The Theory of Money and Credit

Irving Fisher’s scheme is symptomatic of a tendency in contemporary currency policy which is antipathetic to gold. There is an inclination in the United States and in Anglo-Saxon countries generally to overestimate in a quite extraordinary manner the significance of index methods. In these countries, it is entirely overlooked that the scientific exactness of these methods leaves much to be desired, that they can never yield anything more than a rough result at best, and that the question whether one or other method of calculation is preferable can never be solved by scientific means. The question of which method is preferred is always a matter for political judgment. It is a serious error to fall into to imagine that the methods suggested by monetary theorists and currency statisticians can yield unequivocal results that will render the determination of the value of money independent of the political decisions of the governing parties. A monetary system in which variations in the value of money and commodity prices are controlled by the figure calculated from price statistics is not in the slightest degree less dependent upon government influences than any other sort of monetary system in which the government is able to exert an influence on values.

There can be no doubt that the present state of the market for gold makes a decision between two possibilities imperative: a return to the actual use of gold after the fashion of the English gold standard of the nineteenth century, or a transition to a fiat-money standard with purchasing power regulated according to index numbers. The gold-exchange standard might be considered as a possible basis for future currency systems only if an international agreement could impose upon each state the obligation to maintain a stock of gold of a size corresponding to its capacity. A gold-exchange standard with a redemption fund chiefly invested in foreign bills in gold currencies is in the long run not a practicable general solution of the problem.

The first German edition of this work, published in 1912, concluded with an attempt at a glimpse into the future history of money and credit. The important parts of its argument ran as follows:

“It has gradually become recognized as a fundamental principle of monetary policy that intervention must be avoided as far as possible. Fiduciary media are scarcely different in nature from money; a supply of them affects the market in the same way as a supply of money proper; variations in their quantity influence the objective exchange value of money in just the same way as do variations in the quantity of money proper. Hence, they should logically be subjected to the same principles that have been established with regard to money proper; the same attempts should be made in their case as well to eliminate as far as possible human influence on the exchange ratio between money and other economic goods. The possibility of causing temporary fluctuations in the exchange ratios between goods of higher and of lower orders by the issue of fiduciary media, and the pernicious consequences connected with a divergence between the natural and money rates of interest, are circumstances leading to the same conclusion. Now it is obvious that the only way of eliminating human influence on the credit system is to suppress all further issue of fiduciary media. The basic conception of Peel’s Act ought to be restated and more completely implemented than it was in the England of his time by including the issue of credit in the form of bank balances within the legislative prohibition.

“At first it might appear as if the execution of such radical measures would be bound to lead to a rise in the objective exchange-value of money. But this is not necessarily the case. It is not improbable that the production of gold and the increase in the issue of bank credit are at present increasing considerably faster than the demand for money and are consequently leading to a steady diminution of the objective exchange value of money. And there can be no doubt that a similar result follows from the apparently one-sided fixing of prices by sellers, the effect of which in diminishing the value of money has already been examined in detail. The complaints about the general increase in the cost of living, which will continue for a long time yet, may serve as a confirmation of the correctness of this assumption, which can be neither confirmed nor refuted statistically. Thus, a restriction of the growth of the stock of money in the broader sense need not unconditionally lead to a rise in the purchasing power of the monetary unit; it is possible that it might have the effect of completely or partly counteracting the fall in the value of money which might otherwise have occurred.

“It is not entirely out of the question that the monetary and credit policy of the future will attempt to check any further fall in the objective exchange value of money. Large classes of the population—wage and salary earners—feel that the continuous fall in the value of money is unjust. It is most certain that any proposals that promise them any relief in this direction will receive their warmest support. What these proposals will be like, and how far they will go, are matters that it is difficult to foresee. In any case, economists are not called upon to act as prophets.”

Elsewhere in the course of the argument it was claimed that it would be useless to try and improve the monetary system at all in the way envisaged by the tabular standard. “We must abandon all attempts to render the organization of the market even more perfect than it is and content ourselves with what has been attained already; or rather, we must strive to retain what has been attained already; and that is not such an easy matter as it seems to appear to those who have been more concerned to improve the apparatus of exchange than to note the dangers that implied its maintenance at its present level of perfection.

“It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown. Once common principles for their circulation-credit policy are agreed to by the different credit-issuing banks, or once the multiplicity of credit-issuing banks is replaced by a single world bank, there will no longer be any limit to the issue of fiduciary media. At first, it will be possible to increase the issue of fiduciary media only until the objective exchange value of money is depressed to the level determined by the other possible uses of the monetary metal. But in the case of fiat money and credit money there is no such limit, and even in the case of commodity money it cannot prove impassable. For once the employment of money substitutes has superseded the employment of money for actual employment in exchange transactions mediated by money, and we are by no means very far from this state of affairs, the moment the limit was passed the obligation to redeem the money substitutes would be removed and so the transition to bank-credit money would easily be completed. Then the only limit to the issue would be constituted by the technical costs of the banking business. In any case, long before these limits are reached, the consequences of the increase in the issue of fiduciary media will make themselves felt acutely.”

Since then we have experienced the collapse, sudden enough, of the monetary systems in a whole series of European states. The inflation of the war and postwar periods, exceeding everything that could have been foreseen, has created an unexampled chaos. Now we are on the way to mastering this chaos and to returning to a new organization of the monetary system which will be all the better the less it differs from the system in force before the war.

The organization of exchange that will thus be achieved again will exhibit all the shortcomings that have continually been referred to with emphasis throughout the present book. It will be a task for the future to erect safeguards against the inflationary misuse of the monetary system by the government and against the extension of the circulation of fiduciary media by the banks.

Yet such safeguards alone will not suffice to avert the dangers that menace the peaceful development of the function of money and fiduciary media in facilitating exchange. Money is part of the mechanism of the free market in a social order based on private property in the means of production. Only where political forces are not antagonistic to private property in the means of production is it possible to work out a policy aiming at the greatest possible stability of the objective exchange value of money.