That the objective exchange value of money as historically transmitted (der geschichtlich überkommene objektive Tauschwert des Geldes) is affected not only by the industrial use of the material from which it is made, but also by its monetary use, is a proposition which hardly any economist would nowadays deny. It is true that lay opinion was molded entirely by the contrary belief until very recent times. To a naive observer, money made out of precious metal was “sound money” because the piece of precious metal was an “intrinsically” valuable object, while paper money was “bad money” because its value was only “artificial.” But even the layman who holds this opinion accepts the money in the course of business transactions, not for the sake of its industrial use-value, but for the sake of its objective exchange value, which depends largely upon its monetary employment. He values a gold coin not merely for the sake of its industrial use-value, say because of the possibility of using it as jewelry, but chiefly on account of its monetary utility. But, of course, to do something, and to render an account to oneself of what one does and why one does it, are quite different things.26

Judgment upon the shortcomings of popular views about money and its value must be lenient, for even the attitude of science toward this problem has not always been free from error. Happily, the last few years have seen a gradual but definite change in popular monetary theory. It is now generally recognized that the value of money depends partly on its monetary function. This is due to the increased attention that has been devoted to questions of monetary policy since the commencement of the great controversy about the standards. The old theories proved unsatisfactory; it was not possible to explain phenomena such as those of the Austrian or Indian currency systems without invoking the assumption that the value of money originates partly in its monetary function. The naivety of the numerous writings which attacked this opinion and their complete freedom from the restraining influence of any sort of knowledge of the theory of value may occasionally lead the economist to regard them as unimportant; but they may at least claim to have performed the service of shaking deep-rooted prejudices and stimulating a general interest in the problem of prices. No doubt they are a gratifying indication of a growing interest in economic questions; if this is kept in mind, it is possible to think more generously of many erroneous monetary theories.

It is true that there has been no lack of attempts to explain the peculiar phenomena of modern monetary systems in other ways. But they have all been unsuccessful. Thus, in particular, Laughlin’s theory comes to grief in failing to take account of the special aspects of the value of money that are associated with the specifically monetary function. Quite correctly, Laughlin stresses as the peculiar characteristic of money substitutes their constant and immediate convertibility into money.27  Nevertheless, he would seem to be mistaken on a fundamental point when he applies the name of token money to such currencies as the rupee from 1893 to 1899 and the Russian ruble and Austrian gulden at the time of the suspension of cash payments. He accounts for the fact that a piece of paper which is not immediately convertible into gold can have any value at all, by reference to the possibility that it will nevertheless someday be converted. He compares inconvertible paper money with the shares of a concern which is temporarily not paying any dividend but whose shares may nevertheless have a certain exchange value because of the possibility of future dividends. And he says that the fluctuations in the exchange value of such paper money are consequently based upon the varying prospects of its ultimate conversion.28

The error in this conclusion may be most simply demonstrated by means of an actual example. Let us select for this purpose the monetary history of Austria, which Laughlin also uses as an illustration. From 1859 onward the Austrian National Bank was released from the obligation to convert its notes on demand into silver, and nobody could tell when the state paper money issued in 1866 would be redeemed, or even if it would be redeemed at all. It was not until the later 1890s that the transition to metallic money was completed by the actual resumption of cash payments on the part of the Austro-Hungarian Bank.

Now Laughlin attempts to explain the value of the Austrian currency during this period by reference to the prospect of a future conversion of the notes into metallic commodity money. He finds the basis of its value, at first in an expectation that it would be converted into silver, and afterward in an expectation that it would be converted into gold, and traces the vicissitudes of its purchasing power to the varying chances of its ultimate conversion.29

The inadmissibility of this argument can be demonstrated in a striking fashion. In the year 1884—the year is chosen at random—the five percent Austrian government bonds were quoted on the Viennese Stock Exchange at an average rate of 95.81, or 4.19 percent below par. The quotation was in terms of Austrian paper gulden. The government bonds represented claims against the Austrian state bearing interest at five percent. Thus both the bonds and the notes were claims against the same debtor. It is true that these government bonds were not repayable, that is to say, not redeemable on the part of the creditor. Nevertheless, seeing that interest was paid on them, this could not prejudice their value in comparison with that of the non-interest-bearing currency notes, which also were not redeemable; furthermore, the interest on the bonds was payable in paper money, and, if the government redeemed them, it could do this also in paper money. In fact, the bonds in question were redeemed voluntarily in 1892, long before the currency notes were converted into gold. The question now arises: How could it come about that the government bonds, bearing interest at five percent, could be valued less highly than the non-interest-bearing currency notes? This could not possibly be attributed, say, to the fact that people hoped that the currency notes would be converted into gold before the bonds were redeemed. There was no suggestion of such an expectation. Quite another circumstance decided the matter.

The currency notes were common media of exchange—they were money—and consequently, besides the value that they possessed as claims against the state, they also had a value as money. It is beyond doubt that their value as claims alone would not have been an adequate basis even for a relatively large proportion of their actual exchange value. The date of repayment of the claims that were embodied in these notes was in fact quite uncertain, but in any case very distant. As claims, it was impossible for them to have a higher exchange value than corresponded to the then value of the expectation of their repayment. Now, after the cessation of free coinage of silver it was fairly obvious that the paper gulden (and incidentally the silver gulden) would not be converted at a rate appreciably in excess of the average rate at which it circulated in the period immediately preceding the conversion. In any case, after the legal determination of the conversion ratio by the Currency Regulation Law of August 2, 1892, it was settled that the conversion of the currency notes would not take place at any higher rate than this. How could it come about, then, that the gold value of the krone (the half-gulden) already fluctuated about this rate as early as the second half of the year 1892 although the date of conversion was then still quite unknown? Usually a claim to a fixed sum, the date of payment of which lies in the uncertain future, is valued considerably less highly than the sum to which it refers. To this question Laughlin’s theory cannot offer an answer; only by taking account of the fact that the monetary function also contributes toward value is it possible to find a satisfactory explanation.

The attempts that have so far been made, to determine the quantitative significance of the forces emanating from the side of money that affect the exchange ratio existing between money and other economic goods, have followed throughout the line of thought of the quantity theory. This is not to say that all the exponents of the quantity theory had realized that the value of money is not determined solely by its nonmonetary, industrial employment, but also or even solely by its monetary function. Many quantity theorists have been of another opinion on this point and have believed that the value of money depends solely on the industrial employment of the monetary material. The majority have had no clear conception of the question at all; very few have approached its true solution. It is often hard to decide in which class certain of these authors should be placed; their phraseology is often obscure and their theories not seldom contradictory. All the same, let us suppose that all quantity theorists had recognized the significance of the monetary function in the determination of the value of the monetary material, and criticize the usefulness of their theory from this point of view.

When the determinants of the exchange ratios between economic goods were first inquired into, attention was early devoted to two factors whose importance for the pricing process was not to be denied. It was impossible to overlook the well-known connection between variations in the available quantity of goods and variations in prices, and the proposition was soon formulated that a good would rise in price if the available quantity of it diminished. Similarly, the importance of the total volume of transactions in the determination of prices was also realized. Thus, a mechanical theory of price determination was arrived at—the doctrine of supply and demand, which until very recently held such a prominent position in our science. Of all explanations of prices it is the oldest. We cannot dismiss it offhand as erroneous; the only valid objection to it is that it does not go back to the ultimate determinants of prices. It is correct or incorrect, according to the content given to the words demand and supply. It is correct, if account is taken of all the factors that motivate people in buying and selling. It is incorrect, if supply and demand are interpreted and compared in a merely quantitative sense.30

It was an obvious step to take this theory, that had been constructed to explain the reciprocal exchange ratios of commodities, and apply it to fluctuations in the relative values of commodities and money also. As soon as people became conscious of the fact of variations in the value of money at all, and gave up the naive conception of money as an invariable measure of value, they began to explain these variations also by quantitative changes in supply and demand.

It is true that the usual criticism of the quantity theory (often expressed with more resentment than is consonant with that objectivity which alone should be the distinctive mark of scientific investigation) had an easy task so far as it was leveled against the older, incomplete, version. It was not difficult to prove that the supposition that changes in the value of money must be proportionate to changes in the quantity of money, so that for example a doubling of the quantity of money would lead to a doubling of prices also, was not in accordance with facts and could not be theoretically established in any way whatever.31  It was still simpler to show the untenability of the naive version of the theory which regarded the total quantity of money and the total stock of money as equivalent.

But all these objections do not touch the essence of the doctrine. Neither can any sort of refutation or limitation of the quantity theory be deduced from the fact that a number of writers claim validity for it only on the assumption ceteris paribus; not even though they state further that this supposition never is fulfilled and never could be fulfilled.32  The assumption ceteris paribus is the self-evident appendage of every scientific doctrine and there is no economic law that can dispense with it.

Against such superficial criticism the quantity theory has been well able to defend itself triumphantly, and through the centuries, condemned by some and exalted as an indisputable truth by others, it has always been in the very center of scientific discussion. It has been dealt with in an immense literature, far beyond the power of any one person to master. It is true that the scientific harvest of these writings is but small. The theory has been adjudged “right” or “wrong,” and statistical data (mostly incomplete and incorrectly interpreted) have been used both to “prove” and to “disprove” it—although sufficient care has seldom been taken to eliminate variations brought about by accidental circumstances. On the other hand, investigation on a basis of the theory of value has but seldom been attempted.

If we wish to arrive at a just appraisal of the quantity theory we must consider it in the light of the contemporary theories of value. The core of the doctrine consists in the proposition that the supply of money and the demand for it both affect its value. This proposition is probably a sufficiently good hypothesis to explain big changes in prices; but it is far from containing a complete theory of the value of money. It describes one cause of changes in prices; it is nevertheless inadequate for dealing with the problem exhaustively. By itself it does not comprise a theory of the value of money; it needs the basis of a general value theory. One after another, the doctrine of supply and demand, the cost-of-production theory, and the subjective theory of value have had to provide the foundations for the quantity theory.

If we make use in our discussion of only one fundamental idea contained in the quantity theory, the idea that a connection exists between variations in the value of money on the one hand and variations in the relations between the demand for money and the supply of it on the other hand, our reason is not that this is the most correct expression of the content of the theory from the historical point of view, but that it constitutes that core of truth in the theory which even the modern investigator can and must recognize as useful. Although the historian of economic theory may find this formulation inexact and produce quotations to refute it, he must nevertheless admit that it contains the correct expression of what is valuable in the quantity theory and usable as a cornerstone for a theory of the value of money.

Beyond this proposition, the quantity theory can provide us with nothing. Above all, it fails to explain the mechanism of variations in the value of money. Some of its expositors do not touch upon this question at all; the others employ an inadequate principle for dealing with it. Observation teaches us that certain relations of the kind suggested between the available stock of money and the need for money do in fact exist; the problem is to deduce these relations from the fundamental laws of value and so at last to comprehend their true significance.

• 26See Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Wertes, op. cit., pp. iii.
• 27See Laughlin, The Principles of Money (London, 1903), pp. 513 f.
• 28Ibid., pp. 530 f.
• 29Ibid., pp. 531 ff.
• 30See Zuckerkandl, op. cit., pp. 123 ff.
• 31See Mill, Principles of Political Economy (London, 1867), p. 299.
• 32Cf. Marshall, before the Indian Currency Committee, “Report” (London, 1898—99; Q. 11759), in Official Papers (London, 1926), p. 267.

The process, by which supply and demand are accommodated to each other until a position of equilibrium is established and both are brought into quantitative and qualitative coincidence, is the higgling of the market. But supply and demand are only the links in a chain of phenomena, one end of which has this visible manifestation in the market, while the other is anchored deep in the human mind. The intensity with which supply and demand are expressed, and consequently the level of the exchange ratio at which both coincide, depends on the subjective valuations of individuals. This is true, not only of the direct exchange ratios between economic goods other than money, but also of the exchange ratio between money on the one hand and commodities on the other.

For a long time it was believed that the demand for money was a quantity determined by objective factors and independently of subjective considerations. It was thought that the demand for money in an economic community was determined, on the one hand by the total quantity of commodities that had to be paid for during a given period, and on the other hand by the velocity of circulation of the money. There is an error in the very starting point of this way of regarding the matter, which was first successfully attacked by Menger.33  It is inadmissible to begin with the demand for money of the community. The individualistic economic community as such, which is the only sort of community in which there is a demand for money, is not an economic agent. It demands money only insofar as its individual members demand money. The demand for money of the economic community is nothing but the sum of the demands for money of the individual economic agents composing it. But for individual economic agents it is impossible to make use of the formula: total volume of transactions ÷ velocity of circulation. If we wish to arrive at a description of the demand for money of an individual we must start with the considerations that influence such an individual in receiving and paying out money.

Every economic agent is obliged to hold a stock of the common medium of exchange sufficient to cover his probable business and personal requirements. The amount that will be required depends upon individual circumstances. It is influenced both by the custom and habits of the individual and by the organization of the whole social apparatus of production and exchange.

But all of these objective factors always affect the matter only as motivations of the individual. They are never capable of a direct influence upon the actual amount of his demand for money. Here, as in all departments of economic life, it is the subjective valuations of the separate economic agents that alone are derisive. The store of purchasing power held by two such agents whose objective economic circumstances were identical might be quite different if the advantages and disadvantages of such a store were estimated differently by the different agents.

The cash balance held by an individual need by no means consist entirely of money. If secure claims to money, payable on demand, are employed commercially as substitutes for money, being tendered and accepted in place of money, then individuals’ stores of money can be entirely or partly replaced by a corresponding store of these substitutes. In fact, for technical reasons (such, for example, as the need for having money of various denominations on hand) this may sometimes prove an unavoidable necessity. It follows that we can speak of a demand for money in a broader and in a narrower sense. The former comprises the entire demand of an individual for money and money substitutes; the second, merely his demand for money proper. The former is determined by the will of the economic agent in question. The latter is fairly independent of individual influences, if we disregard the question of denomination referred to above. Apart from this, the question whether a greater or smaller part of the cash balance held by an individual shall consist of money substitutes is only of importance to him when he has the opportunity of acquiring money substitutes which bear interest, such as interest-bearing banknotes—a rare case—or bank deposits. In all other cases it is a matter of complete indifference to him.

The individual’s demand and stock of money are the basis of the demand and stock in the whole community. So long as there are no money substitutes in use, the social demand for money and the social stock of money are merely the respective sums of the individual demands and stocks. But this is changed with the advent of money substitutes. The social demand for money in the narrower sense is no longer the sum of the individual demands for money in the narrower sense, and the social demand for money in the broader sense is by no means the sum of the individual demands for money in the broader sense. Part of the money substitutes functioning as money in the cash holdings of individuals are “covered” by sums of money held as “redemption funds” at the place where the money substitutes are cashable, which is usually, although not necessarily, the issuing concern. We shall use the term money certificates for those money substitutes that are completely covered by the reservation of corresponding sums of money, and the term fiduciary media34  for those which are not covered in this way. The suitability of this terminology, which has been chosen with regard to the problem to be dealt with in the third part of the present work, must be demonstrated in that place. It is not to be understood in the light of banking technique or in a juristic sense; it is merely intended to serve the ends of economic argument.

Only in the rarest cases can any particular money substitutes be immediately assigned to the one or the other group. That is possible only for those money substitutes of which the whole species is either entirely covered by money or not covered by money at all. In the case of all other money substitutes, those the total quantity of which is partly covered by money and partly not covered by money, only an imaginary ascription of an aliquot part to each of the two groups can take place. This involves no fresh difficulty. If, for example, there are banknotes in circulation one-third of the quantity of which is covered by money and two-thirds not covered, then each individual note is to be reckoned as two-thirds fiduciary medium and one-third money certificate. It is thus obvious that a community’s demand for money in the broader sense cannot be the sum of the demands of individuals for money and money substitutes, because to reckon in the demand for money certificates as well as that for the money that serves as a cover for them as the banks and elsewhere is to count the same amount twice over. A community’s demand for money in the broader sense is the sum of the demands of the individual economic agents for money proper and fiduciary media (including the demand for cover). And a community’s demands for money in the narrower sense are the sum of the demands of the individual economic agents for money and money certificates (this time not including cover).

In this part we shall ignore the existence of fiduciary media and assume that the demands for money of individual economic agents can be satisfied merely by money and money certificates, and consequently that the demand for money of the whole economic community can be satisfied merely by money proper.35  The third part of this book is devoted to an examination of the important and difficult problems arising from the creation and circulation of fiduciary media.

The demand for money and its relations to the stock of money form the starting point for an explanation of fluctuations in the objective exchange value of money. Not to understand the nature of the demand for money is to fail at the very outset of any attempt to grapple with the problem of variations in the value of money. If we start with a formula that attempts to explain the demand for money from the point of view of the community instead of from that of the individual, we shall fail to discover the connection between the stock of money and the subjective valuations of individuals—the foundation of all economic activity. But on the other hand, this problem is solved without difficulty if we approach the phenomena from the individual agent’s point of view.

No longer explanation is necessary, of the way in which an individual will behave in the market when his demand for money exceeds his stock of it. He who has more money on hand than he thinks he needs, will buy, in order to dispose of the superfluous stock of money that lies useless on his hands. If he is an entrepreneur, he will possibly enlarge his business. If this use of the money is not open to him, he may purchase interest-bearing securities; or possibly he may decide to purchase consumption goods. But in any case, he expresses by a suitable behavior in the market the fact that he regards his reserve of purchasing power as too large.

And he whose demand for money is less than his stock of it will behave in an exactly contrary fashion. If an individual’s stock of money diminishes (his property or income remaining the same), then he will take steps to reach the desired level of reserve purchasing power by suitable behavior in making sales and purchases. A shortage of money means a difficulty in disposing of commodities for money. He who is obliged to dispose of a commodity by way of exchange will prefer to acquire some of the common medium of exchange for it, and only when this acquisition involves too great a sacrifice will he be content with some other economic good, which will indeed be more marketable than that which he wishes to dispose of but less marketable than the common medium of exchange. Under the present organization of the market, which leaves a deep gulf between the marketability of money on the one hand and the marketability of other economic goods on the other hand, nothing but money enters into consideration at all as a medium of exchange. Only in exceptional circumstances is any other economic good pressed into this service. In the case mentioned, therefore, every seller will be willing to accept a smaller quantity of money than he otherwise would have demanded, so as to avoid the fresh loss that he would have to suffer in again exchanging the commodity that he has acquired, which is harder to dispose of than money, for the commodity that he actually requires for consumption.

The older theories, which started from an erroneous conception of the social demand for money, could never arrive at a solution of this problem. Their sole contribution is limited to paraphrases of the proposition that an increase in the stock of money at the disposal of the community while the demand for it remains the same decreases the objective exchange value of money, and that an increase of the demand with a constant available stock has the contrary effect, and so on. By a flash of genius, the formulators of the quantity theory had already recognized this. We cannot by any means call it an advance when the formula giving the amount of the demand for money (volume of transactions ÷ velocity of circulation) was reduced to its elements, or when the attempt was made to give exact precision to the idea of a stock of money, so long as this occurred under a misapprehension of the nature of fiduciary media and of clearing transactions. No approach whatever was made toward the central problem of this part of the theory of money so long as theorists were unable to show the way in which subjective valuations are affected by variations in the ratio between the stock of money and the demand for money. But this task was necessarily beyond the power of these theories; they break down at the crucial point.36

Recently, Wieser has expressed himself against employing the “collective concept of the demand for money” as the starting point for a theory of fluctuations in the objective exchange value of money. He says that in an investigation of the value of money we are not concerned with the total demand for money. The demand for money to pay taxes with, for example, does not come into consideration, for these payments do not affect the value of money but only transfer purchasing power from those who pay the taxes to those who receive them. In the same way, capital and interest payments in loan transactions and the making of gifts and bequests merely involve a transference of purchasing power between persons and not an augmentation or diminution of it. A functional theory of the value of money must, in stating its problem, have regard only to those factors by which the value of money is determined. The value of money is determined in the process of exchange. Consequently the theory of the value of money must take account only of those quantifies which enter into the process of exchange.37

But these objections of Wieser’s are not only rebutted by the fact that even the surrender of money in paying taxes, in making capital and interest payments, and in giving presents and bequests, falls into the economic category of exchange. Even if we accept Wieser’s narrow definition of exchange, we must still oppose his argument. It is not a peculiarity of money that its value (Wieser obviously means its objective exchange value) is determined in the process of exchange; the same is true of all other economic goods. For all economic goods it must therefore be correct to say that the theory of value has to investigate only certain quantities, namely, only those that are involved in the process of exchange. But there is no such thing in economics as a quantity that is not involved in the process of exchange. From the economic point of view, a quantity has no other relationships than those which exercise some influence upon the valuations of individuals concerned in some process or other of exchange.

This is true, even if we admit that value only arises in connection with exchange in the narrow sense intended by Wieser. But those who participate in exchange transactions, and consequently desire to acquire or dispose of money do not value the monetary unit solely with regard to the fact that they can use it in other acts of exchange (in Wieser’s narrower sense of the expression), but also because they require money in order to pay taxes, to transfer borrowed capital and pay interest, and to make presents. They consider the level of their purchasing-power reserves with a view to the necessity of having money ready for all these purposes, and their judgment as to the extent of their requirements for money is what decides the demand for money with which they enter the market.

• 33See Menger, op. cit., pp. 325 ff.; also Helfferich, op. cit., pp. 500 ff.
• 34See Appendix B.
• 35Examination of the relationship of this supposition to the doctrine of the “purely metallic currency” as expounded by the Currency School would necessitate a discussion of the criticism that has been leveled at it by the Banking School; but certain remarks in the third part of the present work on fiduciary media and the clearing system will fill the gap left above.
• 36It is remarkable that even investigators who otherwise take their stand upon the subjective theory of value have been able to fall into this error. So, for example, Fisher and Brown, The Purchasing Power of Money (New York, 1911), pp. 8 ff.
• 37See Wieser, “Der Geldwert und seine Veränderungen,” pp. 515 ff.

Those variations in the ratio between the individual’s demand for money and his stock of it that arise from purely individual causes cannot as a rule have a very large quantitative influence in the market. In most cases they will be entirely, or at least partly, compensated by contrary variations emanating from other individuals in the market. But a variation in the objective exchange value of money can arise only when a force is exerted in one direction that is not canceled by a counteracting force in the opposite direction. If the causes that alter the ratio between the stock of money and the demand for it from the point of view of an individual consist merely in accidental and personal factors that concern that particular individual only, then, according to the law of large numbers, it is likely that the forces arising from this cause, and acting in both directions in the market, will counterbalance each other. The probability that the compensation will be complete is the greater, the more individual economic agents there are.

It is otherwise when disturbances occur in the community as a whole, of a kind to alter the ratio existing between the individual’s stock of money and his demand for it. Such disturbances, of course, cannot have an effect except by altering the subjective valuations of the individual; but they are social economic phenomena in the sense that they influence the subjective valuations of a large number of individuals, if not simultaneously and in the same degree, at least in the same direction, so that there must necessarily be some resultant effect on the objective exchange value of money.

In the history of money a particularly important part has been played by those variations in its objective exchange value that have arisen in consequence of an increase in the stock of money while the demand for it has remained unchanged or has at least not increased to the same extent. These variations, in fact, were what first attracted the attention of economists; it was in order to explain them that the quantity theory of money was first propounded. All writers have dealt most thoroughly with them. It is perhaps justifiable, therefore, to devote special attention to them and to use them to illuminate certain important theoretical points.

In whatever way we care to picture to ourselves the increase in the stock of money, whether as arising from increased production or importation of the substance of which commodity money is made, or through a new issue of fiat or credit money, the new money always increases the stock of money at the disposal of certain individual economic agents. An increase in the stock of money in a community always means an increase in the money incomes of a number of individuals; but it need not necessarily mean at the same time an increase in the quantity of goods that are at the disposal of the community, that is to say, it need not mean an increase in the national dividend. An increase in the amount of fiat or credit money is only to be regarded as an increase in the stock of goods at the disposal of society if it permits the satisfaction of a demand for money which would otherwise have been satisfied by commodity money instead, since the material for the commodity money would then have had to be procured by the surrender of other goods in exchange or produced at the cost of renouncing some other sort of production. If, on the other hand, the nonexistence of the new issue of fiat or credit money would not have involved an increase in the quantity of commodity money, then the increase of money cannot be regarded as an increase of the income or wealth of society.

An increase in a community’s stock of money always means an increase in the amount of money held by a number of economic agents, whether these are the issuers of fiat or credit money or the producers of the substance of which commodity money is made. For these persons, the ratio between the demand for money and the stock of it is altered; they have a relative superfluity of money and a relative shortage of other economic goods. The immediate consequence of both circumstances is that the marginal utility to them of the monetary unit diminishes. This necessarily influences their behavior in the market. They are in a stronger position as buyers. They will now express in the market their demand for the objects they desire more intensively than before; they are able to offer more money for the commodities that they wish to acquire. It will be the obvious result of this that the prices of the goods concerned will rise, and that the objective exchange value of money will fall in comparison.

But this rise of prices will by no means be restricted to the market for those goods that are desired by those who originally have the new money at their disposal. In addition, those who have brought these goods to market will have their incomes and their proportionate stocks of money increased and, in their turn, will be in a position to demand more intensively the goods they want, so that these goods will also rise in price. Thus the increase of prices continues, having a diminishing effect, until all commodities, some to a greater and some to a lesser extent, are reached by it.38

The increase in the quantity of money does not mean an increase of income for all individuals. On the contrary, those sections of the community that are the last to be reached by the additional quantity of money have their incomes reduced, as a consequence of the decrease in the value of money called forth by the increase in its quantity; this will be referred to later. The reduction in the income of these classes now starts a countertendency, which opposes the tendency to a diminution of the value of money due to the increase of income of the other classes, without being able to rob it completely of its effect.

Those who hold the mechanical version of the quantity theory will be the more inclined to believe that the increase in the quantity of money must eventually lead to a uniform increase in the prices of all economic goods, the less clear their concept is of the way in which the determination of prices is affected by it. Thorough comprehension of the mechanism by means of which the quantity of money affects the prices of commodities makes their point of view altogether untenable. Since the increased quantity of money is received in the first place by a limited number of economic agents only and not by all, the increase of prices at first embraces only those goods that are demanded by these persons; further, it affects these goods more than it afterward affects any others. When the increase of prices spreads farther, if the increase in the quantity of money is only a single transient phenomenon, it will not be possible for the differential increase of prices of these goods to be completely maintained; a certain degree of adjustment will take place. But there will not be such a complete adjustment of the increases that all prices increase in the same proportion. The prices of commodities after the rise of prices will not bear the same relation to each other as before its commencement; the decrease in the purchasing power of money will not be uniform with regard to different economic goods.

Hume, it may be remarked, bases his argument concerning this matter on the supposition that every Englishman is miraculously endowed with five pieces of gold during the night.39  Mill rightly remarks on this, that it would not lead to a uniform increase in the demand for separate commodities; the luxury articles of the poorer classes would rise more in price than the others. All the same, he believes that a uniform increase in the prices of all commodities, and this exactly in proportion to the increase in the quantity of money, would occur, if “the wants and inclinations of the community collectively in respect to consumption” remained the same. He assumes, no less artificially than Hume, that “to every pound, or shilling, or penny, in the possession of any one, another pound, shilling, or penny were suddenly added.”40  But Mill fails to see that even in this case a uniform rise of prices would not occur, even supposing that for each member of the community the proportion between stock of money and total wealth was the same, so that the addition of the supplementary quantity of money did not result in an alteration of the relative wealth of individuals. For, even in this quite impossible case, every increase in the quantity of money would necessarily cause an alteration in the conditions of demand, which would lead to a disparate increase in the prices of the individual economic goods. Not all commodities would be demanded more intensively, and not all of those that were demanded more intensively would be affected in the same degree.41

There is no justification whatever for the widespread belief that variations in the quantity of money must lead to inversely proportionate variations in the objective exchange value of money, so that, for example, a doubling of the quantity of money must lead to a halving of the purchasing power of money.

Even assuming that in some way or other—it is confessedly difficult to imagine in what way—very individual’s stock of money were to be increased so that his relative position as regards other holders of property was unaltered, it is not difficult to prove that the subsequent variation in the objective exchange value of money would not be proportioned to the variation in the quantity of money. For, in fact, the way in which an individual values a variation in the quantity of money at his disposal is by no means directly dependent on the amount of this variation; but we should have to assume that it was, if we wished to conclude that there would be a proportionate variation in the objective exchange value of money. If the possessor of a units of money receives b additional units, then it is not at all true to say that he will value the total stock a + b exactly as highly as he had previously valued the stock a alone. Because he now has disposal over a larger stock, he will now value each unit less than he did before; but how much less will depend upon a whole series of individual circumstances, upon subjective valuations that will be different for each individual. Two individuals who are equally wealthy and who each possess a stock of money a, will not by any means arrive at the same variation in their estimation of money after an increase of b units in each of their stocks of money. It is nothing short of absurdity to assume that, say, doubling the amount of money at the disposal of an individual must lead to a halving of the exchange value that he ascribes to each monetary unit. Let us, for example, imagine an individual who is in the habit of holding a stock of a hundred kronen and assume that a sum of a further hundred kronen is paid by somebody or other to this individual. Mere consideration of this example is sufficient to show the complete unreality of all the theories that ascribe to variations in the quantity of money a uniformly proportionate effect on the purchasing power of money. For it involves no essential modification of this example to assume that similar increases in the quantity of money are experienced by all the members of the community at once.

The mistake in the argument of those who suppose that a variation in the quantity of money results in an inversely proportionate variation in its purchasing power lies in its starting point. If we wish to arrive at a correct conclusion, we must start with the valuations of separate individuals; we must examine the way in which an increase or decrease in the quantity of money affects the value scales of individuals, for it is from these alone that variations in the exchange ratios of goods proceed. The initial assumption in the arguments of those who maintain the theory that changes in the quantity of money have a proportionate effect on the purchasing power of money is the proposition that if the value of the monetary unit were doubled, half of the stock of money at the disposal of the community would yield the same utility as that previously yielded by the whole stock. The correctness of this proposition is not disputed; nevertheless, it does not prove what it is meant to prove.

In the first place, it must be pointed out that the levels of the total stock of money and of the value of the money unit are matters of complete indifference as far as the utility obtained from the use of the money is concerned. Society is always in enjoyment of the maximum utility obtainable from the use of money. Half of the money at the disposal of the community would yield the same utility as the whole stock, even if the variation in the value of the monetary unit was not proportioned to the variation in the stock of money. But it is important to note that it by no means follows from this that doubling the quantity of money means halving the objective exchange value of money. It would have to be shown that forces emanate from the valuations of individual economic agents which are able to bring about such a proportionate variation. This can never be proved; in fact, its contrary is likely. We have already given a proof of this for the case in which an increase of the quantity of money held by individual economic agents involves at the same time an increase of their income or wealth. But even when the increase in the quantity of money does not affect the wealth or income of the individual economic agents, the effect is still the same.

Let us assume that a man gets half his income in the form of interest-bearing securities and half in the form of money; and that he is in the habit of saving three-quarters of his income, and does this by retaining the securities and using that half of his income which he receives in cash in equal parts for paying for current con sumption and for the purchase of further securities. Now let us assume that a variation in the composition of his income occurs, so that he receives three-quarters of it in cash and only one-quarter in securities. From now on this man will use two-thirds of his cash receipts for the purchase of interest-bearing securities. If the price of the securities rises or, which is the same thing, if their rate of interest falls, then in either case he will be less willing to buy and will reduce the sum of money that he would otherwise have employed for their purchase; he is likely to find that the advantage of a slightly increased reserve exceeds that which could be obtained from the acquisition of the securities. In the second case he will doubtless be inclined to pay a higher price, or more correctly, to purchase a greater quantity at the higher price, than in the first case. But he will certainly not be prepared to pay double as much for a unit of securities in the second case as in the first case.

As far as the earlier exponents of the quantity theory are concerned, the assumption that variations in the quantity of money would have an inversely proportionate effect on its purchasing power may nevertheless be excusable. It is easy to go astray on this point if the attempt is made to explain the value phenomena of the market by reference to exchange value. But it is inexplicable that those theorists also who suppose they are taking their stand on the subjective theory of value could fall into similar errors. The blame here can only be laid to the account of a mechanical conception of market processes. Thus even Fisher and Brown, whose concept of the quantity theory is a mechanical one, and who attempt to express in mathematical equations the law according to which the value of money is determined, necessarily arrive at the conclusion that variations in the ratio between the quantity of money and the demand for it lead to proportionate variations in the objective exchange value of money.42  How and through what channels this comes about is not disclosed by the formula, for it contains no reference at all to the only factors that are decisive in causing variations of the exchange ratios, that is, variations in the subjective valuations of individuals.

Fisher and Brown give three examples to prove the correctness of their conclusions. In the first, they start with the supposition that the government changes the denomination of the money, so that, for example, what was previously called a half-dollar is now called a whole dollar. It is obvious, they say, that this will cause an increase in the number of dollars in circulation and that prices reckoned in the new dollars will have to be twice as high as they were previously. Fisher and Brown may be right so far, but not in the conclusions that they proceed to draw. What their example actually deals with is not an increase in the quantity of money but merely an alteration in its name. What does the “money” referred to in this example really consist of? Is it the stuff of which dollars are made, the claim that lies behind a credit dollar, the token that is used as money, or is it the word dollar?

The second example given by Fisher and Brown is no less incorrectly interpreted. They start from the assumption that the government divides each dollar into two and mints a new dollar from each half. Here again all that occurs is a change of name.

In their third example they do at least deal with a real increase in the quantity of money. But this example is just as artificial and misleading as those of Hume and Mill which we have already dealt with in some detail. They suppose that the government gives everybody an extra dollar for each dollar that he already possesses. We have already shown that even in this case a proportionate change in the objective exchange value of money cannot follow.

One thing only can explain how Fisher is able to maintain his mechanical quantity theory. To him the quantity theory seems a doctrine peculiar to the value of money; in fact, he contrasts it outright with the laws of value of other economic goods. He says that if the world’s stock of sugar increases from a million pounds to a million hundredweight, it would not follow that a hundredweight would have the value that is now possessed by a pound. Money only is peculiar in this respect, according to Fisher. But he does not give a proof of this assertion. With as much justification as that of Fisher and Brown for their mechanical formula for the value of money, a similar formula could be set out for the value of any commodity, and similar conclusions drawn from it. That nobody attempts to do this is to be explained simply and solely by the circumstance that such a formula would so clearly contradict our experience of the demand curves for most commodities, that it could not be maintained even for a moment.

If we compare two static economic systems, which differ in no way from one another except that in one there is twice as much money as in the other, it appears that the purchasing power of the monetary unit in the one system must be equal to half that of the monetary unit in the other. Nevertheless, we may not conclude from this that a doubling of the quantity of money must lead to a halving of the purchasing power of the monetary unit; for every variation in the quantity of money introduces a dynamic factor into the static economic system. The new position of static equilibrium that is established when the effects of the fluctuations thus set in motion are completed cannot be the same as that which existed before the introduction of the additional quantity of money. Consequently, in the new state of equilibrium the conditions of demand for money, given a certain exchange value of the monetary unit, will also be different. If the purchasing power of each unit of the doubled quantity of money were halved, the unit would not have the same significance for each individual under the new conditions as it had in the static system before the increase in the quantity of money. All those who ascribe to variations in the quantity of money an inverse proportionate effect on the value of the monetary unit are applying to dynamic conditions a method of analysis that is only suitable for static conditions.

It is also entirely incorrect to think of the quantity theory as if the characteristics in question affecting the determination of value were peculiar to money. Most of both the earlier and the later adherents of the theory have fallen into this error, and the fierce and often unfair attacks that have been directed against it appear in a better light when we know of this and other errors of a like kind of which its champions have been guilty.

• 38See Hume, Essays, ed. Frowde (London), pp. 294 ff.; Mill, op. cit., pp. 298 ff.; Cairnes, Essays in Political Economy, Theoretical and Applied (London, 1873), pp. 57 ff.; Spiethoff, “Die Quantitätstheorie insbesondere in ihrer Verwertbarkeit als Haussetheorie,” Festgaben für Adolf Wagner (Leipzig, 1905), pp. 250 ff.
• 39Hume, op. cit., p. 307
• 40Mill, op. cit., p. 299.
• 41See Conant, “What Determines the Value of Money?” Quarterly Journal of Economics 18 (1904): 559 ff.
• 42See Fisher and Brown, op. cit., pp. 28 ff., 157 ff.

We have already examined one of the objections that have been brought against the quantity theory: the objection that it only holds good ceteris paribus. No more tenable as an objection against the determinateness of our conclusions is reference to the possibility that an additional quantity of money may be hoarded. This argument has played a prominent role in the history of monetary theory; it was one of the sharpest weapons in the armory of the opponents of the quantity theory. Among the arguments of the opponents of the currency theory it immediately follows the proposition relating to the elasticity of cash-economizing methods of payment, to which it also bears a close relation as far as its content is concerned. We shall deal with it here separately; nevertheless all that we can say about it in the present place needs to be set in its proper light by the arguments contained in the third part of this book, which is devoted to the doctrine of fiduciary media.

For Fullarton, hoards are the regular deus ex machina. They absorb the superfluous quantity of money and prevent it from flowing into circulation until it is needed.43  Thus they constitute a sort of reservoir which accommodates the ebb and flow of money in the market to the variations in the demand for money. The sums of money collected in hoards lie there idle, waiting for the moment when commerce needs them for maintaining the stability of the objective exchange value of money; and all those sums of money, that might threaten this stability when the demand for money decreases, flow back out of circulation into these hoards to slumber quietly until they are called forth again. This tacitly assumes44  the fundamental correctness of the arguments of the quantity theory, but asserts that there is nevertheless a principle inherent in the economic system that always prevents the working out of the processes that the quantity theory describes.

But Fullarton and his followers unfortunately neglected to indicate the way in which variations in the demand for money set in motion the mechanism of the hoards. Obviously they supposed this to proceed without the will of the transacting parties entering into the matter at all. Such a view surpasses the naivest versions of the quantity theory in its purely mechanical conception of market transactions. Even the most superficial investigation into the problem of the demand for money could not have failed to demonstrate the untenability of the doctrine of hoards.

In the first place, it must be recognized that from the economic point of view there is no such thing as money lying idle. All money, whether in reserves or literally in circulation (that is, in process of changing hands at the very moment under consideration), is devoted in exactly the same way to the performance of a monetary function.45  In fact, since money that is surrendered in an exchange is immediately transferred from the ownership of the one party to that of the other, and no period of time can be discovered in which it is actually in movement, all money must be regarded as at rest in the cash reserve of some individual or other The stock of money of the community is the sum of the stocks of individuals; there is no such thing as errant money, no money which even for a moment does not form part of somebody’s stock. All money, that is to say, lies in some individual’s stock, ready for eventual use. It is a matter of indifference how soon the moment occurs when a demand for money next arises and the sum of money in question is paid out. In every household or family the members of which are at least moderately prosperous there is a minimum reserve whose level is constantly maintained by replenishment. (The fact has already been mentioned, that besides objective conditions, subjective factors influencing the individual economic agent help to determine the amount of the individual demand for money.) What is called storing money is a way of using wealth. The uncertainty of the future makes it seem advisable to hold a larger or smaller part of one’s possessions in a form that will facilitate a change from one way of using wealth to another, or transition from the ownership of one good to that of another, in order to preserve the opportunity of being able without difficulty to satisfy urgent demands that may possibly arise in the future for goods that will have to be obtained by way of exchange. So long as the market has not reached a stage of development in which all, or at least certain, economic goods can be sold (that is, turned into money) at any time under conditions that are not too unfavorable, this aim can be achieved only by holding a stock of money of a suitable size. The more active the life of the market becomes, the more can this stock be diminished. At the present day, the possession of certain sorts of securities which have a large market so that they can be realized without delay and without very considerable loss, at least in normal times, may make the holding of large cash reserves to a certain extent unnecessary.

The demand for money for storage purposes is not separable from the demand for money for other purposes. Hoarding money is nothing but the custom of holding a greater stock of it than is usual with other economic agents, at other times, or in other places. The hoarded sums of money do not lie idle, whether they are regarded from the social or from the individual point of view. They serve to satisfy a demand for money just as much as any other money does. Now the adherents of the banking principle seem to hold the opinion that the demand for storing purposes is elastic and conforms to variations in the demand for money for other purposes in such a way that the total demand for money, that is, that for storing purposes and that for other purposes taken together, adjusts itself to the existing stock of money without any variation in the objective exchange value of the monetary unit. This view is entirely mistaken. In fact, the conditions of demand for money, including the demand for storage purposes, is independent of the circumstances of the supply of money. The contrary supposition can be supported only by supporting a connection between the quantity of money and the rate of interest,46  that is, by asserting that the variations arising from changes in the ratio between the demand for money and the supply of it, influence to a different degree the prices of goods of the first order and those of goods of higher orders, so that the proportion between the prices of these two classes of goods is altered. The question of the tenability of this proposition, which is based on the view that the rate of interest is dependent on the greater or lesser quantity of money, will have to be brought up again in part three. There the opportunity will also arise for showing that the cash reserves of the banks that issue fudiciary media no more act as a buffer in this way than these mythical hoards do. There is no such thing as a “reserve store” of money out of which commerce can at any time supply its extra requirements or into which it can direct its surpluses.

The doctrine of the importance of hoards for stabilizing the objective exchange value of money has gradually lost its adherents with the passing of time. Nowadays its supporters are few. Even Diehl’s membership of this group is only apparent. He agrees, it is true, with the criticism directed by Fullarton against the currency theory. On the other hand, he concedes that Fullarton’s expressions inert and dormant are erroneously applied to reserves of money; since these reserves are not idle but merely serve a different purpose from that served by circulating money; he also agrees that sums of money in such reserves and sums used for purposes of payment are not sharply distinguishable, and that the same sums serve now one purpose and now the other. In spite of this, however, he supports Fullarton as against Ricardo. He says that, even if the sums taken out of the reserves must again be replaced out of the stocks of money present in the community; this need not occur immediately; a long period may elapse before it is necessary; and that in any case it follows that the mechanical connection which Ricardo assumes to exist between the quantity of money in circulation and the prices of commodities cannot be accepted, even with regard to hoards.47  Diehl does not show in greater detail why a long period may elapse before the sums supposed to be taken from the reserves are replaced. But he does admit the fundamental correctness of the criticism leveled at Fullarton’s arguments; it is possible to grant the sole reservation that he makes if we interpret it as meaning that time may and must elapse before changes in the quantity of money express themselves all over the market in a variation of the objective exchange value of money. For that the increase in individuals’ stocks of money which results from the inflow of the additional quantity of money must bring about a change in the subjective valuations of the individuals, and that this occurs immediately and begins immediately to have an effect in the market, can hardly be denied. On the other hand, an increase in an individual’s demand for money while his stock remains the same, or a decrease of his stock while his demand remains the same, must lead at once to changes in subjective valuations which must be expressed in the market, even if not all at once, in an increase of the objective exchange value of money. It may be admitted that every variation in the quantity of money will impel the individual to check his judgment as to the extent of his requirements for money and that this may result in a reduction of his demand in the case of a diminishing stock of money and an augmentation of it in the case of an increasing stock, but the assumption that such a limitation or extension must occur has no logical foundation, not to speak of the assumption that it must occur in such a degree as to keep the objective exchange value of money stable.

A weightier objection is the denial of the practical importance of the quantity theory, that is implied in the attribution to the present organization of the money, payment, and credit system of a tendency to cancel out variations in the quantity of money and prevent them from becoming effective. It is said that the fluctuating velocity of circulation of money, and the elasticity of methods of payment made possible by the credit system and the progressive improvement of banking organization and technique, that is, the facility with which methods of payment can be adjusted to expanded or contracted business, have made the movement of prices as far as is possible independent of variations in the quantity of money, especially since there exists no quantitative relation between money and its substitutes, that is, between the stock of money and the volume of transactions and payments. It is said that if in such circumstances we still wish to preserve the quantity theory we must not base it merely upon current money but “extend it to embrace all money whatever, including not only all the tangible money substitutes that are capable of circulation, but also every transaction of the banking system or agreement between two parties to a contract that replaces a payment of money.” It is admitted that this would make the theory quite useless in practice, but it would secure its theoretical universality. And it is not denied that this raises an almost insoluble problem—that of the conditions under which credit comes into being and of the manner in which it affects the determination of values and prices.48

The answer to this is contained in the third part of the present work, where the problem of the alleged elasticity of credit is discussed.49

• 43See Fullarton, On the Regulation of Currencies, 2d ed. (London, 1845), pp. 69 ff., 138 f.; Wagner, Die Geld-und Kredittheorie der Peelschen Bankakte (Vienna, 1862), pp. 97 ff.
• 44Elsewhere, explicitly as well. See Fullarton, op. cit., pp. 57 f.; Wagner, op. cit., p. 70.
• 45See also Knies, Geld und Kredit (Berlin, 1876), vol. 2, 1st half, pp. 284 ff.
• 46See Fullarton, op. cit., p. 71.
• 47See Diehl, Sozialwissenschaftliche Erläuterungen zu David Ricardos Grundsätzen der Volkswirtschaft und Besteuerung, 3d ed. (Leipzig, 1922), Part 2, p. 230.
• 48See Spiethoff, op. cit., pp. 263 ff.; Kemmerer, op. cit., pp. 67 ff.; Mill, op. cit., pp, 316 ff.
• 49See pp. 302 ff. below.

In general the quantity theory has not been used for investigating the consequences that would follow a decrease in the demand for money while the stock of money remained the same. There has been no historical motive for such an investigation. The problem has never been a live one; for there has never been even a shadow of justification for attempting to solve controversial questions of economic policy by answering it. Economic history shows us a continual increase in the demand for money. The characteristic feature of the development of the demand for money is its intensification; the growth of division of labor and consequently of exchange transactions, which have constantly become more and more indirect and dependent on the use of money, have helped to bring this about, as well as the increase of population and prosperity. The tendencies which result in an increase in the demand for money became so strong in the years preceding the war that even if the increase in the stock of money had been very much greater than it actually was, the objective exchange value of money would have been sure to increase. Only the circumstance that this increase in the demand for money was accompanied by an extraordinarily large expansion of credit, which certainly exceeded the increase in the demand for money in the broader sense, can serve to explain the fact that the objective exchange value of money during this period not only failed to increase, but actually decreased. (Another factor that was concerned in this is referred to later in this chapter.)

If we were to apply the mechanical version of the quantity theory to the case of a decrease in the demand for money while the stock of money remained unaltered, we should have to conclude that there would be a uniform increase in all commodity prices, arithmetically proportional to the change in the ratio between the stock of money and the demand for it. We should expect the same results as would follow upon an increase of the stock of money while the demand for it remained the same. But the mechanical version of the theory, based as it is upon an erroneous transference of static law to the dynamic sphere, is just as inadequate in this case as in the other It cannot satisfy us because it does not explain what we want to have explained. We must build up a theory that will show us how a decrease in the demand for money while the stock of it remains the same affects prices by affecting the subjective valuations of money on the part of individual economic agents. A diminution of the demand for money while the stock remained the same would in the first place lead to the discovery by a number of persons that their cash reserves were too great in relation to their needs. They would therefore enter the market as buyers with their surpluses. From this point, a general rise in prices would come into operation, a diminution of the exchange value of money. More detailed explanation of what would happen then is unnecessary.

Very closely related to this case is another, whose practical significance is incomparably greater. Even if we think of the demand for money as constantly increasing it may happen that the demand for particular kinds of money diminishes, or even ceases altogether so far as it depends upon their characteristics as general media of exchange, and this is all we have to deal with here. If any given kind of money is deprived of its monetary characteristics, then naturally it also loses the special value that depends on its use as a common medium of exchange, and only retains that value which depends upon its other employment. In the course of history this has always occurred when a good has been excluded from the constantly narrowing circle of common media of exchange. Generally speaking, we do not know much about this process, which to a large extent took place in times about which our information is scanty. But recent times have provided an outstanding example: the almost complete demonetization of silver. Silver, which previously was widely used as money, has been almost entirely expelled from this position, and there can be no doubt that at a time not very far off, perhaps even in a few years only, it will have played out its part as money altogether. The result of the demonetization of silver has been a diminution of its objective exchange value. The price of silver in London fell from 60-9/10d. on an average in 1870 to 23-12/16d. on an average in 1909. Its value was bound to fall, because the sphere of its employment had contracted. Similar examples can be provided from the history of credit money also. For instance, the notes of the southern states in the American Civil War may be mentioned, which as the successes of the northern states increased, lost pari passu their monetary value as well as their value as claims.50

More deeply than with the problem of the consequences of a diminishing demand for money while the stock of it remains the same, which possesses only a small practical importance, the adherents of the quantity theory have occupied themselves with the problem of a diminishing stock of money while the demand for it remains the same and with that of an increasing demand for money while the stock of it remains the same. It was believed that complete answers to both questions could easily be obtained in accordance with the mechanical version of the quantity theory, if the general formula, which appeared to embrace the essence of the problems, was applied to them. Both cases were treated as inversions of the case of an increase in the quantity of money while the demand for it remained the same; and from this the corresponding conclusions were drawn. Just as the attempt was made to explain the depreciation of credit money simply by reference to the enormous increase in the quantity of money, so the attempt was made to explain the depression of the seventies and eighties by reference to an increase of the demand for money while the quantity of money did not increase sufficiently. This proposition lay at the root of most of the measures of currency policy of the nineteenth century. The aim was to regulate the value of money by increasing or diminishing the quantity of it. The effects of these measures appeared to provide an inductive proof of the correctness of this superficial version of the quantity theory, and incidentally concealed the weaknesses of its logic. This supposition alone can explain why no attempt was ever made to exhibit the mechanism of the increase of the value of money as a result of the decrease in the volume of circulation. Here again the old theory needs to be supplemented, as has been done in our argument above.

Normally the increase in the demand for money is slow, so that any effect on the exchange ratio between money and commodities is discernible only with difficulty. Nevertheless, cases do occur in which the demand for money in the narrower sense increases suddenly and to an unusually large degree, so that the prices of commodities drop suddenly. Such cases occur when the public loses faith in an issuer of fiduciary media at a time of crisis, and the fiduciary media cease to be capable of circulation. Many examples of this sort are known to history (one of them is provided by the experiences of the United States in the late autumn of 1907), and it is possible that similar cases may occur in the future.

• 50See White, Money and Banking Illustrated by American History (Boston, 1895), pp. 166 ff.