Art. 9. THE RISE IN PRICES AND THE QUANTITY THEORY OF MONEY.

1. The Principles of Money. By J. Laurence Laughlin, Professor of Political Economy in the University of Chicago. London: Murray, 1903.

2. The Meaning of Money. By Hartley Withers. London: Smith, Elder, 1909.

3. The Purchasing Power of Money. By Irving Fisher, Professor of Political Economy in Yale University. New York: Macmillan Co., 1911.

4. The Standard of Value.

London: Macmillan, 1912.

By Sir David Barbour.

5. An Introduction to the Study of Prices. Layton. London: Macmillan, 1912.

By W. T

THE recent rise in prices, especially in the articles that enter into the consumption of the masses of the people, has been so widespread and accompanied by such symptoms of social unrest that it has aroused the interest not only of economists and statisticians, but of the general politician and the general reader. What are the causes of the rise? How much longer will it continue? What are the remedies for the evils? These are questions being asked on all sides. Some of the consequences of a general rise in prices are obvious and none the less serious and difficult to adjust becaus they are plain to view. Even in this age of legislation the greater part of all the business of the world is carried on by means of voluntary contracts; and these contracts involve the element of time, and are expressed in term of money. If, then, in the course of time the meaning of money' changes, the real meaning of the contract also changes, unless such a change was contemplated an allowed for. Apart from definite legal contracts ther are still, all the world over, numbers of agreement and customs involving money payments that are on capable of gradual and unequal change. The moder theory of wages asserts that in the case of any definit vendible product wages are paid out of the price of th product; and various methods are adopted in practic by sliding scales and boards of conciliation and the like

to make wages respond to movements in the prices of the products. But wages are only one element in the cost of production; and the equitable relation of wages to prices is always difficult of determination, even if the parties are agreed on the principles to be applied.

The difficulty of adjustment is all the greater when the rise in prices is not a rise in the relative prices of particular commodities, but is more or less general. Any general rise in prices must affect directly or indirectly all the factors of production as well as labour. The difficulty in the readjustment of wages, and the comparative immobility of labour as compared with capital in general, cause the wages of labour, considered as the price of labour, to lag behind the upward movement of prices. This result, which is probable in theory, has been abundantly confirmed by experience. Nearly every country has, at some time or other, suffered from a general rise in its prices, caused by the depreciation of its currency, whether metallic or paper, and whether the depreciation is due to the act of the Government or to the cumulative effect of natural causes. And it has been observed in practically all cases that money wages rise much more slowly than the articles on which the wages are spent. The general consequence is that, so far, the economic condition of the labouring classes is adversely affected as compared with that of owners and employers of capital. The relative prosperity of capital with rising prices is shown by booming trade, and the relative depression of labour is shown by strikes. The truth of the reasoning as regards rising prices is confirmed by taking the converse case of a fall. The Commission on the Depression of Trade (Final Report, 1886), and that on Gold and Silver (Final Report, 1888), found that, with the general fall in prices which marked the depression, wages had not fallen, and in consequence that the relative economic position of labour had improved; while the indirect effects of the depression of capital did not seriously affect the great mass of the workers.

The recent rise in general prices has been associated with a rise in the rate of interest. But in this case the causal connexion is not so easy to trace. With booming trade and greater demand for capital, with new issues of

shares of all sorts of industrial undertakings competing for new accumulations, and with the spending powers of the richer classes increasing, the demand for capital is likely to rise faster than the supply. The natural consequence is a rise in the rate of interest. But there can be little doubt that the recent rise in the rate of interest is to be ascribed largely to the general increase of security all the world over. Capital is now sent into places and employments which were formerly considered too dangerous by the mass of ordinary investors; they had found too often that high interest meant bad security. But in these days it has been discovered that relatively high interest can be obtained with proper distribution in new fields on practically as good security as low interest in the older fields. And, if regard is had not only to the yields of interest, but to stability in the capital value, the security of the older kinds of investments, with their low interest, seems less than that of the new with the high rate. As a natural consequence, capital has been diverted from the older modes of investment to the new; and the yield of the older securities has risen with the fall in the capital value, as in the notorious case of Consols. How much of the fall in the price of Consols (or, what is the same thing, the rise in the yield) is due to the general extension of security, and how much to the rise in general prices, is a problem so difficult that most financial authorities leave out, in their enumeration of the causes of the fall in Consols, any consideration of the rise in general prices. But, if the rise in prices is the cause of the rise in the rate of interest, it is so far a cause of the fall in Consols. As it happens, people who take a very mild concern in changes in the cost of living, and would not feel appreciably a rise in the cost of bread and butter of 20 or even 100 per cent., are specially concerned with any movements in the rate of interest; for movements in the rate of interest affect all kinds of investments, and affect them in different ways.

The position, then, is this: whether we look to social unrest and labour troubles, or to the gains of investors, or to the necessities of Governments in the way of borrowings, the economic question of perhaps greatest importance at the present time is the rise in prices and

the associated (if not consequent) rise in the rate of interest. To provide remedies for the social unrest and to reap the harvest of movements in securities (so far as they depend on the rise in prices), it is necessary to discover the causes; and this brings us to the 'quantity theory' of money. The most common explanation of the rise in prices is the increase in the supplies of gold from the mines; and the way in which the increase in gold raises prices is supposed to be given by the 'quantity theory' of money.

J. S. Mill, who more than anyone gave popular authority to the theories of Ricardo, wrote in the middle of the nineteenth century ('Pol. Ec.' ii, 19): 'That an increase in the quantity of money raises prices, and a diminution lowers them, is the most elementary proposition in the theory of currency, and without it we should have no key to any of the others.' In its simplest form, carefully guarded by hypotheses, which, however, lay down conditions for the most part the reverse of those that prevail in the actual world, this proposition is indeed elementary. It may be made as simple as the proposition that if in a game you increase the number of counters you diminish proportionately the value of each. In its simplest form, also, the rise in prices consequent on an increase in the supply of money is supposed to be exactly proportioned to the increase in the quantity; or, put otherwise, the value (or the purchasing power) of each piece of money falls in exact proportion with the increase of supply. This exact fall in value as supply increases is, as Mill says, true of no other commodity; or, in modern phrase, the effect on value of the increase of the supply of other things will depend on the elasticity of the demand.

The quantity theory in its simple form has been associated with other propositions equally simple under similarly simple conditions, e.g., that money is merely a medium of exchange; that all exchange is ultimately barter; and that it makes no real difference to the economic forces by which wealth is produced and distributed whether the range of general prices is high or low. In the long run or ultimately, it is said, whatever the movement in prices through the rise or fall in the quantity of money, everything (including labour and capital) will find its proper price-level. By the aid of

these and similar assumptions the quantity theory may be reduced to a harmless and uninteresting truism.

But, as soon as we apply the quantity theory to practical conditions and get rid of the hypothetical safeguards, the simplicity vanishes. At the end of the chapter in which he sets forth the quantity theory, Mill. after giving some of the most important and obvious qualifications, remarks (op. cit. p. 22):

'The sequel of our investigation will point out many other qualifications with which the proposition must be received, that the value of the circulating medium depends on the demand and supply, and is in the inverse ratio of the quantity; qualifications which, under a complex system of credit like that existing in England, render the proposition an extremely incorrect expression of the fact.'

If the proposition was extremely incorrect as applied to England seventy years ago, what are we to expect when the theory is applied to the determination of prices in England at the present time, and to the still more complex problem of the world prices of the great staples of international trade?

At first sight it is true that recent monetary history seems to show that, roughly, the quantity theory is true in the case of an increase or diminution in the supply of gold. It is commonly said that general prices rose after the discoveries in the fifties in Australia and California; that they fell with the falling-off in production in the seventies; while in the first years of the new century, with a great increase in the supplies of gold, we have the rise that is now attracting so much attention. On closer examination this verification of the theory does not seem so satisfactory. The estimated annual production of gold during the twenty-five years 1851-75 was 25,000,000l., as compared with an annual production of 24,500,000l. for the twenty years 1876 to 1895. The former period was a period of high prices, varying, according to the usual estimates, from twenty to thirty per cent. above the level of 1845-50; and the culminating point in the rise was about 1875, although the supplies of gold had already begun to fall off a little. In the next period (1876-95) there was a very great fall in prices (measured by the same index-numbers), and the lowest point was