§ 9. Interpretation of the quantity theory. The quantity theory must be carefully interpreted to avoid various misunderstandings of it that have appeared again and again in economic discussion.

(1)   It does not mean that the price level changes with the absolute quantity of money, independently of growth of population and of the corresponding growth in the volume of exchanges.

(2)   It is not a mere per capita rule to be applied at a certain moment to different countries. For example, Mexico may have $9 per capita and the United States $35, while average prices may not differ in anything like that proportion. But in these two countries not only the amounts of exchanges per capita but the methods of exchange and the rapidity of the circulation of money differ greatly.5

(3)   It cannot be applied as a per capita rule to the same country through a series of years, without taking account of the many changing factors. It is estimated that in 1800 the money stock was about $5 per capita in the United States, and in 1914 about $35 6 but average prices have not necessarily changed in the same ratio. In a period of years a country may change in a multitude of ways, in complexity of industry, modes of exchange, transportation, wealth, and income. These changes require some larger, others smaller, per capita amounts of money to maintain the same level of prices. For example, the substitution of cash payments for book-credit in retail trade is equivalent to increasing N in the formula; whereas an increased use of banks and checking accounts, by economizing the use of money, enables a smaller amount of money to maintain the same level, and may be considered as increasing R in the formula.7

4 This formula is presented by E. W. Kemmerer in "Money and Prices" (2d ed., 1909), p. 15 ff. 5 See table in ch. 2, § 7.

(4) Tho applied originally to standard money, the quantity theory applies to all other kinds of money circulating side by side and at a parity of value, as far as these fulfil the definition of money and are not merely supplementary aids to money. These supplementary forms of money enable each standard dollar to do more work, to circulate more rapidly. If the standard money alone were doubled in quantity, while the various forms of fiduciary money (smaller coins, banknotes, government notes) remained unchanged, the quantity of money as a whole would not be doubled. Indeed, in such a case the method of exchange would be greatly altered. According to the quantity theory, therefore, prices would not be expected to double.

§ 10. Practical application of the quantity theory. Despite the number of changing factors affecting the methods of exchange and the amount of business, the quantity theory is a rule usable at any moment. These various factors change slowly, and the quantity theory answers the question: What general change occurs in prices as a result of the increase or decrease of the money in a given community at a given moment? Like the law of gravitation and the law of projectiles, the theory must be interpreted with relation to actual conditions.

6 Per Capita Circulation of Money (Estimated) in the United States in Various Years.

The quantity theory makes intelligible the great and rapid changes in prices which have followed sudden changes in the quantity of money. Inductive demonstration of broadly stated economic principles is usually difficult, but there have been many "monetary experiments" to teach their lessons. Many inflations and contractions of the circulating medium have occurred, now in a single country, again in the whole world; and the local or general results have helped to exemplify richly the working of the quantity principle. the scanty yield of silver- and gold-mines during the Middle Ages, prices were low. After the discovery of America, especially in the sixteenth century, quantities of silver flowed into Europe. The great rise of prices that occurred was explained by the keenest thinkers of that day along the essential lines of the quantity theory, tho there were many monetary fallacies current at that time. The experience in England during the Napoleonic wars, when the money of England was inflated (by the forced issue of large amounts of banknotes) and prices rose above those of the Continent, led to the modern formulation of the theory of Ricardo and others about 1810. The discovery of gold in California and Australia in 1848-50 greatly increased the gold supply, and gold prices rose throughout the world. Between 1870 and 1890 the' production of gold fell off while its use as money increased greatly, and prices fell. A great increase of gold production has occurred in the period since 1890. The wave - like movements of prices since 1897 are explicable as the periodic up and down swings of confidence and credit, but in the main the general trend upward has been due to the stimulus of increasing gold supplies.8 These are but a few of many instances in monetary history, which, taken together, make an argument of probability in favor of the quantity theory so strong as to constitute practically an inductive proof.

8 Consult Figures 1 and 2 in chapter 5 for the graphic presentation of these and related facts.

References

Fisher, Irving, The purchasing power of money. N. Y. Macmillan.

1913. Johnson, J. F., Money and currency. N. Y. Ginn. 1905. Chs. III- VIII, X. Kemmerer, E. W., Money and credit instruments in their relation to general prices. 2d ed. N. Y. Holt. 1909. Phillips, C. A., Readings in money and banking. N. Y. Macmillan.

1916. Walker, F. A., Money. N. Y. Holt. Chs. IV, V.