by Thomas Allen

Inconvertible paper money is money that is not convertible into full-weight metallic coin, such as gold and silver coin, on the demand of its holder in spite of its promises or guarantees. Proponents of inconvertible paper money consider it the “ideal money” as it has no intrinsic value and it represents no metallic coin, which they believe to be inferior to paper money.

Inconvertible paper money derives from two sources. First, and the most common today, are bank notes that become inconvertible because of a suspension of redemption in specie. Today’s federal reserve note is an example of this type of inconvertible paper money. When bank notes are no longer convertible to specie, they begin to behave like inconvertible government notes — especially if the government makes them legal tender and if the government controls their issue either directly or indirectly. Government notes are the second source of inconvertible paper money. That is, the government issues its paper money directly. Examples of government notes are the Assignat, the Continental and the U.S. note between 1862 and 1879. This type of inconvertible paper money was much more common before World War I than it is today. (Today, most inconvertible paper money is bank notes issued for  governments by their central banks, which often have the appearance of independence, but which are really subject to governmental control. Although this money is usually labeled as bank notes, functionally, and for all practical purposes, they are government notes.)

Promoters of inconvertible paper money based their assertion of the superiority of inconvertible paper to metallic coin on several principles. A discussion of the chief ones follows.

1. Medium of exchange. According to the adherents of inconvertible paper money, it is superior to metallic money as a medium of exchange. Paper money is a convention and does not have any “intrinsic value.” However, by general consent, it may become the medium of exchange of a country. It may become so acceptable that it cannot be distinguished from the acceptance of gold. This is true as long as custom or law forces people to use the paper money. If gold coin is allowed to circulate, its circulation will cease as people prefer to hoard the more valuable money, gold, and spend the less valuable money, paper. If gold coin does circulate, it will trade at a premium to the paper money.
2. Common denominator in exchanges. Adherents of inconvertible paper money claim that it functions as well as, if not better than, metallic money as a common denominator in exchanges. Producers want an article of uniform quality that can be easily divided to serve as a common denominator in exchanges. Thus, money is a mere convention to facilitate exchanges. Inconvertible paper money can serve this purpose as well as, if not better than, gold.

What is called “a common denominator in exchanges” is called “a measure of value” by most economists. Gold coin is superior to inconvertible paper money as a measure of value as its value as money is independent of itself. Inconvertible paper money is inferior to full-weight gold coin in that its monetary unit does not measure anything tangible that is independent of itself. For example, the Gold Standard Act of 1900 defines the dollar as 23.22 grains of gold, which means that it has a value equivalent to 23.22 grains of gold. When the redemption of federal reserve notes in gold coin ceased, federal reserve notes had a value of 23.22 grains of gold. However, as federal reserve notes were no longer convertible to gold, the dollar ceased having the value of 23.22 grains of gold. It ceased having an independent unit of measure. Its measure of value became what a dollar could buy, which is a highly inferior measure of value.

3. Standard of deferred payment. Adherents of inconvertible paper money assert that it can function better than metallic money as a standard of deferred payment. The better a money can ensure the same purchasing power during the duration of the contract or loan, the better it functions as a standard of deferred payments. Advocates of inconvertible paper money claim that it maintains its purchasing power better than metallic coin.

Inconvertible paper money can perform as a standard of deferred payment (it does so today) as long as it has popular acceptance. How well it performs this function depends on the regulation of its quality — so assert its proponents. Gold often proves inadequate in performing this function. Nevertheless, gold has historically done a better job of preserving value and, by that, its purchasing power than has inconvertible paper money. Eventually, inconvertible paper money loses popular acceptance. Gold never has although governments have often intervened to prevent its use, as occurred in the United States between 1933 and 1974.

Moreover, the advocates of inconvertible paper money seldom admit that depreciation, as revealed by a premium on gold or silver, is proof that the paper money has failed as a standard of deferred payment. They argue that the value of paper has not fallen; the value of gold and silver has risen. Whenever they do admit to depreciation, the fault is not with inconvertible paper money itself. It is with the government’s failure to use the correct formula or technique, which they are ready to provide, to regulate the quantity of money. If the depreciation occurs during wartime, the argument is that the enemy is flooding the country with counterfeit notes.

4. Natural limitations on quantity. Adherents of inconvertible paper money argue that it is superior to metallic money because it is not subject to natural limitations as is metallic money. Unlike gold, inconvertible paper money is not subject to any natural limitations. Coins, hoards, ornamentation, plat, and the like along with mines limit the quantity of gold available for monetary use. The only limitation to the quantity of paper money is the speed at which printing presses can run and the speed at which printing presses, inks, and papers can be manufactured. These limitations can be overcome by putting an ever larger number on the paper notes.

The production of gold can vary significantly over the years. However, the quantity of newly mined gold entering the market is extremely small when compared with the aboveground stock of gold available for money. This high stock-to-flow ratio stabilizes the value of gold and prevents it from changing significantly. With no restriction other than governmental fiat placed on the production of inconvertible paper money, its quantity can increase without limit — or at least increase until it becomes worthless and no one accepts it.

According to the advocates of inconvertible paper money, another advantage that it has over metallic money is that the cost of manufacturing paper money is extremely low. Mining gold is expensive.

5. Not exportable. Adherents identify the inability of inconvertible paper money to be exported to other countries as an advantage that it has over metallic money, which is easily transported. Inconvertible paper money is limited in its circulation to the country of issue. (This may have been true in the past, but it is not true today. The U.S. dollar circulates worldwide. Other fiat inconvertible paper moneys also circulate outside their country of issue.)

Under the gold standard, an overissue of money is halted by the exportation of gold. No such mechanism exists to halt the overissue of inconvertible paper money.

Moreover, unlike gold under the gold standard, inconvertible paper money is independent of the actions and monetary policies of other countries. Advocates of inconvertible paper money consider this independence to be a great benefit.

6. Overissue. Adherents of inconvertible paper money firmly believe that if the government follows the correct formula or technique in issuing it, overissue is impossible. So far, no one has found the correct formula or technique, although fiat money reformers have come forth with several techniques to use to issue the right amount. However, the temptation to issue ever more notes is often too great. Governments find issuing new notes easier and more acceptable than raising taxes. One of the few exceptions is the U.S. note: The government reduced the quantity in circulation and eventually redeemed them in gold.

Under the gold standard, overissue is a self-correcting, short-lived problem. Any excess gold coins will be exported or converted to bullion. Excess convertible bank notes will be converted to gold coin, which will then be exported or converted to bullion. Thus, the overissue is quickly halted and reversed.

7. Overissue leads to more issue. Adherents of inconvertible paper money who believe that it may be overissued are convinced that the overissue can be halted instead of leading to more issuance. However, the overissue of inconvertible paper money is seldom halted; the overissue nearly always leads to evermore increases in the money supply.

When gold is the money, supply and demand applies. Demand creates supply; supply satisfies demand. Excess monetary gold is exported or converted to bullion.

However, paper money is seldom exportable; it can only be used in the domestic markets. (Today, the U.S. dollar is a notable exception. Being the primary reserve currency of the world and the primary currency for buying and selling goods on the world markets, it is highly exportable. This exportation has spared Americans an enormous rise in prices.) When prices begin to rise because of excessive issuance, the government has to issue more notes just to maintain its current level of consumption. This new issuance leads to more rising prices, which leads to more issuance. Thus, a vicious cycle is created. Soon speculators enter the markets to buy goods before their prices rise to sell them at a higher price later; thus, prices begin to rise even more rapidly. A prime example of this phenomenon is the Assignat of the French Revolution.

In spite of all the historical evidence to the contrary, advocates of inconvertible paper money are convinced that no government can issue more notes than the real necessities of the government require. Unlike banks, governments cannot issue notes for profit. Therefore, the issue of government notes is limited to the absolute wants of the government. Most often governments under issue their notes — so assert some advocates of inconvertible paper money.

8. Stability. Adherents of inconvertible paper money claim that it is more stable, i.e., maintains constant purchasing power, than is metallic money. An abstract paper monetary unit is more likely to be less variable in value, purchasing power, than gold. Yet, history has shown that the value of inconvertible paper money is much less stable than the value of gold under the gold standard.

Historically, gold’s purchasing power tends to rise for a decade or two and decline for a decade or two. However, over decades, its purchasing power is fairly constant. (See Roy Jastram’s study on gold’s purchasing power.)

On the other hand, inconvertible paper money’s purchasing power tends to decline at varying rates. Moreover, the decline accelerates as the currency approaches its death.

Depreciating paper money fluctuates primarily for two reasons. First, the demand for money varies. Under the gold standard, this variation in demand is smoothed by gold moving into and out of the country. However, inconvertible paper money remains in the country; thus, its value fluctuates with changing demand. Second, the depreciation of inconvertible paper money impairs its circulation. Depreciation affects confidence in the currency. Inconvertible paper money depreciates more rapidly when confidence is falling and less rapidly when confidence is steady or rising. A rise in confidence may lead to a rise in purchasing power for a while. Political events affect confidence more than the volume of money in circulation.

9. Benefits the working class. Adherents of inconvertible paper money are adamant in that the primary beneficiary of inconvertible paper money is the working class. They present it as benefitting the working class and gold standard as harming the working class. As with most claims of these advocates, the opposite is true. Inconvertible paper money is an egregious tax on production and labor. It leads to speculation, which benefits sharpies at the expense of workers. Initially, depreciating paper money increases the profits of businesses at the expense of consumers, most of whom are workers. However, these excess profits are short-lived as they attract more businesses. Moreover, inconvertible paper money leads to wasteful habits. As it is nearly always depreciating, its loss of purchasing power causes prices to rise. Moreover, prices rise before wages do and faster than wages. Thus, workers must pay more for goods and services with the same amount of labor. Also, most workers lack the means to hoard goods to sell in the future at much higher prices, or even for their own use. Worse, inconvertible paper money undermines the virtues needed to support the social system of the community. It destroys industry, frugality, and economy while promoting extravagance and speculation. Inconvertible paper money is the most effective means to cheat workers as it transfers the wealth of workers to the rich and the government.
10. Gold is not essential to the monetary unit. Adherents of inconvertible paper money argue that gold is not essential to defining the monetary unit. They

assert that gold is no more essential to the monetary unit than brass or wood of a ruler is to the yard or meter. The yard and meter are not defined by the material of which a ruler is made. They are defined by the distance that light travels in a specific fraction of a second. Likewise, the value of the monetary unit is not defined by the material of which money is made. Under the gold standard, it is defined by the value of a specific weight and purity of gold. For example, the dollar was defined as 23.22 grains of fine gold, and, thus, had a value equal to 23.22 grains of gold. Under today’s monetary standard, the dollar is a nebulous abstraction whose value cannot be defined except in terms of itself.

Defining the value of the monetary unit, such as the dollar, peso, pound, or euro, as equal to the value of what the monetary unit buys gives the illusion of stability. The dollar always buys a dollar’s worth of goods. However, the quantity and often the quality of goods that a dollar buys declines over time. Anyone who has lived during the permanent suspension of the gold-coin standard and later the suspension of the gold exchange standard has personally witnessed the instability of an abstract monetary unit and its constant deterioration and loss of value.

Inconvertible paper money may be as bank notes for which redemption has been suspended, such as federal reserve notes after 1932, or forced government notes, such as U.S. notes before 1879. No matter which, both derive their initial value as money from the commodity money, e.g., gold coin, that they replace.

Unlike gold, which has value both as money and as bullion for ornamentation, etc., inconvertible paper money has only one use and that is as money, purchasing medium, a unit of account, and payment of debt and taxes. Therefore, it is low quality money. Lacking quality, it is a poor store of value. Likewise, its poor quality as money makes it a poor standard of exchange value, that is a standard of prices and accounts, or a measure of value.

Inconvertible paper money does have value, but that value is derived from its use as money, and that value depends on the confidence that people have in it. Also, it depends to a limited extent on the authority and power of the government to force it on the people. Once the value of money degenerates beyond a certain point, the power of government can no longer force the people to accept it, even with the death penalty. Examples are the Assignat and the Continental. Unless the government gives a believable promise that the paper money will soon be convertible on demand in full-weight metallic coin, that confidence declines. Declining confidences leads to declining value, purchasing power, of inconvertible paper money.

As the value of inconvertible paper money declines, so does the demand for it. When demand declines, its value declines. Therefore, more is needed to make the same quantity of purchases, Thus, its supply must increase to maintain the same level of purchases. Increasing supply leads to further loss of confidence and decline in demand for the money. As a result, general prices continue to rise.

Inconvertible paper money does function as money although inferior to gold coin. It can serve as a medium of exchange, a standard for the payment of debt, especially when it is legal tender, a measure of value, and even a store of value. However, it swindles creditors and impoverishes workers as it generally loses value over time. Moreover, as it loses value at varying rates, it is a poor measure of value and a poor standard of value. However, unlike gold coin, inconvertible paper money cannot extinguish debt. It merely discharges debt by transferring it to the issuer of the paper money.

Copyright © 2017 by Thomas Coley Allen

From the ‘pen’ of Thomas Allen comes this savagely gentle critique of Francis Walker’s book ‘Money’ (1878).  Walker claimed that Gold neither stores nor measures value…

In Money (1878), Francis Walker discusses his concept of money. He identifies what he considers the basic functions of money: a medium of exchange (it facilitates exchanges), a common denominator (this function should not be confused with money as a measure of value), and a standard for deferred payments (it is a standard of value for paying debt). Walker rejects two functions of money that most economists hold: money as a measure of value and money as a store of value. At least before the demise of money’s connection to gold in 1971, most economists disagree with Walker on these two functions.

Measure of Value

Under the gold standard, when an economist claims that gold is a measure of value, he means that the value of goods and services are compared with the value of a specific weight and fineness of gold. This comparison results in the price of the good or service. For example, between 1837 and 1934, the US dollar was defined as 23.22 grains of fine (pure) gold or 25.80 grains of standard gold, which was 90 percent pure. Thus, a theater ticket that cost $10 had the same value as 232.2 grains of gold.

According to Walker, when most economists are describing money as a measure of value, they are really describing it as a common denominator. Although some use the two terms interchangeably, they are really two different things. Moreover, “they have no necessary relation to each other.”

Walker defines the value of money the way that adherents of inconvertible paper money define the value of money. That is, the value of a gold coin is the value of what it can purchase. According to Walker, the value of a gold coin is determined by its use as a medium of exchange and is independent of its gold content. (Presumably, if the gold content of a gold coin were doubled or halved, its purchasing power would not change. Even Walker and the opponents of gold know that this is absurd.) To most adherents of the gold standard, the value of a gold coin is the value of the material of which it is made, although some of them argued against this notion by claiming that the quantity of gold coins was the primary determinant of their value. Others, such as George Weston, argue that the value of the gold coin determines the value of its metal content, and the value of the gold coin is determined by the supply of metallic and paper money. To illustrate the difference between the two, today, the value of the dollar is the value of a dollar’s worth of goods. Between 1837 and 1934, the value of a dollar was the value of 23.22 grains of gold. The latter definition is superior to the former because it defines the value of the dollar independently of itself. The former defines the value of the dollar in terms of itself.

Walker argues that when values are measured, they may be expressed relatively to each other as a scale of numbers. Perceiving money as providing a scale of value instead of a measure of value, was not original with Walker. Dugald Stewart had earlier argued this notion. Like Stewart, Walker seems to believe that gold is the best form or type of money. Yet, if his argument that money does not measure value, but merely provides a scale for relative values is correct, then the material of which the money is made is irrelevant. Like Stewart, Walker does not consider money as capital but as an aid in enumeration and arithmetic. Many economists, especially today, and even in the nineteenth century, concur with Walker and Stewart. Thus, for example, if item A has a value of 1 and item B, of 5, then item B is worth 5 times more than A.

He notes that advocates of Ideal Money, which is inconvertible paper money, maintain that money merely provides a common denominator by which the relative values of various goods can be compared. Advocates of Real Money, which is full-weight metallic coin either gold or silver, maintain that money provides a common measure of value to which various goods are compared and measured. (Ironically, while supporting the adherents of Ideal Money on money being merely a numeric that compares but measures nothing, he abhors inconvertible paper money.)

Instead of money measuring value, Walker argues that money merely provides a common denominator. If money is merely a numeric, as today’s money essentially is, although it does measure value, albeit poorly, what purpose do such apparent units of measure as the dollar, pound, franc, mark, or peso, serve? Walker does not say. If money merely provides a common denominator, then the coin or paper note would only need a number stamped on it. Adding “dollar,” “pound,” “franc,” “mark,” or “peso” is superfluous and can be confusing (misleading one to believe that value is being measured). Why make a $10 gold coin twice the size of a $5 gold coin and a $20 gold coin twice the size of a $10 gold coin, if the coin does not measure value? Why not just use paper money with numbers and no units printed on them? Yet Walker abhors inconvertible paper money.

Following the lead of Prof. Rogers, Walker compares measuring value to measuring distances. If the distance between A and B is 1 and the distance between B and C is 10, then the distance between B and C is ten times greater than the distance between A and B. However, one does not know if the distance is in zeptometers (an extremely short distance) or in zettameters (an extremely long distance). Without a unit of measure, one does not know whether the distances are short or long. Moreover, a unit of measure is needed to ensure that the relative values are understood correctly. Thus, the distance between A and B compared with B and C is much greater than it appears if the distance between A and B is in zeptometers and B and C is in zettameters. Instead of the relative distance between B and C being ten times greater than A and B, it is 10 to the 43^rd power greater (a enormous number). (Another example of the inadequacy of relative comparisons occurs with corporate profits. Corporation X has a 100 percent increase in profit compared with the previous year, while corporation Y has only a 1 percent increase in profit. In relative terms, corporation X appears to have a greater profit. However, when absolute profits are considered, a different story is revealed. Corporation X had a profit of $1 the previous year and $2 this year; thus, it had an increase in profit of 100 percent. Corporation Y had a profit of $1 billion last year and $1.01 this year, which is an increase in profit of 1 percent. Of the two which did the best?)

When comparing values, a measure of value, that is a unit of value, is also needed. For example, the US dollar had a value of 23.22 grains of gold and the British pound had a value of 113 grains of gold. Thus, the value of the British pound was about 4.86 times greater than the value of the US dollar. One needs to know whether prices are being compared in dollars or pounds or both. The relative values may be the same, but the absolute values may not be. For example, if item X costs £2 and item Y costs £1, then item X costs twice as much as item Y. If item A costs $2 and item B costs $1, then item A costs twice as much as item B. Although both X and A have twice the value of Y and B respectively, X is worth 4.86 times A and 9.72 times B. Thus, more than a common denominator is needed to estimate value or even to measure relative differences. A unit of measure, i.e., a unit of value, is also needed. Furthermore, that unit of value must have value in and of itself.

As shown above, when distance or value is being compared, more than a numeric value is needed. Moreover, that unit of measure must possess what is being measured.

Walker does admit that to measure value, a value must be used. Nevertheless, that value can be relative and expressed as a pure number without reference to any common value. He states, “Value is a relation. Relations may be expressed, but not measured.” He illustrates this with distance by claiming that the relationship between a furlong and a mile cannot be measured but can only be expressed as 8 to 1. (By definition, a mile equals eight furlongs. However, as discussed above, if no units of measure are attached to the relative numbers, one has no clue about the distances being expressed.)

Furthermore, Walker uses seigniorage as an argument that money does not measure value. Because of seigniorage, the monetary value stamped on the coin exceeds the value of its metal content. This is true. Seigniorage may cause the coin to be overvalued domestically, but not necessarily so. If the seigniorage is too high, coins will exchange based on the value of their metal content and not based on the monetary value stamped on them — even if such exchanges are illegal. Nevertheless, the seigniorage premium disappears once the coin leaves the country of issue. Outside the country of issue, its purchasing power is that of its metal content and not that which is stamped on it.

Unlike Walker, most economists argue that to measure and compare values of various items, these items have to be compared with a common item, which under the gold standard is a specific weight and fineness of gold. Moreover, this standard to which items are compared has to have value in and of itself, which is often called “intrinsic value.” Walker argues that money cannot measure value because unlike the yardstick or meterstick, its value is not fixed, even for a gold coin. (Even the definition of the meter has changed several times since it was first invented. Therefore, the measure of distance has changed over time, although minutely.) It varies with time, place, and circumstances. This is true. Being subjective, value is not constant — not even for money regardless of the material of which it is made. Moreover, relative values vary with time, place, and circumstances. Yet nothing cannot measure something as Walker seems to argue. If it could, unitless numbers on paper could serve as money as well as full-weight gold coin. Moreover, paper money would be much cheaper to manufacture. However, Walker presents a convincing argument that inconvertible paper money is vastly inferior to gold coin. (Nevertheless, he uses inconvertible paper money to argue against the notion that money can measure value and has to have value in and of itself to do so.)

Store of Value

Most economists who support the gold standard assert that one of the important functions of money is to serve as a store of value. Some even claim that this is the most important function of money.

Contrary to the assertion of these economists, Walker argues that money does not serve as a store of value. About this function of money, or more correctly, lack of it, he agrees with the proponents of inconvertible paper money.

The store of value is closely related to the measure of value. If money does not and cannot measure value, it need not store value. However, if money is the measure of value, then it needs to be able to store value so that it can measure value. That is, money has to have value in and of itself to measure value. Value can only be measured against value and with value.

Walker identifies money serving as the standard for deferred payments as an important function of money; that is, money serves as the payment for debt. Why would anyone give up something of value, whatever is lent, in exchange for payments of no value? To function as payment for debt, money has to be able to transfer value through time and often through space. Even inconvertible paper money transfers value through time to a highly limited degree.

Furthermore, money functioning as a medium of exchange implies that money is a store of value. It must store value so that it can carry value from its receipt to its expenditure so that little or no value is lost. Also, why would anyone sell his goods or labor in exchange for that which has no value? Evidently, Walker believes that people are willing to make such exchanges. Contrary to Walker’s belief, money’s function as a medium of exchange cannot be separated from its function as a store of value. This is true not only for full-weight metallic coin but also for inconvertible paper money. (Generally, losing value over time at various rates, inconvertible paper money stores value poorly and becomes a poor medium of exchange.)

Moreover, Walker states, “When a commodity comes to serve as a store of value, it ceases to be money.” Gold in hoards, treasures, plate, and ornamentation is not money. (At the other extreme is Murray Rothbard, who claims that gold is money whatever its form.) Walker is unclear whether gold coins held in reserves by banks for payment of their notes and checkable deposits are money. Based on his argument, bank reserves should not be considered money.

On the other hand, being a good economist, he asserts that gold’s ability to be used as a store of value is an important attribute that qualifies it as money. Is this not confusing? Gold stores value, but once it is coined and used to buy something or pay a debt, it ceases to store value. However, if the recipient puts the coin in his pocket and does not spend it for a year, i.e., hoards it, it ceases being money and becomes a store of value. (This is akin to the gold-is-sterile argument against the gold standard.)

To add to the confusion of gold being either money or ornamentation, i.e., a store of value, Walker describes the use of gold as jewelry, such as ring-money worn as rings or necklaces, being used as money. Presumably, when the owner was wearing the ring-money on his finger, it was a store of value, but not money. However, when he took the ring off and bought an item with it, the gold ring ceased storing value and became money. (How long does a gold coin have to remain in one’s purse before it ceases being money and becomes a store of value? Walker does not say.)

In summary, Walker argues that money does not measure value; it merely serves a common denominator by which the values of various goods and services are compared. Furthermore, money does not and cannot store value, although the material of which it is made can often store value. On these two points, most economists who support the gold standard disagree. However, most economists who support inconvertible paper money agree with Walker.

Copyright © 2017 by Thomas Coley Allen.

This article marks the last in the series of reviews of the writings of Henry Varnum Poor by Thomas Allen.  PB

In 1877, Henry Varnum Poor (1812-1905) wrote Money and Its Laws: Embracing a History of Monetary Theories, and a History of the Currency of the United States. He was a financial analyst and founder of a company that evolved into Standard & Poor’s. Poor was a proponent of the real bills doctrine and the classical gold-coin standard and, thus, the quality theory of money. He gave little credence to the quantity theory of money — especially if credit money, such as bank notes, were convertible on demand in species. Also, he contended that the value of money depends on and is derived from the value of the material of which it is made and with paper money, its representation of such value.

In the latter part of his book, he discusses leading monetary theorists from Aristotle (350 B.C.) to David A. Wells (1875). Most of the economists whom he discussed were proponents of the quantity theory of money. We will look at his discussion on William G. Sumner. My comments are in brackets. Referenced page numbers enclosed in parentheses are to Poor’s book.

William G. Sumner (1840-1910) was a classical liberal American social scientist. He was a professor of political economics at Yale where he taught social sciences and held the first professorship in sociology in the United States. He supported free trade, free markets, and the gold standard and opposed imperialism. Among his many works are A History of American Currency (1874) and Problems in Political Economy (1883). Poor reviews the part of A History of American Currency that discusses the report of the Bullion Committee. [The British Parliament established the Bullion Committee to study returning to the gold standard after the Napoleonic wars and to make recommendations about how to return Britain to the gold standard.]

Sumner claims that the report of the Bullion Committee “solved the whole subject of money” (p. 416). He declares that money does not flow from poorer agricultural regions to richer financial cities. To the contrary, it flows from the richer regions to the poorer regions (p. 416). As for the balance of trade, if it means “equilibrium,” then exports equal imports and trade regulates itself. If it means “remainder,” it is a myth (p. 417).

Summarizing the doctrines of the Bullion Committee, Sumner writes:

1. The value of an inconvertible currency depends on its amount relatively to the needs of the country for circulating medium (only to a very subordinate degree on the security on which it is based or the credit of the issuer).
2. If gold is at a premium in paper, the paper is redundant and depreciated. The premium measures the depreciation.

According to Sumner, for “a system of even nominal convertibility, the motives of speculation and of price fluctuations lie outside of the currency in industrial and commercial circumstances. Speculation . . . controls the amount of the currency” (p. 417). Whereas, “[o]n an inconvertible system, the amount of the currency controls speculation” (p. 417). Thus, if an inconvertible currency “is not redundant, its effect is slight; if it is very excessive, it ‘floats’ every thing, and becomes the controlling consideration” (p. 417). The quantity of inconvertible paper money determines its value and prices. [Uncertainty causes inconvertible legal-tender government notes to depreciate. The excessive issue of these notes, as Sumner and the quantity theory of money claim, is not the cause of their depreciation. However, an excess of issue can influence the value of these notes by affecting uncertainty. Uncertainties that affect the value of inconvertible government notes include (1) the uncertainty of when they will be paid or even if they will be a paid, (2) the ability of the government to pay, (3) the willingness of the government to pay, and (4) the kind of coin that will be used for payment. Inconvertible paper money is what the world has had ever since 1971. However, today, much of this uncertainty has been eliminated. Almost no one now believes that governments will ever pay their notes, i.e., redeem their notes in a commodity that has intrinsic value at that intrinsic value.] However, Sumner comments that the quantity of the U.S. notes is fixed. Therefore, the answer to its value lies in its adverse foreign exchange, i.e., outflows of gold. He asks, “Is it [the gold outflow] due to the balance of payments, or to some deterioration of the currency” (p. 418)? According to the Bullion Committee, with which Sumner agrees, “the balance of imports and exports never can move the exchanges, either above or below par, more than just enough to start a movement of bullion” (p. 418). Thus, “[o]n a specie system, any outflow of bullion would bring down prices, and immediately make a remittance of goods more profitable than one of bullion; and, if the exportation of bullion was artificially continued (as, for instance, to pay the expenses of a foreign war), it would reduce prices until a counter current would set in and restore the former relative distribution all the world over” (p. 418). Continuing, Sumner writes, “If, therefore, there is an outflow of gold, serious and long continued, accompanied by an unfavorable exchange, it is a sign that there is an inferior currency behind the gold, which is displacing it. The surplus of imports of goods above the exports of goods is nothing but the return payment for this export of gold, and is not a cause, but a consequence” (p. 418). To produce an influx of gold, the inferior currency, inconvertible notes, needs to be removed. If foreign exchanges are adverse, gold will be exported; this exportation of gold is an indication that the paper money is excessive. Thus, inconvertible paper money should be issued in such quantity to prevent the exportation of gold (pp. 418-419).

Poor disagrees with Sumner’s notions on the balance of trade. Particularly, Poor disagrees with Sumner’s notion that if a country exports gold that it necessarily receives an equal value of merchandise. Or, if it imports gold, it exports an equal value of merchandise (p. 419).

Poor illustrates his disagreement with an analogy:

Suppose an individual possessed of a thousand dollars in coin to expend it in the purchase of the necessaries of life even, his means are reduced in like ratio. If he would reinstate his former condition, he must forego future expenditures to an equal amount. So, if a person run into debt to his shopkeeper to the amount of a thousand dollars, if he would pay it, he must forego a like amount of his future earnings. His indebtedness until paid would very properly be termed a balance of trade against him. So with a nation (p. 419).

[Sumner is closer to the truth than Poor. An exchange is only made when both parties of the exchange believe that he is receiving greater value than he is giving up. Poor has a point if the long-run consequences are considered. However, the long run is considered when an exchange is made. Unfortunately, many people do an extremely poor job of considering long-run consequences,  and some give it no weight.]

Continuing, Poor writes:

If it [a country] import more in value of ordinary merchandise than it exports, its specie will have to go to make up the deficit. Now, no nation not producing gold can part with any considerable amount of it without causing embarrassment to its industries and trade; for the reason that that which it possessed and exported was a part of the machinery by which these were carried on. The tendency of the precious metals the world over is to distribute themselves according to the means and needs of those using them. If there be no movement in any direction, it is assumed that they are in proper equilibrium (p. 419).

Furthermore, Poor remarks, “The export of a large amount of coin is usually due to a vicious paper currency, and such a currency is always attended with wasteful expenditure” (p. 420). [Perhaps, politicians ought to heed Poor’s wisdom here. Could trade imbalances be caused more by “a vicious paper currency” and “wasteful expenditures” than the shenanigans of foreign countries to give their domestic industries advantages in foreign and even domestic trade at the expense of their own citizens?] When a country exports gold, it becomes weaker, “for she has parted with that which is essential to her welfare, and must be reclaimed by future accumulations” (p. 420). [The development in the use of bills of exchange reduced the need to export gold. Moreover, the elimination of gold from the monetary systems of the world today makes the exportation of gold irrelevant — at least in theory. Now a country only exports the inconvertible paper money of another country or its own inconvertible paper money, which it can replace without having to import it. Furthermore, most countries would prefer never having to import any of their currency that has been exported, except to tax it.]

Admitting that Sumner may be correct about inferior currency causing the outflow of gold, Poor asks, “may not the loss as well be described as an ‘unfavorable balance of trade’ as by any other term” (p. 420)? Then Poor remarks:

A nation that has parted with its coin, which has to be brought back again, would have been much better off had it never parted with it. That which has been received will never suffice to bring it back; and, if it would, the charges of transportation and interest would involve a large loss; so that, after all, “balance of trade” is a veritable fact, and always exists to a greater or less extent in commerce between nations, and must always exist until human affairs reach the accuracy and certainty of natural laws (p. 420).

Next, Poor asks, “[W]hat is an ‘inferior currency’” (p. 420)? He answers, “One kind is the inconvertible notes of government, issued not for the purpose of loaning capital, but to supply the lack of it” (p. 420). About inconvertible governments notes, he writes, “The demand for merchandise must increase in ratio to its amount; for it is always superadded to the existing currencies. As such notes are always made legal tender, they not only drive coin out of the country, but keep it out till they are retired. Such a currency admits of no corrective by the laws of trade” (p. 420).

“Another ‘inferior’ currency,” Poor writes, “is that issued by Banks, without a constituent” (p. 420). Initially, it acts like government notes in driving gold out of the country. However, since these bank notes are convertible to gold coin, banks must supply the gold to meet their redemption. As a result, “[t]hey must pay for the excess of imports over exports from their reserves” (p. 421). Poor writes:

It is impossible, however, for them [bankers] to tell whether all the bills discounted by them have their proper constituent: they can only determine the fact by the result. If they see gold beginning to move, they understand at once that improper bills have been discounted; that the currency has been issued in excess, and must so far be taken in by a reduction of their line of discounts. The movement of gold, therefore, is an indication of the state of the currency, as infallible as is that of the mercury of meteoric conditions (p. 421).

[Poor is describing the operation of the real bills doctrine correcting the overissue of bank notes and checkable deposits resulting from discounted faulty bills.]

Sumner’s test of an ‘inferior currency’ differs greatly from what Poor has described. Sumner’s test is that of quantity; Poor’s is that of quality. To Sumner, a currency is not “inferior” if “its amount does not exceed that required by a country in its exchanges, even if it be not backed by a single dollar of coin” (p. 421). Thus, according to Sumner, “the value of money depends upon its quantity, not upon the provision made for its convertibility, [and] ‘are not matters of opinion, but of demonstration’” (p. 421). To this, Poor replies, “If so, then it is a matter of demonstration that one and one make four” (p. 421). Poor adds “that the real or estimated value of articles, whether they be merchandise or money, is their exchangeable value. To assume otherwise, would be to say that the exchangeable value of a piece of silver having the weight and insignia of a sovereign equals the value of a sovereign. Humanity is not yet brought to so low a pitch as this” (p. 421). [The sovereign is a gold coin that contains 0.23542 troy ounces, i.e., 113 grains of gold, which was the British pound from 1816 until Great Britain left the gold standard. A century after Poor wrote, humanity, or at least mainstream economists, had reached such a low level that they fell for the pitch that a piece of paper with the government’s seal on it was the same as gold.]

Poor concludes his review of Sumner:

Even the Economists are by no means the simple race their theories would make them. In spite of the conclusions of the Bullion Committee, which, with Mr. Sumner, are the very acme of financial wisdom, he would be the last man to take a bank or government note without especial reference to the provision made for its discharge. If their creed were their law, a few days would suffice for the Economists to fool away whatever they possessed (pp. 421-422).

Copyright © 2017 by Thomas Coley Allen.

by Thomas Allen

In 1877, Henry Varnum Poor (1812-1905) wrote Money and Its Laws: Embracing a History of Monetary Theories, and a History of the Currency of the United States. He was a financial analyst and founder of a company that evolved into Standard & Poor’s. Poor was a proponent of the real bills doctrine and the classical gold-coin standard and, thus, the quality theory of money. He gave little credence to the quantity theory of money — especially if credit money, such as bank notes, were convertible on demand in species. Also, he contended that the value of money depends on and is derived from the value of the material of which it is made and with paper money, its representation of such value.

In the latter part of his book, he discusses leading monetary theorists from Aristotle (350 B.C.) to David A. Wells (1875). Most of the economists whom he discussed were proponents of the quantity theory of money. We will look at his discussion on Francis Bowen. My comments are in brackets. Referenced page numbers enclosed in parentheses are to Poor’s book.

Francis Bowen (1811-1890) was an American philosopher, writer, and educationalist and a professor of political economy at Harvard University. Among his works are Lectures on Political Economy (1850), The Principles of Political Economy applied to the Condition, Resources and Institutions of the American People (1856), and American Political Economy (1870), which Poor reviews.

Poor describes American Political Economy as “a feeble and garrulous restatement of Adam Smith, Stewart, Ricardo, Tooke, McCulloch, and Mill, to whose absurdities and errors an emphasis is given by no means to be found in the originals” (p. 409).

Bowen writes “that money is merely a contrivance for diminishing the friction of exchange; and, though safe and convenient, it is also a very costly contrivance for this end” (p. 409). Money is part of a country’s wealth, but it is not capital. It does not yield profit or interest. Only the goods transferred by the means of money yield profit. Because money is not consumed, “it is not productive” (p. 409). Therefore, “[t]he specie which a merchant or a banker holds in store, to provide against daily calls or sudden emergencies, is the only unproductive portion of his capital: he is subject to a loss of interest on the whole amount thus retained” (p. 409). “The coin which a man keeps in his pocket does not, like his shoes or his hat, contribute to his comfort: it is a convenience to him only as it supplies immediate means for making small purchases or satisfying small demands” (p. 409).

Poor replies

[Coin has a great many functions beside “diminishing the friction of exchange.” It cannot be called unproductive so long as it can be loaned at interest, and is absolutely indispensable in the process of distribution, without which there can be no capital worthy the name. It would be just as proper to say that a wagon or railroad car was unproductive, for the reason that it did not produce the merchandise transported by it (pp. 409-410).

[Expressing the same sentiment, Hutt states, “The essences of all these services [of money] is availability. . . . [M]oney assets are not unemployed or resting when they are in our pockets, or in our tills, or in our banking accounts, but in pseudo-idleness, like a piano when it is not being played, or a fireman or a fire engine when there are no fires.”[1] In essence, Bowen is presenting the sterility-gold-coin argument against the gold standard.]

About exchanges, Bowen writes, “Every exchange is a barter of a quantity of merchandise for a certain sum of money which is its equivalent” (p. 410). Because money is not consumed when it is exchanged, a community does not need as much money as there is merchandise; therefore, money is immediately ready for another purchase. Bowen declares:

The circulation of money and of merchandise bears some relation to the momentum spoken of in physical science, which is composed of the velocity multiplied by the mass; the momenta are equal, though the velocity should be increased tenfold, provided that the mass is but one tenth part as great. So, also, the momentum of wealth is its value multiplied by the rapidity of its circulation. As money circulates far more rapidly than merchandise, it is evident that (the number of exchanges on both sides being equal) there must necessarily be less value in the money than in the merchandise, and as much less as the circulation of the money is more rapid than that of the merchandise (p. 410).

Next Bowen presents an algebraic equation to describe his concept: gs=mr,

where g = quantity of goods on sale; s = number of times the goods are resold; m = quantity of money in circulation; r = number of purchases effected by each piece of money. [This equation is similar to Irvin Fisher’s equation: MV=PT, where M = the amount of money; V = the velocity of money; P = prices; T = the number of transactions. In The Value of Money, Benjamin Anderson explains in great detail the flaws of Fisher’s equation and the quantity theory of money.]

With this equation, Bowen shows “that the value of money will be inversely as its quantity” (p. 411). [That is, as the quantity of money increases, its value decreases if everything else remains constant. By value, he seems to mean purchasing power.]

Poor remarks that Bowen errs because “[m]omentum and effective value are identical terms. All kinds of merchandise, wealth being a generic term, obey the same law. Whatever value can be predicated of one kind, due to the rapidity of its circulation, can be of all other kinds” (p. 411).

Continuing, if Bowen is correct, then according to Poor, “the great problem for society is to determine the degree of momentum that can be secured for its merchandise, as its wealth will be increased in like ratio” (p. 411). Then, using Bowen’s equation, Poor defines “g” to stand for the “goose” instead of “goods.” Next, he states:

Now, “the value of the goose is inversely as its quantity multiplied by the rapidity of its circulation.” Assuming the formula given to express the ordinary rapidity of circulation, or, what is equivalent, the momentum, and consequently, value of the goose; then, if its momentum, or value, be doubled, the formula has only to be altered; thus: — gs=2mr, or mr=gs/2. The goose has now a value twice greater than it had before (pp. 411-412).

According to Bowen’s equation, the value of the goose is inverse to its quantity. Therefore, using Bowen’s equation, if the quantity of the goose is reduced by half, the quantity of money doubles — assuming that demand remains the same. Thus, Poor notes:

If the crop of geese should be short, and it should be desirable to increase their momentum, or effective value, say tenfold, all that would have to be done would be to increase their rapidity of circulation to be expressed by the following change in Mr. Bowen’s formula; thus: — gs/10=mr, or 10mr=gs. When the last degree of momentum was secured, a wing or a leg of the goose would have a value equal to that of the whole bird. Society will be the gainer in an equal degree, by being able to devote to other purposes the land formerly dedicated to goose-culture.

Continuing, Poor writes:

Admitting the conclusiveness of his demonstration, it must be applicable to all kinds of merchandise; for, as has already been shown, money, after it has been spent, is as functus officio to its late owner as is the goose to its owner after it is eaten. If it be objected that the money is still in existence, and the goose is not, it may be replied: that the goose has indeed been eaten, but productively, to appear in new geese, or, in other kinds of merchandise; so that whoever uses the money the second time is still confronted by a new goose or its equivalent. If the goose or its equivalent do not reappear, then the money does not. Each responds, and with equal alacrity, to the call of the other (pp. 412-413).

Bowen notes that a large portion of specie currency can be replaced with paper currency or other substitutes. However, “the total amount of the currency will remain just as before; the value of the paper and the precious metals, taken together, will be just what the specie alone would be if paper were not used” (p. 413). Wealth and commodities are estimated in the monetary unit, such as the dollar, “and it is by the aid of such estimates that all exchanges are made” (p. 413). “Thus, the idea of money aids us, when the reality is seldom employed” (p. 413). He asserts, “Money is even now only a hypothetical or abstract medium of exchange in all the larger transactions of commerce” (p. 413). Bowen anticipates “the time, in the progress of invention and the discovery of new expedients and facilities in commerce, when it will become so universally; when, at any rate, so costly and useless a realization of the idea as gold and silver coin will be entirely done away” (p. 413). [If Bowen had lived another 85 years, he would have witnessed his dream as gold and silver were no longer part of the monetary system. Also, he could have witnessed the economic disaster that the abandonment of gold and silver coin has brought.]

Poor responds that Bowen is greatly mistaken:

Money is still, as many find to their cost, far more than a mere scale of valuation. The holders of property, when they sell it, still persist in demanding something more than “hypothetical or abstract media of exchange.” They may be very uncivilized and selfish to demand a quid pro quo in all transactions, and the laws which uphold them very barbarous; but these laws, nevertheless, have maintained their force since laws existed (pp. 413-414).

[Today, what passes for money is little more than an abstract counter, an abstract medium of exchange. It cannot extinguish debt as it is debt. At least mankind is no longer “uncivilized and selfish” as they no longer demand “quid pro quo.” They exchange goods and services for that which has no value in itself and does not represent value.]

Bowen explains the difference between convertible bank currency and inconvertible paper money. Convertible currency cannot be overissued. If inconvertible paper money “could be kept precisely equal to what the amount of metallic currency would be in case there were no paper in circulation, then there would be no depreciation of the paper; nay, the paper might even command a premium over the coin, if the aggregate value of it were made less than what the coin would amount to, and if it were also possible to prevent the importation of specie.” (p. 414). [Bowen errs. Uncertainty causes inconvertible legal-tender government notes to depreciate. The excessive issue of these notes, as Bowen and the quantity theory of money claims, is not the cause of their depreciation. However, an excess of issue can influence the value of these notes by affecting uncertainty. Uncertainties that affect the value of inconvertible government notes include (1) the uncertainty of when they will be paid or even if they will be a paid, (2) the ability of the government to pay, (3) the willingness of the government to pay, and (4) the kind of coin that will be used for payment. S. McLean Hardy’s statistical study of the U.S. note between 1862 and 1873 shows that uncertainty, and not the quantity of notes, was the driving force behind the depreciation of U.S. notes.] Bowen adds, “Money acquires the power of exercising its functions, not from any intrinsic quality that it possesses, but solely from convention” (p. 414). [The economists whom Poor reviews needed to study the origins of money. They would have found that money acquired “the power of exercising its functions” not from convention, but solely from its intrinsic quality that it possesses. A good place to start is the works of Karl Menger and William W. Carlile.] Continuing, Bowen writes, “The value of paper money, not depending at all upon its cost of production, is regulated solely by its quantity” (p. 414). [Thus, the quantity theory of money explains the value of money. However, the quantity theory of money seems to have failed to explain the downward trend in prices during the last three decades of the nineteenth century in the United States. Money supply more than doubled, yet general prices declined.] Then he remarks:

A certain determinable sum of money is needed in every nation to effect its current exchanges, and to maintain prices at an equilibrium with the average prices of commodities throughout the commercial world. Coin being banished, if the issue of paper money is less than this sum, the paper will be at a premium; if greater, it will be at a discount (pp. 414-415).

[For decades, every country has operated with a monetary system of inconvertible paper money completely divorced from gold. If Bowen is correct in that the managers of the inconvertible currency can maintain price stability, then the monetary system of every country is operated by either incompetents who lack the knowledge and ability to manage properly their monetary systems or criminals who are deliberately destroying the currencies of their countries. Fiat monetary reformers would argue that they are both. They are criminals transporting the country’s wealth to the rich and powerful by destroying the currency. They are ignorant incompetents for failing to follow the fiat money reformer’s scheme for issuing the currency. However, the fiat money reformers do not agree on the correct scheme to follow except that the government, which is controlled by the rich and powerful, should issue the currency. The fiat money reformers are probably correct in that the money managers are both incompetent and criminals. For that reason, the issuance and regulation of money should be taken from governments and their central banks and left to the markets. In monetary matters, the only action required by the government is to define the monetary unit as a specific weight of precious metal and to punish violations of contracts and acts of fraud.]

In his concluding remarks about Bowen, Poor writes:

Were Mr. Bowen the only one to be affected by his opinions, they would be of very little consequence; but they become of the greatest importance when taught to young men about to enter the world of affairs, especially when they relate to a subject which concerns, more deeply almost than any other, the welfare of society. What would be thought of a professorship in a university that should still seek to establish the wonderful properties of the philosopher’s stone? The attempt would not be a whit more absurd than his teachings upon the subject of money. The thing chiefly to be regretted is, that there does not seem to be any way in which to rid the universities and the world of such nonsense. So far as money is concerned, all are Alchemists, all are believers in the philosopher’s stone, all are intent upon its realization. The first step in the way of reform should be to abolish the “professorship of Political Economy,” not only in this, but in all institutions in which it is now pretended to be taught; and either abandon instruction in it altogether, or put its duties in commission. In the latter case, whatever was taught would at least have the merit of being as broad as the course of instruction would allow (p. 415).

Copyright © 2017 by Thomas Coley Allen.

Endnote

^[1].  William Harold Hutt, Individual Freedom: Selected Works of William H. Hutt, editors Svetozar Pejovich and David Klingaman (Westport, Connecticut: Greenwood Press, 1975), pp.207-209.