As stated by the early economists, the quantity theory of money holds that the value of money depends on its quantity, and that, other things being equal, prices vary directly with the amount of money in circulation.2 This bald statement of the theory, however, disregards certain fundamental considerations. In the first place, the value of money, as of other things, depends neither upon supply alone nor upon demand alone, but upon the balancing of supply and demand. As we have seen, the level of prices may be influenced on the one hand by changes in the rapidity of circulation as well as in the quantity of money, and on the other hand by changes in the volume and velocity of exchanges. This theory also disregards credit operations and the use of money as a reserve and as a store of value. The statement, therefore, that the value of money varies with its quantity, holds good only under the simplest conditions.

A more nearly exact and acceptable statement of the quantity theory is that the value of money or the general level of prices depends on the total purchasing power expressed in terms of money. As expressed by Professor Irving Fisher, the purchasing power of money, that is, the general level of prices, depends on five factors: the quantity of money in circulation, its velocity of circulation, the quantity of deposits subject to check, its velocity, and the volume of trade. These groups of causes and their effects, prices, he connects by an "equation of exchange," a statement in mathematical form of the total transactions effected in a given community in a certain period, and he shows that "prices must as a whole vary proportionally with the quantity of money and with its velocity of circulation, and inversely with the quantity of goods exchanged." 3 The groups of causes or magnitudes determining the purchasing power of money are, in turn, effects of antecedent causes which he summarizes as follows: "The volume of trade will be increased, and therefore the price level correspondingly decreased, by the differentiation of human wants; by diversification of industry; and by facilitation of communication. The velocities of circulation will be increased, and therefore the price level increased, by improvident habits; by the use of book credit; and by rapid transportation. The quantity of money will be increased, and therefore the price level increased, by the import and minting of money, and antecedently by the mining of the money metal; by the introduction of another and initially cheaper money metal through bimetallism; and by the issue of bank notes and other paper money. The quantity of deposits will be increased, and therefore the price level increased, by extension of the banking system and by the use of book credit. The reverse causes produce, of course, reverse effects."1

1 Johnson: Money and Currency, p. 28.

2 For a criticism of this theory, see Laughlin: Principles of Money, Chs. VII-IX; and Scott: Money and Banking, Ch. IV.

3 Fisher: Purchasing Power of Money, p. 18.

As evidence of the soundness of their position, advocates of the quantity theory of money point to the movement of prices in the past which has been in great cycles, with rising prices in a period of increasing production of gold and silver and falling prices in a period of diminished output of specie. Thus, it is claimed, the revolution of prices in the sixteenth century was due to the discovery of the South American and Mexican silver mines and the introduction into Europe of great quantities of new specie. By the middle of the seventeenth century such large additions had been made to the world's stock of gold and silver that new supplies had less effect upon their value and prices were fairly stable. A steady increase in population, wealth and the volume of exchanges tended to offset the increased supply of specie. During the first half of the nineteenth century this expansion of business increased even more rapidly than the new supplies of specie and prices trended downward.

1 Ibid,, p. 149.

The discovery of very rich gold deposits in California and Australia about 1850 added enormously to the world's supply of gold. Rough estimates show that in the quarter century following 1850 as much gold was added to the world's stock as had been produced during the whole previous period since the discovery of America. In the ten years following 1850 the monetary supply of money had doubled.1 It might be expected that this rapid and enormous increase in the supply of money would be attended by a marked increase in prices. Prices did rise and remained at a comparatively high level until about 1875, but the advance of 20 to 30 per cent was not in proportion to the increase in the new money supply. This comparatively Blight increase in prices is explained on the grounds, first, that the volume of business increased greatly during this period, causing a larger demand for money; second, that the new supplies of gold were added to an existing stock composed of both gold and silver under bimetallic systems then prevailing; and, third, that a considerable amount of the new gold simply displaced silver which was exported to the Orient.2

A period of falling prices set in about 1873, and continued until about 1896, at which time the price level was some 50 per cent lower than in 1870, indicating that the purchasing power of gold had doubled. It will be remembered that in the decade following 1870 the United States and several European countries discarded silver as a standard of prices and adopted the gold standard. This was a period, too, of rapid expansion of trade and industry traceable in part to the construction of great railway systems. The resulting monetary demand for gold coming at a period when the production of gold was declining, increased its value greatly and caused the long period of low prices. The past twenty-five years have witnessed another phenomenal increase in gold production, due mainly to the discovery of new mines in South Africa and in the Klondike. In the decade following 1880 the world's annual output of gold averaged about $100,000,000 a year; in the year 1900 it amounted to $251,000,000; and in 1912 to $466,000,000. By 1896 prices began to reflect the increase in the new gold from South Africa and since that time the tendency has been steadily upward. Doubtless the enormous increase in the supply of gold during the past two decades has been an important factor in the worldwide rise in prices.

1 Report of the Director of the Mint (1913), p. 315. 2 Taussig: Vol. I, p. 259.