The Common Sense of Political Economy

These two claims for gold, so far as they go, will cancel each other, and only the balance need be paid. Gold as a standard of value and a potential medium of exchange has been associated with the whole transaction; gold as an actual medium of exchange, only with a small part of it. But suppose A is under obligation to pay gold to B, and B is under obligation to pay gold not to him but to C, who in his turn is under obligation to pay gold not to B but to A. Then A is to receive gold from C and pay gold to B, B is to receive from A and pay to C, and C is to receive from B and pay to A—

so that in the end the gold will be exactly where it was at the beginning, if the obligations are equal; and if the various transactions are not of the same value in gold, the final state will only differ from the initial state by the margin beyond the area of coincidence. Here again it is clear that a sum of gold passing from A to B, and from B to C, and from C to A again, is making the same superfluous journeys that it was found easy to avoid in the simpler case when it passed from A to B and then back again from B to A.

Now any one of these three, B for instance, might say to C: “I owe you money, but A owes me money. Instead of paying you I will tell A to pay you, and will accept your assurance that he has discharged my obligation to you in lieu of his payment to me.” If C accepts this arrangement, then the form

has been reduced to the form

and, as we have seen, these claims cancel each other; so that the whole of the three transactions can be cancelled, so far as the gold is concerned, except for the settlement of the balances. If A, B, and C are in easy connection with each other, it does not matter whether they live in the same house or in the same city or in the same country. They might be one in New York, one in Berlin, and one in London; or they might be next-door neighbours; or they might be (as they often are) members of the same family liquidating their obligations across the table. It is easy to see that the same principle might be successfully applied to any number of persons and to any network of cross obligations and combinations if a system of cancelling could be established that involves less expense and inconvenience than the keeping and transferring of the metal would. Now the actual transfer of gold may be a more serious matter between Glasgow and London than between two streets in Glasgow, and a more serious matter between Glasgow and Berlin than between Glasgow and London. Therefore if two persons, A
₁ and A
₂, live within easy access of each other and are in habitual communication, and two other persons, B
₁ and B
₂, are similarly situated with respect to each other, then suppose A
₁ is under obligation to pay gold to B
₂, and B
₁ under a similar obligation to pay gold to A
₂, we should have

that is to say, A
₁ and B
₁ are to pay, and A
₂ and B
₂ are to receive. Then let A
₁ pay A
₂ on behalf of B
₁, and let B
₁ pay B
₂ on behalf of A
₁—

the result being the same, namely, that A
₂ and B
₂ have received money, and A
₁ and B
₁ have paid it. Thus, if we regard A
₁ and A
₂ as a single group, and B
₁ and B
₂ as another single group, the form

may be regarded as reducing itself to the form

and only the balance between the total obligations of the A’s to the B’s or the B’s to the A’s will have to be settled by the transfer of gold. And in the same way the A, B, and C of a former example may be groups of persons living respectively in London, Berlin, and New York.

This is the whole theory and principle of foreign exchanges and international trade, but we must further examine the machinery through which it is applied. Before proceeding with this branch of our inquiry, however, we must consider another closely connected but also contrasted financial scheme.

Let us suppose that a man who has numerous transactions with his neighbours both buys and sells with most of them, though there are some from whom he buys only and others to whom he only sells. This still is, or recently was, very much the case in remote country districts. Such a man may, by the cancelling process already described, conduct a great part of his exchanges under the denomination of gold but without the intervention of gold as an actual medium. But he both receives and pays in gold to some extent, and he must take care to keep by him enough of the gold that he receives to enable him to make his payments. And there are periods during which a considerable amount of coin is simply lying in his cash-box in anticipation of claims that will be made before any more cash has come in. Indeed, to be safe he always aims at having a little more than he is at all likely to want. If he could be sure of its safe custody he would be glad to be rid of the anxiety and risk of keeping this cash himself; and we are told that it was the lodging of sums of money with goldsmiths for safe custody that first gave rise to the system of banking. Let us suppose, then, that a bank is established and that it receives the greater part of the stock of money which the community finds it convenient to have available for paying their balances in gold. The banker credits each of his clients with the amount of his stock. When A has to pay a sum in gold to B, instead of handing over the sovereigns he now gives him an order for those sovereigns upon the banker, and B, if he likes, can go to the bank and get them out. But if he too wants gold chiefly for paying balances, and if he too lodges the greater part of his stock with the banker, it is unlikely that he will draw the sovereigns out at all; he will simply hand over to the bank A’s certificate that so many sovereigns are now his, not A’s, and the banker will transfer the amount from A’s credit to B’s.

This system could be carried on either in conjunction with the cancelling process described above, or apart from it; for A and B may either give each other orders on their bankers for the full amounts of their obligations, or may exchange their bills as far as they go, and only settle the balance by an order on the banker for the transfer of credit from one to the other. And where the accounts of a whole community are thus kept by the banker, it is obvious that machinery is at once established by which many cross transactions may be simplified. Thus, in the instance given on page 579, if A has given an order on his banker to B, B may simply transfer the order to C without knowing that C owes money to A. C, in any case, may go to the bank and draw out the money, or he may leave it there to his own credit. Or if B prefers it he can draw a cheque on his bank in C’s favour, and at the same time pay in A’s order, so that he would at once have the credit transferred to him from A’s account out of which he can meet C’s claim. The more complicated the transactions are the greater the simplification that can be effected by one central recipient who has the whole field under his survey. The transactions of the community, therefore, when banking is firmly established, will be to a very great extent conducted without any physical transfer of gold at all. But so far we have not seen that the banking system effects any further economy in the amount of gold required to carry on the business of the community. It is true that the gold need not be shifted. If it lies at the bank and is now B’s, whereas it was A’s, the shifting is only in the books, not in the cellars, of the bank; but A, B, and C must severally, and therefore collectively, have credit at the bank for the full number of sovereigns that they must otherwise have kept at home. Indeed in some ways the banking system rather tends to limit than to extend the cancelling of obligations, in the strict sense, as between individuals. Every one knows that it often conduces to simplicity and clearness of account-keeping actually to go out of the way to avoid cancelling transactions, and to exchange cheques as well, when exchanging receipts; so that a man may have to keep a larger balance at his banker’s than the reserve of sovereigns that would be necessary if he did business with his neighbours by cancelling accounts. Otherwise there would be danger of overdrawing, at any rate for a few days or hours. For if A owes B £40, and B owes A £38, and neither of them has more than three or four sovereigns, they can settle their accounts when they meet; but if they avail themselves of the conveniences of banking, and without waiting till they meet send each other cheques, if one presents his cheque at the bank a few hours before the other there will be no credit to meet it unless balances of £40 or so are kept at the bank. Thus in some cases the conveniences of banking may be an alternative to those of cancelling , and may involve the maintaining of a larger balance of money in hand. But it is also possible that banking may be resorted to in conjunction with a system of private cancelling, and in any case it may obviously facilitate the interchange of obligations by which A can make his credit with B discharge his obligations to C, and so forth. But all the while it would appear as yet that the gold, whether for paying of balances or total amounts, must exist in the hands of the bankers though it is not transferred. The economy is in moving the gold, not (so far as we have yet seen) in the amount of gold that is kept.

But now we must take another step. The banker finds that only a comparatively small part of the gold with which his clients are credited is ever taken out: the greater part of it is left with him and is simply transferred now to one credit and now to another. The consequence is that he does not find it necessary actually to keep all the gold which stands to the credit of his clients. He can transform the greater part of this wealth into revenue-yielding forms, provided he keeps enough cash to meet all claims that he can in reason expect will be made on it. For, as we have seen, if A gets an order for gold from C, whether he wants it immediately to settle B’s claims, or wishes to keep it ready for any other and future purposes, he will generally not draw out the actual sovereigns, but will simply leave the credit he has received in the banker’s hands, or request him to transfer it to some one else.

But the persons in the neighbourhood of Bank A will not deal exclusively with each other. They will deal to some extent with persons in other parts of the country; so that persons dealing with Bank A may be under obligation to pay sums of money to the clients of Banks B, C, etc., and customers of these banks will be under similar obligations to the clients of the others, including A. All these transactions may also be carried on by means of orders to the bankers to transfer credits, only now the client of Bank A will order his banker to transfer his property not to another of his own clients but to a client of Bank B. Here then is an actual order to transfer gold from his cellar to that of another banker, not from the credit of one of his clients to the credit of another, and it would seem that the gold must be shifted. But there will be a number of such obligations on the part of Bank A to Bank B, and a number of counter obligations on the part of Bank B to Bank A, and now, so far as the transfer of gold is concerned, a genuine cancelling of obligations may take place. Bank A sends a number of orders for gold on Bank B, and Bank B meets a part of these by counter orders for gold on Bank A. Perhaps a balance is still due from Bank B to Bank A in gold, but a balance may be due to Bank B from Bank C, and so forth; and—since all the banks will be connected with each other directly or indirectly, through local branches of the Bank of England, through their agents in London, or otherwise, and since they will all (as we shall see) ultimately have balances at the Bank of England,—partly by a system of cancelling obligations and partly by a system of cheques on the Bank of England, they will probably arrange all their affairs without the material transfer of any coin whatever.

Thus it is only a portion of his property (if he is in trade a small portion) that each individual will wish to command in the form of gold; and of this portion, again, he will only desire to have a fraction, probably a small one, actually in his cash-box in the form of gold; the rest he will hold as a balance at his banker’s, which he is entitled to realise in gold at any moment he chooses. Now of these balances the banks will hold the larger portion in the shape of revenue-yielding forms of wealth; and of the portion which they desire to command in the form of gold the branch banks will, again, only keep a fraction in their tills; the rest will be held by the great houses in Birmingham, Liverpool, Manchester, and so forth; and these, again, will hold only a portion of their reserves in gold, and the rest in the form of credit with the Bank of England. The Bank of England in its turn will hold the greater part of the property with which it is entrusted by the other banks, and which they may at any time claim in the form of gold, in the shape of revenue-yielding forms of property, only maintaining such a reserve in actual coin and bullion as it deems sufficient both to meet the claims that will actually be made upon it and to maintain its credit unshaken.

Thus we see that enormous economies in the use of gold as a medium of exchange are effected. The whole metallic reserve held by all the banks constitutes a very small fraction of the collective liability of the banks to pay gold on demand; for note that every depositor in every bank is entitled at any time to draw out the whole of his property in coin of the realm, or in Bank of England notes, which in their turn he may present at the Bank of England, demanding gold in exchange for them. Every one, then, is entitled to draw out the full amount of his balance in gold, and
any one can actually do this as long as the machinery is working smoothly; but it would be impossible for
every one to do it, because the immensely greater part of the property does not exist in the form of sovereigns or gold at all; it consists of all kinds of property and obligations, of a value equivalent, at the marginal terms of exchange, to the total sum which the public has the theoretical right to draw out in gold. It all exists, however. Every man’s balance severally, and the whole amount of the deposits in the banks collectively, represent real property, and all this property is in the possession of the banks at every moment, to its full amount. It is the greatest mistake to suppose that the whole body of banking transactions reduces itself to mere entries and transfers in books, and that if the banker had simply squandered the property entrusted to him, everything would go on just the same so long as nobody knew it. For it is just because the property is there, and is most of it yielding revenue, that the banker is able to pay his staff and support his own expenses. The property of the clients, represented by their balances at the bank, is real property and is doing real work; and the revenues that accrue to it in virtue of that work are paying for all the privileges and conveniences that the clients enjoy. If five hundred people draw cheques on the same bank on the same day to the extent of £5000, and only 50 sovereigns, one per cent of the whole, are actually drawn out of the bank, nevertheless, each individual cheque has behind it a basis of actual property to which the drawee has received a valid title. If the bank is solvent, then even if it had to “stop payment,” that is to say if it were unable to meet all the simultaneous claims for actual coin made upon it, the holder of credit in it would be the holder of actual property. Thus the man who pays a cheque, hands to his correspondent a document which gives him a substantial claim; and the sum of these substantial claims (unlike the formal right to draw coin) can be met simultaneously; for the holders of the cheques and credits in the bank are entitled, in the last resort, to enter into acknowledged and legal possession of miscellaneous property that is actually bearing revenue and is negotiable, like all other property, in the public markets. So when I receive a cheque in exchange for valuable possessions or services, though I do not thereby enter into possession of the commodities and services that I myself require, yet I do get actual property, not a mere pretence or symbol of property. The actual property I get is valued by some one else, and I can hold it until I find it convenient to exchange it for property that I value myself. Thus by the banking system a vast amount of miscellaneous claims and possessions other than gold are converted into “media of exchange” just as real as gold itself; for they mediate between the things I have and the things I want, and enable me to transform the one into the other without the necessity of a double coincidence between my wants and those of my correspondent. The whole mass of cheques which is exchanged day by day is therefore not an economy of “media of exchange” at large. It is a calling into partnership with gold, as a medium of exchange (but not as a standard of value), of an immense amount of other property. To regard the banking system of England as consisting in a cunning device to make sovereigns that only exist as entries in a book do the work of real sovereigns, is a fundamental misconception.

The great bulk of the business of the country, therefore, is still carried on by the intervention of media of exchange, but only a little of it by the medium of gold; whereas almost the whole of it is carried on under the denomination of gold. Gold, therefore, has a far wider application as a standard of value than as a medium of exchange. But even in this last capacity it is still active. Actual transfers of gold are constantly made from individual to individual, from bank to bank, and from city to city. The obligations of the bankers in Edinburgh and the bankers in Liverpool may not accurately balance each other, and even if the balances are settled by cheques on the Bank of England the receiving banks may find it convenient to demand cash and not a credit from the Bank of England itself. Or at any time and independently of other banks any given bank may desire to draw cash from the London (or other) agent with whom its reserve is deposited. So there will be a pulsation and ebb and flow of gold not only within any given district but from one district to another, and the banks undertake, as part of their business, to convey the actual coin from one part of the country to another, as may be needed.

Thus if I live in Birmingham and owe money to a man in Leeds, I may send him a cheque on a Birmingham banker, and this will save me the expense and risk of actually sending him the gold. It may turn out, as the result of the whole series of transactions between Birmingham and Leeds, that gold actually has to be transferred directly or indirectly from Birmingham to Leeds, or it may turn out the other way. In the first case the fact that I have transferred a portion of my credit in Birmingham to the credit of some one in Leeds will aggravate the situation. In the other case it will relieve it. And this will make a difference to the bankers, but it will make no difference to me. The banker will conduct my business on the same terms whether this particular transaction happens to increase or to diminish his own expenses. It is indeed possible that if I am dealing with a distant part of the kingdom he may charge a special commission on all cheques, but this commission will be uniform and will not depend on whether this particular transaction tends to involve him in the expense of the transfer of gold or tends to relieve him from it. The expenses of the transfer of gold, then, whenever it may be necessary, are a part of the general obligations incurred by the bank to its clients, and no individual dealing with other individuals through a bank in the United Kingdom has to consider whether this particular transaction is likely to involve the expense of a transfer of gold, for if it does he will not have to pay anything extra, and if it saves such a transfer he will derive no benefit from the fact.

But if a London merchant is under obligation to pay gold to a Paris merchant there is no machinery by which he can once and for all contract himself out of the liabilities or privileges that may be incidental to the money being due in Paris and the gold being in London, when the time of settlement comes. And it is here that the economic difference between home and foreign trade clearly emerges.

There is obviously no reason why the purely economic forces which urge men to further the purposes of others in order that they may thereby further their own, should in any way be limited or qualified by national boundaries. And from the economic point of view it therefore seems impossible to conceive that there should be any essential difference between foreign and domestic trade. Whatever differences there are must apparently be differences of condition or of machinery, not of economic principle or theory. But what are these differentiating considerations? Some of the conditions under which, and obstacles in the face of which, the economic forces act may indeed be determined by a difference of government or language, or both. But it is difficult to assign any general or dominant efficacy to them even when they coincide with the areas of “home” and “foreign” trade. Familiarity and confidence are essential elements for the carrying on of business, and this may, in a vague way, be furthered by a common nationality, language, or government; but it is hard to see why a merchant in Dover should necessarily have more familiarity with or confidence in a merchant in the Hebrides as against a merchant in Calais. English and Americans speak the same language, yet their dealings constitute a branch of foreign trade. Englishmen and Welshmen deal with each other, and their dealings are a branch of domestic trade, even if they habitually speak different languages. English and Irish trade is domestic, and English and French trade foreign quite irrespective of the
cordialité or otherwise of any
entente that may exist between the peoples. Colonial trade is usually (and rightly, as we shall see) classed with foreign rather than home trade, though by the sentimental tests it should belong to the latter. Tariff boundaries seem to promise a more important distinction; but the trade between England and Denmark is foreign trade though there are practically no tariff barriers to overcome, and the trade between Florence and the surrounding agricultural districts is domestic although a tariff barrier is drawn round the city. Where, then, are we to look for any essential differences? Is it in the different systems of currency? No; for the standard coins minted by any one of the countries forming the “Latin Union” were made legal tender in the public treasuries of all the others by a treaty of 1866, and were practically received as such in all private transactions. Moreover, even where there is no such legal or conventional equivalence of currencies, transactions are conducted under a common standard. The affairs between Germany and England are conducted in terms of gold, and the sums of gold which people in London and people in Berlin have engaged to pay each other can be cancelled directly or indirectly, as between Liverpool and Glasgow; the balances in either case being ultimately paid in gold which has to be physically transported from the one centre to the other. But, as we have seen, there is a real difference in the machinery by which the cancelling is effected and the form in which the individual trader meets his share in the expense of the necessary transfers; and it is to the examination of this point that we must now return.

Let us revert to the case examined on page 579. We suppose that three persons, A, B, and C, are in such relations with each other that A owes to B, B to C, and C to A. That is, B having supplied things to A, sends him in a bill, C sends in a bill for the like sum to B, and A to C. Let A send in his bill to C and request him not to pay it, but simply to acknowledge that he owes the money and will pay it to any one A may nominate. Let C send back A’s bill with this undertaking endorsed on it, and then let A write on it a statement that it is B to whom the money is to be paid, and let him then forward the document with these two endorsements upon it to B. B has now a claim upon C for the money which A owes him, and as C has a claim for the same amount on B, the two claims meet each other and there is no transfer of coin at all. A has settled his account with B by giving him a bill upon C; and this is the type of the instruments by which international obligations are cancelled. We have only to suppose that A lives in London, B in Bombay, and C in Amsterdam to transform this into an actual case of settlement of international accounts by bills.

We may note exactly equivalent ways of settling such a group of accounts.

may be resolved into

into

or into

according as A “draws a bill” on C, B draws a bill on A, or C draws a bill on B. All these processes are identical in principle and in effect. Custom determines the prevailing practice in each important case.

But the “double coincidence” implied in this example will be rare. An English merchant may well export woollen goods to New York, a New York merchant wheat to Amsterdam, and a Dutch merchant dairy produce to London; but it is not likely that it will be the same English merchant that sells the woollen goods and buys the dairy produce. And so with the others.

We shall therefore have, in the simpler case of the two countries, dealing with each other both ways,

resolving itself, by the agency of a bill, into

That is to say: the Paris merchant B
₁ who owes money to the London merchant A
₂ will find another Paris merchant B
₂ who has a bill against another London merchant A
₁; he will pay it and will then send B
₂‘s order on A
₁ in payment of his own obligation. B
₂ will then have been paid by B
₁, and A
₂ will draw upon A
₁, who will pay him.

In the more complex case we have

An English merchant A
₂ has bought dairy produce from a Dutch merchant C
₁. C
₁ finds another Dutch merchant who has bought wheat from a New York merchant B
₂ and wishes to pay him. C
₁ sells his bill on A
₂ to C
₂, who forwards it in payment to B
₂. B
₂ finds another New York merchant B
₁ who owes money to an English merchant A
₁ for woollen goods. He buys the bill on A
₂ from B
₂, and forwards it in payment to A
₁, who presents it to A
₂ and receives payment for it. Thus A
₂ has paid A
₁ instead of C
₁; C
₁ has been paid by C
₂ instead of by A
₂; C
₂ has paid C
₁ instead of paying B
₂; B
₂ has been paid by B
₁ instead of by C
₂; B
₁ has paid B
₂ instead of paying A
₁; and A
₁ has been paid by A
₂ instead of by B
₁.

The movement has been

A
₂, C
₂, and B
₁ have paid, and A
₁, C
₁, and B
₂ have received, as was due; but the settlements have all been made without transfer of coin from country to country.

The instrument of liquidation has been a bill on London; but theoretically it might equally well have been A
₁‘s bill on B
₁ in New York, or B
₂‘s bill on C
₂ in Amsterdam. But it is manifestly unnecessary for more than one bill to circulate.

Thus we see that in international or colonial trade (for we might just as well have had Quebec as New York in our example), through the instrumentality of bills payments within a country may be substituted for payments from one country to another, even when all the transactions are conducted and all the obligations incurred in terms of gold, and even if every one of the creditors requires and receives full payment in gold.

But the most important and complex part of the investigation still remains. How are balances settled? They might be, and sometimes are, settled by the actual transfer of gold, but the expense of transferring gold from Berlin to London, for example, is about ¼ per cent. More closely, if a German has to fulfil an obligation to a London merchant for £1000, it would cost him about £1002:9s. if he actually sent the gold. Now in any given state of trade there will always be German merchants who would be prepared to export, say, musical instruments or glass to London, if they could get a very little better price than they can actually command. A German merchant who would just not be induced to accept a certain order at £1000 might just be induced to accept it at £1001. If such a man, having an offer of £1000 for certain goods, were to say to the German who owes £1000 in London, “I will discharge your debt for you by sending goods to London which will be accepted as the full value of £1000, if you will give me £1 for doing so,” it would pay the German debtor to accept the offer. The German manufacturer would present him with a bill against his correspondent to the full amount of £1000, he would despatch it to London in payment of his obligation, and it would have cost him £1001 only, instead of £1002:9s. Thus the exports to England will increase, and the balance “against” Germany (that is to say, the obligations of Germany to England in excess of those of England to Germany) will be reduced. But it may be that in spite of this Germans are still buying more from England than England is buying from Germany, so that the obligations of Germany are still mounting, and German debtors, having exhausted all the possibilities of finding German manufacturers who are within £1 on the £1000 of striking bargains in England and so creating bills on her, will have to offer better terms and make use of those who are, say, only within £1:5s. on the £1000. And this process may go on until there is no German manufacturer or exporter who will undertake to deliver any goods in London which will have the market value of £1000 there, unless he receives a premium of £2:9s. for doing so. When it comes to this, if there is still a balance to be paid, the German debtor will have nothing to lose by despatching the gold, and he will therefore do so.

If the balance is the other way it will be the English debtor who may have to pay a premium on getting his debt discharged, and the English manufacturer of woollen or leather goods, or hardware, who may be induced to sell his wares in Berlin at a lower price, after allowing for transport, than he would accept in England, because he will receive a premium for discharging a debt in Berlin. In a word, when there is a balance due from London to Berlin, a claim for money in Berlin being worth more to a London merchant than a claim for money in London, the export trade will be stimulated. And when the balance is the other way of course the reversed relation holds.

Sums approximating to £99:16s. and £100:5s. are known as the
gold points between London and Berlin. Naturally the gold points between any other two centres are different. They are the points to which the premium must rise either way in order to make the actual export of gold the cheapest way of settling a balance. Within the gold points balances are settled by exporting goods which would not have yielded a profit had exchange been at par.

The gold balance will, normally, be “against” gold-producing countries, where gold is a staple export and obligations are normally discharged in it, for these countries normally export gold and receive other commodities in exchange; whereas in other countries the balance will prevailingly be “favourable,” that is to say, they will receive their share in the increasing supply of gold in return for export of other commodities.

On the basis of these actual “bills” a fabric of drafts and instruments of every kind is raised, by which international obligations are liquidated. Thus a cheque on my London banker sent to a friend in Berlin becomes a “bill” on London, that is to say, a claim for so much gold in London; and if such claims are at a premium in Berlin, it will sell for more than the metallic value of the gold it represents. And so, too, with Bank of England notes.
*51 The case of actual coin seems anomalous. By hypothesis gold in London is of more value to the Berlin merchant than gold in Berlin. Yet when, for that very reason, bills on London are at a premium, English sovereigns follow the bills and will exchange for more than their metallic weight in German coin.
Qua gold they are worth less, but
qua instruments by which obligations can be discharged in London they are worth more, and persons who are intending to go to London and spend money there will pay more for them, just as willingly as for notes. If there were a large number of them, and their export to settle obligations in London became a business, a man who undertook to send them to England for the convenience of others, instead of desiring to take them across for his own convenience, would have to be paid. But as there are not enough to satisfy all the wants of those who desire them, not as gold but as English coin, they remain at par with the notes this purpose of which they serve equally well. The chief centre of the “bill” business in the larger sense is London, and “drafts” on London are drawn by all nations in settlement of their accounts.

Expositions of the theory of foreign exchanges often dwell too much upon the form which the transactions take without connecting it sufficiently closely with the ultimate movements of trade which it represents. We do not find in practice that one man goes to another, as we have supposed, and says, “I will discharge your debt for £1000 in London if you will give me a commission of £1 for doing so.” But the man who owes £1000 goes into the market to buy a bill by which he can discharge his debt, and finds he has to pay £1001 for it. This of course simply means that to induce some one to create a bill for £1000 on Berlin, that is to say, to supply goods for which he will receive £1000, he must offer him a premium of £1 for doing so. A man who has a bill must sell it for what it can fetch, but he will not create a bill, by a transaction which taken alone would involve a loss, unless he can sell it at a profit. If there is a profit of £1 to be made on creating a bill for £1000, any one can do it if it is worth his while. And as a matter of fact bargains are struck by telegraph all over the world in accordance with the rate of exchange, which varies from day to day; and the amount for which a man can negotiate a bill on such and such a centre is a material consideration in the terms which he can offer his correspondent. All this is perfectly understood, but a delusive simplicity can be given to the exposition by simply treating bills as though they were themselves commodities, and saying that if bills on Berlin are scarce they will rise in value like any other commodity, and if they are abundant will fall, only that they cannot rise or fall beyond the gold points because there would then be cheaper substitutes for them. The superficiality of this treatment need hardly be pointed out. The bill is not a commodity, and we must go behind the phenomena of the bill market to the actual commercial facts which it represents.

Our treatment of the principles of banking and of foreign exchange has necessarily been extremely brief and imperfect, and it is not compatible with the scope and aim of this work to go into further detail. There is, however, one branch of the subject which still remains for examination, and it cannot be wholly neglected. It is the question of the principles which regulate the distribution of the precious metals, and specifically gold, between its uses in the arts and in the currency.
*52 The difficulties that surround this question do not arise so much from the use of gold as currency as from its use as a standard of value, and with this we will therefore begin. There should be no real difficulty in understanding the fundamental relation between gold and other commodities. But it is extremely difficult not to be confused by the language in which we have to express the facts. Thus high gold prices mean low price of gold; for the gold prices of other things are the amounts of gold that must be given for them, whereas the price of gold is the amount of other things that must be given for it. Thus, abundant gold means high prices (in gold), and scarce gold means low prices (in gold). Whereas abundant wheat means low prices (of wheat), and scarce wheat means high prices (of wheat). This is perfectly consistent; but since, when we are speaking of gold, “prices” mean the prices
in the commodity of which we are discoursing, and when we are speaking of other things prices mean the prices
of the commodities of which we are discoursing, the terms constantly confuse and frequently betray us when we are considering the theory of finance and currency. The most experienced scalers of the Alpine heights of speculation in the currency have constantly to steady their heads in these regions of discourse, and the novice is almost certain to be the victim of aggravated
vertigo. The facts, however, that lie behind these bewildering phrases are intelligible enough. We will approach them by forgetting gold for a moment and speaking of wheat. If there is a good wheat harvest, a given amount of wheat will exchange for less of any other commodity or service, and any other commodity or service will exchange for more wheat than if the harvest is bad. High wheat prices would correspond to a relative abundance of wheat; that is to say, a value which was expressed as ten pecks of wheat when wheat was relatively scarce might be expressed as eleven pecks when it was relatively abundant. Consequently if a man had a fixed income of so many quarters of wheat, independently of its abundance or scarcity, he would find when wheat was abundant that prices had risen against him, and although his nominal wheat income would be the same, his real income in the general command of commodities and services would have fallen. But if the man’s nominal income were increased so as to make his real income the same, he would find that wheat being cheaper than before relatively to other things, that is to say, the sacrifice of other things involved in consuming a peck of wheat being smaller than before, there would be a tendency in his administration (imperceptible if he were rich, very marked if he were poor) to consume more wheat in proportion to other things than he had done previously.

On the other hand, if the crop of wheat relatively to the number and habits of the population remained constant for a long series of years, and the amount of gold increased, people would gradually discover that all articles made of gold became relatively cheaper, whether measured in wheat prices or in the equivalents of other services and commodities; and men who had hesitated to pay the extra price for the use of gold in dentistry, or publishers who had refrained from attractive touches of gold in the make-up of their cheap issues, would find that it was now worth their while to incur the lessened expense. Thus, if a man were considering whether he would order a set of artificial teeth, containing a certain amount of gold in the plate, he would find that whereas the extra cost would formerly have been a quarter of wheat, now that gold is cheaper it will be less by a few pecks. He may think this lower (wheat) price worth giving for the additional advantage, in durability and comfort, of having the gold in his plate, whereas at the former price he would not have ordered it. Gold being cheaper it can be had at less sacrifice of other things.

Now these consequences of an increased crop of wheat or an increased output of gold will remain exactly the same if gold, instead of wheat, is the standard. If gold becomes relatively more abundant, gold prices rise, and the man whose real income remains the same (his nominal income being raised, as in the case of the wheat standard) finds gold articles relatively cheaper because all other things are dearer in gold prices, so that the amount of other things he would be able to get instead of the gold in his plate is now smaller than it was, and the sacrifice of other things now involved in securing the plate being therefore smaller, he may be willing to incur it. If, on the other hand, the relative supply of gold remains constant for a series of years and wheat becomes more plentiful, there will be a tendency to substitute the consumption of wheat for that of certain possible alternatives. Thus the relative value of wheat or of gold in relation to other things, and the extent to which they are used by individual consumers, depend on the relative abundance of wheat or of gold, and are entirely independent of the standard in which values are measured, though the position of a man with a fixed income is naturally dependent on the article in which that income is fixed.

If our general thesis is correct that the economic forces tend to secure remuneration to every man and prices to all articles in accord with the marginal significance of the services they render, then there would always be a tendency for nominal wages in wheat to increase if wheat became more abundant and for nominal wages in gold to increase if gold became more abundant; but this tendency may have serious obstructions to overcome. Confining ourselves to the case of the gold standard and the gold prices with which we are familiar, it is obvious that even if a man has not a fixed salary expressed in terms of gold, there may be a traditional price of his services which will offer a certain opposition to change. It would not be easy for a man to change his terms from 7s. 6d. to 7s. 8d. an hour for some kind of instruction, or from 4s. or 10s. a thousand words for translation to the same sum for 1010 words, if the ratio in which gold exchanges for wheat and other commodities had changed. This inertia, or friction, affects all kinds of bargains, the terms of which ought, on the general principles of exchange, to fluctuate not only with the supply of the commodity or capacity concerned and its place on the communal scale, but also with the change in the significance of the unit in which it is expressed; and schemes of a complex standard of value that would automatically preserve the ratio between established prices and their purchasing power have been designed; but they have never come into use; and therefore any man may find himself prejudiced or advantaged by a contract or convention that only yields to the changing facts under severe pressure; and he may therefore be giving either more or less than the value of what he gets, because the terms of his bargain have ceased to correspond with the facts. There is a specially marked tendency to retain certain retail prices at a fixed nominal level, and the fact that this can continue—that the price of a hat, for instance, or the admission to an exhibition remaining fixed through great fluctuations in the purchasing power of gold—shews how much friction counts for, and how much the action of the general economic trends is impeded when it has to force itself through the narrower channels of the commercial system.

But when the amplest allowance has been made for all this friction the general proposition remains true that whether wheat or gold were the standard an increased crop of wheat would at once raise wheat prices and encourage the consumption of wheat, whereas an increased supply of gold would raise gold prices and encourage the use of gold. We have, therefore, to keep in mind that, under a gold standard, high prices correspond to cheap gold and low prices to dear gold; and that in principle and in the long-run this difference of expression is the only difference which the selection of gold as the standard of value really makes,
except in so far as the use of gold as a standard of value involves its use as a medium of exchange. This use as a medium of exchange constitutes an extra use for gold, and consequently raises its value, just as every additional use for any other commodity would, and does. Every individual finds it convenient to hold a portion of his property in the form of gold (or the subsidiary currencies, into the relation of which with gold we need not enter), and therefore a certain amount of gold is withdrawn from other uses, and its marginal significance in these other uses rises. How much does each individual thus set aside? If he is living from week to week or from year to year upon his current earnings, he will practically desire to have the whole of his income immediately available in this form, for he never has enough property for a long enough time to enable him to invest it in revenue-yielding ways. But if he is engaged in any kind of trade or any occupation which involves the acquisition and maintenance of capital, or if he is spending less than his income, or if his earnings are considerable and his expenditure is irregular over long periods, there will be a perpetual question in his mind how much of his property to keep immediately realisable in gold and how much to employ remuneratively. He will not, indeed, in any case keep any large stock of actual coin about him, but he will keep a certain amount of his property as a fluctuating balance at his banker’s, and all of this is available at any moment in the form of gold. This balance he will not make larger than necessary, for (neglecting the details of the arrangement with his banker) it will be practically “lying idle.” The adjustment, then, of the portion of his income which he keeps available in coin to the rest of his income will be determined on exactly the same principles as all other distributions. A very small balance might be inconvenient, a somewhat larger balance less inconvenient, and the marginal inconvenience of this larger balance might not be sufficient to compensate the advantages of investment. When we come to the bankers we are in face of exactly the same problem. They must be prepared to meet all claims for coin. This they will do by keeping actual coin in their tills and by keeping a balance, that is to say, a claim for gold which will ultimately lie for the most part against the Bank of England. They do not wish this balance to be more than enough to keep them safe, for it is from the revenues derived from the rest of the property which they hold in trust that they derive their own incomes. And the same is true of the Bank of England itself.

But we have still not quite come to the question of the currency. We have been speaking chiefly of gold rather than of sovereigns, and the great reserve in the Bank of England is, as a matter of fact, largely in bullion, not in sovereigns. What determines the amount of gold which is actually coined? The answer to this question is at bottom quite simple. The process of converting bullion into sovereigns or sovereigns into bullion is supposed to cost about 1½d. an ounce either way, and if any competent firm were allowed to undertake the minting of sovereigns, and were to do it at that price, it is clear that the value of an ounce of gold in sovereigns could not remain greater or less than that of an ounce of gold in bullion by more than 1½d. an ounce (which is about 0.16 per cent), for the one could be converted into the other at that price. For the purpose of actual currency the gold must be in the form of sovereigns, for that is the certificate (of the Government in the actual fact, of the issuing firm in the case we are supposing) of the quality and quantity of the gold, and such a certificate would be required by all persons, not experts, as a guarantee that they were really receiving the gold. Now it might be worth any one’s while to pay something for this convenience; that is to say, he might be willing to receive a little less gold in a form in which it would be accepted and could be exchanged by any one, rather than a little more in a form in which it could only be accepted by or exchanged with experts. The ordinary man, indeed, desires to have no gold except in this form and incidentally in his bookbinding, jewellery, and so forth. But the goldsmith, the bookbinder, the dentist, and others who put gold into their business in the most literal sense, desire gold both in coin and otherwise, and they will not take a smaller quantity in sovereigns in preference to a larger quantity in bullion unless they derive some corresponding convenience from it. And this they will only find to be the case to a limited extent. Thus, with the goldsmith in particular, the balance which we have seen other men strike between the amount of property which they keep in their business and the amount which they keep at the banker’s will resolve itself to a great extent in his case into a distribution between the amount which he keeps in bullion or manufactured articles and the amount he keeps in coin or as a balance with his banker. Now, seeing that it costs the equivalent of 1½d. an ounce to convert bullion into sovereigns, one might naturally expect under the conditions we have supposed that sovereigns would be worth more than bullion at the rate of 1½d. an ounce, for why should any one be at the expense of making them to such an extent as to bring their marginal significance below that point? Whereas until it has reached that point there will be a profit in coining; so it will not rest anywhere above it. But we have seen that there is always a risk of the price of manufactured articles being less than their cost of production, and it is therefore conceivable, in the abstract, that such changes should take place in the demand for sovereigns and the demand for bullion as to reduce the marginal value of sovereigns below the point which alone would have justified their manufacture. But neither could the departure in this sense be more than 1½d. an ounce, for if bullion rose above that point it would become profitable to melt sovereigns. Now the gold contained in sovereigns is at the rate of an ounce to £3:17:10½. It follows, therefore, that the price of gold, if any one were at liberty to mint it, could never, except for a short time and under quite exceptional circumstances, sink below £3:17:9 an ounce, or rise above £3:18s.

Now this state of things, which we should expect if coining were an ordinary industry, corresponds exactly to the actual facts. In explaining this we will confine ourselves to the conditions established by law in England. Every man has a right to take properly assayed and certified gold to the Mint and have it coined into sovereigns gratuitously, at the rate of £3:17:10½ the ounce. Any valuable alloy there may be in it belongs to the Mint, but
per contra the Mint makes no charge for the alloy in the sovereigns.

But though the Mint is compelled by law to coin and return the gold handed in to it, yet it is not bound to give it back at once. It is to treat all customers without favour in the order of application; and since there are always orders on hand from the Bank of England that it would take months to execute, any one who should apply to have his gold coined would be likely to have to wait, say, six months for his turn. If you reckon interest at four per cent the delay would be equivalent to a payment at the rate of about 1s. 7d. an ounce for mintage. The consequence is that no one ever does take his gold to the Mint. There is, however, another legal provision by which the Bank of England is bound to buy all the gold that is offered to it at the rate of £3:17:9 per ounce. This is only 1½d. on the ounce, or a little above a third of a penny on £1. Any one, therefore, who wishes to have his gold coined can legally command better terms from the Bank of England than he can from the Royal Mint. The Bank of England is not bound to pay in sovereigns; it may pay in its own notes. But the cash department of the Bank of England is compelled to give gold for the notes of the issue department, on demand, and consequently any one who likes may take his gold to the issue department and receive notes for it at the rate of £3:17:9 per ounce, and may then go round the corner to the other department and receive the gold. If he does this it will not hurt the Bank of England, for the Bank of England does not pay for having its gold minted; nor will it be embarrassed by an excess of gold in its cellars, for the gold will be drawn out in sovereigns as rapidly as it is put into the cellars in bullion, and the Bank may have its gold coined as fast as it pleases by the Mint. The Bank of England, therefore, will be the gainer by 1½d. for every ounce of gold that is thus given it. The country, indeed, will be the loser by the expense of coining, for which it, not the Bank of England, pays. Whether by a coincidence or not, it happens that this 1½d. that the Bank of England may take off the value of the gold in the sovereigns it returns, coincides with the best estimates of the cost of minting, so that while the country loses and the Bank of England gains 1½d. on every ounce of gold that is minted, the net result to the man who sells the gold is exactly the same as if he had paid for the minting. There is, therefore, exactly the same check on reckless turning of gold into sovereigns that there would have been under the conditions we imagined of a country in which any firm might mint gold into coin, the cost of doing so being 1½d. an ounce.

As a rule, however, the persons selling gold to the Bank of England will not at once cash the notes. Bank-notes are legal tender, and it will be convenient to the man who has disposed of a large amount of gold (if he does not wish to open a credit with the Bank of England
*53) to take away the legal tender that he desires in the form of bank-notes rather than in the actual sovereigns. The Bank is compelled to hold actual gold against every one of its notes that is in circulation beyond the eleven millions guaranteed by the nation. Consequently, the Bank will hold the gold that is brought in, against the notes that it issues, and if the country already has as many notes in circulation as suits the convenience of the public a large fresh issue will determine, not immediately but in a short time, the presentation of a corresponding number of notes at the cash department, in which case the effect will be the same as if the sovereigns had been taken out directly. If the number of notes issued is not such as materially to swell the body of notes in circulation, no perceptible effect will take place, but in any case the Bank cannot be inconvenienced. It gains its 1½d. an ounce and loses nothing.

Our investigations so far would lead us to expect that the market price of gold bullion in the open market would be £3:17:9, and this may in truth be regarded as the normal state of things, but there are occasions on which the price rises not only to the metallic par of £3:17:10½, but even to £3:18s. We saw but now
*54 that such a state of things is not inconceivable, but the examination of the conditions under which it may arise will lead us to the most difficult part of our subject.

We have seen that the Bank of England holds a great part of the gold reserve of the world, and occasions arise on which the bankers of some one or more countries may wish to withdraw a large amount of the gold which stands to their credit. There may be danger that when called upon thus actually to pay an abnormal proportion of the claims for gold which some of its clients are in a position to make, the Bank may feel that the remaining reserve threatens to be reduced to an alarmingly low proportion of the total claim which it is still nominally liable to have to meet. It must, therefore, “protect its reserves,” that is to say, prevent their being further depleted. Now what is really wanted is some means of inducing people not to draw gold, but to settle their affairs by transfers of credit; and a very small charge on actually cashing cheques in gold instead of paying them in to the accounts of the drawers, or on withdrawing gold from an account instead of transferring the credit, would suffice to accomplish this. But it is impossible to make such a charge. The value of a cheque or of a bank credit is due to the fact that though you are not likely to cash it you always can. And to place any obstacle in the way of cashing it would amount to a qualified “stoppage of payment,” and it is of the essence of the security and credit of the Bank that it should be prepared at any moment and to any extent to meet its nominal obligations to pay gold. The difficulty, then, has to be met by circuitous and wasteful processes. In the first place the Bank of England does a great business in discounting bills. We have hitherto
*55 spoken of bills as though they were claims for the instant payment of money at such and such a place, and so they may be; but many of them are claims for money, not now, but six months hence; and a merchant who holds such a bill, that is to say, who has supplied goods to a customer, whether at home or abroad, for money that will not be due for three or six months, may want to have the money either in cash or, more probably, in credit with his banker, at once. If the Bank accepts his bill, that is to say, the promise of his correspondent for money three or six months hence, and gives him present cash or credit in exchange for it, it will, of course, make a charge corresponding to the interest on the money which it lends, so that when the bill becomes due it will not only repay the loan but pay interest on it also. This charge is discount. Now the Bank of England cannot prevent its clients who actually have credit from withdrawing as much gold as they choose, but it can discourage the formation of credits by raising the terms on which it discounts bills. It can, therefore, to a great extent regulate the proportion between its reserves and its liabilities by refusing to enter into fresh liabilities and so contracting its business. It thus limits the potential calls for gold, and thereby restricts the actual calls which stand in a definite relation to them. This is a wasteful and indirect process, and it affects the terms on which loans are made all over the country, often to the extreme embarrassment of business; but no more direct or economical device has yet been hit upon.

But the Bank has another means of protecting its reserves,—the very curious one of bidding for gold in the open market and offering more sovereigns for it than would make its own weight if melted. This may seem at first sight a strange way of increasing its reserves, for it is offering more than an ounce of gold in payment for an ounce; but the Bank will pay for the gold either in bank-notes or in acknowledgments, that is to say, in credit, and it calculates that the credit of the importer of gold will not actually be drawn out in sovereigns to any greater extent than the credit of its other clients will, and, therefore, by buying gold for notes or credit it will increase its reserves in larger proportion than its business. Thus, by buying gold and at the same time raising discount it protects its reserves from depletion, partly by contracting its general business and so reducing the claims on its reserve, and partly by increasing its dealings with a particular set of clients who will actually bring gold into its cellars, to the full amount of their accounts, and will only draw the ordinary proportion of them out again in gold. These are the conditions under which the value of bullion in the market per ounce rises above the value of sovereigns per ounce. But except for a very short time and in very exceptional circumstances this excess cannot exceed 1½d. an ounce, for if the Bank of England bought gold at a higher rate than this its clients would proceed to draw out sovereigns simply for the purpose of melting them down, and bringing them back again to sell at a profit as bullion.

But we have not even yet answered the question what determines the amount of gold that is actually minted into sovereigns. The whole reserve of the Bank of England need not be, and is not, coin; and the means the Bank takes to protect its reserves has no immediate connection with the amount of gold that is minted. What then determines this amount? The answer is simple. The private individual, who deals in gold little and indirectly except as coin, places an amount of his property determined by considerations already explained
*56 with his banker. It is registered in terms not of bullion but of sovereigns, and he can draw out absolutely as much of it as he chooses in the form of sovereigns. Provided he has a balance at the banker’s, or a claim on any one else’s balance, it costs him absolutely nothing to get it in the form of coin. Hence the celebrated declaration of a Member of Parliament: “We all of us have as much money as we want.” So the depositors in the banks can, and do, take out as many sovereigns as it suits their convenience to have, and the Bank of England has to see to it that enough sovereigns are minted to meet the demands. The answer to the question, “What determines the number of sovereigns coined?” is therefore, “the estimate formed by the Bank of England of the number of sovereigns that the depositors in the banks collectively want to have.” As it costs the Bank of England nothing to have the sovereigns coined, and as it always has plenty of gold, there is no reason why any one should be stinted. The country, therefore, bears the expense of providing all the depositors with as much coin as they call for.

But the importers of gold are in a different position. They cannot generally exchange their gold for sovereigns at weight par. They may have to pay .16 per cent premium. Thus there is generally a check, not indeed to the minting of gold, but to the flow of gold into the cellars of the Bank of England, where it lies ready to be coined. But the Bank may reduce or remove this check or substitute a stimulus for it within certain limits, whenever it conduces to its credit to do so. On the other hand, there should be a normal check to the flow of gold out of the currency into the form of bullion again, and so to a certain extent there is. If it were not for a certain abuse, to be explained presently, all persons who required gold for their business would have a slight advantage in buying it direct from the importers rather than drawing it out of the currency. For it would seem that if the market price of gold is £3:17:9 an ounce, a man would be able to get more gold by .16 per cent in return for his cheque if he paid it to an importer than he would get from his banker by drawing out the sovereigns and melting them. And there would be the additional expense of the melting. If we put that at 1½d. he would lose .32 per cent by drawing his gold out of the currency instead of out of the market. And if the market price rose for any reason, though this advantage would be diminished, it would still always be on the side of buying gold in the market. It is true that most persons whose business requires them to deal in gold will tell you that they are not conscious of being influenced by this consideration, and that whether they buy gold from a merchant or take it out of the currency is determined by considerations of convenience quite independent of this premium, even supposing that the market price of gold perceptibly affects transactions of the scale on which they conduct them. But in the nature of things this cannot be universally true. A market price is after all a market price, and means that gold or sovereigns are actually at a commercial premium, that is to say, that a preference for one or the other is actually felt by some one, presumably by the large dealers in bullion.

But this difference between the market price of gold and the gold weight of the sovereigns in which that price is paid, is crossed in the case of the working jewellers by a practice which we must now examine. Those of them who deal with branches of the Bank of England are in the habit of requesting their bankers to select the heaviest sovereigns and put them aside to meet the cheques that they draw in their own favour, for purposes of melting.
*57 Now the standard weight of a sovereign in England is 123.27447 grains. But a “remedy” is allowed to the mint-master; that is to say, an allowance for the imperfection of workmanship; so that if a sovereign does not weigh more than 123.474 or less than 123.074 it may be issued by the Mint; and it is legal tender, and may be issued by the Bank of England against its own notes and cheques, until it has sunk by abrasion to 122.50047. Between the heaviest and the lightest sovereigns paid out by the Bank of England and its branches there may therefore be a difference of .97353 grains, which is about .79 per cent. But presumably the Mint keeps very well within the allowed “remedy,” and we may suppose that there are few sovereigns in the currency much above the standard weight, whereas the sovereigns issued against a cheque in the ordinary way would, on an average, be far above the lower limit. We shall therefore perhaps not be far wrong if we say that the average weight of the selected sovereigns exceeds the average weight of the unselected sovereigns by something less than .387 gr. or .315 per cent, which would be very close to the full amount of 3d. on the ounce, which marks the maximum theoretical advantage on buying in the market as against melting the currency. The subject is one as to which it would be a matter of some delicacy to make close inquiry, and I do not profess to have any accurate information. The practice, as far as it goes, is obviously an abuse, and together with the fact that the Mint (and therefore indirectly the Bank of England) throws in the excess of the alloy in the sovereigns which it issues above that in the gold it receives, it establishes a permanent leakage in the currency for which there is no theoretical necessity, and which constitutes a loss to the nation.
*58 The activity of the Mint must be sufficient to keep the public stocked with all the sovereigns it wants in spite of this leakage; and the Bank of England must maintain its reserves against it.

We have concluded our positive examination of the selected points of financial science; but one theory must still be examined, for it seems to be not only unsound in itself but a fruitful source of confusion throughout the whole range of monetary science.

A treatise on currency frequently expounds what is known as the “quantity law,” as regulating the value of the currency. The supposed law may be stated as follows: “The exchange medium of every country (coined gold in the case of England) has to carry on the business of the country, and this business consists in the whole volume of exchanges conducted day by day or year by year. Seeing then that the whole body of the currency, consisting of so many pieces, has to conduct the volume of exchange, each passage of a coin from hand to hand will have to conduct a certain fraction of it, and this fraction will be determined by a division sum; the dividend being the volume of exchanges, and the divisor being the number of coins employed multiplied by the average number of times that each coin changes hands during the period over which the volume of business has been taken.” Hence the name “quantity” law, from the supposed determination of the value of each unit of the currency in inverse ratio to the quantity of the currency as a whole.

The unsatisfactory character of the statement must be obvious at once, and it is noteworthy that there is (unless it has escaped me) no mention of any such law, nor any implication direct or indirect of its existence, to be found from end to end of the numerous works on currency and finance of the late Professor Jevons. To begin with we may eliminate all mention of the number of coins and the “average” number of times that each changes hands. For this “average” can only be arrived at by adding together the number of times which each coin has circulated and then dividing by the number of coins. When we multiply
a (number of coins) by
b (number of times each circulates on an average) to obtain
c (total number of transactions) we have really already assumed
c and obtained
b by dividing
c by
a. We start with
c then, and as it is
c we want we may dispense with the process of first dividing by
b to get
a and then multiplying by
b again to get back to
c.

The simplified statement of the quantity law would then be: “A certain total volume of trade has to be conducted by a given number of changes of a sovereign from hand to hand. Therefore each one of those changes has to conduct a given volume of exchange, arrived at by division. And as it ‘has’ to do this, it will do it. The amount of work we set it to do determines the amount of work it does. That is to say, the value in exchange of a sovereign is determined by the work it ‘has’ to do every time it shifts.”

Prima facie this is an inversion. How can we make a sovereign do a certain amount of work by telling it it must? The total business that the sovereigns collectively do is the sum of what each of them does whenever it changes hands. The business the sovereigns
do, one would say, depends on their efficiency severally. How can their efficiency severally depend on the work they
have to do amongst them? Obviously no one would suggest that the services rendered to the community by a pound of potatoes or a ton of iron could be arrived at by determining in the first place the total services that potatoes or iron
have to render annually to the community, and then dividing it by the number of pounds or tons in existence; or determining the amount of earth that a navvy shifts by every swing of his spade by stating how much earth the whole body of navvies
has to shift, and then reckoning up their number and the average number of spade-swings which each of them performs, and dividing the total work they
have to do by the figure so obtained. It is obvious, then, that if any such law holds in the case of the currency, it must be owing to some special characteristic which completely differentiates it from every other article. And this is exactly what is asserted by the exponents of the law in question. Their contention is that currency is a purely legal institution. A government, it is supposed, can make anything currency by declaring that it shall constitute the legal discharge of obligations; and as a proof of this we are referred to the numerous instances in history in which paper currency has been maintained for indefinite periods. In these cases a piece of paper which has an inscription, corresponding to a certain weight of gold, passes as the equivalent of so much gold and is actually received as such an equivalent by persons who deal in gold as a commodity, although it carries no right to demand gold from anybody. A Bank of England note, of course, can be cashed at the Bank of England, that is to say, any one who likes is legally entitled to receive five sovereigns of full weight at the Bank of England in exchange for the note. But in countries where there is no such obligation on the part of any private or public body, nevertheless the dealers in gold are willing to part with it in exchange for paper, and all other persons are willing to receive the paper just as if it were gold. And it is further noted that the value of the notes will not sink below the par of gold unless there has been an over-issue. Thus it seems that the government, by itself giving its servants pieces of paper with the name of an amount of gold upon them, declaring that all its obligations are thus discharged, and that it will regard all other obligations amongst its subjects as discharged in like manner, can actually give a value to the paper that depends on the amount it issues. In other words, by enacting that its paper shall be received in payment of all debts and obligations it can cause all the business transactions of the country to be conducted by its means, and having thus determined the total amount of work that the paper shall do, it can further decree how much paper there shall be to do it; and since the habits of the industrial community determine how much of its business shall be done by the currency, and how much by cheques, paying of balances, and so on, the rate at which the paper will circulate, that is to say, the number of times, on an average, that each piece will change hands in the course, say, of a year regulates itself; and so the amount of the issue will determine the amount of business which each paper unit will conduct each time it changes hands.

These facts being supposed to be established, it would follow that if the business of a country is actually conducted in gold, that is to say, in an article which has an independent industrial value, apart from the enactment which makes it legal tender, this is an unessential incident. Because, as we have seen, all the functions of money can, by hypothesis, be conducted by a unit that has no primary industrial value. If (it is maintained) the currency of any country, England for example, consists of pieces of metal that happen to have a value in the arts and sciences, then there are two independent uses to which a piece of gold can be put, one of them being the natural and direct service which gold, as gold, can render in the arts and sciences; and the other being a fictitious or legally established value, which the legislature has chosen to affix to gold, but might just as well have attached to paper, leather, or anything else, provided it could so stamp its units of currency as to prevent their unauthorised issue by others than itself. Thus, according to this theory, a sovereign as a weight of gold, and a sovereign as a unit of legal tender, are indeed physically identical, but the values that the coin has in its capacity of a legal discharge of debt and in its capacity of a weight of gold have no direct or immediate connection with each other whatever.

But a government which chooses a valuable for its currency saves itself, it is admitted, from the temptation of over-issue; for if it over-issued, then its sovereigns,
qua currency, would have less value than they would have
qua gold, and whoever got hold of them would melt them until their contracting number threw more work upon each individual sovereign, and therefore raised its value in the currency; whilst the increased supply in the arts would lower the significance of gold in them. On the other hand, there can be no possibility of the value in the currency being permanently higher than the value in the arts if (as in England) there is a free mint. For any one who has gold can have it coined at will, and therefore if the amount of work thrown on each sovereign were such as to raise its value in the currency above what it bore in the arts, gold would be coined till the increasing number of sovereigns lightened the amount of work that each had to do, that is to say, reduced its value, whereas the deflection of gold from the arts and sciences would raise its value in them, and equilibrium would be restored. Thus, it is maintained, the two capital functions of gold (one primary and specific, the other wholly legal and independent of the natural properties and uses of the substance gold) will keep in balance with each other.

This theory of currency is fascinating by its ingenuity and neatness, and derives enormous practical support from its harmonising with the psychology of the ordinary man, in whose mind there is no practical connection between the value of gold as currency and its value in the arts. No man is conscious of being willing to work or to surrender his goods for a piece of gold, because gold is valuable for dentistry, for gilding picture frames or book leaves, for setting jewellery, or for making plate. His value of it for currency is something which, if he thinks about it at all, he regards as resting on custom or law. This theory then has the enormous polemic advantage of allying itself directly to the ordinary way of thinking, and as it is easy to expound and has a certain elegance, it is equally popular with teachers. But nevertheless the reasoning on which it rests is throughout topsy-turvy. From first to last it goes on the assumption that sovereigns, collectively and individually, will do what they have to do, and that the legislature can determine what that is; and throughout our exposition of the doctrine it has been obvious that we have been compelled to treat the value of a sovereign not as constituted by anything that it can and will do, but by something which in obedience to law it has to do. Now, that the law can enable any assemblage of things to perform a certain service, or conduct certain operations, collectively, simply by saying that it has got to do so, is so startling a proposition as to demand the closest inspection. If we maintained, for instance, that the government could by decree determine that all the agricultural operations of this country should be carried on by persons and with instruments authorised by itself, and if it were assumed that this would not affect the extent or nature of the operations, but that they would all be necessarily conducted by the authorised men and implements, and therefore if there were few men and implements each would do a great deal of work, whereas if the government issued more each individual would do less, but precisely the same amount would be done altogether, we should at once see the impossibility of supposing that the amount done by each unit was determined by dividing the sum of what they all do by the number of units; because as a matter of fact the amount that each of them does is the primary datum, and what they all do together is arrived at by addition or multiplication. If the government had any power of making each individual do more or less it could make a larger or smaller number of them capable of doing a given amount of work, but it cannot decree how much they
shall do collectively, independently of their numbers, and then determine what each of them does by regulating those numbers.

What, then, are the supposed peculiarities of the work of the currency which have given rise to the belief that these exceptional possibilities exist in this case, though not in others? In the first place, the undoubted fact is pointed out that the amount of transference of goods or services which can be effected under the denomination of a sovereign depends solely upon the value of that sovereign. That is to say, if a quarter of wheat and a ton of hay are each worth the gold in one and a half sovereigns, they can be exchanged under the denomination of one and a half sovereigns. If, on the other hand, they are each worth the gold in a sovereign, they can be exchanged under the denomination of a sovereign. Thus the same amount of business, namely the exchanging a ton of hay for a quarter of wheat, might be conducted with the intervention of one sovereign, of one and a half sovereigns, or of two sovereigns, equally well. And therefore, if, for any reason, the stock of gold were so reduced that the gold in a sovereign should double its value, then the sovereign would be able to conduct twice as much business as it did before. The services that the currency renders to the community at large, therefore, seem to be independent of the number of sovereigns that are in the currency. And it is undoubtedly true that, within wide limits, the money function could be performed equally well, in any community, by a larger or smaller number of sovereigns. This then, we are told, constitutes a fundamental difference between the money function and the functions of other things, for a large or a small number of potatoes will not equally well perform the nutritive functions of potatoes, nor will a large or small number of men or tools be able to perform the same industrial functions equally well. The derivative nature of the exchange function of gold, therefore, seems to differentiate it from the primary functions of other commodities. But, as we have seen, this derivative value is not peculiar to the currency. To any man who is dealing in anything it is a matter of indifference, within wide limits, whether he receives a large or a small quantity of it for any given consideration, provided the small amount in one case is as valuable as the large amount in the other. If, for instance, a certain class of books is worth 5s. a volume in the second-hand trade, and a bookseller has a considerable trade in them, making on an average 10 per cent per annum on his turnover, and if presently this class of books, through a change in the taste of the public, becomes twice as valuable, and the bookseller with the same general apparatus and machinery, and with the same effort of attention and so forth, deals in half the number of books, his purposes will be just as well served, so long as he makes the same profit on his turnover. For neither his expenses nor his income depend on the value that he attaches to the books for his own use. They depend on the value that some one else attaches to them, so that this derivative function which they perform for him can be performed equally well by a smaller number that are highly valued and by a larger number that are valued low. But to the student purchaser of books it is by no means the same thing whether he has a thousand volumes for which he has given, on an average, 5s. each, or five hundred of the same volumes for which he has given, on an average, 10s. each. The five hundred at 10s. each do not facilitate his studies or serve his other purposes any better than if he had only given 5s. each for them. And he is without half the library he would have had on the other supposition. The distinction, then, that we are at present examining is not one between currency and all other commodities, but between primary and derivative values, between the value attached to an article by the user and the value attached to it by the dealer. And in all cases, whether of primary or derivative value, the total service consists in the sum of the individual services. We can in no case get at the individual services by saying that each individual has got to perform, and therefore will perform, its due fraction of the total, fixed as a total by some external power. Surely we should expect that if the government really has the power of making the currency do certain work, it must be by giving to a definite quantity of gold the power to do a definite piece of work, not by enabling an indefinite sum of gold, whether great or small, to do a definite amount of work by its fiat that it shall do it. If, as we have seen, a little gold can under certain circumstances do as much as a great deal under other circumstances, it must be because under those circumstances each unit of gold is made capable of doing a larger amount of work; not because it is told that there is more work for it to do. This is obvious enough in an ordinary way, and the example of the books will again serve our purpose. If the primary services of the books (to the readers) have mounted on the collective scale then their derivative services (to the dealer) mount too, and each book will convert a larger amount of his energy and thought into a correspondingly larger amount of the things he desires. Just so if the primary services of gold mount, either because of a falling off in the rate of production, or because of increased applications of gold to the satisfaction of tastes and wants, or for any other reason, each unit of gold will be able to conduct a larger amount of business.

These considerations suggest that we should begin our inquiry as to the connection between the amount of gold in the currency and the value of each sovereign at the other end from that by which it is usually approached. Granted that, in a general way, the total amount of work that the currency has to do is fixed by the general business habits of the community (though, as we shall see presently, this is a large assumption), it will follow that if the marginal value of an ounce of gold, in the arts, is high, then a small amount of gold will be enough to conduct that part of each man’s transactions for which he employs the currency, and he will become a “dealer in gold” only in small volume. That is to say, the withdrawal of a small volume of gold from its primary applications will suffice to conduct the business of the country because each piece of gold, having a high value, will be able to transact a large amount of business. If, on the other hand, a large output of gold during a series of years, or any cause affecting the use of gold in the arts, should bring down the marginal significance of an ounce of gold in the arts, then each man will find that as a “dealer in gold” he needs a larger volume of gold to do his business for him, and a larger volume will be held out of its primary applications. Thus it is not the amount of gold in the currency that determines how much work each piece shall do, but the amount of work that each piece can do that determines the amount in the currency.

If we now turn to paper currencies, again, we shall remodel the statement thus: It is not true that a government can confer on pieces of paper, or other intrinsically worthless articles, the collective power of doing the business of the country, but it can within certain limits confer a defined power of doing business on certain pieces of printed paper. For the government, as general guardian of contracts and of property, has the power to enforce or to decline to enforce any contracts, and as guardian of the rights of property it can determine whose property anything shall be. It is possible, then, for a Government at any time to say: “There are in this country a number of persons under legal obligation to pay fixed rents for premises, fixed interest on capital, fixed salaries for services, over such periods as their several contracts cover. There are also a number of persons under definite obligations to pay such and such gold, at such and such dates, once for all. Now we, the Government, can, if we like, issue stamped papers bearing various face denominations of one, ten, a hundred, etc., units of gold currency, and we can decree that any one who possesses himself of such papers, to the face value of his debts, and hands them over to his creditor shall be held to have discharged his debt, and we will henceforth defend his property against his late creditor and declare that he has, in the eye of the law, paid the sum of gold which he owed.” It is obvious that these pieces of paper will thereby acquire definite values to all persons who are under obligation to discharge debts or to pay salaries or rents or other sums due under contract; for to command one of these pieces of paper will be, for certain of their purposes, exactly equivalent to commanding a sovereign. As these persons constitute a large and easily accessible portion of the community, there will at first be no difficulty whatever in circulating the notes, for those who have no direct use for them themselves will know that there are plenty of people who have, and a certain number of these certificates can, in this way, be floated. Each will be able to transact business to the same extent as a piece of gold of its face value. But as the contracts gradually expire and the debts are gradually discharged, the original force that gave currency to the Government’s paper will become exhausted. At first the holder of such a bond will from time to time come across men who will say: “Oh, yes, I was just looking out for paper in order to discharge my debt or pay my rent”; and if there were the smallest tendency to depreciation, competition would instantly rise amongst these persons who would be glad to get, at any reduction whatever, these things which their creditors would be compelled to receive at full value. If people chose to go on making fresh contracts and giving fresh credit, without specifying that the payment should be in gold, and thus went on perpetually bringing themselves under legal obligation to receive paper in full payment, the process might go on for a certain time, by its own impetus, but there would be nothing to compel any one to enter into such a contract; and if at any time, for any reason, there were a slight preference for making contracts in gold, so that there was a dearth of people of whom it could be definitely asserted that for their own immediate purposes, independent of the general understanding, the paper was worth the gold, there would obviously be no firm basis for the structure, and every one would become nervous and would want to make some allowance for the risk of not finding any one who would take the paper at or near the face value.

The Government has, however, a further resource. It has the means of maintaining a perpetual recurrence of persons thus desiring money at its face value, for the Government itself has more or less defined powers of taking the possessions of its subjects for public purposes, that is to say, enforcing them to contribute thereto by paying taxes. Ultimately it requires food, clothing, shelter, and a certain amount of amusement and indulgence for its soldiers and all its officials; and it requires fire-arms, ammunition, and the like. And in proportion to its advance in civilization it may have other and humaner purposes to fulfil. Now, as long as gold has any application in the arts and sciences it exchanges at a certain rate with other commodities, just as oxen exchange at a certain rate against potatoes, pig-iron, or the privilege of listening, in a certain kind of seat, to a prima donna at a concert. The Government, then, levying taxes upon the community, may say: “I shall take from you, in proportion to your resources, as a tribute to public expenses, the value of so much gold. You may pay it to me in actual metallic gold or you may pay it to me in anything which I choose to accept in lieu of the gold. If you do not give it me I shall take it from you, in gold or any other such articles as I can find, and which would serve my purpose, to the value of the gold. But if you can give me a piece of paper, of my own issue, to the face value of the gold that I am entitled to claim of you, I will accept that in payment.” Now, as these demands of the Government are recurrent, there will always be a set of persons to whom the Government paper stamped with a unit weight of gold is actually equivalent to that weight of gold itself, because it will secure immunity from requisitions to the exact extent to which the gold would secure it. This gives to the piece of paper an actual power of doing the work that gold to its face value could do, in the way of effecting exchanges; and therefore the Government will find that the persons of whom it has made purchases, or whom it has to pay for their services, will not only be obliged to accept the paper in lieu of payments already due, and which it chooses to say that these papers discharge, but will also be willing to enter into fresh bargains with it, to supply services or to surrender things for the paper, exactly as if it were gold; as long as it is easy to find persons who, being themselves under obligation to the Government, actually find the Government promise to relinquish their claim for gold as valuable as the gold itself. The persons who pay taxes constitute a very large portion of the community and the taxes they have to pay form a very appreciable fraction of their total expenditure, and consequently a very large number of easily accessible persons actually value the paper as much as the gold up to a certain determined point, the point, to wit, of their obligations to the Government. Thus it is that a limited demand for paper, at its face value in gold, constitutes a permanent market, and furnishes a basis on which a certain amount of other transactions will be entered into. The Government, in fact, is in a position very analogous to that of an issuing bank. An issuing bank promises to pay gold to any one who presents its notes, and to a certain extent that promise performs the functions of the gold itself, and a certain volume of notes can be floated as long as the credit of the bank is good. Because bank promises to pay are found to be convenient, as a means of conducting exchanges. After this number has been floated the notes begin to be presented at the bank, and presently it has to redeem its promises as quickly as it issues them. The limit then has been reached and the operation cannot be repeated. After this people will decline to accept the promises of the bank in lieu of the money, or, which is the same thing, they will instantly present the promise and require its fulfillment. The amount of notes in circulation may be maintained, but it cannot be increased. The issuing Government does not, without qualification, say that it will pay gold to any one who presents the note, but, in accepting its own notes instead of gold, it says, in effect, that it will give gold for its own notes to any
of its own debtors; and as long as there is a sufficient body of these debtors to vivify the circulating fluid the Government can get its promises accepted at par. Any Government which, even for a short time, insists on paying in paper and receiving in gold, that is to say, any Government that does not honour its own issue when presented by its debtors, will find that its subjects decline to enter into voluntary contracts with it except on the gold basis; and if its paper still retains any value whatever, it will only be because of an expectation of a different state of things hereafter that gives a certain speculative value to the promise. In fact a Government which refuses to take its own money at par has no vivifying sources to rely on except the very disreputable and rapidly exhausted one of proclaiming to debtors, and persons under contract to pay periodic sums, that they need not do so if they hold a certificate of immunity from the Government. Such immunity will be purchased at a price determined, like all other market prices, by the stock available (qualified by the anticipations of the stock likely to be available presently) and the nature of the services it can render. The power, then, of Governments to make their issues do exchange work depends on their power to make a note of a certain face value do a definite amount of exchange work; and this they can effect by giving it a definite primary value to certain persons, and then keeping the issue within the corresponding limits. It does not consist in an anomalous, and, in fact, inconceivable, power of enabling an indefinite issue to perform a definite work, and arriving at the value of each individual unit by a division sum.

Indeed, this division sum is impossible in any case to make; for the proposed divisor is arrived at by multiplying the number of units in the face value of the issue by the rate at which, on an average, they circulate. Now the Government can undoubtedly regulate the amount of the issue, but it cannot regulate the average rate at which the units will circulate. Nor indeed can it rely on the dividend, namely the amount of business which the circulating medium shall perform, remaining constant. For it is a matter of convenience how much of the business of a country shall be carried on by the aid of a circulating medium and how much without it; and as a matter of fact, at periods when there is a dearth of small change in a country a great amount of retail business is conducted on account, and balances are more often settled in kind. Thus business which would ordinarily have been carried on by the circulating medium is carried on without it, because of its rarity. In Italy, for instance, when coppers were rare the exchange value of a copper did not rise because a smaller number had to do a greater amount of work, but each unit did as much business as it could, and the rest of the business was done without them. Again, the history of paper money abounds in instances of sudden changes, within the country itself, in the value of paper money, caused by reports unfavourable to the Government’s credit. The value of the currency was lowered in these cases by a doubt as to whether the Government would be permanently stable and would be in a position to honour its drafts, that is to say, whether, this day three months, the persons who have the power to take my goods for public purposes will accept a draft of the present Government in lieu of payment. It is not easy to see how, on the theory of the quantity law, such a report could affect very rapidly the magnitudes on which the value of a note is supposed to depend, viz. the quantity of business to be transacted and the amount of the currency. Nor is it easy to see why we should suppose that the frequency with which the notes pass from hand to hand is independently fixed. On the other hand, the quantity of business done by the notes, as distinct from the quantity of business done altogether, and the rapidity of the circulation of the notes may obviously be affected by sinister rumours. Two of the quantities, then, supposed to determine the value of the unit of circulation are themselves liable to be determined by it.