and has long involved Professor Fisher in heated controversies. No one disputed the revealed fact ~hat the rate of interest tended to be higher during rising prices than during falling prices, but they differed in the causal explanation. The usual contention was that interest rates vary with the prevailing opportunity to make profits or returns on investment. Interest rates are high because high profits are the order of the day during rising prices. Interest rates are low during periods of falling prices because profits are low. Fisher, on the other hand contended for years that the changes in the interest rates were largely made to offset appreciations and depreciations in the value of the money loaned. His altered viewpoint is revealed in 1925, in the article mentioned above. He continues to hold tenaciously to the view that price changes and the rate of interest are the primary causes for fluctuations in business, but he does not feel that their actions and interactions are so closely related as he did before. They are a bit more like independent variables, though of course, not wholly. He says, "Until recently I had the idea that these two could best be considered in combination, as the real rate of interest i.e., the sum of the rate of interest in terms of 1noney and the rate of ap preciation (positive or negative) of the purchasing po\ver of the dollar. But I am now inclined to believe that 13

14

Irving Fisher, T'Iie Rate ojlnterest,pp. 78-86. ([9°7-) Ibid., p. 35 8.

J7 8

VALUE

THEOR1~

Al\'D BuSI1\TESS

C1~CLES

the two factors can best be studied separately because, for one reason, the rate of interest (in money) is always perceived while the rate olf appreciation of money is not." 15 From this it would appear that the relation between "Appreciation and Interest" is not so cognizable, nor so direct in its relation to the daily quotations of the current rates of interest as he thought it to be a quarter of a century ago. However, this revision in his theory of interest makes necessary a revision, also, in his explanation of business cycles. For it was the role of the interest rate, moving under the influence of "appreciation and depreciation" which marked the transitions, created the crises and sent business on its somewhat rhythmic oscillations. Consistent with his revised interest theory, Professor Fisher has grO\\?ll more skeptical regarding definite periodicity of a rigorous business cycle. Many factors Inay be at work creating business instability, and some of them may operate in a cyclical manner. There is a tendency for business to oscillate about a mean. There is a coming and going of prosperity and depression, but a single cycle moving under the domination of a dominant cause or set of causes which eternally operate in such a \vay as to yield definite and perlnanent periodicity, is not discernible. Statistical data reveal no such rhythm or periodicity. Therefore, says Fisher, "I see no more reason to believe in 'the' business cycle." "I have no faith whatever in 'the' business cycle." 16 Statistical proof tlrat [Instable Money gives Unstable Business. Although Fisher has rejected the idea of a single major cycle, the instability of busi ness, revealing commercial crises, unemployment and human suffering, still remains. The cause should be discovered and the remedies applied. It would be distinctly unfair to Fisher to accuse him of explaining all business instability with one force or factor. He frankly states that there are many. Yet, in this article of rather recent date, he

\

i

"

( (

15 Irving Fisher, "Our lJnstable Dollar and the So-ca lled Business Cycle," Journal of the A merican Statistical Association, June, 19 2 5, p. 198. ]6 Ibid., pp. 19 2 - 3.

f

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FISIIER

179

reiterates his former contention that to a large degree "business staggers because the dollar staggers." He then submits as proof the evidence [rom correlation. For a number of years, he and his staff gathered extensive data and applied various methods in an attempt to discover the maximum correlation between fluctuations in the value of the dollar and fluctuations in the volume of business. A maximum correlation of .9+1 was achieved by comparinjj the two, giving a lag of approximately nine months between the index level of prices and the volume of business. So high was the correlation between unstable nloney and unstable business that wherever the dollar-our yardstick of commerce-s-suflcrs wide fluctuations in purchasing po\ver, those fluctuations largely determine or, at any rate preceded closely related fluctuations in trade. Such a high degree of correlation argues strongly for a causal relationship. But the logic of reason would point to the same conclusion. "1t has long been recognized that a rising price level ternporarilv stimulates trade and that a falling price level depresses trade. . . . T'he reasoning is simple and obvious: Whe n producers get highe r prices they do not at first have to pay correspondingly higher wages and salaries; much less do the rent and interest which they pay rise. 'This lagging behind of interest, rent, salaries and wages-not to mention raw materials which lag for a somewhat different reasonis inevitable because the laggards are fixed hy contracts or understandings. EviJently the lagging of these important clements of expense practically involves a lagging of total expenses behind total receipts. Consequently profits, the excess of receipts over expenses, tend to be increased, Reversely, falling prices hurt profits." "Since the profit taker is the captain of industry on whose decision depen ds the rate of output, it is further inevitable that whe n profits increase, industry is expanded and business hOOlTIS; while when profi ts decrease industry is contracted and business is depressed." 17

After a thorough presentation of his technique of measurement whereby he found the high correlation of 9470 between the movements of business and the fluctuations in the price 17

Ibid., p.

180.

180

l' ALr.lE THEORY si:» BUSI.LVESS CYCLES

level, he writes, "These correlations are so high as to leave little or no doubt that changes in the price level afford an almost complete explanation of fluctuations in the volume of trade for the period beginning in 19 I 5 and ending in I 9 ~ 3." Many other influences undoubtedly cause some fluctuations in the volume of trade but they are of minor importance. The only logical conclusion that can be drawn from this intensive studv in correlations is that fluctuations in the purchasing po\\;rer of money constitute the major and dominant cause of fluctuations in business.!" But if business tags after the dollar and the price level with an almost unerring and unfailing lag, then it follows that if we stabilize the dollar or the price level, business will be largely stabilized, and commercial crises with their aftermath of depression, unemployment, bankruptcy, anxiety and suffering would also be largely abolish ed. ~'

THE PROBLEM OF CONTROL AND ST,ABILIZ-c-\TION

Being fully convinced that unstable money is a root cause of business instability, Fisher says, "\\That can be done about itj " I. A Tabular Standard, The first step in stabilization is the creation of a reliable and accurate index number which will reveal promptly and accurately any fluctuations in the purchasing po\ver of money. By observing the movements of the index number, business men could rid themselves of "The Money Illusion" and plan the management of their business more intelligently. They could qui te effectively protect themselves against one major risk by "contracting out," in connection with long time contracts. By this he means that creditor and debtor could agree to settle on the basis of index numbers, the debtor paying more in settlement if the price level moves up and less if it falls.!" Ibid., pp. 19 0-1• Note: A practical appl icat ion of this principle in actual business was the "Stabilized Bond" issued by the Rand-Kardex Company, Principal and interest fo llowed a sliding scale, moving upward as the index number rose and falling as the index number fell. 'The bonds were retired after the rnerger with Remington. 18

19

IRVIIVG FISHER

l8I

However, this is merely man's attempt to adjust himself to an unstable dollar from the outside. The real \vay is to attack the problem from the inside and actually eliminate the fluctuations in the monetary unit. Stabilized money has long been a dream of economists, but the new knowledge gained during and since the war, together with improved cen tral banking systems, and provisions for elasticity of currency and credit have virtually made possible the realization of this dream in our time. "Instc~d of resting in a monetary fatalism, S0111e economists, bankc rs and statesmen ha ve come to recognize that nearly all inflation and deflation are man-made, and w hv should we not therefore ha vc a man-made st.tbilization r We had· already seen the need of an 'elastic currency' by '.\7 hich moncv IO~1l1cd by banks should correspond somewhat with business needs. \\T e arc now seeing that we can complete that correspondence between the flow of goods and the flow of mOIlCY by a better control of the flow of n1011cy." "l~hjs

correspondence will not take care of itself with the most

'clastic currency.' 13ut the correspondence is not out of our reach since the InOl1cy stream is under the control of the issuers of 1110ney. l~he great issuers of Inoney today arc the central banks. 'They arc properly expected to provide an 'clastic currency' to expand or shrink with the expansion or shrinkage of the business to be done by it." 20 2. Open Market Operations. One of the greatest devices for monetary stabilization is that of "Open Market Operations." The Federal Reserve System, in 1922 set up the Open Market Committee for the purpose of buying and selling securities, especially government bonds, for the purpose of influencing the credit situation. In 1923, the Committee was reorganized with the more specific instructions that they should operate "with primary regard to the accommodation of commerce and business, and to the effect of sucl: purchases or sales on the general credit situation." The Federal Reserve System thereby tacitly recognized its duty to control or influence credit, and seemed astonished, even a bit frightened, to discover that it possessed the 20

Irving Fisher, T /"e Money Illusion, pp. 126-8.

182

VALUE THEORY AND BUSINESS CirCLES

tremendous power over credit which it has. This power, rightfully used, makes the Federal Reserve System the greatest public service institution in the world." ~1 3. T'he Discount Policy. Open Market Operations alone would not be sufficient for monetary stabilization. Should the Committee, on a falling price level, buy securities in order to put money in circulation, there would be a tendency for member banks to use this money to liquidate their debts to the Federal Reserve Banks. In which case the quantity of money might not be increased or the fall in prices checked. It maybe needful for the Federal Reserve Banks to lower the rediscount rates to the member banks as an inducement not to payoff their borrowings, In a similar way should the Committee sell securities on a rising price level in order to take money out of circulation, there would be a tendency for this money to find its way back to member banks through rediscounted loans. Such a policy could be checked by raising the discount rate. ((These two methods combined-buying and selling in the security market and the influence of the discount or interest rate -give the Federal Reserve System a powerful control over loans, prices and prosperity." In this manner has America, along with some of the European Countries arrived at a "Managed Currency" as a means of safe-guarding the nation against the more serious evils of inflation and deflation, making business more stable by making money more stable. It will be noted that Professor Fisher presents this mechanism for elasticity of credit and currency, as a means of stabilization. If "Properly handled, it permits the stream of money to keep pace with the stream of goods." It does not guarantee such management. There may be ((scientific management" of currency, with respect to index numbers, or there may be "hit-ormiss management" or the banking committee may decide to playa passive role and do nothing-at least until an emergency forces action. His major contention is that the power is there, and the kno1.Dledge of what should be done is available. Whether 21

Ibid., p. 133.

1

IRVING FISHER

or not this knowledge and power will be used for "scientific management" is a problem in human equations. 4. Central Bank Cooperation. Mr. Fisher is well aware that problems of money and banking, prosperity and depression, inflation and deflation, are world problems. Reparations, InterAllied \\Tar Debts, international trade and foreign exchange combine to make for great dependence and interdependence. Elasticity of credit and a managed currency, even when managed scientifically, would not suffice to give stability and continuous prosperity, should foreign banking systems and currencies be deranged. The Central Banking Systems must come into a closely harmonized cooperation. This may come about naturally and graduall)' through "tradition" or it Inay be speeded up by treaty agreen1ents, conventions, or by legislations in the various countries. In any event the result must be harmony and cooperation with a icill to cooperate toward similar ends. \VHA.T CAN GOVERNMENTS DOr

\\Te have been discussing what banks may do in behalf of stable money and stable business. But banks have very definite limitations. SOIne things can be accomplished only by governments. II> Balance the Budget. The first requisite, or even prerequisite for stabilized money and business is a balanced budget. "The worst examples of inflation have come from unbalanced government budgets. • . . When a governnlent cannot make both ends meet, it pays its bills by manufacturing the money needed. Such issues of paper money have often been the chief source of inflation. When this is the case, evidently the first step toward stabilization must be taken by the government and must consist in balancing its buuget. This was the great need in Europe after the World War. Without a balanced budget stable nloney is not a practical possibility. With a balanced budget it becomes possible to return to the gold standard." 22 2. 22

"Return to the Gold Standard." However, if a nation has

Ibid., pp. 145- 6•

1 84

VAL[JE THEORY A}..7D BUSINESS CYCLES

resorted to the issuance of irredeemable currency, there are three \vays to return to the gold standard. They may repudiate the currency and start over with gold, as Germany did following the war ; they rna y redeem at par as England did; or they ma y devaluate, as Italy did by lowering the gold content of standard monev. But whatever the method used, when all nations are on the gold standard, the problem of stabilization is an international one. The free flow of gold in the settlement of international balances tends to equalize price levels among the nations. "By the very act of adopting a gold standard, it (the nation) has actually placed its national destinies at the lllercy of the banking and governmental policies of other nations." ~3 "The gold standard simply puts in J connecting pipe joining together the moner reservoirs of all gold standard coun tries, so that thereafter gold will flow freely back and forth and seck its level. Then English, . Arncricnn and all other price levels wil] rise together and fall together and the dollar, the pound and all other 1110ncy units will rise or fall together in buying power. This international connection of all nloneys will be a chief effect of having a common gold standard." 2-1 CA.N l\N

IN1~ER~:\TIONAL GOLD

STA.ND,ARD

GI\lE STA.BILIT'Y?

When all nations have returned to the gold standard, we have remaining the instability of gold itself. To accomplish that result certain additional factors are necessary. First, the world's gold reserve should be economized and credit issued or managed in such manner or in such ratios as to make money keep pace with business. This could be accomplished within limits by the cooperation of the governments and the central banking systems. But if a shortage of gold should develop so that money could not "keep pace" then Fisher presents two alternatives. Professor Lehfeldt's plan might be adopted in which the League of

»tu«, p.

15 2 . v iiu., p. 153.

18 5

Nations would control the gold mines and production would be maintained at that point which would yield the proper quantity for money and credit stability. It might be necessary to produce gold at a loss to provide adequate supply if business tended to outrun gold production. l\lining might be artificially curtailed if gold became redundant, i.c., tended to make money outrun business. The second plan is Fisher's "Compensated Dollar" where the weights of the gold units would vary sufficiently to keep their value equal. Should neither of these alternatives be acceptable, there is no alternative but to use the automatic gold standard with all its fluctuations such as the world has experienced in years past, or accept the counsel of Professor Keynes of England, who advocates the abandonment of the gold standard completely and resort to "Managed Currency" alone. The price level would be kept constant by issuing just enough currency and credit to keep the tabular standard stationary. Fisher has no doubt of the theoretical possibility of maintaining the price level of a Scientifically Managed Currency divorced from a metal standard. He only fears that management wil l not be scientific because of human frailty and the pressure of cheap money advocates and politics. APPRl\ISAL AND CRITICISM

\\T e have treated Irving Fisher at length because we know of no one who has been so diligent in portraying the degree of monetary instability or the evils which flow from this source. He has long been a veritable crusader for stable money and has not terminated his energy by diagnosis but has been most ingenious and constructive in his proposals for monetary and business stabilization. It was therefore natural that we should turn to him as the key representative of the monetary school after finishing with the Production-Consumption school in connection with crises and business cycles. The major thesis presented by Professor Fisher is contained in his happy phrase, "Business staggers because the dollar stag-

186

llA-LLTE THEORY Al\'D BUSllVESS CYCLES

gers." He immediately takes issue with the whole school of economists who hold that the causes of business cycles or business instability is in the field of production and consumption. In the absence of absolute proof, it would seem that Fisher and the monetary group approach cycles in business with some degree of advantage, viewed from the standpoint of logical probability. For instance, it is a matter of observation that the whole price level does rise and fall. Not only that, but when doing so, virtually all commodities and securities-other than the monetary commodity-move in the same direction at the same time. If money is appreciating or depreciating such a phenomenon would be naturally and logically expected. It is not so clear that there is some force or set of forces that would be making virtually all goods cheap or dear at one and the same time. As Fisher well says cC.LL\re not the coincidences a little too remarkable"? If we attribute the cycle to a waxing and waning of demand for capital goods in the capitalistic or round-a-bout process of production, as did Aftalion, it is too remarkable a coincidence that all producers should find themselves long or short of capital equipment at synchronous moments when the "round-a-boutness' of various processes are so greatly variable in length. On the other hand if money were depreciating and goods appreciating we would logically expect that all would be doing a dynamic business exchanging dollars for goods, and using credit to secure more goods and more productive po\\rer. On the other hand if money were appreciating and prices falling, all producers would reduce their operations, cease their expansions and move in concert. "We all hasten to get rid of any commodity, which, like ripe fruit, is spoiling on our hands." If we turn to the glut theories, which explain the crisis by over-production or under-consumption through the failure of consumer-demand, it is difficult to discover why surpluses become so universal and pronounced in such a brief moment of time. In the "typical cycle" it is normal to experience an apparent shortage and rapidly rising prices in one month, only to be followed a month later with prostrated business, surpluses on

1

IRVIJ."iG FISHER

every hand, with all buyers and consumers "on a strike." Yet it

is logical to have consumers "go" on a buyers' strike" simultaneously, if money has suddenly ceased to depreciate and begun to appreciate. On the rising price level, money was the "spoiling fruit" while on the falling price level, goods become the spoiling fruit. We may therefore say, that if we could take it for granted that some factor "vas operating to make money depreciate for a time, then appreciate, the anticipated results of such a situation would be identical with those we do observe. Y et it is exactly this "taking for granted" which we cannot do. I t is just as imperative that the monetary cycle theorist explain why money changes in value as that the production-consumption group explain why the general price level of goods rises and falls through factors in that realm. Fisher recognizes the burden of proof which goes with his contention and goes directly to the quantity theory of Inoney as the all determining factor in determining the purchasing po\ver of money. The theoretical proof is given in his book on this subject and the statistical evidence is presented in his article on '~Our Unstable Dollar and the So-called Business Cycle" referred to above. \Ve are not convinced, however, that the high degree of correlation as shown in the latter article, presents the type of proof necessary to meet the queries of those who reject the quantity theory of money, or those who hold to the productionconsumption view. In the presentation of his theory he says "It seems certain that wherever the dollar suffers wide fluctuations in purchasing po,ver, those fluctuations largely determine or, at any rate, precede closely related fluctuations in trade." Surely no one would dispute this thesis. It is common knowledge that business is bad when prices (the price level) are falling, and good when the price level is rising. Vl e should expect, not 94 % correlation but approximately 100% correlation between falling prices and bad business and rising prices and good business. It does not answer the query as to whether prices are rising be-

>

188

llALUE......THEORY Al-lD BUSINESS CYCLES

cause of a general scarcity of goods linked with a dynamic demand from both producers and consumers, or because some factor is operating to cheapen money. Aftalion's argument that goods in general fall in price because of a general reduction in marginal utility as supply increases remains wholly unanswered. Furthermore, it does not meet the issue to say that those fluctuations in monetary purchasing po\yer, "predetermine or precede" fluctuations in trade. Correlation is never proof of cause and effect. Two perfect correlations may be the result of some third factor or set of factors reacting upon both of them. Surely, anything which would create a general reduction in the prices of goods would make money appear as appreciating in value because we judge monetary fluctuations by observation of the tabular standard. Neither can we say that since monetary fluctuations precede business fluctuations they are the cause. \\7 e recall perfectly the old maxim in logic "Post hoc, ergo propter hoc." But it is bad logic. In these days of lags and forecasting we can never tell by time observations which is cause and which is effect. Very frequently we may truthfully say "Ante hoc, ergo propter hoc." Thus the battle goes merrily on. The extent to which the causes of business instability reside in the world of production and consumption or in the realm of money and credit remains a matter of debate among the experts. Each presents evidence sufficient to convince himself but not his opponent. The ultimate objective of Fisher, however, is not explanation but control. Moreover, if he has proved conclusively that business fluctuations follow price changes with a nine months lag with almost perfect correlation, then any success achieved in stabilizing the purchasing power of money, or damping out the fluctuations in price changes would also damp out fluctuations in business. The writer is in substantial agreement with Mr. Fisher in the belief that a system of monetary control which would reduce price changes would have a stabilizing effect upon business. The acid test of Fisher's contribution must be applied to the

,j

,/

-\j

I

{

18 9

]RV]}lC FISHER

validity of his arguments for control, and the efficacy of the means suggested when applied in practice. What may be said then, regarding the proposals for monetary control, or means of stabilizing the dollar? \\T e shall omit from our consideration his famous "Corupcnsated Dollar" scheme with its mechanism for "automatic control" since, he, himself, contends that the elasticity features supplied through the Federal Reserve System provide ample opportunity for a "Managed Currency" through "discretionary control" without interfering with the content of the gold coin. \\Te should have found it much easier to appraise the "Managed Currency" proposal of Fisher a few years ago before he published his book on "The Money Illusion." Through his speeches and writings one gained the idea that the Federal Reserve System was so strong, and the gold reserve so large, that by the use of the Open Market Operations and the manipulations of the rediscount rate, the tlow of money could be scientificall y adjusted to the flo\v of business and if the Committee deliberately addressed itself to the task of maintaining a relatively constant index level of prices it could do so. In the light of all that has happened in the last two years, and in the light of the present international situation with respect to money, credit, banking, reparations, war debts, etc., one would be an optimist indeed who would venture that even the United States could ride along smoothly on a stable price level accompanied by stable business, even if the currency of the United States were scientifically managed with that end in view. We feel that Cassel was much more fortunate in his presentation when he carefully qualifies the efficacy of the discount rate, with the words "under normal conditions." ~~ In like manner, Fisher, too, has introduced additional complications into the problems of control in Chapter \TIII of "The Money Illusion" when discussing "\i\That Governments Can Do." Were we to supply the words expressed by Cassel "under 25

Gustav Cassel, Money and Foreign Exchange after 1914> p.

104.

190

l'AL[lE THEORY A.i.\-D BUSIl.\TESS CrCLES

normal conditions," and, we believe, impliecl by Fisher, then we nlay say that under normal conditions the central banking systems (in the U ni ted States, the Federal Reserve System ) could increase the stability of business by stabilizing nloney through the use of Open Market Operations and the use of the Discount Rate. Putting it in other words the banks can insure good business by keeping the flo\v of TIl0ney in pace with the flow of business. This is a captivating suggestion, and we believe gO'vernnlents and central banking systems would do well to address themselves to that end. Undoubtedly the Federal Reserve Board has tremendous po\ycr in this direction. I t particularly has po\ver to "sit on the lid" when inflation phenomena reveal themselves. They appear much more helpless in stimulating business in depression. The po\ver to "manage the currency" however, is a tremendous pOVtrer, and not incapable of abuse. Should this po\ver be given to "statistical Economists" who were immune from all suggestions except those impersonal ones which come from a reliable, abstract index number, we would doubtless be amazed at the degree of stability which might be secured. But what may be expected under a regime of active politics, where debtors demand inflation, creditors demand "sound monev," agriculture demands "a dirt Farmer" on the board- "\\T cal, I hae me doors." But the problem of control, and a "managed Currency" is made immeasurably greater, and more difficult of attainment when conditions are not nOY111al. Fisher now points out that in addition to "Control of Credit" by the banks, there must be "control of gold" by the governnzents. In this contention we believe him to be quite correct. As shown above, he states that before banks can control credit, governments must balance their budgets. Inflation with all its upsetting influences cannot be avoided if governlnents operate for any extended period at a substantial deficit. Having balanced their budgets, they can move to the gold standard. \Xl e may, therefore, say that the normal conditions which the governments must provide before

IRVIJ.\TG FISHER

the banks can function properly in the realm of control is for virtually all the governments of the world to balance their budgets, and operate upon the gold standard. Undoubtedly this qualification, penned by Fisher in the prosperous days of 1928, throws a flood of light upon the problems of monetary and business stability in the years of 1930 to 33. Just at the time when lnany had become convinced that the Federal Reserve System had attained perfection in the maintenance of a stable price level and prosperity, a world crisis broke. After t\VO years, every Central Banking System stands inert and petrified before a catastrophe which it neither comprehends nor knows how to remedy. It would seem, that Fisher had guarded his plan of stabilization rather carefully, and rightly so. But, in doing so, "l\'1anaged Currency" loses much of its tnagic. It will work if tried out internationally, if all nations have their budgets balanced and are functioning normall-y, In concluding our treatment of Irving Fisher we wish to point out a vital similarity between him and Malthus, Malthus insisted that high productivity did not guarantee prosperity. Accompanying adequate supply on the part of producers there must be "adequate consumer-demand." The latter is quite as essential, as the former. Here was a problem in business instability, which could only be stabilized by effective demand. In a similar manner, Fisher with his attention riveted on unstable Inoney and a fluctuating price level, shows clearly how adequate demand inevitably vanishes in every period of falling prices. It is a time when money is appreciating and goods are depreciating. Every rational being "endeavoring to rid himself of the spoiling fruit" attempts to convert goods into money, holds fast to the money and buys as little as possible-for the last drop. Periods of falling price levels and monetary appreciation, inevitably yield depression, and logically must do so. Surplus goods accumulate and effective demand on a normal scale is impossible. We are indebted to Professor Fisher for the emphatic way in which he reveals that the fruits of appreciating money are

19 2

VALUE THEORY si:» BUSIJ.\7ESS crCLES

and must be surpluses and depression. No nation or group of nations can pump, prosperity out of a falling price level, for demand both on the part of producers and consumers will be subnormal. In contrast, it may be said that a rising price level, registering monetary depreciation tends to overstimulate demand, resulting in speculation and a degree of over-expansion which cannot be sustained. Therefore, "good business," with a high degree of balance between demand and supply, is best achieved and maintained on a stable price level. Any advance that can be made in stabilizing money and the price level will add to business stability. Economists, business men and statesmen are indebted to Mr. Fisher for his emphasis upon this point. Yet, Fisher would have us understand that monetary control has definite limitations. It is like the steering wheel of an automobile. "Under normal conditions" the manipulations suffice to keep the machine between the cliff and the precipice. But when a volcanic eruption tosses the machine over the railing, the steering controls are of minor importance. But, even so, should the occupant survive, the experience may induce him to use the controls earlier and steer his machine over a different and less dangerous route.

CHA.PTER XIV

JOHN M.A. )~NARD

KE\~NES

INTRODIJCTION

is a true descendant of Malthus with respect to the importance of the "short-run forces," for he says "this longrun is a misleading guide to current affairs. In the longrun we are all dead. Economists set for themselves too easy, too useless a task if in tempestuous seasons they can only' tell us that when the storm is Jong past the ocean is flat again." 1 Through such a statement we observe that Keynes joins the swelling ranks of those economists who insist that rnajor attention, in the face of business instability, should be given to those short-run forces to which Malthus alluded a century ago. Without formal commitment or verbal definition Keynes consistently utilizes the C01Jl Jnanded -ualue concept. The embodied value theory of Ricardo cannot be fitted into his system of economic thought. Even the purchasing power of gold is determined, not by cost of production or labor embodied, but, to some extent at least, by central banking policies. He is one of the most outstanding exponents of a managed currency. He believes, that by proper management of credit and currency, the purchasing po\ver of money can be made relatively stable; that through monetary stability may be achieved a high degree of business stability. A comprehensive statement of his theory is given in his two volume "Vark, A Treatise on Money.2 The first volume is highly theoretical and gives important background for a thorough consideration of his concrete monetary KEYNES

1 ].

1\1. Keynes, A Tract on Monetary ReforJJz, p. 80. (Macll1illan Company,

19 2 3.) 2 T. M. Keynes, A Treatise on !vlolley, (Harcourt, Brace and Company, 193~).

193

194-

rALUE THEORY

A~\·D

BUSll\":ESS crCLES

proposals. Ho\vever, the treatment here is restricted, primarily, to his applications, ymbodied in \70 1um e II. WEA.Kl'ESSES IN OlJR PRESENT

SYS1'E~I

I. Rigidity of Gold Reserves. The British Bank Act of r8-+4, after some revisions froln time to time provides for "fixed fiduciary issue" which yields a high degree of elasticity with low gold requirements. But most of the modern Central Bank Acts follow the Federal Reserve System of the United States with its '(percentage method" fixed by law, According to Keynes, such a requirement has "no foundation in logic or common sense." Such an arrangement immediately presents an idiotic dilemma. If elasticity is desired-and it is-there is elasticity only to the extent that the reserves are kept above the legal percentage required. If gold imports make gold plenteous it is possible to unduly expand the note issue, create inflation of the price level and a dangerous era of speculation. The on1y safeguard against such a contingency is the wisdom and discretion of the bank managers. But in that case the situation is cared for by bank discretion and not by Iaw. On the other hand, in cases of monetary stringency and the reduction of the reserves to the legal Iimit, the situation calls for elasticity and po\ver of expansion, but the bank has no discretion. A monetary crisis of panic proportions might develop because the bank managers are tied to a legal reserve requirement regardless of the effects upon business and the general price level. Under such an arrangement or bank policy, the only safeguard against a shock is to build bank reserves far above the legal percentage required, for it is readily discernible that there is elasticity only in the stretch between the actual reserve and the legal reserve. But there is not enough gold to permit all countries to keep reserves far above the legal requirements now specified." Thus a conservative banking policy with high gold reserves, designed for safety turns out to be decidedly unsafe for 3 J. M. Keynes, A Treatise Oil Money, VoL II) see tables on pp. 267- & 27 L (Harcourt, Brace and Co., 1930.)

JOH ..\" J\,1A Yl\iARD KE}"J.iES

195

the stability of business. If a bad legal arrangement is saved by the wisdom and discretion of bankers, then more liberty should be given to the bank managers. \\r e believe that Keynes here points out a vital weakness in the wor lcl's financial structure. Reserves are presumably for safety, the idea being that there must be something to "fall back on" in case of an emergency. But if the law prohibits "falling back on them" when the enlergency arises, we have not a reserve, we have a frozen asset. The absurdity of high, rigid reserves, becornes obvious if we apply the principle to a hospital. Let us suppose that a hospital is built with one hundred beds but forty of them must be "kept in reserve" for emergency. Let us suppose that fifty beds are in use. Then occurs a collision of t\VO raiiwav passenger trains near the hospital. Fifty are mangled and in dire nced of immediate hospital care and treatment. Ten can be accommodated but the rest must be turned a\vay, to sutler and perhaps die because the regulations require that forty beds must be kept on reserve. But reserve for what? 4: \'Thy not build a hospital with sixty beds and save the overhead on waste space? By similar analogy the high reserves, legally required of the numerous Central Banking Systems are locking out of use large quantities of gold in a time of emergency. The gold shortage could be partially relieved by a substantial reduction in these legal requirements, or a transition to the Bank of F~ngland Policy. ~. B anlan g I rrrs ponsibili: y. A second weakness in our present monetary and banking systems is the passive and irresponsible attitude of the managers of Central Banks with respect to business stability and price stabilization. The traditional policy of bankers is to let "banking follow business." Banks have performed their function when they have operated conservatively and remained in a liquid and solvent condition by requiring safe n1argins and sound collateral from borrowers. With volume of 4 N ote : We rccognize that the F ~(k ral Rcse rve Board has d iscretionar y po we r to declare an ernergcncy and temporarily suspend the reserve require-

mcnr.

196

FALUE THEORY'

AJ.\~D BUSIl\~ESS

crCLES

credit, the channels into which credit goes, eras of boom and depression, periods of rising and falling prices they are not concerned, at least to the point of admitting responsibility, or conceding that they have a civic or public duty to perform in preventing or mitigating them. "Thus," says Keynes, "the bankers are not even trying to preserve the stability of prices and of employment, and are not open, therefore, to accusations of failure if instability ensues; their object under a gold standard is to keep in step with the average behavior of the banking systems of the world as a whole. Their idea is not to keep sober, but in accordance with a perfect standard of manners, to enjoy just that degree of tipsiness (or sick-headache) as characterizes the cOlnpany as a whole." j 3. Tardy Interference and O~·er-in/t?rfereJ1{t). Ho\vever, the existence of the gold standard and the legal requirements regarding reserves do ultimate! y compel bankers to act. Boom periods and credit inflation with rising price levels create instability, threatening the sol \yency of debtors, and the gold reserves. The situation having become critical, the banking po\ver must be exercised. Having begun control and interference too late there is a tendency to apply remedies over severe or continue their remedial doses too long. "The result is that the rerncdv is overdone. It is as though the family were to go on giving a child successive doses of castor oil every ten minutes until the first dose had done its work. Or-to take a better parallel-it is as though different members of the family were to give successive doses to the child each in ignorance of the doses of the others. 1~he child will be vcry ill. 13isn1uth will then be adrninistcrcd on the same principle. Scicntists will announce that children arc subject to a Diarrhoea-constipation cycle, duc, they will add, to the weather, or failing that, to alternations of optimism and pessimism amongst the members of the family." G

In this humorous and illustrative way does Keynes indicate how the tardy overdoses of banking control operate first to allow 5 6

Keynes, A Treatise on Money, Vol. II, p. Ibid., p. 2 23.

222.

JOHJ.V lJ.IAY}./ARD KEYNES

197

the boom period of speculation and rising prices to be carried to extreme lengths, and then thrown into the deepest depths of depression. Mr. Keynes lays much of the blame for the amplitude and severity of business fluctuations at the door of the managers of the Central Banks. "Booms, I suspect, are almost always due to tardy or inadequate action by the banking system. such as should be avoidable." 7 Furthermore, it is in the boom period when control can be exercised most effectively and judiciously for it is much harder to check a slump than a boom. Slumps may sometimes get out of hand and defy all normal methods of control. 4. T he liTeakness of Gold as an International Standard of Value and Exchan ge. it fourth great weakness in our present monetary system lies in the use of gold as an international standard of exchange. It will be recalled that Fisher required the general use of the gold standard by the nations of the world as a prerequisite for the internal stabilization of price levels. At this point Keynes and Fisher disagree. Keynes holds, on the contrary, that the adoption of the gold standard internationally makes impossible internal or national stabilization. Gold ties all nations together in a world-wide instability, wherein, if one nation "staggers" all must stagger. \'l e must choose between the possibility of internal "Stability of Prices" through a managed currency, or "Stability of Exchange" (internationally) through the general adoption of the gold standard, The latter alternative makes inevitable cyclical fluctuations in the internal price level together with all the evils attendant upon unstable money. We must choose which is more desirable, stability in foreign exchange, or stability of the internal price level by rational and volitional control, \Ve cannot have both. "Since the rate of exchange of a country's currency with the curre ncy of the rest of the world (assuming only one external currency as gold) depends on the relation between the internal price level and the external price level, it follows that the exchange cannot be stable, t

Ibid., p. 370.

unless both internal and external price levels remain stable. If therefore, the external price level lies outside our control, we m ust su brnit either to our own internal price level or to our exchange being pulled about by external inti ue nces. If the external price level is unstable, we cannot keep bot]: our own price level and our exchanges stable, and \VC are compelled to choose." 8

The wisdom of the choice will depend upon the relative importance of foreign and domestic commerce and may not be the same for all nations, but since domestic trade is always the lion's share of business "'[here seems to be in almost every case a presumption in favor of the stability of prices, if only it can be achieved. Stability of exchange is in the nature of a convenience which adds to the efficiency and prosperity of those who engage in foreign trade. Stability of prices, on the other hand, is profoundly important for the avoidance of evils" which beset business men investors and \vage earners. This would appear to constitute a vital disagreenlent between two noted economists who are so similar in their general ceonomic theory and ultimate objectives. It also serves to give Keynes the distinction of being the most absolute, and unqualified "Managed Currency" advocate in the ranks of noteworthy economists. Undoubtedly Fisher would agree with Keynes as to the relative importance of the two types of stability, provided one could be achieved apart from the other. It will be recalled, however, that Fisher's reason for a return to the gold standard internationally was presented in connection with abnormal conditions created by war, inflated and irredeemable currency, unbaJanced budgets, and interlocking debits and credits in the form of reparations and inter-allied war debts. Under such conditions Fisher despairs of the possibility of stabilized internal prices ,by means of a managed currency in any country, particularly the United States which is so vitally involved internationally. Keynes also allows the same fear to creep in when he rings in the phrase "if only it can be achieved." R

A Tract

Oil

M o uctary Reforul, pp. 15+-5.

JOHN AIJYNJRD KEYNES rvlA~L\GED

199

CURRENCY' A.S A. SOLUTION

At the heart of Keynes' system for business stabilization and

monetary control is a "Managed Currency." In adjusting the quantity of nloney to the volume of business in such a \val' as to yield a stable price level, ((Open Market Operations" by the Central Banks is an essential feature, but the greatest and most powerful factor is the Rate of Discount. The banking system has no direct control over individual commodity prices, and indeed, no direct control over the quantity of money. But indirect control of both may come through the rate of discount which is "the Governor of the whole system." o In order to simplify the problem of control, currency should be restricted to one type of note (in the United States, the Federal Reserve note). There should be no infta-tion or deflation. Stability is achieved, deflation and inflation avoided when there is ((the preservation of balance bcttcccn tlrc rate of sa·ving and the value of ne:: inucstmrnt" (italics mine). When credit is issued faster than the rate of savings the value of new investmerits outrun savings yielding inflation. The control board is guilty of deflation if credit is not issued fast enough to make the value of the new investments equal the rate of savings. "The test as to whether or not such equilibrium is being preserved in fact can always be found in the stability or instability of the price level of output as a whole." 10 OBJECTIONS CONSIDERED

All experiments in managed currencies llave been unscientific and rcuealcd great hurnar: '7J.)ealeness. In answer to the inT.

dictrncnt, Keynes states that the issuance of currencies divorced from the gold standard have never been attempted as scientific experiments in controlled currencies with respect to a stable a Keynes, A Treatise on Money, Vol. II, p. A Treatise on M one}', Vol. II, p. :!:! O.

10

21 I.

200

VALUE THEORY A}lD BUSI1VESS CYCLES

price level. The non-metallic standards when adopted, have been involuntarily adopted as measures of last resort in war time or times of great emergency. Stability of price level was neither desired nor considered. It was a form of emergency taxation which operated clandestinely, or sub rosa, as a capital levy, sugar coated under the guise of currency inflation to make the dose palatable, or rather endurable. If nonmetallic standards have been resorted to when other forms have broken down, it is not to their discredit that they failed to give stability. ~. Gold stable enough. The belief that gold is stable enough, comes quite naturally from a generation which has suffered so severely from irredeemable paper currency. For those who lost their fortunes and became penniless through a nonmetallic currency, a return to the gold standard seems to be a haven of rest, yet the instability of the price level in a gold standard country like the United States r ou would belie the contention that gold is stable enough. Furthermore, the value of gold has not been determined wholly by the supply of gold and cost of production. "GoJd has depended and will continue to depend, for its stability of value, not so much on the conditions of its supply, as on deliberate regulation of the demand." 11 To be stable, gold must be managed as well as currency. LII\t1ITATIONS TO CONTROL

When pondering the problem of price stabilization through bank control of money and credit, certain limitations must be recognized. We shall enumerate them without comment. I. It is easier to preserve than to restore stability. 2. Unforseeable events may throw business and the price structure into chaos and confusion, precluding all possibility of forestalling by the wisest and best intentioned bank managers. 3. Social and political forces may not permit the best banking policy to prevail. i oa Note: The reference here is to the monetary instability in the United States while on the gold standard. 11 Qp. cu., p. 294.

201

MAJOR Fr\CTORS CREA"TING POST-\\t.-\R

INST.~BILI1'\"

The most outstanding feature of the post-war period when viewed financiallYJ has been the inordinately high interest rates on long time loans. They have been approximately 50j/;, higher than the prevailing pre-yvar rates. For a few years after the war there were obvious reasons ,"vhy the natural rate of interest should stand above the long-period uornr. There was a shortage of capital and an abnorrna] need. This prevailed till around 1925 when t\VO new factors entered. England (unwiselyJ thinks Keynes) returned to the gold standard which was part of a lTIOVement for a general resumption throughout Europe. Reparations and W ar Debts settlements further complicated the situation. Then in 19'28-9 appeared the "bulpJ speculators on the New IT ark Stock Exchange. These opportunities for high profits accompanied by a halting or lagging bank discount policy, first operated to give extended and violent expansion and speculation. But, in order to stop the speculative mania, vigorous control had to be applied, and the market rate was stepped up decidedly above thc natural rate. Then the slump occurred. "The divergence thus arising between the market-rate of interest and the natural-rate was, therefore, the primary cause of the sagging price level." 1~ But a sagging price level will be very slow to correct itself. Every fall brings out a new group of forced borrowings and "it absorbs just as mncl: savings to finance losses as to finance invcstrneru;" This heavy demand which is ever present on a falling price level, linked with the higher real rate of interest placed upon the debtor as the principal becomes more burdensome, creates a situation of continuing high rates and descending price levels. A policy of laissez faire with respect to banking and interest rates under such conditions is extremely disastrous. The wiser plan is that of daring initiative on the part of the bankers, through which interest rates are artificially lowered to almost zero if necessary, or until the prospective returns on in12

Ibid., p. 3 8 1.

rALb'E THEORY AJ'tlD BUSINESS CrCLES

202

vestment are higher than the interest rates charged at the banks. Then will business quicken) the price level move upwards and business return to normal. "Unless we spill our savings, how are we to go on year after year .finding an outlet for them in projects which will yield anything approaching the present long-term rate of interest? I am bold to predict that to the economic historian of the future the slump of 1930 may present itself as the death struggle of the war-rates of interest and the re-emergence of the pre-war rates." 13

From the above quotation, we discover how vital a factor in monetary control is the discount rate in Mr. Keynes' system of thought. When it is used in advance by bankers as a prophylactic measure, the oscillations of business and price changes are greatly reduced. When the Central Bank policy is one of delay and passivity, business becomes unstable, moving from one extrerne to the other. ClTRRENT REMEDIES NEEDED

While Keynes was writing his two volume work, A Treatise on Money) England was back on the gold standard and he accepted the situation as a sort of necessary evil. "For the present at least we might as well prepare to live with it," he says. But, if the gold standard was to be retained, certain gold economy measures should be adopted. First, gold should be taken out of circulation and be used for reserve purposes only.. Second, certain substitutes for gold should be used as part of the reserve money. Third, and perhaps most important of all, the Central Banks should be given a substantial reduction in legal reserve requirements.. Finally, there should be a "Supernational Bank," partially for purposes of coordinating central banking systems, but also for purposes of "economizing in gold." Unless such a plan is adopted, he predicted that the adherence to an international gold standard would reveal a gold shortage and a declining price 13

Ope

cu., Vol. II,

p. 3 84.

2°3 ";"

t-

level, accompanied by chronic depression for years to comebarring, of course, an unexpected supply of new gold. Since writing his Treatise, England, as we know, has been forced off the gold standard, and Keynes would be among the last to advocate an early return to the gold standard. As a result, the world is given the privilege of witnessing one of the greatest experiments in managed currency ever attempted in peace time. A second part of Keynes' program for the elimination of depression has to do with "Investlnent and Saving." This was at the center of his program as presented to the Economic Conference in Chicago in 193 I, meeting under the auspices of the Harris Foundation to consider "Unemployment as a World Problem." Without attempting to develop his argument in full, and without attempting to show its validity or invalidity, we merely present his conclusions by citing brief quotations. "The whole matter may be summed up by saying that a boom is generated when investment exceeds saving and a slump is generated when saving exceeds investment. . . . It is out of the discquilihrium of savings and investment, and out of nothing else, that the fluctuations of'- profits, of output, and of employment are generated." 14 "There can be . . . no secure basis for a return of to an equilibrium of prosperity except a recovery of fixed investment to a level commensurate with that of national savings in prosperous times." 1r.

The great equilibrating force, by which savings and investment may be kept more nearly in balance, is the interest rate. Thus at the heart of Keynes' system for economic stabilization is "managed currency" and "managed interest rates." HAYEK'S CRITICISM OF KEYNES, AND MANAGED CURREKCY

Hayek attacks the whole theory of a managed currency, and looks upon elasticity of currency and credit as inherently bad. 14 Unem-ployment as a World Problem, Harris Foundation Lectures) "The Originating Causes of World-Unemployment," by Keynes, pp. 21-2. 15 Ibid., p. 27.

20+

l'~AL[}E

THEORr AJ.\rD B[JSIJ.\'ESS CrCLES

"This frantic game of now enlarging now contracting the productive apparatus through increases of the volume of money injected, now on the production, now on the consumption side, is always going on under the present organization of the currency. . . . (But) So long as the volume of 1110ney in circulation is continually changing, we cannot get rid of industrial fluctuation. In particular, every monetary policy whicb aims at stabilizing the value of money and involves, therefore, an increase of its supply with every increase of production, must bring about those very fluctuations which it is trying to prevent." 16 "The notion common . . . to 90j~ of the writings of monetary cranks is that every batch of goods is entitled to be born with a monetary label around its neck, and to carry it round its neck until it dies." 17 "1ith such a notion, Hayek has no sympathy. He takes definite Issue with Cassel, Pigou, and all others who contend that the quantity of money should keep pace with the volume of production; who maintain that the effect of money is neutral, only when such balance is achieved. This prevalent idea that the circulating medium should increase as the volume of production increases is entirely erroneous. The only means of avoiding undue expansion and misdirected production is to allow prices to fall as production increases, and this would necessarily follow if the amount of money remained constant .18 It is not elasticity of money that is desired. It is neutrality of money. And money is neutral with respect to business when it is immune from any disequilibrium resulting from monetary sources. In attempting to keep money neutral, it is important to know says Hayek, that the volume of money can be made invariable. In fact, in order to accomplish the desired end, the volume of money must be kept invariable. "Changes in the 16 F. L;\' Hayek, 'lThc Paradox of Saving," Econo mlca, May, 19]1) p. 16 7A criticism of Profits, by Foster and Catching-so 17 Hayek, Prices an.l Production, p. 89. Quoted from Robertson in Economica; No.2], June, 1928, p. 142. 18 Hayek, Prices and Production, p. 89.

2°5 physical volume of production offer no sufficient reason for variations in the supply of monev." In In support of the theory that elasticity gives instability, while an inelastic currency gives stability, Hayek gocs into an extended analysis of saving and investment. The thesis developed is that if savings precede investment, and are used to finance investment, then the demand for consumers' goods slackens in ad'vance of the increase in demand for producers' goods, thus involving no temporary shortage fronl double demand, nor increase in price. On the other hand, if saving does not precede investment and expansions come from increased credit, then the new demand for producers' goods comes into a market where demand has kept pacc with supply. The effect of this new demand or competition for the products of industry, creates a maladjustment between demand and supply, and an increase in price. Therefore, business expansion on credit, in line with the idea that new capital should be matched with new credit, operates to enhance price and create disequilibrium, whereas, if expansions are made from savings in conjunction with an invariable volume of n10ney and credit, there is no change in prices, no overstirnulus of expansion and no disequilibrium in business, This is an ingenious argumcnt, and worthy of careful consideration. In order to show how money n1ay be kept neutral with respect to price and invariable in volume, Hayek develops a "Pyramid Theory of Money and Credit." The pvrarnid is composed of cash at the base; central bank credit in the second section; commercial bank credit in the third section; and private credit at the top. Now, the maintenance of neutrality and invariable volume does involve a little control, or management, but not elasticity. He admits that it is difficult to control, directly, the volume of private, or commercial credit, yet, if these t\VO expand, control should be exerted to contract the base sufficient to keep the size of the pyramid constant. It is not enough to keep the lower bases from expanding when the top sections are expanding. "It 1~

op. Cit., p.

101.

, FALrJE

206

THEORY Al\TD BUSINESS CrCLES

is necessary for them actually to contract credit proportionally." 20 Hayek hastens to add that he has no hopes that such idealistic, Utopian control can be achieved. "N one the less, I am strongly convinced that, if we want to prevent the periodic condition of production caused by additional credit, something very similar to the policy outlined above, absurd as it may seem . . _ would be necessary." 21 He holds that it is no part of his business to see that such a system is inaugurated. He merely aflirrns, that if his analysis is sound, then only a currency management directed towards rigidity, rather than elasticity, can keep money neutral and business relatively stable. ~ 2 Hayek's final conclusion is that stabilizing business is a far greater problem than that of merely stabilizing the price level, by monetary management. Unless and until we know a great deal more about fundamental monetary theory, we had better beware of shifting from our semi-automatic gold standard to an arbitrarily managed currency_ In fact, he says, the future may disclose that most of the troubles with the gold standard were due to mana ge;ncnl, rather than to weakness in the gold standard itself. FIN:\L OBSER,rrrTIONS ON CLTRRE?\C"{

I\L\N:\GE1\lEN1~

Thc writer is persuaded that it is far more important to keep 1noney neutral than to make it elastic. The rigorous rigidity of money, as advocated by Hayek, represents a definite reaction 20 21

tu«,

p.

tu«, p.

100. 100.

22 Note: Ha yck admits of t\VO exceptions, justifying a va nanon in the volume of nl0ney. Should business bcrornc more integrated, or the niarkct injr system more direct, so thJ t goods passed from stag-e to stage without the use of 1110ncy) where money ha d previously been required, then the ('Coefficient of Moricv T'rn nsact ions" woul d chang-e. In such a case, less moncv would be required relatively, so that proportIons only would be 11IJintainc(l; as a means of kceping money neutral. A second exception is made for variations in the velocity of circulation. If velocity changed, then the volume of lTIOncy would have to change obversely, if money were to remain neutral with respect to price.

2°7 from the craze for elasticity which has featured money and banking policies for the past quarter of a century. The old National Banking- System in the United States was scuttled because of its rigidity, or perverse inelasticity. The Federal Reserve System was constructed with elasticity of currency and credit as a major objective. The extreme violence in business fluctuations the past few years, however, has made mandatory a reappraisal of the machinery for currency control, and the assumed merits of elasticity. Of course, there is much evidence in support of Keynes' contention that bankers have attempted little or no management of a prophylactic nature, designed to reduce business fluctuations. This would appear to be particularly true during the prosperity phase of the cycle when control is easiest applied and most effective. Therefore, it n1ay well be that the provisions made for elasticity of credit and currency have operated to Inagnify the amplitude of business oscillations. Reverting again to Hayek's theory, we wish to state that any conclusions regarding the validity or invalidity of his theory, based upon the meager digest given above would be quite Ut1warranted, I"" et, a thorough study of Hayek's own works has led the writer to the conclusion that a good point has been carried too far. Unless the provisions for elasticity were extended beyond the two "exceptions" given, it is difficult to see how such a monetary policy would adjust itself to the super-dynamics of American business expansion. Some provision is made for business expansion through "Investment and Saving," and his treatment of them should be studied first hand, But his pyramid concept of money and credit, whereby every expansion at the top should be offset by a proportionate contraction at the bottom, provides a monetary straight-jacket, too rigid for dynamic progress in the state of the arts. On the other hand, we agree with him that there is a fundamental error in a theory of managed currency which has as its objective the apportionment of the volume of Inoney to the volume of business in such a way as to maintain the index level of

208

llALUE TliEORY AND BUS/I·lESS CYCLES

" The

prices. error becomes obvious in the light of events in the United States during the past ten years. For several years, prior to 1929, the index level of prices in this country maintained a high degree of stability. There is authority for the belief that this relatively stable price level was the result of definite credit and currency management on the part of the Federal Reserve Board; that they were consciously using their control powers to maintain the wholesale index number constant. Many believe, on the other hand, that the stability of the price level was automatic, and devoid of management. So far as the point is involved here, it makes no difference whether the stability of the price level "vas volitional or accidentaL The fact is that the price level stayed up while technological improvements were driving costs downward, Now, if money were kept neutral; as Hayek suggests, rather than managed to maintain a price level, it would follow that reduced costs of production should yield reduced wholesale prices, on the average. But, if the price level is maintained by currency 111anagement under such conditions, then it is clear that forces in the realm of production, operating to reduce prices, are offset by forces in the realm of money, operating to raise prices. In fact, it might be stated that 1110netary inflation was counteracting technolo gical change, whether volitional or accidentaL But, this increase in the spread between costs and sale prices, yielded abnormal profits. Herein, lies one of the hidden causes of the phenomenal "profitless prosperity" of the late '20'S, as compared with the prosperity of 1919 connected with a rising price level. The excessive profits arising from the divergence of two secular trends; the one a cost reduction trend through technological change j the other a price maintenance trend through managed currency; supplied part of the background for the crisis of 1929- Let us observe the interactions growing out of this situation. In the first place, the enlarged profits stimulated plant expansions beyond that which would have occurred, had prices gone down with costs. Second, the profits afforded extra dividends,

..I

( !

2°9 and served to stimulate speculation in securities. Third, widened margins stimulated the quest for markets, supplying part of the inducement to extend credits on a vast scale to European importers of American goods. And finally, these abnormal profits spurred business men to enlarge their current market by the promotion of installment buying. Each of the four phenomena listed here, acted as a disequilibrating force, which piled up a cumulation of stresses, leading to the crisis in 1929. Of course, other factors were at work, yet the presence of these factors lTIUSt not be neglected. Furthernl0re, if the reasoning is valid, it follo'\vs that a currency, managed in the interests of business stability, must seek to keep tnoner neutral, rather than seek to preserve the price level. If currency is to be Inanaged in reference to an index level of prices, then a nci: index nutnber nrust be found, wllich is corrccicd for clulnges iiI the cost of production, due to technological pro gress. If such an index number is fantastic, and statistical experts find it impossible to devise such a number, then there is little hope of achieving business stability through a managed currency, because of the non-existence of a tabular standard which measures the purchasing po\ver of money in the midst of technological change. On the other hand, if correction can be made for technological change, and currency and credit are so manazcd as to keep money neutral, permitting the price level to fall as averag-e costs of production fall, then intelligent management should yield a high degree of business stability.

CHA.PTER XV

THE

~lALTHUS IAN

SYSTEM OF ECONOMIC THOUGHT

I T is the function of theory to furnish a basis for the adequate explanation of revealed phenomena or facts of life. If the facts are inconsistent with the theory there must arise a doubt as to the validity of the theory. The economic fact in need of explanation is that of business instability and the tendency of business to move in cycles. In Book I, we analyzed the Ricardian system of economic thought, based upon the theory of embodied value and showed how the various exponents of this school attempted to explain disequilibrium and business cycles. The conclusions reached at the end of that study were that Ricardian economics furnished a logical explanation of equilibrium and secular trends. All attempts to explain disequilibrium and business cycles involved the exponent in economic contradictions or logical inconsistencies.. In Book II, we have turned to a study of what may be called Malthusian Economics, based upon commanded value. In this summary chapter of Book II, we wish to bring into closer proximity four cardinal points in the Malthusian System of Economic Thought, and show how each contributes to a more satisfactory explanation of disequilibrium and business cycles. The four cardinal points will be reviewed as follows: first, the Commanded Theory of Value as developed by Malthus; second, the, significance of a money and credit economy as portrayed by Tugan-Baranowsky; third, the principle of diminishing utility, as utilized by Aftalion; and finally, the presence of a vacillating standard of value, linked with the name of Irving Fisher. None of these items is new, yet they have never before 210

THE A1ALTHfJSIAN SYSTEM

(

I

211

been combined in this way, or set up as constituting a Malthusian System of Economic Thought. Y et, they are consistent parts of a theoretical vV hole.

Commanded Value l'heory as Developed by ]vlalthus. It will be recalled that Malthus contended that value might diminish while supply increased, because commodities were worth only what they would "command" in exchange. Four thousand pipes of wine were of more value than five thousand pipes of wine if they commanded more in exchange.' If we grant the validity of this contention, then it follows that an increase in the quantity of things may not confer upon the possessors an increase in purchasing po\ver. Therefore, an increase in physical supply may not yield a proportionate increase in effective demand. The result is disequilibrium. When we ponder disequilibrium, we COIne upon one of the strangest features of our economic order, namely, "a world afraid of production" and wholesale restriction of output. Labor develops a "Lump of \\T ork" theory in defense of restriction of output to make the job last. Entrcp reneurs "intelligently adjust supply to demand" to keep from spoiling the market. Monopolies are established in order that value may not be decreased by an increase in supply. In harmony with a commanded theory of value, an increase in quantity at one time may effect an increase in value and at another time a decrease in value. The value of one crop may be enhanced by enlarging the supply, while the value of another crop is enhanced by reducing the supply. The first tenet in Malthusian economics, then, makes possible a satisfactory explanation of business instability. It is because there is no definite and direct correlation between supply and value. 17"ct, the commanded theory of value, when standing alone furnishes no explanation whatsoever, for commercial crises, business cycles, or even secular trends. It merely explains unbalance between demand and supply. 2. The Role of Money and Credit. The second factor operatI.

1

See above, p.

2;

also review chapter on Malthus.

VALUE THEORr AATD BUS/l\iESS CrCLES

212

ing to create unbalance in industry is our money and credit economy." For more than a century economic literature has been filled with _discussions regarding the possibility of crises from over-production. Could there be general over-production, or only partial over-production r When the issue was stated in this way, the opponents of general over-production appeared to have the better of the argunlent, even though the conclusion seemed to quarrel with the facts. The prolonged discussion has made little contribution to the theory of business cycles, because the issue was improperly stated. The real issue is, can there be a General Depression, and if so can it emerge from a partial depression? No one living at the present time would doubt the possibility of a general depression, yet barter economy and Ricardian economics cannot explain it. Yet a commanded theory of value functioning through a money and credit economy can explain it, and Tugan-Baranowsky has clearly shown how a partial depression may become general. Let us recall briefly his analysis. In a barter economy it is quite possible for one industry to be prosperous and another depressed, but the situation quickly corrects itself by a shift of capital and labor from the more depressed industry to the more prosperous industry. The shift continues until both are equally prosperous again. Recalling the illustration of the wheat and cloth producers, as given by TuganBaranowsky, we remember how an unusually large crop of wheat and a normal supply of cloth enabled the cloth merchants to enjoy a higher standard of living because they received more wheat in exchange for their cloth than previously. The wheat growers were affected adversely because they received less cloth in exchange for their wheat. But the situation corrected itself by a shift of wheat growers into the cloth industry. The case is very different when we have money and credit as a medium of exchange. If there is an unusually large supply of wheat, then, not only is the price of wheat per bushel depressed, but the total income of the wheat growers may be re2

Ch.

Review the argument as developed by Tugan-Baranowsky. Sec above)

x.

THE Jl,1A.LTl/[JSIAJ.V S}"STEJf

21

3

duced. But, if the total crop of wheat is sold for less Inoner, then they are able to buy less cloth. The cloth industry is depressed, even though the production of cloth is normal, and affected internally by no adverse factor. In like manner, if the producers of food and clothing have a reduced income, then they cannot buy the normal amount of furniture, for instance, at the usual price. Either furniture will remain unsold or be sold at a lower price. Either alternative depresses the furniture business. The commanded theory of value functioning through a money and credit economy gives an adequate basis for the explanation of a general depression starting with partial depression. I t explains how a maladjustment in some vital industry tends to depress all industries. Stability in business calls for prosperity among all the vital components of the productive mechanism. lVlanufacturing cannot remain prosperous in the presence of depressed agriculture, nor vice versa. \\'"hen farm incomes run short for a period of time, farmers cease to furnish an adequate market for manufactured commodities. Manufacturing suffers because agriculture suffers. However, the situation does not lead to permanent depression. General depression grows out of the malad justmcnts of a partial depression. But when the depression becomes general, production declines all along the line, demand and supply tend to come to a balance again, and this renewed balance furnishes the basis for convalescence and recovery. Thus we see how the mechanism of money and credit furnishes a vehicle for the movement of business through a sort of economic rhythm, going from partial depression to general depression, recovery and prosperity, which yields partial depression as soon as any factor arises to unbalance the system.

3- The Significance of tlze Principle of Dinzinislzing Utility. The place of this principle in the Malthusian System of has already been developed with care while presenting ments of Aftalion. 3 The issue involved in connection principle is whether or not there is any relationship :3

Sec above) Ch, XI.

Thought the arguwith this or causal

21 4

VALUE THEORY AND BUSINESS CYCLES

connection between the distribution of wealth and income and economic instability or business cycles. It is consistent with the theory of embodied value for Ricardian economics to hold that there is none. Wherever there is supply, there is power to demand. The insatiability of human wants serves as a sufficient inducement for the exercise of that power. Therefore, no matter how great the concentration of wealth or income, demand will equal supply and no disequililibrium will arise from this source." It is consistent with the commanded theory of value for Malthusian economics to conclude that there is a connection, or causal relation. Malthus insisted that business might stagnate, either from the involuntary demand of the poor who have the will but not the po\ver, or from the voluntary failure of demand of the rich who have the power but not the will. All economic theory grants that there may be an involuntary failure of demand by the poor. Yet, if the effective demand of the poor is in proportion to their supply, they constitute no source of unbalance. The disagreement centers around voluntary failure in demand by the rich. Turning to voluntary failure of demand, it will be recalled that Malthus made the assertion without submitting sufficient proof, that "It has always been found that the excessive wealth of the few is in no respect equivalent, with respect to effective demand, to the moderate wealth of the many. . . . Place too much land in the hands of a few rich landed proprietors and the po\ver to supply will outrun the will to consume and the progress of wealth will be checked by the lack of effective demand." 5 It is readily discernible that Malthus was introducing a psychological element into value and price, and the law of demand and supply. The amplification, and clarification of the point was 4 Note: In writing to Ma.lthus, Ricardo said) «I go much further than you in ascribing effects to the 'wants and tastes of mankind; give men but ·th~ means of purchasing and thci r 'wants are insatiable. 11 r. Mills theory is built on this assumption." (James Bonar) Letters of Ricardo to M aitlius, p. 49') [) Malthus, Principles of Political Economy, p. 333-4-.

THE J,JALTHUSIAN SYSTEM

2. 1

5

delayed until the development of the marginal utility analysis of the Austrians, and the ingenious application made by Aftalion. () By a rigorous application of the principle of diminishing utility, Aftalion showed how the intensity of desire for any given good declines as additional units are acquired or con- ' sumed, and in like manner intensity of desire for all goods declines as we climb down the scale of needs from the more necessitous goods to the less necessitous. The logical deduction, then, is that the total supply of goods or wealth will give rise to less total demand if too much of the supply is concentrated in a few hands, because as the rich satisfy more and more of their desires, the intensity of desire declines, and the tcill to demand is lacking even though the po1.-t'er to demand is present. The voluntary failure of demand on the part of the rich is logically possible, if we accept the commanded value theory of Malthus or the more refined marginal utility theory of the Austrians. But, if we grant the validity of the Malthusian position, then it follows that an economic society characterized by extreme concentration of wealth on one hand and extreme poverty on the other, will suffer now and then from a failure of adequate and effective demand, Of, to use business terminology, a lack of markets. The industrial mechanism must slow down at times, because effective demand has not kept pace with supply. N either experimental history nor economic theory reveals the proportionate distribution of wealth and income that would tend to keep total supply and effective demand in balance. Socialism, communism and anarchism have all been proposed. Yet free competition, tempered by equality of bargaining po\ver in the making of contracts continues to present a logical hypothesis. Of one thing we may be sure, if Malthus and Aftalion are correct, and that is that preferential tariffs, class legislation, and monopolistic combinations operating to increase the concentration of wealth and income intensify the struggle for markets and increase the degree of business instability. 6

Review discussion above, p. 144 if.

216

ITAL[TE THEORY

AJ.\~D BUSl~\iESS

crCLES

4. The Role of Unstable Mone», Malthus, TuganBaranowsky and Aftalion all assumed a stable monetary unit. They did not deny the existence of unstable money, but their explanations of commercial crises and business instability in no way required the presence of a fluctuating monetary unit. However, a system of economic thought, proceeding from Malthus, must of necessity take cognizance of this disturbing element. For he criticized Ricardo for oversimplification; for attempting to develop a theory of economic equilibrium, contrary to fact, by ruling out the short-run-forces and disturbing factors. In this sense, then Fisher, Keynes, and others who recognize disequilibrium, and approach it from the monetary angle are strictly Malthusian. It is unnecessary to point out again the way in which monetary instability contributes to business instability. In a later section we shall attempt to show how a monetary unit fixed in weight but varying in value, linked with elasticity of credit and currency, may yield a definite business cycle. Sumniar», By bringing together the four cardinal points enumerated above, and combining them into a general system of thought, there is brought about a greater harmony between economic theory and reality. Malthusian Economics supplies an excellent basis for the explanation of disequilibrium and business cycles. Ricardian Economics supplies a basis for the explanation of equilibrium and secular trends.

Book III THE PROBLEM OF BUSINESS EQUILIBRATION

(

r I

CHA.PTER xvr

THE PROBLEM OF BUSINESS EQUILIBRATION THE STATIC STATE

equilibrium in the economic order is achieved when for every commodity or service a price obtains which throws demand and supply into equivalence and "clears the market." If the economic order were in the static state; if all potential inventers or innovators were stifled in the cradle; if population were stable and no one presumed to touch the sacred arc of the covenant of the status quo, there could be no disequilibrium. Even a dynamic state would remain in balance if functioning through a perfect market with free competition. By this we mean that, if there were free and unlimited competition among oinniscient buyers and sellers of equal bargaining power; if there were timeless and costless mobility of all the factors in production, then, equilibrium, serene and stable would prevail, senzper et ubique. 1 When we take the trouble to define the perfect market as a place or condition where competition, mobility, fluidity, and knowledge are absolute and limitless, it is unthinkable that maladjustments should arise revealing surpluses or a phenomenon of apparent over-production. If supply exceeded demand, price would promptly gravitate to a point where it would not. The only conceivable surplus would be in the nature of free goods where supply exceeds demand in the absence of price. Furthermore, it may be said that a surplus of economic goods is a logical contradiction of terms, for there is never a surplus of anything until supply exceeds demand at a price of zero. When surplus is defined in this way, all who argue against the possibility of crises

.l\BSOLUTE

1 For a clear statement of the requisites of a perfect market, see Frank H. Knight's "Risk, Uncertainty and Profit," pp. 76-8 I.

219

220

l'ALUE THEORY AJ·lD BUSINESS CYCLES

of over-production, or chronic maladjustment between demand and supply, stand in an impregnable position." THE FROZEN PRICE STRUCTURE

Whence then come these maladjustments? Why those periodic depressions when a thousand commodities in a million markets glut the field; when supply exceeds the demand at the prevailing price and price lacks sufficient resilience to move to the point that would clear the market? Here is a problem in economic dynamics of the first magnitude. Obviously, it is because the world of fact is not the one assumed above with the perfect market. What are some of the major points of difference which account for this lack of equilibrium? First and foremost, we live in a world of rapid and cyclonic changes, anything but static. '\1 e create goods by a capitalistic, or extended round-a-bout process. \\Te market through a complex mechanism of exchange. No "continuous, costless, intercommunication" here! Instead of being "continuously complete," the productive process is continuously incomplete, with infinite opportunity for errors in judgment of the first magnitude by the most successful and experienced of business men." Here is a source of instability which is inherent in dynamics involving wide stretches of time between the beginnings of production and the culmination in consumption. Yet even this situation does not explain why prices do not move promptly to points which clear the market. Here we come upon some recent terminology. Formerly, economists held that 2 N ole: In the light of the analysis fo llowcd in this book we pause to repeat tha t it was just such an economic wor ld \\"h1c11 David Rica rdo assumed. Therefore, his logical deductions frorn the premises as given are unassailable. There is considerable evidence to indicate that Ricardo recognized that his assumed wo rl d was "contrary to fact." Many later w rite rs ha ve Blade the mistake of applying his log-ical deductions based upon a theoretical world, to the world o f reality, wide] y at va riancc with the assumptions. (See Ricardo's ~v orks, p. 48, where, in treating of "Natural and Market Price" he says, "The present time appears to be one of the exceptions to the justness of this rcmark."') 3 See above, pp. 153-4.

THE PROBLEjtl OF B[]SINESS EQC.lILIBRATION

221

if prices failed to fall to the market clearing point, it was because of monopoly controL Now we are beginning to speak of the ((frozen zones" in our price structure, or "Institutional frictions" 4 retarding price adjustments. A most vivid and revealing word used by Keynes "is "stickiness." The price structure may not be frozen and wholly independent of demand and supply, but it is alike molasses in January" which requires a long time to move to the point desired. Let us observe for the moment some of the evidences of stickiness in the price process. \Ve may recall at this time Aftalion's discussion of capitalistic production. Entrepreneurs facing an era of good business and high profits enter upon a program of vast capital expenditures. Because of the time involved for capital expansions, it often happens that the peak of demand has passed before the increased supply reaches the market, or at least has not expanded to such an extent as to absorb the greater supply at the prevailing price. Indeed, it often happens that the demand will not clear the market at a price somewhat below the expenses of production. Under such circumstances, many manufacturers have adopted the policy of closing down temporarily, or at most, they operate on fractional capacity. Yet, if the forces of demand, supply, and price are as resilient or fluid as is generally conceived under free competition, the manufacturer would continue to operate at capacity so long as prime costs were covered. Theoretically, as we say, capacity production for all should continue, and prices fall without let or hindrance to the point which covered only prime or operating costs. Yet, in practice, we know this does not often happen. Instead of a resilient price structure and capacity production, we find stickiness in the price structure and restriction of output. In many lines of industry we do not deem it a misstatement to say that it is standard practice to close down 4 "Institutional Frictions and Technological Unemployment" by Alvin H. Hansen, Quarterly Journal of Economics, August, 193 I.

222

VALUE THEORY

ss»

BUS/llESS CYCLES

for the time 'being or operate on partial capacity as soon as it appears that the goods cannot be sold at a price that covers both prime and supplementary costs. Of course, in some of these instances the element of monopoly is definitely present. But in many industries where competition is quite definitely preserved, business men seem to prefer to shoulder the larger temporary losses attendant upon closing down, rather than cut the price too severely and "spoil the market" for future business. Without monopoly, conspiracy, collusion, exchange of price lists, or even gentlemen's agreements, we believe it to be a fair statement to say that the common practice in many lines is to curtail production and maintain price, rather than cut price to prime costs and operate at capacity. We readily recognize that such a practice cannot be followed by those who have little or no reserve to tide them over slack periods. Under such circumstances production must be pushed to the limit, so long as a price can be gained which leaves any residue whatever to apply on fixed costs after prime costs are covered. This was the condition of many Iowa farmers in 192 I I 9~2. The land speculation of 19I 9 had loaded thousands of them up with high interest charges, compulsory partial payments on mortgages, and high taxes. Under such circumstances, with many facing the possibility of losing their farms, the writer watched production pushed to the limit as prices fell below costs of production. Corn acreage increased, meadows and pasture lands were plowed up for the first time in years. Hours of work were lengthened in order to create income if possible in excess of prime costs and have something to apply on fixed charges. Such practices, becoming general, served to increase the surplus, to be sure, but it was the free, fluid, and competitive market working itself out according to Ricardian economics while submarginal farmers were leaving the farms at the rate of one hundred thousand a month. When we turn to the manufacturing and industrial fields where the dominant type of business unit is the corporation with a policy of building up reserves in good years to tide them

THE PROBLEM OF BUSIJ.\7ESS EQ[JILIBRATION

223

over in bad years, we witness no such general practice. Furthermore, we deem it an injustice to indict them of monopolistic collusion. Rather, it seems to be an accepted method of business operations when business is depressed, or when demand is insufficient to drain off the supply at a price which covers the entire costs of production. What then is the point r Just this! Instead of the business world operating in a freely competitive, fluid and mobile way, and in such a manner as to let price serve as an evener to adjust demand and supply, while the productive process moves on at capacity, we find manufacturers dropping out of the market for raw materials and labor in preference to full operations, full employment, and normal purchase of raw materials, such as would be necessary with capacity production at a lower price. This is intended as no indictment of business practice. It nlay be perfectly sound business procedure, and one which in the long run is best for manufacturers, laborers and producers of raw materials. I'" et, it betrays a "stickiness" in the flow of prices which yields unemployment and surplus commodities-a maladjustment between demand and supply-rather than a resilient fluid price structure which falls quickly to the equilibrium point. Let us now push the argument still further. May we not say that unemployment stands as pri1Jza-facie evidence that the price of labor is too high, otherwise, demand and supply would be in equilibrium. The answer is that laborers, to some extent at least, operate upon the same principle as the employers. They prefer a limited amount of idleness, rather than "spoil the market" for the future. Experience teaches that the climb back from a cut \vage scale is a long and tedious one. If labor is organized, there is very definite resistance to a reduction of the price of labor to the point which would "clear the (labor) market." But even unorganized labor does not look with favor upon a promiscuous practice of underbidding the going rate of wages in order to get a j ob. Here in the field of wages we find "stickiness" or an institutional friction, or the sway of custom, intervening to reveal surpluses, in preference to a price that clears the market.

224

r ALUE

THEORY Al'lD BUS1J.VESS CYCLES

The object of the above discussion is not to indicate that every laborer, male or female, should bid against each other until the wage scales are reduced to the point where demand would equal supply and the labor market would clear itself. Neither do we desire to indicate that all manufacturers should, in times of depression, operate at capacity, and cut prices till demand and supply were in equilibrium. Y et, this is exactly the condition which would obtain were the market as free and fluid as assumed in classical economics. Thus far we have dealt with the sticky areas in our price structure. In addition to these we find price areas quite definitely frozen with no mobility whatsoever. Under such conditions it is possible for demand and supply to remain out of balance quite indefinitely. " ery naturally, the least resilient price areas are in the fields where we have definite "price-fixing." A striking illustration was the recent govern men tal attem pt to peg the price of wheat above the competitive price which would have resulted from the free interaction of the forces of demand and supply. The deliberate and conscious objective in this case was the maintenance of an artificial price above the equilibrium price which would clear the market. Not only did the fixed price keep demand from absorbing the supply on hand, but when continued over a period of time served to stimulate supply beyond that which would have been produced had economic forces operated freely to drive price to the equilibrium point. Of course the maladjustment was made worse by the general depression in industry which served to keep too many people in agriculture gro\ving wheat. In addition nature seemed to smile quite generally on all wheat regions, the world around, yielding bumper crops and a world supply above normal expectation. Nevertheless, the experiment does go to show how a frozen and non-resilient price structure may throw demand and supply into unbalance because of artificial restrictions upon the interactions of economic forces. Closely akin to these frozen price structures due to definite price-fixing, are the relatively immobile prices due to indirect' price-fixing. The Farm Board has been severely condemned

THE PROBLEM OF Bf}SIJ./ESS EQUILIBRATION

225

in connection with its price-fixing ventures into the realms of wheat and cotton. IT et such price-fixing is not fundamentally different in character from the indirect price-fixing accomplished through protective tariffs. In both instances we have artificial prices-the result of governmental interference-at variance with those set by the untrammeled economic forces of demand and supply. When generalized into a veritable net-work of tariff barriers throughout the world, trade is hampered, goods glut the markets, and artificial prices fail to gravitate to the equilibrium point. In addition to the areas of governmental interference, there are the fields where a substantial degree of monopoly prevails, resulting from private initiative." Complete monopolies are extrernely rare, but partial monopolies gifted with po"ver to "determine price in their own interest" are common and widespread. The point to be noted in connection with monopolies is that we have "price-fixing" first, accompanied by an attempt to adjust supply to demand, or demand to supply 'by human judgment in such a "'lay as to find the point of monopoly profit, rather than leaving prices mobile and free to move to any equilibrium point. If monopoly force is exerted on the supply side of a manufactured commodity, idle plants and unemployed labor may be necessary for monopoly gains. If monopoly force is exerted on the demand side) goods may remain unsold and producers pushed into bankruptcy because of inability to market at a price that covers cost of production. In either case maladjustments obtain because price lacks mobility. Another vast area of relatively immobile prices is in the field of public expenditures. The total expenditures by all governmental units in the United States, federal, state and local is approximately fifteen billion dollars a year. This is almost one fourth of our national income. Yet the major portion of this fund is spent at fixed prices. Salaries of the President, cabinet 5 "_A.. monopoly exists when a person or group of persons can exercise sufficient control over either the supply or the demand for a good to enable them, under the conditions of the market, to dcte rm ine its price in their own interest." Garver and Hansen, Principles of Economics, p. 253.

226

VAL[IE THEORY

st:»

BUSI1VESS C}-CLES

members, federal judges, congressn1en and commissioners are all fixed. So also is the pay for generals, admirals and the men in the army and navy. Salaries of state governors, legislators, commissioners, state and county officers are fixed salaries. Interest on government bonds is rigorously rigid as compared with the highly competitive call loan rates. Even public works, constructed with governlnent funds are not usually done at highly competitive prices. In the first place, the government is expected to be a sort of "model employer and builder." Therefore, competitive prices are not as keen as when built by private enterprise. Frequently politics enter into the picture, either in the form of graft or by limiting competition through specifications that local or state materials and labor are to be used. Suffice to say then, that one fifth of the annual national dividend is expended at fixed prices or at least at prices decidedly lacking in the competitive resilience necessary for equilibrium conditions. If we add to public expenditures, the goods and services expended at public prices, we enlarge again, the domain of immobile prices. Representative of these are railway rates fixed by government commission, and public utility rates fixed by long period franchises or subject to control by local authority. These sticky, or frozen areas in the economic world serve to give peculiar significance to a very neglected point in economic theory developed by Proudhon. V\T e refer to his "Chemical Theory of Exchange." G It will be recalled how he attributed depression to a shortage of money. Goods and money are like hydrogen and oxygen. In proper ratios the two chemicals unite to form water. If not in proper ratios, one of the chemicals remains free-it is left over because there is not enough of the other element to enter into exchange. I t will be recalled that we criticized the application of his theory to money and goods, on the ground that a shortage of money did not necessarily decree that goods could not enter into exchange but that they entered into exchange at bankruptcy 6

See above, pp. 83-5.

THE PROBLEJ.l1 OF B[]SIi.\':ESS EQUILIBRATIOll

227

prices. But this Chemical Theory does have validity when applied to exchanges of commodities or services where, for any reason, demand and supply are out of balance and the price structure is sticky or frozen. In these cases, a certain quantity does enter into exchange, but a part remains free-is left over-and enters not into exchange. This is exactly what takes place when the price system lacks resilience, or is held in check by friction or stickiness from whatever source. Where competition and fluidity are sufficiently active, maladjusted demand and supply operate to drive prices, speedily and without Iimit to whatever point is necessary to clear the market. But where there is lack of competition; wherever there are immobile prices, whether due to frictions or price-fixing, direct or indirect-then demand and supply may remain out of adjustment quite indefinitely. Labor or goods 111ay be left over. At the prevailing price a certain volume of labor is combined with the money (price); a certain quantity of wheat (or other raw materials) enters into exchange; a certain percent of furniture, flour or harvesters unites with demand; but a part is left over and enters not into exchange. Proudhori's Chemical Theory of Exchange has definite significance wherever, for any reason, prices are relatively immobile. No statistical study of large proportions seems ever to have been made in order to discover what share of the national dividend is spent in these sticky and frozen price areas. Suffice to say, that when one begins to reflect upon the n1agnitude of the field, a start is made towards a better comprehension of the causes of maladjustn1ent in industry, and why the laws of static economics and perfect competition fall so far short of a satisfactory explanation of the problems of every day life. This rather extended consideration of "stickiness" in the price structure may seem to indicate that competition, working through the interaction of demand and supply in conjunction with mobile price is the exception and not the rule. But such is not the case. The law of demand and supply is not obsolete and many prices are quite responsive. But this co-existence of fluid and frozen price structures side by side reveals striking phenomena.

228

VALUE THEORY AND BUSINESS CYCLES

Thanks to technological change; to money and credit disturbances; to the fact that the ratio of money to the volume of business is not constant; to wars and political revolutions; to capricious weather and crop variations-thanks to these and other factors, prices do change. They change individually and collectively. But when these powerful price changing forces are exerted upon a price structure, part of which is fluid and part of which is frozen, the net result is that the full force of change registers itself where competition is keenest, and prices most mobile. The net effect of this composite of conditions, is that price changes are infinitely more violent in the competitive fields than if the forces of change could register throughout the entire price structure with equal effects. Hence we find rigid prices existing alongside violently fluctuating prices, not because demand and supply are in equilibrium in the stable price fields and maladjusted in the others, but because part of the price structure is mobile and part immobile. From this it follows that monopoly prices make competitive prices more unstable. Government pricefixing-whether direct or indirect-automatically works for greater derangement of prices in the "non-fixed" field. The logic of this situation throws peculiar light upon current suggestions for "stabilizing business." Some propose an expansion of government price-fixing. "Stabilize business by stabilizing prices." Others are attracted to stabilization through combination and monopoly control. "l{elax the Anti-Trust Laws," they say, "stabilize price and then adjust supply to demand." But if the analysis above has any degree of validity, every newly created immobile price structure operates to create doubly violent fluctuations in competitive fields. The latter serve as the "escape value" for the excess pressure created by maladjusted demands and supplies linked with prices that do not move to the market-clearing point. It may be argued that resort should be had to universal price-fixing. But fixed prices do not adjust demand to supply or vice-versa. In fact they frequently aggravate maladjustment. If all prices were fixed, the economic boiler would lose its "escape value" and blow up from excessive pressure. Price fixing and

THE PROBLEM OF BUSI1VESS EQUILIBRATION

229

immobile price structures create a serious dilemma, whether arising from monopoly power, government interference, or when the "Best Minds" intervene for the common good. When taken up piece-meal, they serve to augment instability in other fields. When taken universally, the economic system loses its power of adjustment to the increasing strains which develop when demand and supply get out of balance. Governnlent intervention is frequently necessary to prevent exploitation. Without the rate-making powers of the Inter-State Commerce Commission, many abuses arose in the form of discriminations and excessive rates where competition had been eliminated or was non-existent. Minimum wage laws and trade agreements through collective bargaining may be necessary where bargaining po,ver is unequal, and the will to exploit is present. Therefore, it is not necessary to interpret the position taken here as an argunlent for unbridled laissez [aire. But the object of intervention in such cases is protection, rather than stabilization. Efforts at stabilization through piece-meal price-fixing was clearly analyzed by Professor Mitchel], in a recent address to the Chamber of Commerce of the United States. \\T e wish to present a brief section as follows: "Advocates of stabilization commonly argue, and with partial justice, that success in stabilizing one basic factor in the business complex would tend towards stabilizing other factors also. Thus, if employment and wage rates were stabilized, payroll disbursements would fluctuate little, consumers' demand for all sorts of consumers' goods would be steadier, manufacturers of such goods could schedule their output and their purchases of materials with greater confidence, one important cause of price fluctuations would be minimized, the volume of credit required by business would be more calculable, betterments and extensions of plant facilities could be planned with less risk. In short, stable employment at stable w~ges woulJ act like a gyroscope in the ship of business. "But it is equally plain that stable employment at stable wages would tend also to Blake certain other factors in the business complex less stable. It would change the payroll from a variable into a fixed charge upon earnings, like interest on bonds and office rentals. Of

230

VALUE THEORY A1VD PUSINESS CYCLES

course, increasing the fixed charges in a business w hose gross earnings vary tends to make net earnings still more variable than they were be fore. Further, increasing the variability of profits tends to increase the variability of dividends. Next to wages and salaries, dividends is the largest of the streams that flow from highly organized business to individuals. Hence the very measure which tended to stabilize one type of consumer demand directly would tend indirectly to make another type of consumer demand less stable. Also, the greater instability of profits would increase the speculative element in business ventures. Investment of capital would become even more risky than at present. 1~hat would tend to make the demand for and the construction of buildings and all sorts of industrial equipment even less calculable than they now are. It would be harder to maintain the original plan of stabilizing employment in the construction, buildingmaterials, and equipment industries, and if, despite all difficulties, wage disbursements were kept fairly stable it would be at the cost of extrerne variations in profits." 7

The writer feels that this is a very clear statement of the inherent difficulties resident in all attempts at the stabilization of business by "piece-meal price-fixing" or an expansion of the frozen price areas. Of course, the point could be developed with equal validity that stabilized prices for finished products, which are maintained by closing down factories or limiting output, throws the high variability into the gross wages item in the operating statement, in which case labor becomes the chief victim of fixed prices. There can be no escape from the irrefutable logic that expansions of the non-resilient price lists serve to create more violent fluctuations into the resilient price list. To the extent that we use the theory of equilibrium economics to gain greater stability in business, to that extent must we approximate the more nearly to the conditions of free competition and the perfect market with its mobile, fluid price structure. The analysis of immobile price structures has been developed at some length in order to show how widely at variance is the actual economic world with the assumed world with its perfect 7.A.ddress of Wesley C. Mitchell on «What is Stabilization" at the Nineteenth Annual Meeting of the Chamber of Commerce of the United States, held at Atlantic City, N. J., April 29 to May I, 1931.

THE PROBLEA1 OF B[JSIJ.\TESS EQ[JILIBRJ T10l\T

23 1

market depicted earlier. Our actual world, with its forces of monopoly, custom, institutional frictions, and sticky areas, presents a thicket of problems in maladjusted production and consumption, revealing demand and supply in disequilibrium, quite different from the assumed world of free competition, with its mobility of factors and fluidity of prices. It is in the midst of these maladjustn1ents that \VC observe a "\\T orld Afraid of Production't-c-whcre production does not automatically finance consumption; where supply does not serve to create adequate and effective demand-s-a world about which it may be said that "we have produced so n1any houses that people are homeless; we have produced so much food that people are starving; we have produced so much clothing that people are in rags." When we contrast the given conditions with those assumed at the opening of this chapter in connection with the perfect market, we begin to realize why demand and supply get out of adjustn1cnt; why price does not serve to create equilibrium and clear the market-in fine-why the classical "Doctrine of Markets," facing a world afflicted with business cycles, unemploymerit, surplus supplies and ineffective demand seems like a stranger in a foreign land. Perhaps, rather should one say that it is a foreigner in a strange land.

CHAPTER XVlI

AVOIDABLE CAUSES OF INSTABILITY INSTABILITY is the price we pay for progress. In the foregoing chapter, we set forth the conditions essential for equilibrium, together with a number of forces, most of them inherent in a dynamic society, which make complete stability and balance impossible. While fully recognizing a degree of unavoidable instability, inherent in dynamics as enumerated above, it would appear that a substantial part of this instability comes from a definite violation of the principles of economics by business and government. Many minor causes might be analyzed, but we shall pause for a brief consideration of three major causes of business instability -not inherent in dynamics. They are (I) Tariff, (2) War, and (3) Unstable Money. TIfE TARIFF I.

TARIFFS AND THE PROBLEM OF EFFECTIVE DEMAND

We trust the time is propitious for a reasoned and dispassionate consideration of tariffs in their relation to business cycles and depressions. More specifically is it necessary to consider the tariff from the standpoint of effective demand. In the preceding chapter, we laid down the conditions essential for the validity of the law of markets. Production finances consumption and supply calls forth effective demand under certain conditions and only under those conditions. The first and Ioremost of those conditions was free and unlimited competition. According to the law of markets, "The Road to Plenty" is through greater and ever increasing productivity. As producers we have been quick to take advantage of territorial, functional, 232

AVOIDABLE CA[/SES OF IJ.VSTABILITY

233

and technological division of labor. Goods should be produced, we say,_ under the most advantageous circumstances possible, in plants of optimum capacity, strategically situated. Business entrepreneurs have sought to produce as efficiently as possible, have viewed the world as the prospective market, and set up merchandising organizations to reach the farthest corners of the globe. All this we have done as producers. Yet, if production is to finance consumption, and supply give rise to adequate and effective demand, consumers must have as much liberty as producers. If, as producers, we are to be free to enjoy the advantages of low production costs resulting from territorial division of labor, racial aptitudes and natural resources, then as consumers we must have free access to markets where prices are competitively determined in the light of these most efficient and low cost production units; i.e., consumers musi have this free access if production is to finance consumption and supply create demand proportionately, pari passu. The law of markets demands this freedom in trade as a prerequisite for its validity. When we observe the artificial, and uneconomic prices, which demanders are compelled to pay in the various countries because of legislative interference in the fornl of protective tariffs, it must not be presumed that production will finance consumption; that increase in supply will call forth effective demand. It cannot be presumed that price structures, fixed or affected by protective tariffs supplemented by domestic monopolies, will be flexible and fluid enough to move to the market-clearing point. It must be expected that maladjustn1ents will arise; that business will languish for lack of markets; that much of the gain from higher prices will be lost through the restricted volume of business which can take place at these higher prices; that restriction of output will be necessary to remove gluts from the market; that unemployment will arise because consumers are penalized; as B. M. Anderson has succinctly stated it, we witness "A V\T orld Afraid of Production" partially at least, because of "The Tariff in an Unbalanced World."

2. TARIFFS, REPARATIONS AND INTER-i\.LLIED

\\T AR

DEBTS

International tariffs take on additional and peculiar significance since the war, on account of Reparations and Inter-Allied "Tar Debts. These international settlements involve sums of huge proportions, and the means of settlement are highly limited and difficult. I'" et large as these SUIns are, they could be cared for through the natural channels of commerce if international trade were relatively free. Of course, the creditor nations and those receiving reparations would have to experience an unfavorable balance in trade, and cancellation might be wiser economics in the long run. I'" et the point remains that if collection is to be insisted 011, a means of pa)',nent must be provided, The economics involved in this situation was carefully analyzed and presented by Moulton and l\lcGuire, in their notable book "Germany's Capacity to Pay" published in 1923. After analyzing the various means of paynlent, they concluded that Gerlnan exports on a vast scale constituted the only available alternative. I~ et, they say, "A recovery of Ccrrnan exports is almost universally regarded as something to be prevented at any cost. Emergency tariffs, anti-dumping laws, and safeguarding of industry acts are the striking features of post-war commercial legislation." Commenting further, they state that "One can find no more striking illustration of human fatuity than the demand on the part of the Allied countries that Gernlany must make vast reparation payments and the simultaneous erection of tariff barriers, the result of which is to make such payments impossible. The tragedy is that even yet few people realize that any inconsistency is invol ved." 1 For more than a decade international policies have violated this basic economics. The attempt to enforce collection while prohibiting payment has led from one crisis to another. First, Germany failed to meet the reparations requirements of the Treaty of Versailles and France occupied the Ruhr. Then came 1

Moulton and McGuire , Germany's Capacity to Pay, p. 138, McGra\v-

Hill, (1923).

A FOlDABLE CA USES OF INSTABILITY

235

the Dawes Plan which broke down and the Y oung Plan superceded it. This schedule of payments "vas met for a time because loans to Germany in the form of investment by Americans in German bonds quite consistently equalled the remittances by Germany on reparations. When it became evident that the only real( r) payers of reparations were American purchasers of German bonds, the purchases suddenly ceased, Germany was on the point of default and the Hoover Moratorium was proclaimed. The tentative agreement at Lausanne in 1932 revealed a belated recognition that political policies cannot permanently ignore fundamental economic laws. What is true of German reparations is equally true of the debts of the Allies to the United States. The standstill agreements and recent defaults represent the logical culmination of the inherent conflict in governmental policy which insists upon collection, yet by trade restrictions prohibits payment. The gold alternative is not available. Tourist expenditures are but a bagatelle when compared to reparations and war debts. The longer we finance remittances on old accounts by new loans and additional investments, the longer do we postpone the day of ultimate settlement. its N orman Angell once remarked in a conversation with the writer, "If America is to receive something from Europe, then America is to receive something from Europe." As a creditor nation, she cannot follow a tariff policy designed to assure a favorable balance in trade on the one hand and collect debts with the other." The financial chaos into which nations and business have fallen today is definitely linked with tariff walls. They constitute an economic veto of the political decree that reparations and debts must be settled in full. They account in a large measure for the frozen condition of international credit at the present time. A policy of enforced collection and prohibited payn~ent have yielded an impasse. ~ N ote : Of course the "Three Cornered Trade .A.. rgurnent" is relevant here, yet it matters not how Inany corners there are to trade, a creditor nation must experience an unfavorable balance in trade while collecting debts, if visible and invisible exports and imports are both included.

23 6

VALl.IE THEORY Al\'D BllSINESS CYCLES

The situation is vividly portrayed by B. M. Anderson, Jr. of the Chase National Bank. "1 like to use a homely figure of speech in describing our foreign investment and trade policy situation. The dehts of the outside world to us arc ropes about their necks, by means of which we pull them toward us. Our trade restrictions are pitchforks pressed against their bodies, bv means of which we hold them off. This situation can obviously' involve a yerr painful strain for the foreign debtor, But for the period from the middle of 1924 to the middle of 1928, we steadily eased the strain by feeding- out more rope. rT'hcn, in the second half of 192 S, what rope we did feed out, we fed out painfully and slowly. \Ve ceased to lend very much to the outside world." 3

\\Te are not unmindful of the standard view with respect to tariffs, that it is only net: tariffs which operate as a veto on international trade; that in the long run, bus] ness and national price levels adjust rhernsclvcs to any given tariff situation. Therefore, tariffs cannot permanently prohibit the movement of international trade in such directions or in such volumes as to make the payment of reparations and war debts impossible. This view of the tariff is basically sound under normal conditions, particularly if nations cling to an automatic, free-gold standard. For it is the movement of gold which works out the correction for price differentials and exchange rates. 'V\T e are familiar with the argument that if a nation enacts a protective tariff as a means of securing a favorable balance of trade, under an automatic gold standard the favorable balance will be paid in gold. But the export of gold makes gold dearer and prices lower in the gold exporting country, and vice versa cheapens gold and raises prices in the importing country experiencing the favorable balance. Thus each gold shipment operates as a corrective making it more difficult and less advantageous to sell in the lower priced, dear gold country, and easier to sellin the gold importing country with its rising prices. Give the system time to work itself out and the time will come sooner or 3

B. M. Anderson,

Market/' Cltase

Jr.,

EC0J201nic

"OUf Export Trade and the International Money

Bulletin, March 14, 1930.

AVOIDABLE CA[ISES OF

1J.\~STABILITr

237

later when the price differential will equal the tariff and goods will move in over the tariff wa ll. With this orthodox view of the tariff, the writer is in substantial agreement. How then may it be said that tariffs are operating to prohibit the pajrment of reparations and war debts, and create vast frozen credits incapable of liquidation? In the first place, the tariff fixing bodies in the various countries do not let their tariffs get old, Many nations, political parties, and tariff commissions have adopted the "cost equalization" principle, with the result that any natural tendencies operating to nullify tariff effectiveness is promptly met with tariff revisions. The continuous "merry-go-round" of protective, retaliatory, and counter-tariffs is the major characteristic of postwar tariff legislation. Through such devices, it is possible to strangle international trade and thereby prohibit the payn1ent of reparations and war debts. The acme of absurdity, in this connection, has been attained by France through the adoption of the "Quota System." Although France has been the most insistent of all that German }{.eparations be kept large and collected in full, no nation has gone so far in making such payments impossible. The quota system goes completely beyond even a prohibitive tariff, and comes to a modified form of definite embargo. Of course, no orthodox view of the tariff ever held that business and national price levels could be adjusted to such conditions as these. In the second place, the automatic gold standard, has ceased to exist. Since it was free-gold movements which furnished the major corrective for tariff restrictions, the world is robbed of its major instrument of adjustment. It might be logically advanced that the suspension of specie payment only lengthened the projection of the corrective instrument, making it still harder to sell in the country whose gold had vanished, and easier to sell in the gold standard countries. It might have worked out thus, were it not for the tariff "watch-dogs" in other countries who quickly adjusted upwards their tariffs to wipe out the new differential.

238

VALUE THEORY Al\TD BUSI.LVESS CYCLES

In the third place, we believe that the attempt to collect reparations and war debts in full, while maintaining high tariffs, must lead to an impasse, because the forces of adjustment cannot be geared to a speed high enough to keep pace with the successive payments demanded. According to the Y oung Plan, Germany "vas to pay reparations at the rate of approximately one-half billion dollars a year. On account of the Inter-Allied War Debts, and the fact that the United States "vas the ultimate and dominant creditor, Great Britain "vas to pay to the United States almost as much as she received from Germany, or $ I 60,000,000; while France was to remit a bit less than half, or $ 100,000,000. Other nations receive and remit in varying quantities and ratios." While, relatively, these represent a small fraction of the annual income of these nations, yet in the absolute they represent stupendous sums, related as they are to an international gold standard, and gold movements. Granting the general tendency for old tariffs to be counterbalanced by changes in business costs and national price levels, it must be remembered that each pay day calls for a new and further adjustment, and they come too close together for complete adjustment ever to catch up. It is like a marathon runner competing with a relay team. Just about the time the distance runner has his first man winded, he must take on a new and fresh competitor. In like manner, the long time forces working to adjust prices and costs to the tariffs, are called upon to meet new needs for adjustment before there has been complete accommodation to what has gone before. If it is to be possible for countries to do business on the gold standard, avoid a worldwide frozen credit structure, and periodic moratoriums, then reparations and debts must be radically reduced, or tariffs drastically lowered, or both. The normal forces of adjustment are inadequate to the strain created by these opposing forces. 4

England receives $ 18 1,000,000 and remits to U. S. $ 160,000)000. France " 250,000,000" " " « 100,000,000. Italy " 50)000)000" " " " 35,000,000. Belgium" 27,000,000 cc " ,,(( 7,000,000.

I

A rOfDABLE CA USES OF IlvSTABfLfTY

3.

THE NATION THAT

\\T O U L D

SELL MUST

239

Buy

During the early part of the year 1933, the people of the United States have been subjected to a tremendous "Buy American" campaign. Buy American made goods and Anlerican labor is set to work. Buy foreign made goods and American labor is thrown out of work. If America would eliminate unemployment, let her surround herself with a prohibitive tariff wall that effectively eliminates imports, thereby guaranteeing the domestic market to horne industries employing home labor. It is a plausible argulllent when given superficial consideration, but falls to the ground when tested by experience and careful analysis. It is a matter of historical record that ((the nation that icould scll rnust bu»;" Every attempt to put labor to work by reducing imports, serves to create unemployment alnong laborers producing goods for export. As Professor Alvin Hansen has wcl l said, "the balance of trade is . . . not materially affected by a tariff policy. What is affected is not the balance of trade but the -oolu me of trade." 5 From this it follows that restrictive policies which reduce imports operate to reduce exports. The table below is most illuminating in this connection. () American Exports, Imports and Foreign Loans (000,000 ornitted) E'XCf!SS

19 22 ~923

19 2 4 19 2 5 19 26 - 19 2 7 19 28 19 2 9

Exports

l m ports

3,83 2 4,168 4,59 1 4,9 10 4,808 4, 86 5 5,128

3,113

5,24 1

3,79 2 3,610

7 19 37 6 981

4,227

68 3

4,43 1 4, 185 4,°9 1

377

4,399

of

Exports

680 1,037 84 2

.L~Tf!·U)

Foreign Security Issues

63 0

267 1,047 1,07 8 1,145 1,5 62

1,3 19 759

[) A.1vin II. Hansen, EC0110JJzic Stabili-;:,atioIl ill an Unbalanced vJlorLd, p. 85. (Harcourt, Brace and Company, 1932.) "Taken frorn the Chase Economic Bulletin for November, 1932, p. I I .

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333

255

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nine months.

No one can study the figures above without observing a high correlation between volume of exports and volume of imports. It is also significant to observe that our foreign loans and security purchases exceeded our "favorable commodity balance in trade" by over t\VO billion dollars. But most significant is the fact that while our increasing- trade restrictions served to reduce imports from four billion in 1928 to one billion in 1932, our exports shrank from a little over five billion to a little over one billion, or almost exactly four billion dollars. One wonders how many laborers have been thrown out of work, and how many businesses have gone bankrupt because of this four billion dollar shrinkage in commodity exports in the brief space of five years. The major tragedy coming from this shrinkage of exports, or the inability to sell because we will not buy, has been a reduction in agricultural exports of approxirnately one and one-half billion dollars. This vast quantity of goods norrnal ly exported has been hurled back upon the domestic market, demoralized prices, bankrupting farmers, the farmers' banker and the farmers' business man. So acute has the situation become that the new Administration is led to consider the ]\llotment Plan, in order to ad just the supply to the domestic market. If the restrictions on international trade could be relaxed, permitting commerce on the seas to resume its normal volume, agriculture would need no subsidy, and the increased buying po\ver of American farmers would set in motion more labor than was ever employed in the manufacture of goods to replace foreign imports. Such are the ramifications of the tariff in our modern world. It prevents production from financing consumption, thereby contributing to maladjustrnent. It creates artificial and relatively

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AVOIDABLE CA []SES OF Il'lSTABILITY

24 1

rigid prices which fail to gravitate to the equilibrium point. It brings the settlement of reparations and Allied war debts to an impasse by blocking the only effective channel for liquidation and settlement. It operates to reduce international trade to a minimum and prostrates all business units and enterprises dependent upon foreign trade for prosperity and stability. Effective demand can come only from customers with means or ability to pay. Business is short of customers because of tariffs. The writer has listed the tariff as a major factor contributing to economic disequilibrium in general and the present depression in particular. There is great need for an International Conference that would pave the way for a general shrinkage of the restrictions on trade to the end that international commerce may be restored, and businesses find their lost markets.

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\\Te have chosen to list unstable money as one of the "Avoidable Factors" operating to create business instability. \\T e are under no delusions regarding the possibility of complete monetary stability. Absolute stability of purchasing po\ver for the standard monetary unit may be neither possible nor desirable. But we are persuaded that there is a high degree of monetary instability which can be avoided if we collectively agree that such an objective as stable money is desirable and direct our efforts to such an end. The debate is an old one, and the question still unsettled as to whether the general price level falls because of factors at work in the realm of production and consumption, i.e., the commodity world, or because of disturbances in the monetary world causing the unit of value to appreciate or depreciate. Cause and effect seem to be so inextricably interwoven that the easy, and perhaps the correct \\ray out is to say that the two act and react upon each other in a continuous cycle of causation. We trust that in our division of emphasis the factors at work in the commodity world of production and consumption have not been neglected. We wish to return, however, at this time to

24 2

VALUE THEORY

A~\~D BLrSll\~ESS

CY'CLES

a final consideration of the problem of unstable money, partially because of the importance which we attach to this factor, and partially because intelligent control may be more readily applied at this point. The world of business is keenly cognizant of the evils which have come from bad money and deranged currencies. Lord Macaulay, in his celebrated Htstorv of Engla1ul, when treating of the misery within his land in 1695, gives us the following remarkable statement: ((It may well be doubted whether all the misery which had been inflicted upon the English nation in a quarter of n century by bad Kings, bad l\1inisters, bad Parliaments and bad Judges, was equal to the rniserv caused in a single year by bad CrO\VllS and bad shillings. Whe n the great instrument of exchange became thorough] r deran 6ecl, nll trade, .111 industrv, were smitten as with a palsy, l"'he c"11 was feIt daily and hourly in almost ever:r place and by almost every class, in the dairy and on the threshing floor, hy the anvii and by the loom, on the billows of the OCC:ln and in the: depths of the mine. 1\~othing could be purchased without dispute. Oyer every counter there was wranglillg from morn inv tin night, the workman and his cruplovcr had :l quarrel as regularly as the Saturday carne around. On a fair day or a market day, the clamours, the reproaches, the taunts, the curses we re incessant; arid it was well if no hooth was overturned and no head broken." 7 a

•

•

When we recall that the misery referred to here is fast upon the heels of the Glorious Revolution of 1688; that within a single year is crowded more suffering and injustice than was experienced in the quarter of a century preceding under the "Perfidious Stuarts," when the English nation was driven for the first and only time to execute a Sovereign King; one marvels at the language of this great Historian. Y et the downward path of Russian rubles during and follo\ving the War was probably strewn with more wreckage and human suffering than was ever experienced under the tyranny of the Czars. \\Te have all heard of the aging Gertnan Professor who had laid aside one hundred t Macaulay's History of England, Vol. V., pp. 'Thomas, Chicago.)

90-1.

(Tholnpson and

AVOIDABLE CA[]SES OF INSTABILITY

243

thousand marks to care for himself and his family in his retirement. Yet the time came when those savings of a life time would not purchase an egg for breakfast. We have read of the fortunes lost in such experiments as "The Mississippi Bubble." We laugh with the facetious Southern Colonel, who in commenting upon the Confederate Currency, remarked that "the difference between the old and the new order of things is a trifling one. Before the war I went to market with the money in my pocket, and brought back my purchases in a basket; now I take the money in the basket, and bring home the things in my pocket." S The above citations have reference to experiments with irredeemable paper currencies. Y et similar difficulties in milder form are linked with the gold standard. \\T. I. King has estimated that the shrinking dollar and its counterpart in a rising price level so operated as to effect an automatic transfer of sixty billion dollars in purchasing po\ver from creditors to debtors between the years of 19 13 and 1920.9 Of course the crisis of 1920 reversed the current and in a Iew months the burden of debt was almost doubled by sudden monetary appreciation. The drastic decline in the price level during the past four years has worked similar hardships upon all debtor groups and accounts for many of the proceedings in bankruptcy, bank failures, and indeed for the rise in the suicide rate. The evils of unstable money are patent to alL Of course the question may be raised as to whether the recent increase in the purchasing power of money is due to gold appreciation or to "too many goods," in relation to effective demand. Undoubtedly the latter is a contributing factor. Yet, the monetary angle deserves careful scrutiny. Let us pause for a brief consideration of the monetary phases of the crisis of 1929 and the depression following as presented to The American Economic Association in Cleveland by Carl 8 G. C. Eggleston, A Rebel's Recollections. ,.,1aterials for the Study of Eiem entary Economics, T'wlarshall, Wright and Field) p. 495. 9 W. 1. King, "Circulating Credit," American Economic Review, VoL X, NO·4, pp. 73 8-54.

244

VALUE THEORY AND BUSINESS CYCLES

Snyder, of the Federal Reserve Bank of New Y'" ork. The first monetary factor to consider is the concentration of the ma j or portion of the world's gold supply in two countries, the United States and France. The United States gained a billion dollars in gold during the War and another billion and a quarter in the six years following. This concentration of the world's gold supply was going on while the various nations were making the painful trek back to gold culminating in the final re-establishment of the gold standard. The maintenance of the gold standard "vas extremely difficult with unfavorable trade balances in some instances and unbalanced government budgets obtaining quite generally. "While other countries were struggling to escape from the demoralizing influence of huge paper money circulations, this country was able to indulge in a considerable monetary inflation after 192 I, on a gold basis; and there seems little reason to question that then, as always, this was one of the dominating factors that made possible a period of such great . . . prosperity." 10 Directly associated with this, or resulting from it, was the speculative mania which struck the securities market in 1929. As a result it became necessary to screw up the discount rates quite materially as a means of curbing the speculative mania, This sudden and substantial rise in the interest rates constitutes the second major factor in the monetary realm, operating to cause the crisis, because of its effects upon gold movements and interest rates abroad. Says Snyder, "When, in consequence of the lure of rising share prices and our rising interest rates, we began again to draw gold heavily from other countries which could ill afford to lose it, there teas the beginning of the disturbance. (Italics mine) When finally interest rates rose here to extreme figures, this cut off foreign loans in this country, and, on the other hand, forced almost all the cen tral banks of the world likewise to raise their discount rates to figures prohibitive to free 10 Carl Snyder, "The World-Wide Depression of 1930," TIle American Economic Review, Supplement, VoL XXI, No. I, March, 193 1, p. 175.

A rOIDABLE CA USES OF IJiSTABILITY

borrowings by merchants. The result was a severe crrmp in almost every nation all around the world." 11

245 ))1

credit

Thus do we observe how a concentration of gold in France and the United States laid the foundation for a period of superprosperity culminating in a riot of speculation, which in turn made necessary the imposition of high interest rates, which in turn made credit tight, causing money to appreciate and prices decline, thereby ushering in one of the major financial depressions of history. The vital point to be noted in this connection is that all these things happened under the gold standard. And since October, 1929 the gold dollar has appreciated 35%.1~ Furthermore, the movements of international trade, the international debits and credits gro\ving out of the \var, and the flight of gold from the "shaky" monetary centers have served to drive one nation after another off the gold standard. The inference is clear. The gold standard fails to furnish a stable unit of value, and has ceased to be automatic in its adjustments to world trade and commerce. Both the need for, and the problem of "managed money and credit" is before us. To attempt to dodge the responsibility and follow a policy of laissez-jaire is to prolong economic chaos and business instability. The suggestion that an approach to greater stability in business be made through credit, currency, and monetary control continues to carry with it a suggestion of the visionary or fantastic. Yet actions are being taken almost every day in banking and governmental circles which bear directly upon credit and indirectly on the value of the monetary unit. The decision of the Federal Reserve Banks in the autumn of 1929 to take some action that would damp down the speculative mania in the securities market, was a volitional and deliberate act of credit control. A very definite degree of power would seem to lie with 11 1~

uu., p.

175.

According to the M ontlily Labor Reoieno, the wholesale index number has fallen from 97 in October) 19 29 to 62 in December, 1932.

246

VALfJE THEOR}" AATD BUSll\TESS crCLES

the directors of every Central Banking System. The practical problem is to discover how to apply it properly and to what ends. On this point we wish to quote from Professor Cassel. There are many people who, against all-even the most rationally conceived-schemes for restoring normal exchange conditions, raise the objection that it is no use introducing artificial remedies, that developments must be allowed to take their course and that time alone can repair the damage that has been done. It is a rather cheap kind of wisdom that finds expression in utterances of this sort. Anyone who closely studies the exchange problem will soon discover that it is practically impossible for either the state authorities or the central banks to avoid exercising an influence on the nl0netary system of the world. In sonle \vay or other policy will always affect its development. Is there any reason for calling this influence a natural one when it is poorly thought out or else dictated by harmful political motives, while describing it as artificial when it is a link in a chain of systematic endea vor to provide .1. rational solution of the monetary problem r All civilization presents one mighty effort of man to OVerCOlTIe difficulties instead of passively allowing himself to be carried a\vay by them, At the present moment the future of civilization rests in no small degree upon this central will to conquer being able to assert itself in the sphere of money." 13

Beyond question, credit and currency control by the Central Banking Systems can and is being exercised in such a way as to affect the purchasing po\ver of money. On this point the Federal Reserve Bulletin for October, 1919, stated that "The objects to be obtained are . . . clear and vastly important. They are to regulate the volume and uses of credit so as to give the productive industry at all times the beneficial effects of credit stimulus and support, without however, opening the way to the costly evils of credit and price inflation." 14 When the Federal Reserve Board faced the concrete situation arising out of the credit inflation during and follo\ving the war, the announcement was made through the Bulletin that 13 Cassel, Money and Foreign Exchange after 1914, p. 2&2. (Concluding paragraph of the book.) 14 Federal Reserve Bulletin, October, 1919, Vol. V, p. 9 1 1.

A"VOIDABLE CAUSES OF INSTABILITY

247

"T'he problem of red ucing the cost of living is, however, mainly that of restoring the purchasing powe r of the dollar. The dollar has lost purchasing power because expansion of credit, under the necessities of war financing, proceeded at a rate more rapid than the production and saving of goods. The return to a sound economic condition, and one which will involve as little disturbance of normal relationships as possible, will be reversal of the process which has brought the country to its present pass. In other words, the way in is the way out." 15

The same issue stated that "To accept the depreciation worked in the dollar by war conditions, and to standardize the dollar of the future on that basis, would be to ratify the inflation wrought by the war and the injustices it produced." 16 Reg~.rding the technique by which this objective might be achieved, they observe that "The usual method of restricting the und ue use of the rediscount privilege is to advance rates. This policy would have been put into operation several months ago except for its bearing upon Governmerit financing. . . . . The advance in discount rates by Federal Rcser,'c Banks announced early in November, was intended as a warning to the community." 17

With respect to the famous Quarterly l\Jeeting of the Federal Reserve Board in May, 1920, the minutes carry this item.

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"With reference to the immediate measures to be taken by the Federal Reserve Banks, the Advisory Council recommended the plan of 'urging upon member banks through the Federal Reserve Banks the wisdom of showing borrowers the necessity of the curtailment of general credits, as well as continuing to discourage loans for capital and speculative purposes; by checking excessive borrowings through the application of higher rates.' " 18

After six months of deliberate and volitional credit control, it was possible to state in the July issue of the Bulletin that 15/bicl·,P·9 14· 16 I bid., p. 9 I 5. 11

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1108.

24 8

VALUE THEORY AND BUSINESS CYCLES

"Beginning with November, 1919, effort was definitely made to control the reserve position through the application of higher rates of discount at Federal Reserve Banks. "T'he general conclusion to be drawn is unmistakably to the effect that the operation of credit control through the higher discount rates had been a marked success." 19

The purpose in presenting these various quotations issued from month to month during a critical monetary period is that we may observe the conscious, premeditated efforts on the part of the Federal Reserve Board to curtail speculation and move the purchasing po\ver of the dollar back towards its pre-"\\'ar strength, by managed currency and credit control. The power "vas exercised and the results were in line with expectancy. The writer has no comment on this control policy, further than to say that the same power existed one year earlier, and business would have been saved from much of the severity of the crash of 19~0, had the restrictive measures been applied a year earlier. The Board admits as much but shows how it delayed in deference to government financing. The Victory Bond Issue was probably floated at a lower interest rate on account of this "deference." But it was "cheap interest" dearly purchased. The point may be made that the gravitation of the gold reserve to the minimum legal limit made such action imperative in 1920, whereas it was optional in 1919. This is quite true, but if so, it gives concrete significance to the point presented earlier 20 that the Banking Powers tend to wait for the emergency before applying the brakes, and then set them too suddenly and rigorously. If it be argued that business men would not tolerate the use of arbitrary power by bankers except in the protection of the gold reserve, or the maintenance of bank solvency, then the problem involved is not economic and the economist has little to say. Our objective is to set up sign-posts which will direct busi19 20

Ope Cit., July, See above) pp.

1920, 19 6-

pp. 663 and 665. 7.

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AVOIDABLE CA fJSES OF INSTABILITY

249

ness over a safer and smoother road. If the "Tour Conductors" prefer to take their parties over the hillier and rockier road with its jolts and bumps we do not presume to prevent them. But in such case, the Economists must not be accused of incompetence; of being incapable either of making a correct diagnosis, or of prescribing a remedy for the malady. As Schumpeter facetiously remarks, "In cases like the one before us economics is not inferior to medicine, either in diagnosis or in remedial advice. The difference and the difficulty lies in the fact that our patient will not take what we might be able to prescribe." 21 In connection with credit and currency control, one point should be kept clearly in mind. The controls, such as the discount rate and open market operations are delicate instruments, whollv incapable of handling emergencies. Their po\ver is limited. They are most effective under "normal conditions." They break down in time of war, and lose effectiveness in the presence of major crises and the depressions following. Deranged currencies resulting from war and the wholesale insolvency of governments defy control. As stated above :22 the controls may serve in normal times to keep the car of finance between the cliff and the precipice, but are of no avail when a volcanic eruption tosses vehicle, driver and controls allover the railing. If we wish a safe journey we must avoid the road that goes by the volcano. If we desire business and monetary stability we must steer clear of the road that leads to war. Furthermore, as brought out by Fisher and Keynes, the forces of control are much more effective in preventing inflation and speculation, than in terminating depression. If we would avoid such years as 1931 we must also avoid such years as 1929. If we treat ourselves to a 1919, we must accept 1920. The evidence is abundant that restrictive appliances were available in the speculative years-in fact were ultimately brought into use-which could have been effectively used much earlier. 21 Address made to The American Economic Association in Cleveland, December, 1930, Sec Proceedings. 22 See above, p. 19 2 •

250

VALUE THEORY AND BUSINESS CYCLES

WAR AND BUSINESS INSTABILITY

Last, but not least, in the ((Great Triumvirate" making for business instability is War.. We have just finished our treatment of the problem of unstable money in its relation to business instability, and the need for correction at that point. But stable money remains a mirage of the desert, a quixotic fantasy so long as international difficulties are settled by means of war . Every statistical and business forecasting bureau portraying business conditions over an extended period of time clearly reveals the periods of war and the years following as the years of maximum instability. The procedure is quite simple, and regular. First, comes the instability arising out of the sudden shift of men and industries from peace to a war basis. Long time planning is impossible, patriotism takes precedence over pondered business judgment, errors in judgment are more numerous and wider of the mark. All is flux and change and uncertainty to the entrepreneur till the shift has been made from peace to war and back to peace again and the return of normal business. But the greatest source of instability comes through derangement of the currencies.. War costs throw governments into deep deficits. While taxation is usually increased, the major increase in expenditures is met either by the sale of bonds on a vast scale, or direct inflation of the currency or both. The price level mounts rapidly, money depreciates, speculation runs riot, and if the war continues long or attains major proportions, specie payment is suspended, savings shrink in value, creditors are ruined, while the financial backbone of the nation becomes weakened by the silent seepage of wealth attendant upon the debasement of the currency. Yet there is a temporary and tonic effect from inflation and a rising price level, which yields a feeling of buoyancy and dynamic business. Human nature reveals itself in a buying mania because goods, securities, and real estate are appreciating while money is depreciating. Business never attains such dynamic levels as are revealed in war time when the printing presses are

AVOIDABLE CAUSES OF INSTABILITY

25 1

rolling out currency, prices are rising and money depreciating. The method of drastic taxation by inflation is painless for the moment and the 4:4:patient" feels temporary exhilaration. Sooner or later hostilities cease, an armistice is signed and then begins the painful trek 4:4:back to gold." Currencies are con.. tracted, depression strikes with death dealing suddenness as money appreciates, prices fall and taxes increase. This abnormal fluctuation in the currency greatly magnifies the usual amplitude of the business cycle as it moves through the phases of prosperity, inflation, speculation, crisis and depression. So deeply does war penetrate the monetary and business structure, it is impossible to return to '4:normalcy" for a considerable period of time. The \\Torld \\! ar is proving no exception. To the extent that it was wider in scope and more costly in men and money than any previous war, the past fifteen years have yielded a measure of instability, currency chaos, and governmental stress to a degree never before experienced. The devastating prostration of the present depression is definitely linked with the W or ld War" If we look to the gold shortage and England's recent desertion of the gold standard, followed by other desertions throughout the world, the root cause is the war. Germany's financial debacle linked with reparations and currency derangements lead back to war causation. The virtual insolvency of governments, the Debt Moratorium, and the terrific losses of International and Central Banking Systems are the effects of the war. Further complicating and aggravating the situation are the crushing tax burdens which the war entailed. Unquestionably, the greatest cause of business instability, maladjusted production and consumption, depression and unemployment, deranged currencies and wildly fluctuating price levels, is war. Therefore, any serious consideration of the problem of business and monetary stabilization must place high in the list of objectives the ELIMINATION OF WAR. War is bad business. It will be readily granted that modern wars are not business

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THE CHANGIKG PRICE LEVEL

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AVOIDABLE CA"(JSES OF INSTABILITY

253

enterprises entered into deliberately for "booty and beauty." Rather are they fought for national honor, self defense, democracy, etc. Such are the slogans of the patriots and the patrioteers, Were the idealistic goals achieved, it migh t be admitted that war is bad business but good et/2ics. Yet every Peace Conference following the armistice faces a thicket of problems, vastly more complex and difficult of solution than any presented before hostilities began. \\7 ere half the brains given to the settlement of the pre-\var problems by pacific means that are required to cope successfully with the post-war problems, there would be no war.. Given a generation of men and women and governments unequivocally committed to the outlawry of \var; resolved that no matter what the provocation, there shall never be resort to the arbitrament of war, but all international questions must be settled by pacific means ;-given these conditions for an extended period and business would gravitate towards a normal dynamics; would reveal oscillations milder in their swings; the normal controls available to Central Banking Systems would be more effective j errors in judgment would be less erroneous; risks would be reduced, losses lessened, and the rate of profit smaller but more certain.

CHAPTER XVIII

AMERICA GOES OFF THE GOLD STANDARD SINCE writing the preceding chapter with the section on aUnstable Money" the seemingly impossible has happened. At one of the most dramatic moments in American History the United States was suddenly knocked off the gold standard. The largest creditor nation in the world with the lion's share of the gold supply has found itself in the grip of a banking panic culminating in a general run on the banks from coast to coast. The first act of a new President of the United States, Vias the declaration of a national emergency and the temporary closing of all banks in the country. The first official act of the new Secretary of the Treasury was "Suspension of Specie Payment." Not even a gold certificate may be redeemed in coin. In bringing this crisis to a climax three specific factors contributed, in addition to the more general causes of business instability, as presented in the last two chapters. I. A Technical Weakness in the Gold Standard. Since the dollar is a standard of value, then the first and foremost requisite of the dollar is stability of value. Yet the dollar is an outlaw in the realm of measurement. It is the only unit of measurement which has not been stabilized.' The standard of length has a fixed length. It is a bronze bar in a glass case, which at a certain temperature is a yard long. The standard of weight has a fixed weight. The avoirdupois pound, under certain atmospheric pressure at sea level weighs a pound. The standard of volume is a fixed volume. The standard of area has a fixed area. But the standard of value has a fixed weight. For almost one hundred years the dollar has been 23.22 grains of gold. 1

Note: No unit of value has been stabilized. 254

AMERICA GOES OFF THE GOLD

STAJv~DARD

255

But gold is a metal like copper, silver, steel, and aluminum. Like all other metals, the value of gold is governed by the laws of demand and supply, and by costs of production. It follows, therefore, that a gold coin of fixed weight must vary in value. By consequence, the value of the gold dollar has been fluctuating almost continuously, sometimes mildly and sometimes wildly. The most violent fluctuations have occurred during the past two decades. Part of the time it has been appreciating and part of the time depreciating, but since the latter part of 1929 there has been a continuous and phenomenal increase in the value of gold, or the purchasing power of the gold dollar, with a corresponding price decline. ~ The Stable Money League was correct when it had for its motto "T'h» only sound trtoney is stable money." Therefore a gold monetary unit of fixed weight and varying value has an inherent, technical weakness as a unit of measurement. This weakness has been peculiarly evident the past three years. Commodities, securities and real estate continuously depreciated in the hands of all who held them. Virtually all entrepreneurs attempting to carryon in the usual manner, found that prices fell so fast between the time when commitments were made and the time when the goods could be marketed, that it was almost impossible to engage in any enterprise without loss. Goods spoiled in the hands of all who held them, or burned the fingers of all who touched them. The one exception was money. All who held money experienced the gain of appreciation in purchasing power. Under the circumstances, the stars in their courses decreed that hoarding would become one of the nation's major enterprises." 2. An Intolerable Banking System. In addition to a defective monetary unit, the United States has been cursed by a defective banking system. First, and foremost, is our dual system of state and national banks, linked with dual sovereignty in government, federal and state. 2 Note: It need not be inferred that the entire price decline has been due to gold and monetary appreciation but the evidence is clear that this is true to a marked degree. 3 Note: For a fuller treatment of this point) see above, pp. 170 fl.

256

~'ALUE

THEORY AND BUSIJ.VESS CYCLES

Incompetent bankers and pernicious banking practices have been tolerated among national banks, because, if regulations were made too stringent, the national charters would be surrendered and state charters secured. Consequently, the Federal Reserve Banking policy had to be toned down to keep in step with state banks, which in many instances were insufficiently controlled or regulated. Second, the American flare for rugged individualism and personal independence, has led us to cling to the single, independent bank . But the independent bank reveals weakness at a number of points.. It frequently lacks the investment wisdom and experience, necessary for sound banking-experience which would be readily available, in fact demanded, under branch banking.. Again, the local banker is frequently compelled to make investments and carry risks, which he would prefer to avoid, but fears the ill will of some dominant local business man. These are inherent in independent banking, and can be.remedied only by the establishment of branch banking, which makes expert counsel available and local pressure of little avail. A third, and wholly devastating arrangement in recent American banking policy is that of «Security Affiliates" associated with regular commercial banks . It would take us too far afield to give an exhaustive analysis of all that is involved in this connection.. Suffice to say that this arrangement is at the bottom of the National City Bank scandal involving Charles E. Mitchell and Hugh B. Baker.. It is the evil which Winthrop \V. Aldrich, new President of the Chase National Bank, seeks to remedy by his sweeping proposal to divorce all commercial banks and investment affiliates.. 4 It is the matter of major concern for Senator Glass as he presents his banking reform bill to Congress.. The inherent evil arises out of the fact that those who manage the commercial banks and deal with depositors that come to them for investment counsel, are also the same men who manage the security affiliate, organized for security speculation and .. See Commercial and Financial Chronicle, March

11)

1933, p. 1603_

\

AltIERlCJ GOES OFF THE GOLD STAJiDARD

257

brokerage fees. As commercial bankers they are supposed to al\\rays advise depositors seeking investment counsel, in the buyers' interest. I\.S managers of the investment affiliate, they promote the sale of all weak securities which betray signs of souring on their hands. By consequence, depositors have bought, upon the advice of their o\vn banker, the weakest securities in the whole investment portfolio of the "Investment Affiliate." The arrangement creates a situation, impossible with the best of men, and intolerable with the worst of men. Banking is based upon credit, and credit is based upon faith. Depositors cannot keep faith in banks and bankers when the financial interest of the banker runs counter to the interest of his depositor. It is a reasonable inference that one of the reasons for the banking panic and the desire of depositors to remove their deposits wholesale, \NaS due to the revelations of the interrelations between the depositor's commercial bank and the "Investment Affiliate." Congress should lose no time in enacting the legislation proposed by Senator Carter Glass in this connection and strongly seconded by Aldrich of the Chase National Bank. 3. Liquidation Has Failed to Liquidate. A third reason for the collapse of our banking structure and loss of the gold standard, was because liquidation had failed to liquidate. The normal era of speculation and overexpansion corrects itself by passing through a period of deflation and liquidation. When prices have been carried to speculative heights, not justified by earnings; when plants have been overexpanded, not justified by consumer demand; when ~rages, interest, and overhead costs have been carried to heights which cannot be permanently supported; then liquidation and adjustment of costs and prices to fundamental conditions, represents the quickest and surest road to equiiibrium and renewed prosperity. Two factors have interfered to block this usual adjustment. The depression has been world-wide, and the forces at work quite decidedly international in their scope. The recent years have witnessed so great a growth in Cartels, price maintenance

,

25 8

VALUE TIIEORY

Al\~D

BUSIl"./ESS CYCLES

combinations, and a world-wide net-work of high tariff barriers, that the price structure is a strange patch-work of frozen and liquid areas." Therefore, when the forces of deflation and liquidation hit the price structure, competitive prices fell, but controlled prices did not, or at least failed to make the proportionate ad justmcnt. The result is, that whereas, one of the functions of liquidation is to bring prices into ad j ustment and balance, at the end of three and one-half years, prices in basic industries are further out of line than at the start. Hence, prosperity has not returned. If liquidation is to yield recovery, the governn1ent at Washington, and in other Capitals, must invent a technique for liquidating frozen price structures. But the major reason why liquidation has failed to liquidate, is because of the abnormal volume of indebtedness. In addition to the normal indebtedness which arises out of a prolonged period of prosperity and speculation, there is added the vast internal debts, Inter-Allied Debts and Reparations gro\ving out of the W orld \V ar. Moreover, none of these debts or investments, served to create productive equipment such as railroads, or factories, which would yield revenue and be self-liquidating. They were debts incurred wholly in destructive enterprises, which left nothing behind to yield dividends or funds for amortization. Y et, the major task of any period of depression, is that of debt liquidation, and recapitalization of industries on the basis of normal business and profits. The Deflation Spiral. G We n1ay neglect at this point the cause of the crisis in 1929, as we are concerned only with the process of liquidation. Suffice to say that the crisis caught the nations of the world with vast external debts, and the United States with an internal debt situation never before approximated. Recounting some of the major sources of these debts we n1ay list securities purchased on thin margins, in the bull market days of 19 2 8 and '29; the unliquidated carry-over in farm and real estate mortgages from 1919; new bond issues, railroad and industrial; 5 B

See above, pp. 220 ff. See Irving Fisher's B 00l1U and Depressions, p.

25

:£f.

AMERICA GOES OFF THE GOLD STANDARD

259

and the pyramid of government debts, composed of Liberty Bonds, road bonds, school bonds, etc., owing by federal, state and local units. It was upon this top-heavy, unstable financial structure that the liquidation process began late in 1929. Forced selling first came from those who were dealing on the thinnest margins, whose equities had been five, ten, or twenty percent. But the volume of indebtedness of this type was so large, and the forced selling so heavy that by the time they were liquidated, prices had fallen until those dealing on a thirty percent margin, were compelled to cover or sellout. When this forced selling had taken place, the price structure had fallen till those dealing on forty and fifty percent margins were forced to cover or sellout. This deflation spiral has continued until ((blue chips" such as General Electric, United States Steel, and National City Bank have fallen over 905!c, which means that an equity of 90% in many instances finally involved forced selling. What happened in the securities market, took place in a similar way in the field of farm mortgages. Forced sales drove down the price, falling prices made necessary more forced sales, and so on down the deflation spiral. The liquidation of each layer of indebtedness entailed so much forced selling that the consequent price fall operated in such a way as to freeze the next layer. Therefore, at the end of three and one-half years we appear to be no nearer the end of liquidation than at the beginning. Had the ratio of debts to wealth been smaller, as is true in the normal cycle, then forced selling would have grown less and less and liquidation would have found its logical stopping point. The normal spiral is shaped like a cone) and descends to a stopping point. But the spiral of the past deflation period has been a cylinder. Each frozen layer appears to be as large as the last one liquidated. The major reasons are, first) volume and second, war debts, which created no debt-liquidating enterprises. A second angle to the deflation spiral involves the institutional instruments and techniques for handling liquidation. At the heart of the structure are our banking and investment houses. Through loans to depositors and investments in securities, banks

260

llALUE THEORY AND BUSINESS CrCLES

are automatically linked with the general business situation. The falling price level operated to wipe out profits, and the deflation spiral drove borrowers into bankruptcy, and bonds to a heavy discount, First, the weaker banks failed, then those that were stronger. Since 1920 approximately 11,000 banks have failed with losses in the neighborhood of eight billion dollars for the depositors. Of course, most of these failures have come since the crisis of 1929. At the same time, the financial position of all banks were weakened, as they became the unwilling owners of real estate, and the possessors of many non-interest bearing investments. The general knowledpc of the weakened position of banks led to heavy withdrawals and hoarding. But this too, runs in a vicious circle. Increased withdrawals, necessitates forced selling by the banks of its best and most liquid assets. Bonds, stocks, and real estate fall still further which weakens the banks and stimulates increased withdrawals, The logical culmination carne with a general run on the banks and the bank moratorium, beginning March 4, 1933The other instrument playing a major role in the process of liquidation is the monetary unit or standard of value. Every period of liquidation, carrying with it a general fall of the price level, works an automatic appreciation in the value of the monetary unit. This is an additional reason why liquidation may not liquidate. If the volume of debt is sufficiently great, as it apparently was in 19:!9, then a liquidation of 40% of the dollar indebtedness may involve enough forced selling to force the price level down 401~. If so, the economic burden of debt, has not been eased in the slightest. We have only run as fast as we could in order to stay in the same place. But there is a by-product of monetary appreciation which is highly significant. Since virtually all securities and commodities are falling and profits are negligible, and deficits the rule, men cease to be entrepreneurs in so far as it is possible and become quiescent capitalists. They attempt to convert their property or holdings into money, rather than engage in business, This is the

AMERICA GOES OFF TIlE GOLD STANDARD

261

stage in the depression when bank deposits rise. But, if prices fall too far, faith is lost in the banks, and there is faith only in the appreciating dollar. This is the hoarding stage. If the gold standard is operating, but the government is doing deficit financiering, some lose faith in fiduciary currency, and the final stage is gold hoarding, terminating in the suspension of specie payment, and departure from the gold standard. The period since 1929 has carried us through all of these stages. With an embargo on the export of gold for foreign account, and the suspension of specie payment at the treasury on gold certificates, the United States is definitely off the gold standard. If liquidation has failed to liquidate and deflation has brought us to our present pass (or impasse), what is the constructive way out r It was not the original intent of the writer to present another "plan J J for getting us out of the depression. It was intended that the book should deal-as its title indicates-with "Value Theory and Business Cycles." A substantial portion of the work had been finished before the crisis of I9~9. However, the study would appear to furnish some background for a few suggestions in the present crisis. We trust we shall be pardoned by any reader who has followed the analysis through for its theoretical content, if we cross over for the moment into the field of specific prescription. First, and foremost, we see little to be gained in the immediate future, from laissez-faire and the inherent workings of the automatic forces. We have neither the competitive conditions, nor the resilient price structure to which these forces are adapted. If costs and prices are to be further liquidated, it must be, as indicated above, by governmental intervention in the fields of monopoly and controlled prices, where the relative adjustments have not yet been made. These adjustments are essential to that balanced economy, from which prosperity emerges. In the second place, the liquidation of the future should involve as little forced selling as possible, for forced selling has perpetuated only the vicious circle. The new banking arrangement would appear to be admirably suited to accomplish this

262

VALUE THEORY AND BUSINESS CYCLES

desired end. Prior to March 4, a run on a bank forced the bankers to sell their most liquid ~ssets in the open market and convert them into cash. Under the new arrangement, good collateral may be sent to the Federal Reserve Bank in exchange for currency, similar to the old Federal Reserve Bank Notes. Since they rest upon sound collateral, rather than on a specified gold reserve, there would appear to be little need for a forced sale of good securities by a solvent bank, in order to supply depositors with currency. Furthermore, the presence of such a banking alternative, should lead bankers to return to normal banking functions, part of which is loans and investments, rather than being concerned wholly with liquidity. Finally, there should be no attempt to return to the gold standard until the forces of liquidation have thoroughly spent themselves and business is definitely on the road to recovery. There can be no business recovery on a rapidly falling price leveL If there are forces at work in the realm of production and consumption, or debt liquidation which tend to drive the price level lower, then currency management should be used to offset it. Such management was impossible with the gold standard, due partly to the peculiar distribution of gold in the world and also to manipulations on the foreign exchanges. Furthermore, the technical weakness in a monetary unit of fixed weight but variable value makes it a disturbing factor rather than a stabilizing factor in a period of deflation or liquidation. It is quite conceivable that the peace-time experiments now being made in the world with a managed currency may lead to a tabular standard of value superior to the gold standard. At least the experiment should teach us how to manage the gold standard itself in such a way as to yield a higher degree of monetary and business stability.

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REFERENCES CITED IN FOOTNOTES Aftalion, A. "La Rcal itc des Surproductions Generales," Reiu» d' Eco!1omie Politique. 19°9. -Les Crises Pcriodiques de Sur-production, 1913. -L'CEuf{}re Ecottotnique de Simon de de Sismondl, 1899. Anderson, B. M. "Our Export Trade and the International Money rvlarkct, Chase E conomic Bulletin, March, 1930. -"The Business and Financial Situation," Chase Economic Bulletin, March, 1930. Bohm-Bawerk, E. Karl Marx. 1898. Bonar, James. Letters of R icardo to M althus, 1887. Campbell, A. The True Greenback. 1868. Cassel, Gustav. Money and Foreign Exchange after I9I4. 1922. Ely, R. T. Property and Contract. 1914-. Eggleston, G. C. A Rebel's Recollections. I 875. Fisher, Irving. The Purchasing Pozcer of Mones, 191 I. - The Rate of Interest. 19 0 7. -Stabilizi1zg the Dollar. 1920. -Booms and Depressions. 1932. -The Money Illusion. 19 28. -"Our UnstabJe Dollar and the So-Called Business Cycle," Journal of the A merican Statistical Association, June, 1925. Foster, William T., and Catchings, Waddill. Money. 1923. -Profits. 1925. -The Road to Plenty. 1928 . Francis, John. Histor)' of the Bank of England. 184-7. Garver, F. B., and Hansen, A. H. Principles of Economics. 1928. Gide, Charles, and Rist, Char lese History of E conomic Doctrines. 19 15. Hansen, A. H. Btuiness Cycle Theory. 1927. -Econollzic Stabiliz.ation in an Unbalanced World. 1932. Haney, L. H. History of Economic Thought. 1920. Hayek, F. A. "The Paradox of Saving." Economlca, May, 1931 . -Prices and Production, 193 I. Irving, Washington. "The Great Mississippi Bubble" from Wolfert's Roost. 1861. Kellogg, Edward. Labor and Other Capital. 184-9. -A Nezv Monetary System. 1861. Keynes, J. M. A Tract on Monetary Reform. 192 3. -A Treatise on Money. 1930. -"The Originating Causes of World Unemployment," Unemployment as a rVorld Problem, Harris Foundation Lectures, 1932. 263 )1

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REFERENCES CITED IN FOOTJ-.,70TES

Knight, F. H. Risk, Uncertainty, and Profit, 1921. King, W. L "Circulating Credit,'~ A merican Economic Ret'leu', \'01. X, NO·4· Lauderdal e, The Earl of. A n Inquiry into the Nature and Origin of Public Wealt», 1819. Macaulay, T. B. History of England. 1849-55. MacLeod, H. D. Theory and Practice of Banking. 6th ed., 1902-1 I. Malthus, T. R. Principles of Political Econom», 1821. Marshall, Alfred. Principles of Economics. 1 9~20. Marx, Karl. Capital, Kerr's Edition. 19°9-12. - The Poverty of Philosoph», 1847. Mill, J. S. Principles of Political ECOJlO1Jl~'. De Luxe Edition, 1906. Mitchell, W. C. Business Cvcl»), 1913. -,,\\-rhat is Stabilization," Address at Nineteenth. A nnual Meeting of t h c ChaJnber of Commerce of tIle Uriit ed States. 193 I. Moulton, H. G. and l\lcGuire, C. E. Cerrn anv'» Capacity to Pa», 1923. Owen, Robert. Life of Robert Gzcer: by' Himself. 1920. Patten, S. N. "Malthus and Ricardo," Publications of the American Economic Association, Vol, Il'. 1889Podrnore, Frank. Robert Otcen, 1906. Proudhon, P. J. C ontradictions Economioues, 1846. Ricardo's If/orks) McCulloch's Edi tiona 1888. Robertson, D. H. "Review of Aftalion's Work," E ronomlc J ournol, 1C) 14. Say, J. B. Tralte d'Economie Politique. 1826. -eEut'res Dloerses, 1848. Sismondi, Simondc de. Nouoeaux Prlncipes Ti'Economie Politique. 1827. -Political Economy and Pliiloso-ph», (Translated by 1\1. Mignct ) 1847. -Etudes sur L' Economic Polltioue, 1837-8. Smith, Adam. Wealth of Notions, 1776. Snyder, Carl. "The World Wide Depression of 1930," American Economic R etieso, Supplement. March, 193 I. Tugan-Baranowsky, M, Studien zur T'heorie und Ceschichte der Handelskrisen in Enf}alld. 19°1. Wiston-Glynn, A. W. John Law of Lauriston. 1907. A merican Labor Legislation Reoieza, March. 1928. "War and the Changing Price Level." Federal Rcseroe Bulletin, October, 1919, December, 1919, June and July, 1920. C ommercial and Financial Chronicle, March II, 1933.

INDEX

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INDEX Aftalion, A., 19, 21, 142-56, 213-6, 221. Theory of crises, 145-9. Theory of business cycles, 15°-4. Aldrich, W. W., 256, 257. Allotment Plan, 240. America-off the gold standard, 25462. Anarchists and anarchism, 58, 80-9 2 • Anderson, B. I\1., 233, 236, 239. .A ngell, Nonnan, 235. Anti-Trust Laws, 228. Arkwright, R., 18. Assignats, French, 75,108, 113. Austrian School, 14, 135, L t 3, Lt·+, 2 I 5. Baker, Hugh B.) 256. Banking Irresponsibility, 195. Tardy interference and over-interference, 196. Banking System, Intolerable, 255. Banks. Amsterdam, 62. Ayr Bank, Scotland, 74-. Currency Principle, 61. Bank of England, 64, 68, 194. Bank of Norway, at Drontheim, 62. Bank of Venice, 62. Banks of Partial Reserve, 63. Hamburg, 62. Barter Economy, 137 ff. Bohm-Ba we rk, E. von, 52, 54, 9 1, 143· Bonar, Jamcs, 3, 122, 214. Budget, balancing, 183Business cycles, I I , 13,14,30,31,39, 4 6,55,5 6,97,9 8,119,120,13 6, 137,15 0-4,168,174,17 6, 187, 260.

Business equilibration, 219-31. Business instability Avoidable causes, 232-53. Unavoidable causes, 219-3 I. Campbell, A., 100, 110. Cassel, Gustav, 189,204-,246. Catchings, \V., 157-68. Chamberlain, Lord, 69-72. Chemical Theory of Exchange, 83, 9 1,108-9. Circuit flow of money, 160- I. Commercial crises, 15,24,26,3°,35, 39,49,53,5 6,79,9 0,110,135, 13 6,137,14-5-9,168,17 6,197. Commodatum, 59, 66. Commodity tickets, 58-60, 66. Commodity value-tickets, 58, 60-1, 66. Compensated Dollar, 185, 189. Confederate currency, 243. Consumers' Fund, 164. Costs, Prime, 221,222. Supplementary, 222. Credit expansion, 163. Currency, early types, 58-66. Davenport) H. J., 135. Deflation, 172, 199, 258. Deflation spiral, 25 8• Demand. Involuntary failure, 13 1, 135, 15768. Voluntary failure, 13 1, 135, 14256. Law of demand and supply, 8, 10, 24-, 35, 37, 51, 52. Depression. General, 137, 21 3. Partial, 137, 21 3.

INDEX

268 Dilemma of Thrift, 159-62. Diminishing utility, 146-9, 21 3- 5. Dynamic state, 219.

Engels, F.) 5 L Ely, R. T., 61. Errors in judgment, 17, 150 H., 167. Fisher, Irving, 169-92, 197,198,210, 2 16, 249. Ford, Henry, 1 I I. Foster, W. T., 157-68Francis, John, 73. Freedom of Competition, 10, IS, 18, 219,23I. French Revolution, 35Frozen price structures, 220. Garver, F. B., 225. Germany's capacity to pay, 234-. Gide, C., 80, 8 I. Glass, Carter, 256, 257. Gold reserves. Elastic, 194. Rigid, 194-. Gold Standard, 183, 184, 197, 200, 262.

Technical weakness, 254Goldsmiths, 59-62, 67. Great Tri urn viratc, 232, 25 0 • Greenbackisrn, 58, 100- 1 5.

Institutional frictions, 168,221. Interest rate, 174-8. Investment affiliatcs, 256, 257. Iowa fanners, 222. Irving, Washington, 67.

j'cvons, S., 143, 145Kellogg, Edward, 100- I 5. "Father of Greenbackisrn," 1 00. National Safety Fund, 100 ff. Safety Fund Notes, 102. Nature of Inoney, 104. Amount of money needed, 107. Keynes, J. M., 18 5, 193-209, 216, 221) 249. King, W. 1., 2+3. Knight, F. H., 219. Labo r-tirnc note, Frontispiece, 94. Laude rdale , Lord, 8,14 2-3,145. Lausanne Agreerncnt, 235. Law, John, 67-79, 97. "Law ism, " 5 8) 6 6, 6 7 if., 7 8- 9, I 12-5. Experiments in "Lawisrn," 72-7. Law of Markets, 144-9, 231. La\v of statist ical regularity, 63. Liquidation fails to liquidate, 257. Lump of labor theory, 21 I. Macaulay, T. B., 242.

Malthus, T. R., 3, 4, 5, 8, 13,

Haney, L. H., 143. Hansen) A. H., 150,

168,2.21,225,

239-

Hayek, F. A., 167-8. Criticism of Foster and Catchings, 16 7- 8 . Criticism of Keynes and "Managed Currency," 203-9. Historical School, 36. Hoover Moratorium, 235. Industrial Revol ution, 16) 29, 35. Industries de luxe, 29. Inflation, 40, 98, 113, 17 2 , 199.

1 19-36, 16 9 , 19 1, 193· Malthusian System of Economic Thought, 119-20, 210-6. Manag-ed currency, 182, 185, 18 9 , 19 0, 19 8 , 199, 203,262. Marginal utility, 135, 143-4, 145-9) (5 0 , 2 15Markct-clcaring point, 21 9Marshall, Alfred, 14-. Marx, Karl, 4, 7, IS, 22, 33, 41-56, 85,137,145. Theory of value, 4 I. Surplus value and business cycles,

46.

INDEX Menger, C., 143, 145. Mercantilism, 20, 70, 7 8. Mieux value, 2 I, 30) 37, 38. Mignet, M.) 16, 17. Mill) J. S., 112-4, 122, 124, 14-2-3,

Theory of money and prices, 85. Banque du Peuple, 86.

Chemical Theory of Exchange, 83, 9 1, 226-7· Public works, 132-4, 163_

2 1 4.

Mirabeau, G., 76. Mississippi Bubble, 67, 72, 243. Mitchell, Charles E., 256. Mitchell, W. C., 3 I, 229. Money, significance, 137-4 I, 158, 211-2. Money Illusion, 170, 18o, 189. Quantity theory, 171-3. Monopoly, 222, 225, 228. Moulton) H. G., 234-. Muscle Shoals, 112. Mutuum, 60, 66. MacLeod, H. D., 58, 62, 66, 69, 7 1, 7 6• McCulloch, J. R., 6, 27. McGuire, C,) 234. National Equitable Labor Exchange, 93- 6 • National Safety Fund, 100-4. Neo-Classical School, 14. New Harmony, Ind., 93. New Lanark, Scotland, 93.

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Open Market Operations, 181. Opportunity cost) 135, 144. Owen, Robert, 93-9. Parsimony) 142. Patten) S. N., 121. Pigou, A. C., 204. Podrnore, Frank, 93. Populism, 58, 110-5. Price-fixing, 224, 229. Produit net, 6.

Profits, 159, and dynamics, 166. Prometheus, 83-5, 88-9· Proudhon, P., 80-9 2, 97. Theory of value, 81. Constituted value, 82.

Quota System, 237. Rand-Kardex Stabilized Bond, 18o. Reparations, 183, 20 I, 258. Restriction of output, 221. Ricardo, David, 3-15, 23,41,51, 119, 120, 121, 122, 124-, 128, 129, 13 1, 13 6, 14 2, 144, 193, 210, 2 14,220. Rist, C., 80, 81. Road to Plenty, 162. Robertson, D. H., 148-9Round-about production, 150, 186. Saving and investment, 123, 125, 199, 2 ° 3, 20 7Say, J. B., 7, 23, 24,26, 124,144. Schumpeter, Joseph, 249. Secular trends, 10,45, 55, 79, 90, 97, 9 8)110,119. Sisrnondi, Simond de, 7, 15-39, 145, Multiple theory of crises) 15 ff., 53. Smith, Adam, 3,4,6,7,10,123,131, 13 2,14 2 • Snyder, Carl, 244. South Sea Bubble, 73. Stabilization, Problem of, 18o. Static State, 219. Suspension of Specie payment, 254. Tabular Standard, 180, 262. Tariff, 232-41. Tariffs and effective demand, 232. Tariffs and 'war debts, 234. «Ten Minus One Theorem," 162, 164-8. Tugan-Baranowsky, M., 137-41,210, 212, 216. Unproductive consumption, 129 ..

INDEX Unstable money and unstable business, 17°,17 8,216,23 2,24 1-9,254.

Value, Commanded value, 3, 4, 5, 13, 37, 115, 119, 121) 1 24, 135, 137, 144, 2 I 0-1 1. Embodied value, 3, 4, 5, 6, 7, 13, 37,41,42,55,71,77, 115,119, 120, 137, 144. Versailles, Treaty of, 234.

Wage-Fund Theory, 143. War, 23 2, 250-3, and the changing price level, 252. debts and reparations, 183, 201 J 23 8,25 8 .

Wieser, F. von, 143, 145. Wild-Cat Banking, 64World afraid of production, 23 I.

Young Plan, 238.

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