According to the quantity theory, changes in the volume of the currency are primary causes of changes in prices; while according to the other explanation the causal relation is the reverse, the quantity of money being the result of price changes which in turn are due to modifications in the ratio of exchange between the standard and other commodities. Suppose, for example, that a considerable rise in prices has taken place, and that the statistics of the mints, banks, and other money-producing agencies show that the quantity of money has also increased. The quantity theorists would assert that the rise was the result of the activity of the mints and the banks, while those who believed in the other explanation would search for the causes of the rise of prices in changed conditions in the demand and supply of commodities or of gold or of both, and would explain the increase in the volume of the currency as the necessary result of an increase in the demand for money caused by the rise of prices, and in proof would refer to the axiom of monetary science that when prices are high a larger amount of money is needed to effect the exchange of a given number of commodities than when they are low.

The great practical significance of the difference between these two methods of explaining changes in prices has been repeatedly illustrated in the recent history of the United States. Since the early seventies a considerable fall in the prices of staple commodities has been observed and in various ways measured by statistical processes. Reasoning logically on the basis of the quantity theory, a considerable proportion of our population, led by brilliant orators and skilful casuists in and out of Congress, accordingly concluded that the currency must be very deficient in volume, and that a considerable increase would remedy what they regarded as the great evil of falling prices. Hence the agitation for the free coinage of silver which gave us in turn the Bland and the Sherman acts, and was responsible for the sturdy opposition to the retirement of the greenbacks and Sherman notes after these attempts to inject large masses of depreciated silver into our currency had brought our treasury into serious embarrassment and had helped to bring on one of the severest commercial crises of the century. The plausible fabric of reasoning by which a large proportion of our people was drawn to the support of this agitation was built upon the quantity theory, and could not have endured for a day had it been understood and accepted by all that the volume of the currency was not responsible for the fall of prices, but changed conditions of production and consumption which had effected enormous modifications in the relations between the demand and supply of all the staple commodities, and changed conditions also in the production and use of the precious metals which had radically modified the relations of demand and supply in their cases as well. Many of those who were convinced of the falsity of the conclusions of the advocates of an inflation of the currency found great difficulty in combating their reasoning, because they too assumed the quantity theory to be an axiom of monetary science.

Many other illustrations of the practical significance of the distinction between these two methods of explaining prices will appear in subsequent chapters. In fact, one's attitude toward such questions as seigniorage, inconvertible government notes, bimetallism, and indeed all questions in which the interpretation of prices is involved, is apt to be very different according as he adopts the one explanation or the other.

The fact, often attested by observation, that there is some relation between the quantity of money and prices cannot be cited in support of the quantity theory, that theory being simply an explanation of the observed relation which happens to be incorrect. That the total volume of the currency is an effect of which prices are one of the causes, is, as we have already remarked, axiomatic. It follows from the very nature of a medium of exchange. As a go-between in every trade, money must reflect prices, and there must be as many units as there are dollars' worth of value exchanged at one time. The number of dollars' worth of value exchanged, however, is determined by the number of times the value of the specific amount of gold or some other commodity, which we have agreed to call a dollar, is contained in the value of the commodities bought and sold upon the markets, and not by the number of pieces of money which may chance to be somewhere stored away or capable of being manufactured. In other words, the money is manufactured for the exchanges, instead of the exchanges being effected for the purpose of using the money.

Certain changes in the currency may be primary causes of fluctuations in prices, but these are not quantitative changes in its total volume, but changes in its composition. Suppose, by way of illustration, gold being the standard, that silver coins or paper money be substituted in large quantities for gold coins in the circulation. It is highly probable that these coins would eventually be melted down and sold as bullion, in which case, the market supply having been increased, the value of gold would fall, and with it the value of the standard, and prices would rise. For example, there can be little doubt that, if various forms of bank currency were substituted for the English sovereigns and half-sovereigns, the French twenty- and ten-franc pieces, and the German twenty- and ten-mark pieces now in circulation, the value of gold would be affected, and with it prices. Such a substitution, however, would not necessarily involve any change in the total volume of the currencies of those countries. As we shall show in a subsequent chapter, the circulation of inconvertible government notes almost always affects prices, but it does not necessarily affect the total volume of the currency, and, if it does, such an effect follows and does not precede the change in prices. As soon as the notes begin to depreciate, prices begin to rise, but for some time the only change in the currency may be the substitution of these notes for coin and all other forms of undepreciated money. The total volume of the currency may for a time be actually diminished, and an increase will come, if at all, only in later stages of the issue. A considerable substitution of silver for gold in the currencies of the world, as proposed by the bimetallists, would doubtless affect prices, but it would not necessarily affect the total volume of the world's money. The rise of prices would be caused either by a fall in the value of gold due to its increased supply upon the bullion market, or to the substitution of silver for gold as the standard of value.

The inadequacy of the quantity theory appears in a striking manner when one attempts to explain a series of price fluctuations and currency movements. The following will serve as an illustration: The most reliable statistical investigations show that in the United States between 1861 and 1891 the general level of prices fell about 8.3 per cent, while the volume of the currency during the same period increased nearly 350 per cent. From 1865 to 1890 prices decreased about 57 per cent and the volume of the currency increased about 124 per cent. Only during the four years 1861 to 1865 did the general level of prices and the volume of the currency move in the same direction, the statistics of the former indicating an increase of 115 per cent and those of the latter an increase of 59.4 per cent.* The statistics regarding the volume of the currency in this investigation omitted checks, drafts, and bills of exchange. Had these been included, the increase would have been indicated by a still greater percentage.

The only explanation of these facts which the advocates of the quantity theory are able to give is the claim that the number of exchanges increased to an even greater extent than the volume of the currency. It is impossible either satisfactorily to prove or to disprove this claim by an appeal to statistics, since even approximately accurate numerical statements of the number of exchange transactions in a given day or week or year do not exist. Such statistics bearing upon this question as are available, however, - for example, those pertaining to the increase in the production of various staple products, and to changes in the number of hands through which goods pass on the road from the producer to the consumer, - do not support this claim, but seem rather to reveal a great discrepancy between the facts and the quantity theory. After a careful investigation of the situation for the period 1860-1891, a recent writer* drew the following conclusion: -

* See article by Miss Jane Hardy, on " The Quantity of Money and Prices," in Journal of Political Economy, March, 1895.

"Summing up the evidence which has been presented, it seems (1) that the total increase in the amount of goods to be exchanged varied, so far as estimated, from about twofold in agriculture to a little less than fivefold in manufactures; (2) that the ratio of increase in the volume of transactions was less than this, because the average number of times that the same goods changed hands in passing from producer to consumer decreased, owing to alterations in business methods; (3) that of the means for accomplishing this growing money work, the use of credit instruments, as indicated in bank deposits, increased over eleven times for the country as a whole; while (4) the amount of money in use increased three and one-half times.

"By a different combination these data may be made to yield a more definite result. . . . The increased money work in the United States may be roughly measured by taking the increase of transactions as fivefold, which is certainly an exaggerated estimate. Thus, if there were a hundred units of money work to be performed in 1860, there were five hundred in 1891. At the former date the money + circulation of the country formed 63 per cent of the total medium of exchange; that is, of the bank-deposit currency plus the money. At the latter date it formed 33 per cent. Then in 1860 the work performed by money was 63 per cent of 100 units, or 63 units. In 1891 it was 33 per cent of 500 units, or 165 units. This is an increase of not quite two and two-thirds times in the work done by money. But meanwhile the amount of the circulating medium had increased nearly three and one-half times."

* Mr. Mitchell in Journal of Political Economy for March, 1896, p. 164.

+ Under the term money, checks, drafts, etc., were not included.

Attempts to explain actual price movements thus force the quantity-theorists to overlook some very obvious facts. When a case of a fall of prices accompanied by an increase in the volume of the currency presents itself, their only resort is an attempt to show not only that the number of exchanges has increased, but that it has increased more rapidly than the volume of the currency, the whole point of their argument depending upon the accuracy of their claims regarding the degree of the increase, and this they are never able to establish by statistics or convincing facts of any kind. The argument itself, as we have seen, is faulty in that it overlooks the very obvious fact that the demand for currency is measured not by the number of commodities to be exchanged at a given time, but by the number of each multiplied by its value or price, and the explanation of this value or price is precisely the point at issue.