§ 10. Various ideal standards suggested. Price history since 1873, however varied, teaches one lesson clearly: that our "standard" unit of price has in fact been subject to great fluctuations in its value. We escape the evils of a rising standard of deferred payments (falling prices) only to meet those of a falling standard (rising prices). And as long as we have so fluctuating a standard these difficulties must arise again and again, continually repeated, causing unmerited gains and undeserved losses to individuals. But what standard would be better than that of gold? It may, perhaps, be agreed that the ideal standard of deferred payments is one that would insure justice between borrower and lender. Yet different views may be and have been taken as to what constitutes justice in this matter. The suggestion is attractive that repayment should involve the return of enjoyment equal to that which could be purchased with the sum at the time of the loan. Such a standard is impossible of perfect realization in any general way, for men's circumstances are constantly changing. To insure even to the average man the same amount of enjoyment is only roughly possible. The same goods do not afford the same enjoyment when conditions, either subjective or objective, have changed. Another suggestion is that the goods returned should represent the same sacrifice as those lent. Here again the difficulty is in the lack of a standard applicable to all men. Whose sacrifice? That of the lender, who may be rich, or that of the borrower, who may be poor? Some have supposed that the condition of equal sacrifices was met by the labor standard, according to which the sum returned should purchase the same number of days of labor as when borrowed. But what kind of labor is to be taken, that of the lender, or that of the borrower, or that of some one else ? Labor is of many different qualities, which can be exactly compared only through their objective value in terms of some one good.3

Fig. 7. Average Weekly Earnings and Cost of Living of Factory Employees in New York State

Fig. 8. Cost of Living in the U. S. (By permission of the National Industrial Conference Board.)

It must be recognized that any possible concrete standard of deferred payments will* sometimes work hardship in individual cases. The best average results for justice and social welfare will be secured by measuring debts in some standard that will change least often, and least rapidly, in relation to the great majority of people of all classes in the community.

§ 11. The tabular or multiple standard. Gold is the best standard yet devised and put into actual practice, but it is very imperfect. A standard better than a single metal, more stable than a single commodity, is desirable if it can be found. Apart from the difficulties of its practical operation, such a standard would be a tabular standard, consisting of a number of leading commodities in fixed proportions, such as is used in calculating index numbers expressing the general scale of prices. This averages the fluctuations of particular goods and would give a fair approximation in practice to the ideals of equal sacrifice and equal enjoyment (on the average, though not in individual cases). While some natural materials are growing more scarce and call for more sacrifice, other products are by industrial progress becoming more plentiful. This kind of standard has been viewed with favor by many monetary authorities, and, despite the administrative difficulties, ways may yet be found for putting it into practice.

a See on the labor theory of value, Vol. I, pp. 210, 228-229, 502.

After choosing the components of the multiple standard, the actual regulation of the quantity of money to make prices conform to the standard might be accomplished in one of several ways. It might be done by letting the value of the gold dollar fluctuate as it does now, while requiring a greater or less number of dollars to be given in fulfillment of all outstanding contracts. For example, if prices by the multiple standard fell from 100 to 95 in the time between the origin of a debt of $100 and its payment, the debt would be discharged by paying $95; if prices rose to $110, the debt would be discharged only by the payment of $110.

Another plan is that of a " compensated gold dollar." By this plan the legal weight of gold coins would be increased or decreased from time to time to conform with the changing index numbers. Still a third method would be to regulate the issue of standard paper money, contracting and expanding its amount by issue and redemption, by deposit in and withdrawal from depository banks, at regular intervals to bring prices into conformity with the tabular standard. These are as yet but distant possibilities, and for some time to come gold will continue to serve as the standard money in the same manner as in the past.

§ 12. Fluctuating standard and the interest rate. In connection with the standard of deferred payments there is presented a problem of the effect that fluctuations of the standard may have upon the interest rate.4 As the general price level falls or rises, the monetary standard conversely appreciates or depreciates.5 If these changes are slight in amount and imperceptible in their direction they may not affect considerably the motives of borrowers and lenders. Therefore, the rate of interest this year in long-time loans would be just that resulting from the expectation, on all hands, of a stationary level of general prices. Suppose that rate to be 5 per cent on the standard investment (such as real-estate loans and good bonds). Then the lender of $1000 will receive each year a $50 income and at the end of the investment period $1000 principal, each dollar of which will purchase the same composite quantum of goods that a dollar would have purchased at the time the loan was made. Likewise, the borrower would pay interest and principal in a standard that reflected an unchanging general level of prices. But, now, if the general level of prices unexpectedly falls 1 per cent within the year, the creditor of a loan maturing at the end of the year would receive (principal and interest) $1050, which will purchase 1 per cent more goods per dollar than the sum he lent, or (approximately) $1060 worth of goods. Hence, he has received, in quantum of goods, a yield of 6 per cent on his investment. If this change continues for five years, the lender of a five-year loan would receive each year $50, having a purchasing power successively 1, 2, 3, 4, and 5 per cent greater than the same sum had at the making of the loan; and at the end of the five years would collect the principal, having a purchasing power 5 per cent greater. The borrower, on his part, would have to pay interest and re - pay the principal in a money that is to be obtained only in exchange for a larger sum of goods than that which could be bought with each dollar that he borrowed. This means that, with individual exceptions, creditors generally gain and debtors lose by falling prices.

4 This could not be treated in connection with the interest rate in Vol. I, Part IV, for the reason that even its elementary treatment must presuppose the fuller study of the nature of money and the study of changes-in the level of prices, that has just been given in this and the three preceding chapters. The theory of interest in Vol. I, therefore, is a static theory in respect to the standard of deferred payments, and requires adjustment to apply to a condition of a changing price level.

5 See ch. 5, § 1.

But this is fully true only in respect to loans already made. For, just to the extent that such a movement of prices comes to be more or less regularly in the same direction, both borrowers and lenders are able to take it into account, and, as experience shows, do take it into account.6 When prices fall men become more eager to sell wealth, to lend the proceeds, and more reluctant to borrow for investment at the prevailing rate of interest and at the prevailing prices. There is an incentive to divest one's self of ownership (e.g., by selling stocks) and to become a lender (e. g., by buying bonds). This whole situation is reversed in a period of rising prices. The result is that the rate of interest in any long-continued period of falling prices (such as from 1873 to 1896) has a trend downward and in a period of rising prices (such as from 1897 to 1915) has a trend upward. This movement of readjustment would not go on indefinitely, even if the same trend of prices continued; for in the strict theory of the case the adjustment would be complete when the interest rate had changed by just the amount of the annual change in the level of prices. For example, if 5 per cent is the static normal rate of interest, then when prices are falling 1 per cent each year, the adjusted rate of interest would be 4 per cent; and when prices were rising 1 per cent each year, the adjusted rate of interest would be 6 per cent. Such adjustments serve to some extent to neutralize the effects of changes in the standard of deferred payments as far as concerns new loans made in view of just such a change and in expectation of its continuance. But no one can foresee exactly, and most persons take little account of, such a change until it has continued for several years in the same direction. The adjustment is therefore never very prompt or very exact. In some years the general level of prices has risen more than 5 per cent, or more than enough to offset the entire interest received by most lenders. The principal and interest combined have no greater purchasing power at the end of the period than the principal alone had at the beginning of it. It is the same as if the dollars had been buried during a period of stationary prices.7

6 Mention was made in Vol. I, of the prospect of profit as affecting the motives of commercial borrowers; e. g., pp. 298, 335, 348, 495.

7 The modern explanation of this phenomenon was worked out in the period of falling prices before 1896, and hence was referred to as the theory of "appreciation and interest" (meaning the relation of the appreciating dollar to a falling rate of interest). More generally the theory is that of the relation of a changing standard of deferred payments and the rate of interest.

References

Bureau of Applied Economics, Changes in the cost of living 1914- 1919. P. 55. Washington. 1919. Fisher, Irving, Appreciation and interest. A. E. Assn., Pubs. 11: 331-442. 1896. Same, Stabilizing the dollar. P. 205. New York. Macmillan.

1920. Jevons, W. S., Money and the mechanism of exchange. N. Y. Ap pleton, 1875. Ch. XXV. Johnson, J. F., Money and currency. Bost. Ginn. 1905. Chs. XI, XII, XVII. Marshall, L. P. and others, Materials for the study of elementary economics, Chicago University Press, 1913, 787, 788 (extract from Brown, H. G.,), 788, 789 (extract from Clark, W. E., in "How to invest when prices are rising." 1912). Noyes, A. D., Forty years of American finance. N. Y. Putnam.

1909. Chs. MIL Phillips, C. A., Ed., Readings in Money and banking. N. Y. Macmillan. 1879. Chs. VI, VII, XIII. Walker, F. A., Money. N. Y. Holt. Chs. III, VI, VII.