SOCIALISM AND PLANNING by F. A. Hayek

We have now reached a point where it becomes necessary clearly to separate several different aspects of the programmes which we have so far lumped together as socialistic. For the earlier part of the period in which the belief in central planning grew it is historically justified to identify, without much qualification, the idea of socialism and that of planning. And in so far as the main economic problems are concerned, this is still the case to-day. Yet it must be admitted that in many other respects modern socialists and other modern planners are fully entitled to disclaim any responsibility for each other’s programmes. What we must distinguish here are the ends aimed at and the means which have been proposed or are in fact necessary for the purpose. The ambiguities which exist in this connection arise out of the fact that the means necessary to achieve the ends of socialism in the narrower sense may be used for other ends, and that the problems with which we are concerned arise out of the means and not the ends.
The common end of all socialism in the narrower sense, of “proletarian” socialism, is the improvement of the position of the propertyless classes of society by a redistribution of income derived from property. This implies collective ownership of the material means of production and collectivist direction and control of their use. The same collectivist methods may, however, be applied in the service of quite different ends. An aristocratic dictatorship, for example, may use the same methods to further the interest of some racial or other élite or in the service of some other decidedly antiequalitarian purpose. The situation is further complicated by the fact that the method of collectivist ownership and control which is essential for any of these attempts to dissociate the distribution of income from the private ownership of the means of production, admits of application in different degrees. For the present it will be convenient to use the term socialism to describe the traditional socialist ends and to use the term planning to describe the method, although later we shall use socialism in the wider sense. In the narrower sense of the term it can be said, then, that it is possible to have much planning with little socialism or little planning and much socialism. The method of planning in any case can certainly be used for purposes which have nothing to do with the ethical aims of socialism. Whether it is equally possible to dissociate socialism completely from planning—and the criticism directed against the method have led to attempts in this direction—is a question which we shall have to investigate later.
That it is possible, not only in theory but also in practice, to separate the problem of the method from that of the end is very fortunate for the purposes of scientific discussion. On the validity of the ultimate ends science has nothing to say. They may be accepted or rejected, but they cannot be proved or disproved. All that we can rationally argue about is whether and to what extent given measures will lead to the desired results. If, however, the method in question were only proposed as a means for one particular end it might prove difficult, in practice, to keep the argument about the technical question and the judgments of value quite apart. But since the same problem of means arises in connection with altogether different ethical ideals, one may hope that it will be possible to keep value judgments altogether out of the discussion.
The common condition necessary for the achievement of a distribution of income which is independent of individual ownership of resources—the common proximate end of socialism and other anti-capitalistic movements—is that the authority which decides on the principles of this distribution should also have control over the resources. Now whatever the substance of these principles of distribution, these ideas about the just or otherwise desirable division of income, they must be similar in one purely formal but highly important respect : they must be stated in the form of a scale of importance of a number of competing individual ends. It is this formal aspect, this fact that one central authority has to solve the economic problem of distributing a limited amount of resources between a practically infinite number of competing purposes, that constitutes the problem of socialism as a method. And the fundamental question is whether it is possible under the complex conditions of a large modern society for such a central authority to carry out the implications of any such scale of values with a reasonable degree of accuracy, with a degree of success equalling or approaching the results of competitive capitalism, not whether any particular set of values of this sort is in any way superior to another. It is the methods common to socialism in the narrower sense and all the other modern movements for a planned society, not the particular ends of socialism with which we are here concerned.

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THE ATTITUDE OF MARXISM by F. A. Hayek

In many respects the most powerful school of socialism the world has so far seen is essentially a product of this kind of “Historismus”. Although in some points Karl Marx adopted the tools of the classical economists, he made little use of their main permanent contribution, their analysis of competition. But he did wholeheartedly accept the central contention of the historical school that most of the phenomena of economic life were not the result of permanent causes but only the product of a special historical development. It is no accident that the country where the historical school had had the greatest vogue, Germany, was also the country where Marxism was most readily accepted.
The fact that this most influential school of socialism was so closely related to the general antitheoretical tendencies in the social sciences of the time had a most profound effect on all further discussion of the real problems of socialism. Not only did the whole outlook create a peculiar inability to see any of the permanent economic problems which are independent of the historical framework, but Marx and the Marxians also proceeded, quite consistently, positively to discourage any inquiry into the actual organization and working of the socialist society of the future. If the change was to be brought about by the inexorable logic of history, if it was the inevitable result of evolution, there was little need for knowing in detail what exactly the new society would be like. And if nearly all the factors which determined economic activity in the present society would be absent, if there would be no problems in the new society except those determined by the new institutions which the process of historical change would have created, then there was indeed little possibility of solving any of its problems beforehand. Marx himself had only scorn and ridicule for any such attempt deliberately to construct a working plan of such an “utopia”. Only occasionally, and then in this negative form, do we find in his works statements about what the new society would not be like. One may search his writings in vain for any definite statement of the general principles on which the economic activity in the socialist community would be directed.1
Marx’s attitude on this point had a lasting effect on the socialist of his school. To speculate about the actual organization of the socialist society immediately stigmatized the unfortunate writer as being “unscientific” the most dreaded condemnation to which a member of the “scientific” school of socialism could expose himself. But even outside the Marxian camp the common descent of all modern branches of socialism from some essentially historical or “institutional” view of economic phenomena had the effect of successfully smothering all attempts to study the problems any constructive socialist policy would have to solve. As we shall see later, it was only in reply to criticism from the outside that this task was ultimately undertaken.

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THE DECAY OF ECONOMIC INSIGHT by F. A. Hayek

There are, however, other reasons besides the increasing conspicuousness of the elaborate modern technique of production which are responsible for our contemporary failure to see the existence of economic problems. It was not always so. For a comparatively short period in the middle of last century, the degree to which the economic problems were seen and understood by the general public was undoubtedly much higher than it is at present. But the classical system of political economy whose extraordinary influence facilitated this understanding had been based on insecure and in parts definitely faulty foundations, and its popularity had been achieved at the price of a degree of over-simplification which proved to be its undoing. It was only much later, after its teaching had lost influence, that the gradual reconstruction of economic theory showed that what defects there were in its basic concepts had invalidated its explanation of the working of the economic system to a much smaller degree than had at first seemed probable. But in the interval irreparable harm had been done. The downfall of the classical system tended to discredit the very idea of theoretical analysis, and it was attempted to substitute for an understanding of the why of economic phenomena a mere description of their occurrence. In consequence, the comprehension of the nature of the economic problem, the achievement of generations of teaching, was lost. The economists who were still interested in general analysis were far too much concerned with the reconstructing of the purely abstract foundations of economic science to exert a noticeable influence on opinion regarding policy.
It was largely owing to this temporary eclipse of analytical economics that the real problems connected with the suggestions of a planned economy have received so surprisingly little careful examination. But this eclipse itself was by no means only due to the inherent weaknesses and the consequent need for reconstruction of the old economics. Nor would it have had the same effect if it had not coincided with the rise of another movement definitely hostile to rational methods in economics. The common cause which at the same time undermined the position of economic theory and furthered the growth of a school of socialism, which positively discouraged any speculation of the actual working of the society of the future, was the rise of the so-called historical school in economics.1 For it was the essence of the standpoint of this school, that the laws of economics could only be established by the application to the material of history of the methods of the natural sciences. And the nature of this material is such that any such attempt is bound to degenerate into mere record and description and a total scepticism concerning the existence of any laws at all.
It is not difficult to see why this should happen. In all sciences except those which deal with social phenomena all that experience shows us is the result of processes which we cannot directly observe and which it is our task to reconstruct. All our conclusions concerning the nature of these processes are of necessity hypothetical, and the only test of the validity of these hypotheses is that they prove equally applicable to the explanation of other phenomena. And what enables us to arrive by this process of induction at the formulation of general laws or hypotheses regarding the process of causation is the fact that the possibility of experimenting, of observing the repetition of the same phenomena under identical conditions, shows the existence of definite regularities in the observed phenomena.
In the social sciences, however, the situation is the exact reverse. On the one hand, experiment is impossible, and we have therefore no knowledge of definite regularities in the complex phenomena in the same sense as we have in the natural sciences. But on the other hand the position of man, midway between natural and social phenomena—of the one of which he is an effect and of the other a causes—brings it about that the essential basic facts which we need for the explanation of social phenomena are part of common experience, part of the stuff of our thinking. In the social sciences it is the elements of the complex phenomena which are known beyond the possibility of dispute. In the natural sciences they can only be at best surmised. The existence of these elements is so much more certain than any regularities in the complex phenomena to which they give rise, that it is they which constitute the truly empirical factor in the social sciences. There can be little doubt that it is this different position of the empirical factor in the process of reasoning in the two groups of disciplines which is at the root of much of the confusion with regard to their logical character. There can be no doubt, the social as well as natural sciences have to employ deductive reasoning. The essential difference is that in the natural sciences the process of deduction has to start from some hypothesis which is the result of inductive generalizations, while in the social sciences it starts directly from known empirical elements and uses them to find the regularities in the complex phenomena which direct observations cannot establish. They are, so to speak, empirically deductive sciences, proceeding from the known elements to the regularities in the complex phenomena which cannot be directly established. But this is not the place to discuss questions of methodology for their own sake. Our concern is only to show how it came that in the era of the great triumphs of empiricism in the natural sciences the attempt to force the same empirical methods on the social sciences was bound to lead to disaster. To start here at the wrong end, to seek for regularities of complex phenomena which could never be observed twice under identical conditions, could not but lead to the conclusion that there were no general laws, no inherent necessities determined by the permanent nature of the constituting elements, and that the only task of economic science in particular was a description of historical change. It was only with this abandonment of the appropriate methods of procedure, well established in the classical period, that it began to be thought that there were no other laws of social life than those made by men, that all observed phenomena were all only the product of social or legal institutions, merely “historical categories” and not in any way arising out of the basic economic problems which humanity has to face.

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ECONOMIC AND TECHNOLOGICAL PROBLEMS - by F. A. Hayek

Whether this widespread belief is based on a clear conviction that there would be no economic problems in a socialist world, or whether it simply proves that the people who hold it do not know what economic problems are, is not always evident. Probably usually the latter. This is not at all surprising. The big economic problems which the economist sees and which he contends will also have to be solved in a collectivist society, are not problems which at present are solved deliberately by anybody in the sense in which the economic problems of a household reach solution. In a purely competitive society nobody bothers about any but his own economic problems. There is therefore no reason why the existence of economic problems, in the sense in which the economist uses the term, should be known to others. But the distribution of available resources between different uses which is the economic problem is no less a problem for society than for the individual, and although the decision is not consciously made by anybody, the competitive mechanism does bring about some sort of solution.
No doubt if it were put in this general way everybody would be ready to admit that such a problem exists. But few realize that it is fundamentally different not only in difficulty but also in character from the problems of engineering. The increasing preoccupation of the modern world with problems of an engineering character tends to blind people to the totally different character of the economic problem, and is probably the main cause why the nature of the latter was less and less understood. At the same time everyday terminology used in discussing either sort of problem has greatly enhanced the confusion. The familiar phrase of “trying to get the greatest results from the given means” covers both problems. The metallurgist who seeks for a method which will enable him to extract a maximum amount of metal from a given quantity of ore, the military engineer who tries to build a bridge with a given number of men in the shortest possible time, or the optician who endeavours to construct a telescope which will enable the astronomer to penetrate to still more distant stars, all are concerned solely with technological problems. The common character of these problems is determined by the singleness of their purpose in every case, the absolutely determined nature of the ends to which the available means are to be devoted. Nor does it alter the fundamental character of the problem if the means available for a definite purpose is a fixed amount of money to be spent on factors of production with given prices. From this point of view the industrial engineer who decides on the best method of production of a given commodity on the basis of given prices is concerned only with technological problems although he may speak of his trying to find the most economical method. But the only element which makes his decision in its effects an economic one is not any part of his calculations but only the fact that he uses, as a basis for these calculations, prices as he finds them on the market.
The problems which the director of all economic activities of a community would have to face would only be similar to those solved by an engineer if the order of importance of the different needs of the community were fixed in such a definite and absolute way that provision for one could always be made irrespective of cost. If it were possible for him first to decide on the best way to produce the necessary supply of, say, food as the most important need, as if it were the only need, and would think about the supply, say of clothing, only if and when some means were left over after the demand for food had been fully satisfied, then there would be no economic problem. For in such a case nothing would be left over except what could not possibly be used for the first purpose, either because it could not be turned into food or because there was no further demand for food. The criterion would simply be whether the possible maximum of foodstuffs had been produced or whether the application of different methods might not lead to a greater output. But the task would cease to be merely technological in character and would assume an entirely different nature if it were further postulated that as many resources as possible should be left over for other purposes. Then the question arises what is a greater quantity of resources. If one engineer proposed a method which would leave a great deal of land but only little labour for other purposes, while another would leave much labour and little land, how in the absence of any standard of value could it be decided which was the greater quantity? If there were only one factor of production this could be decided unequivocally on merely technical grounds, for then the main problem in every line of production would again be reduced to one of getting the maximum quantity of product out of any given amount of the same resources. The remaining economic problem of how much to produce in every line of production would in this case be of a very simple and almost negligible nature. As soon as there are two or more factors, however, this possibility is not present.
The economic problem arises therefore as soon as different purposes compete for the available resources. And the criterion of its presence is that costs have to be taken into account. Cost here, as anywhere, means nothing but the advantages to be derived from the use of given resources in other directions. Whether this is simply the use of part of the possible working day for recreation, or the use of material resources in an alternative line of production, makes little difference. It is clear that decisions of this sort will have to be made in any conceivable kind of economic system, wherever one has to choose between alternative employments of given resources. But the decisions between two possible alternative uses cannot be made in the absolute way which was possible in our earlier example. Even if the director of the economic system were quite clear in his mind that the food of one person is always more important than the clothing of another, that would by no means necessarily imply that it is also more important than the clothing of two or ten others. How critical the question is becomes clearer if we look at the less elementary wants. It may well be that although the need for one additional doctor is greater than the need for one additional school teacher, yet under conditions where it costs three times as much to train an additional doctor as it costs to train an additional school teacher, three additional school teachers may appear preferable to one doctor.
As has been said before, the fact that in the present order of things such economic problems are not solved by the conscious decision of anybody has the effect that most people are not conscious of their existence. Decisions whether and how much to produce a thing are economic decisions in this sense. But the making of such a decision by a single individual is only part of the solution of the economic problem involved. The person making such a decision makes it on the basis of given prices. The fact that by this decision he influences these prices to a certain, probably very small, extent will not influence his choice. The other part of the problem is solved by the functioning of the price system. But it is solved in a way which only a systematic study of the working of this system reveals. It has been already suggested that it is not necessary for the working of this system, that anybody should understand it. But people are not likely to let it work if they do not understand it.
The real situation in this respect is very well reflected in the popular estimate of the relative merits of the economists and the engineer. It is probably no exaggeration to say that to most people the engineer is the person who actually does things and the economist the odious individual who sits back in his armchair and explains why the well-meaning efforts of the former are frustrated. In a sense this is not untrue. But the implication that the forces which the economist studies and the engineer is likely to disregard are unimportant and ought to be disregarded is absurd. It needs the special training of the economist to see that the spontaneous forces which limit the ambitions of the engineer themselves provide a way of solving a problem which otherwise would have to be solved deliberately.

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THE UNSEEN PROBLEM by F. A. Hayek

THERE is reason to believe that we are at last entering an era of reasoned discussion of what has long uncritically been assumed to be a reconstruction of society on rational lines. For more than half a century, the belief that deliberate regulation of all social affairs must necessarily be more successful than the apparent haphazard interplay of independent individuals has continuously gained ground until to-day there is hardly a political group anywhere in the world which does not want central direction of most human activities in the service of one aim or another. It seemed so easy to improve upon the institutions of a free society which had come more and more to be considered as the result of mere accident, the product of a peculiar historical growth which might as well have taken a different direction. To bring order to such a chaos, to apply reason to the organization of society, and to shape it deliberately in every detail according to human wishes and the common ideas of justice seemed the only course of action worthy of a reasonable being.

But at the present day it is clear—it would probably be admitted by all sides—that during the greater part of the growth of this belief, some of the most serious problems of such a reconstruction have not even been recognized, much less successfully answered. For many years discussion of socialism—and for the greater part of the period it was only from socialism proper that the movement sprang—turned almost exclusively on ethical and psychological issues. On the one hand there was the general question whether justice required a reorganization of society on socialist lines and what principles of the distribution of income were to be regarded as just. On the other hand there was the question whether men in general could be trusted to have the moral and psychological qualities which were dimly seen to be essential if a socialist system was to work. But although this latter question does raise some of the real difficulties, it does not really touch the heart of the problem. What was questioned was only whether the authorities in the new state would be in a position to make people carry out their plans properly. Only the practical possibility of the execution of the plans was called in question, not whether planning, even in the ideal case where these difficulties were absent, would achieve the desired end. The problem seemed therefore to be “only” one of psychology or education, the “only” meaning that after initial difficulties these obstacles would certainly be overcome.
If this were true, then the economist would have nothing to say on the feasibility of such proposals, and indeed it is improbable that any scientific discussion of their merits would be possible. It would be a problem of ethics, or rather of individual judgments of value, on which different people might agree or disagree, but on which no reasoned arguments would be possible. Some of the questions might be left to the psychologist to decide, if he has really any means of saying what men would be like under entirely different circumstances. Apart from this no scientist, and least of all the economist, would have anything to say about the problems of Socialism. And many people believing that the knowledge of the economist is only applicable to the problems of a capitalist society (i.e. to problems arising out of peculiar human institutions which would be absent in a world organized on different lines), still think this to be the case.

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Further Reflections on the Increase and Decrease of Money in a State

Increases in the supply of money from a balance of trade eventually causes prices to rise. This in turn puts pressure on domestic producers and increases imports. The result is that the balance of trade is reduced and eventually is negative. This is Cantillon’s price specie-flow mechanism which demonstrates the reasons for the tendency for equilibrium in international monetary flows. The balance of trade can result in economic power, but this also causes the economy to lapse into luxury and decline.

WE HAVE SEEN THAT THE QUANTITY of money circulating in a state may be increased by working its mines, by subsidies from foreign powers, by the immigration of foreign families, by the residence of ambassadors and travelers, but above all, by a regular and annual balance of trade, from supplying goods to foreigners, and by receiving from them at least part of the price in gold and silver. It is by this last means that a state grows most substantially, especially when its trade is accompanied and supported by ample shipping and by a significant output of the raw materials necessary for the production of exported manufactured goods.
However, the continuation of this commerce gradually introduces a great abundance of money and, little by little, increases consumption. Foreign products must be imported to meet this demand and must be paid for by a reduction in the annual balance of trade. On the other hand, increased expenditures increase the cost of labor and the prices of manufactured goods. It often happens that some foreign countries try to set up the same kinds of factories for themselves, in which case they stop buying those of the state in question. Although these newly established factories and manufactures are not perfect at first, they reduce and even prevent the export of those goods from the neighboring state into their own country, where they can be acquired at a better price.
In this manner, the state begins to lose some branches of its profitable trade and many of its workmen and artisans who lose their jobs will leave the state to find employment in new foreign factories. In spite of this diminution in the balance of trade, the custom of importing various products will continue. If the manufactured products of a state have a great reputation and can be shipped to distant countries at low cost, the state will maintain its advantage over the new foreign manufacturers for many years and will maintain a small balance of trade, or at least keep it even. If, however, some other maritime state tries to perfect the same articles and its navigation at the same time, it will, because of the cheapness of its manufactures, take away several branches of trade from the state in question. Consequently, this state will begin to lose its balance of trade and will be forced to send a part of its money abroad every year in order to pay for its imports.
Moreover, even if the state in question could keep a balance of trade and its greater abundance of money, it is reasonable to suppose that this abundance will plunge many wealthy individuals into luxury. They will buy paintings, precious stones from abroad, they will want silks and rare objects, and they set such an example of luxury in the state that in spite of the advantage of its ordinary trade, its money will flow abroad annually to pay for this luxury. This will gradually impoverish the state and cause it to pass from great power to great weakness.
When a state has arrived at the highest point of wealth, and I always assume that the comparative wealth of states consists mainly in their respective quantities of money, it will inevitably fall back into poverty by the ordinary course of things. The too-great abundance of money, which gives power to states so long as it lasts, throws them back imperceptibly, but naturally, into poverty. Thus it would seem that when a state expands by trade, and the abundance of money raises the price of land and labor, the prince or the legislator ought to withdraw money from circulation, keep it for emergencies, and try to slow down its circulation by every means, except compulsion and bad faith, to prevent its goods from becoming too expensive and avoid the drawbacks of luxury.
However, it is not easy to perceive the opportune time for this, or to know when money has become more abundant than it ought to be for the good and preservation of the advantages of the state. Therefore, princes and heads of republics do not concern themselves much with this sort of knowledge and strive only to make use of the abundance of their state revenues, to extend their power and to insult other countries on the most frivolous pretexts. All things considered, working to perpetuate the glory of their reigns and administration and to leaving monuments of their power and wealth is perhaps the best they can do because according to the natural course of humanity, the state must collapse on its own, they only accelerate its fall a little. Nevertheless, it seems that they should try to make their power last during the time of their own administration.
Few years are needed to raise abundance to the highest point in a state, however still fewer are needed to bring it to poverty for lack of commerce and manufacturing. Without speaking of the rise and fall of the Venice Republic, Hanseatic cities,85 Flanders and Brabant, the Dutch Republic, etc., who have succeeded each other in profitable branches of trade, one may say that France’s power has only been on the rise from 1646 (when factories were established to produce clothing which had previously been imported) to 1684 when a number of Protestant entrepreneurs and artisans were driven out of France.86 That kingdom has done nothing but recede since this last date.
I know no better measure than the leases and rents of property owners to judge the abundance and scarcity of money in circulation. When land is leased at high rates, it is a sign that there is plenty of money in the state; but when land has to be leased at much lower rates, it shows, other things being equal, that money is scarce. I have read in The State of France87 that acres of vineyard near Mantes—not far from the French capital—which leased for 200 livres tournois88 of full weight in 1660, only leased for 100 livres tournois of lighter money in 1700. However, the silver brought from the West Indies in the interval should naturally have raised the price of land in Europe.
The author [of The State of France] attributes this fall in rent to defective consumption. In fact, it seems that he observed a reduction in wine consumption. However, I think he has mistaken the effect for the cause. The cause was a greater rarity of money in France, and the effect of this was naturally a decrease in consumption. In this essay, I have always suggested, on the contrary, that an abundance of money naturally increases consumption and contributes above everything else to a higher valuation of the land. When abundant money raises products to honest prices, the inhabitants eagerly work to acquire them; although they do not show the same eagerness to acquire food and merchandise beyond what is needed for their maintenance.
It is clear that a state with more money in circulation than its neighbors has an advantage over them, so long as it maintains this abundance of money.89
In the first place, given that the price of land and labor are calculated in terms of money, the state where money is most abundant will give up less land and labor than it receives in all areas of trade. Thus the state in question sometimes receives the product of two acres of land in exchange for that of one acre, and the work of two men for that of only one. It is because of this abundance of money in circulation in London that the work of one English embroiderer costs more than that of 10 Chinese embroiderers, though the Chinese embroider much better and turn out more work in a day. In Europe, people are amazed that these people can live by working so cheap and that the wonderful fabrics they send us cost so little.
Secondly, tax revenues are more easily raised in a state where money is plentiful, and in relatively larger amounts. This gives the state, in case of war or dispute, the means to gain all sorts of advantages over its adversaries with whom money is scarce.
If there are two princes at war over the sovereignty or conquest of a state, where one has much money and the other has little money but many estates worth twice the money of his enemy, the first will be better able to attract generals and officers with gifts of money than the second will be by giving twice the value in lands and estates. Grants of land are subject to challenge and revocation and cannot be relied upon like money. With money, munitions of war and food can be bought, even from the enemies of the state. Money can be given for secret services without witnesses, but land, produce and goods would not serve for these purposes, not even jewels or diamonds, because they are easily recognized. After all, it seems to me that the comparative power and wealth of states consist, other things being equal, in the greater or less abundance of money circulating in them hic et nunc.90
I still have to mention two other methods of increasing the amount of money circulating in a state. The first is when entrepreneurs and private individuals borrow money from their foreign correspondents at interest, or when foreigners send their money into the state to buy shares or government stocks. This often amounts to very considerable sums on which the state must annually pay interest to these foreigners. These methods for increasing money in the state do make it more abundant and diminish the rate of interest. With this money, the entrepreneurs in the state find it possible to borrow more cheaply, to provide work, and to establish factories with the anticipation of a profit. The artisans, and all those whose hands this money passes through, consume more than they would have done if they had not been employed by means of this money. This consequently increases prices just as if the money belonged to the state and through the increased consumption or expenditures this causes, public revenues derived from taxes on consumption are increased. Money lent to the state in this manner brings many advantages with it, but in the end, it is always burdensome and harmful. The state must pay the interest to the foreigners every year and, aside from this loss, the state is at the mercy of the foreigners who can always cause trouble if they decide to withdraw their capital. Surely, they will want to withdraw their capital when the state needs it the most, as when preparing for war and defeat is feared. The interest paid to the foreigner is always much more considerable than the increase in pubic revenue caused by this money. One can observe these loans passing from one country to another, according to investors’ confidence in the states to which they are sent. But in reality, states that have paid heavy interest on these loans for many years will often find themselves bankrupt and unable to repay the capital. When trust is shaken, shares or public stocks fall; foreign shareholders do not like to sustain losses, preferring to content themselves with collecting interest, while waiting for confidence to return. But sometimes it does not return. In declining states, the principal objective of public administrators usually is to restore confidence in order to attract foreign loans. If the ministry does not act in bad faith and keeps its obligations, the money of the subjects will circulate without interruption. In this case, money from abroad has the power of increasing the quantity of money in a state.
But the borrowing road, which holds an advantage in the present, leads to a dead end and is but a flash in the pan. To restore a poor state with a shortage of money, a constant and real balance of trade is needed on an annual basis, as is the development, through navigation, of the articles and manufactures produced cheaper and thereby suitable for exportation.91 Merchants are the first to make their fortunes, then the lawyers may get part of it, the prince and tax collectors get a share at the expense of all the others, and distribute their graces as they please. When money becomes too plentiful in the state, luxury will follow and the state will fall into poverty.
This is roughly the cycle that may be experienced by a large state which has both capital and industrious inhabitants. A talented public administrator is always able to begin the cycle over again. Not many years are needed to see it tried and succeed, at least in the beginning, which makes for the most interesting situation. The increased quantity of money in circulation will be brought about by several factors that my argument does not allow me to examine now.
As for states without much capital and where capital can only be increased by accidents or by particular circumstances of the times, it is difficult to find the means that would allow them to flourish by trade. No administrator can restore the Republics of Venice and Holland to the brilliant situation from which they have fallen. But Italy, Spain, France, and England, however poor they may be, are still capable of attaining a high degree of power by trade alone if led by a good administration and if they operate separately. If all these states were equally well administered, they would be great only in proportion to their respective capital and to the greater or lesser industriousness of their people.92
The last method I can think of to increase the quantity of money actually circulating in a state is by violence and arms, and this method is often blended with the others, since in all peace treaties one will try to maintain trading rights and other privileges one could obtain. When a state mandates contributions or makes several other states tributary to it, this is a very sure method of obtaining their money. I will not examine the methods of putting this theory into practice, but I will say that all the nations who have flourished in this manner have not failed to decline, like states that have flourished through their commerce. The ancient Romans were more powerful in this manner than all the other peoples we know of. Nevertheless, these same Romans, before losing an inch of the land of their vast states, fell into decadence through luxury and impoverished themselves by the reduction of money which circulated among them, and it was this luxury that caused their empire to pass into the hands of the eastern nations of the Orient.
So long as Romans’ luxury (which did not begin until after the defeat of Antiochus, King of Asia, around A.U.C. 564)93 came from the product of the land and the labor of all the vast estates of their dominion, the circulation of money only increased instead of decreasing. The public was in possession of all the gold, silver, and copper mines in the empire. They had the gold mines of Asia, Macedonia, Aquileia94 and the rich mines, both gold and silver, of Spain and other countries. They had several mints where gold, silver and copper coins were struck. In Rome, the consumption of all the goods and merchandise drawn from their vast provinces did not diminish the circulation of money, any more than the pictures, statues and jewels themselves. Although the wealthy landlords spent excessive amounts for their feasts, and paid 15,000 ounces of silver for a single fish, all that did not diminish the quantity of money circulating in Rome, given that the provinces made tributes regularly, not to mention the money brought in by lenders and by governors with their extortions. The amounts annually extracted from the mines increased the circulation in Rome during Augustus’ whole reign. However, luxury was already on a very great scale, and there was much eagerness, not only for curiosities produced in the empire, but also for jewels from India, pepper and spices, and all the rarities of Arabia. Silks, which were not made in the empire, began to be in demand there. Nevertheless, the money drawn from the mines still exceeded the sums sent out of the empire to buy all these things. However, under Tiberius, money became scarce when that emperor collected 2.7 billion sesterces95 in his treasury. To restore an abundant circulation, he only needed to borrow 300 million on a mortgage of his estates. After his death, Caligula spent all of Tiberius’ treasure in less than one year, and it was then that the abundance of money in circulation was at its highest in Rome and the wind of luxury kept on blowing. The historian Pliny96 estimated that in his time the empire exported at least 100 million sesterces annually. This was more than was drawn from the mines. Under Trajan, land prices fell by one-third or more, according to the younger Pliny, and money continued to decrease until the time of the Emperor Septimus Severus.97 Money was then so scarce in Rome that the emperor collected enormous quantities of wheat, being unable to collect enough tax money for his enterprises. Thus the Roman Empire declined through the loss of its money before losing any of its estates. That is what luxury brought about, and what it always will bring about in similar circumstances.

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The Increase and Decrease of the Quantity of Money in a State

Here Cantillon uses his price-specie flow mechanism to analyze some of the effects of inflation. Increasing the supply of money by mining hurts some people and benefits others because certain prices and incomes rise faster than others. However, if the new money is accumulated and saved by those who successfully export goods, either because of superior quality or more efficient transportation, it will lead to higher standards of living.

IF GOLD OR SILVER MINES were found in a state, and considerable quantities of minerals were extracted from them, the owners of these mines, the entrepreneurs, and all those who work there, will increase their expenditures in proportion to the wealth and profit they make. They will also lend the money they have over and above what they need for their expenses and earn interest.
All this money, whether lent or spent, will enter into circulation and will not fail to raise the price of commodities and goods in all the channels of circulation it enters. Increased money will bring about increased expenditure, and this will cause an increase of market prices in the good years and to a lesser degree in bad years.
Everybody agrees that the abundance of money, or an increase in its use in exchange, raises the price of everything. This truth is substantiated in experience by the quantity of money brought to Europe from America for the last two centuries.80
Mr. Locke lays it down as a fundamental maxim that the quantity of goods in proportion to the quantity of money is a regulator of market prices. I have tried to elucidate his idea in the preceding chapters: he has clearly seen that the abundance of money makes everything more expensive, but he has not considered how this happens. The great difficulty of this question consists in knowing in what way and in what proportion the increase of money raises the price of things.
I have already noted that acceleration or a greater pace in the circulation of money in exchange, is equivalent to, to a certain degree, an increase of actual money. I have also noted that an increase or decrease of prices in a distant market, domestic or foreign, influences the local market prices. On the other hand, money flows through so many retail channels that it seems impossible not to lose sight of it, seeing that having been amassed to make large sums, it is distributed in small amounts in exchange, and then gradually accumulated again to make large payments. For these operations, it is necessary to constantly exchange between gold, silver and copper money, according to the requirements of exchange. It is also usually the case that the increase or decrease of hard money in a state is not perceived because it comes into a state from foreign countries by such imperceptible means and proportions that it is impossible to know exactly the quantity which enters or leaves the state.
However, all these operations happen before our eyes and everybody takes a direct part in them. I therefore venture to offer a few observations on the subject, even though I may not be able to give an exact and precise account.
In general, an increase of hard money in a state will cause a corresponding increase in consumption and this will gradually produce increased prices.
If the increase of hard money comes from gold and silver mines within the state, the owner of these mines, the entrepreneurs, the smelters, refiners, and all the other workers will increase their expenses in proportion to their profits. Their households will consume more meat, wine, or beer than before. They will become accustomed to wearing better clothes, having finer linens, and to having more ornate houses and other desirable goods. Consequently, they will give employment to several artisans who did not have that much work before and who, for the same reason, will increase their expenditures. All this increased expenditures on meat, wine, wool, etc., necessarily reduces the share of the other inhabitants in the state who do not participate at first in the wealth of the mines in question. The bargaining process of the market, with the demand for meat, wine, wool, etc., being stronger than usual, will not fail to increase their prices. These high prices will encourage farmers to employ more land to produce the following year, and these same farmers will profit from the increased prices and will increase their expenditure on their families like the others. Those who will suffer from these higher prices and increased consumption will be, first of all, the property owners, during the term of their leases, then their domestic servants and all the workmen or fixed wage earners who support their families on a salary. They all must diminish their expenditures in proportion to the new consumption, which will compel a large number of them to emigrate and to seek a living elsewhere. The property owners will dismiss many of them, and the rest will demand a wage increase in order to live as before. It is in this manner that a considerable increase of money from mines increases consumption and, by diminishing the number of inhabitants, greater expenditures result by those who remain.
If money continues to be extracted from the mines, the abundance of money will increase all prices to such a point that not only will the property owners raise their rents considerably when the leases expire and resume their old lifestyle, increasing their servants’ wages proportionally, but the artisans and workmen will increase the prices of the articles they produce so high that there will be a considerable gains in buying them from foreigners who make them much cheaper. This will naturally encourage several people to import products at lower prices from foreign factories, and this will gradually ruin the artisans and manufacturers of the state who will be unable to sustain themselves by working at such low rates because of the high cost of living.
When the overabundance of money from the mines has diminished the number of inhabitants in a state, accustomed those who remain to excessive expenditures, raised the prices of farm products and the wages for labor to high levels, and ruined the manufactures of the state by the purchase of foreign products by property owners and mine workers, the money produced by the mines will necessarily go abroad to pay for the imports. This will gradually impoverish the state and make it, in a way, dependent on foreigners to whom it is obliged to send money every year as it is extracted from the mines. The great circulation of money, which was widespread in the beginning, ceases; poverty and misery follow and the exploitation of the mines appears to be only advantageous to those employed in them and to the foreigners who profit thereby.
This is approximately what has happened to Spain since the discovery of the Indies.81 As for the Portuguese, since the discovery of gold mines in Brazil, they have nearly always used foreign articles and manufactured goods; and it seems that they worked the mines only for the account and advantage of foreigners. All the gold and silver that these two states extract from the mines does not supply them with more precious metal in circulation than others. England and France usually have even more.
Now, if the increase of money in the state comes from a balance of foreign trade (i.e., from sending abroad articles and manufactured goods of greater value and quantity than is imported and consequently receiving the surplus in money), this annual increase of money will enrich a great number of merchants and entrepreneurs in the state, and will give employment to numerous artisans and workmen who provide the goods sent to the foreigner from whom money is drawn. This will gradually increase the consumption of these industrious inhabitants and will raise the price of land and labor. But the industrious people who are eager to acquire property will not at first increase their expenditures, They will wait until they have accumulated a large sum from which they can draw a secure interest income, independent of their occupation. Once a large number of inhabitants have acquired considerable fortunes from this money, which enters the state regularly and annually, they will not fail to increase their consumption and raise the price of everything. Although these higher prices result in greater expenditures than they at first contemplated, they will, for the most part, continue so long as their capital lasts, for nothing is easier or more pleasant than to increase the family expenditures, and nothing is more difficult or unpleasant than to decrease them.
If an annual and continuous balance has caused a considerable increase of money in a state, it will not fail to increase consumption, raise the price of everything and even diminish the number of inhabitants, unless additional products are drawn from abroad proportionate to the increased consumption. Moreover, in states that have acquired a considerable abundance of money, it is natural to import many goods from neighboring countries where money is rare and consequently everything is cheap. However, as money must be exchanged for these products, the balance of trade will become smaller. The cheapness of land and labor in foreign countries where money is rare will naturally cause the building of factories and businesses similar to those of the state, but which will not, at first, be as perfect or as highly valued.
In this situation, the state can retain its abundance of money, consume all its own products and a great deal of foreign products and, over and above all this, maintain a small balance of trade against the foreigner or at least keep the balance leveled for many years. In other words, the state will import, in exchange for its commodities and manufactured goods, as much money from these foreign countries as it sends to them for the goods or products of the land it takes from them. If the state is a maritime state, the easiness and low cost of its shipping for the transport of its commodities and manufactured goods to foreign countries may compensate, in some way, for the high cost of labor caused by the overabundance of money. Therefore, the commodities and manufactured goods of this state, expensive though they may be, will continue to sell in foreign countries, and sometimes will be cheaper than the manufactured goods of another state where labor is paid less.
The cost of transport greatly increases the prices of goods sent to distant countries. However, these costs are very moderate in maritime states, where there is regular shipping to all foreign ports and ships are nearly always found there ready to sail, taking on board all cargoes entrusted to them at a very reasonable freight.
This is not so in states where navigation does not flourish. There, it is necessary to build ships especially for the transportation of goods and this sometimes absorbs all the profit; and transportation there is always very expensive, which entirely discourages commerce.
England today consumes not only most of its own small production, but also a large amount of foreign products, such as silks, wines, fruits, linens in great quantity, etc. Meanwhile, she sends abroad the products of her mines and manufactured goods, for the most part. No matter how expensive labor is due to the abundance of money, she does not fail to sell her products to distant countries, because of her maritime advantage, at prices as reasonable as those of France, where these same products are cheaper.
The increased quantity of money in a state may also be caused, without a balance of trade, by subsidies paid to this state by foreign powers, by the expenditures of several ambassadors or travelers wanting to stay there for political reasons, curiosity, or pleasure, or by the transfer of the property and wealth of families who choose to leave their country to seek religious freedom or for other reasons, and to settle down in this state. In all these cases, the sums entering the state always cause an increase in expenditures and consumption, and consequently increase the prices of all goods in the channels of exchange where money enters.82
Before the increase in the quantity of money, suppose that a quarter of the inhabitants of the state consume meat, wine, beer, etc., on a daily basis and frequently acquire clothes, linens, etc., but that after the increase, a third or half of the inhabitants consume these same things. Prices for these goods will increase and the high price of meat will convince several of those who formed the original quarter, to consume less meat than usual. A man who eats three pounds of meat daily will manage with two pounds, but he feels the reduction. Meanwhile, the other half of the inhabitants who hardly ate any meat at all will not feel the reduction. The price of bread will increase gradually because of increased consumption, as I have often suggested, but it will be proportionally less expensive than meat. The increase in the price of meat is noticeably felt because it causes a reduction in consumption on the part of a small portion of the people, but the increased price of bread is less noticeable because the decreased consumption is spread across the entire population. If 100,000 extra people move to a state with 10 millions inhabitants, their extra consumption of bread will amount to only one pound in 100, which must be subtracted from the old inhabitants. But when a man consumes 99 pounds of bread for his subsistence instead of 100, he hardly feels the reduction.
When the consumption of meat increases, farmers increase the size of their pastures to produce more meat, and this diminishes cropland, and consequently the amount of wheat produced. However, what generally causes meat to become proportionally more expensive than bread is that imports of foreign wheat are usually permitted while imports of beef are absolutely forbidden, as is the case in England, or heavy import duties are imposed as in other states. This is the reason why the rents for meadows and pastures rise in England, with the abundance of money, three times more than the rents of cropland.
There is no doubt that when ambassadors, travelers, and families move to a state, the increased consumption will cause higher prices in all the markets where they spend their money.
As for the subsidies the state has received from foreign powers, they are either hoarded for state necessities or are put into circulation. If we assume they are hoarded, they do not concern my argument for I am considering only money in circulation. Hoarded money, silverware, churches’ money, etc., are resources that the state turns to in emergency situations, but are of no present utility. If the state puts these funds into circulation, it can only do so by spending them and this will certainly increase consumption and raise the price of all goods. Whoever receives this money will set it in motion the principal business of life—which is the food—either for himself or someone else, since everything is connected to this, directly or indirectly.

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On the Inequality of the Circulation of Money in a State

Rural France was impoverished because commodities had to be sent to the capital and major cities to pay taxes to the state and rents to the property owners living there. It is argued here that if factories were permitted in rural areas, basic commodities could be turned into goods, which could then be sent to the cities at a much lower transport cost. This would save resources in transportation and benefit both rural populations and property owners.


THE CITY ALWAYS SUPPLIES various goods to the country, and the property owners who reside in the city should always receive about onethird of the production of their land. The country thus owes to the city more than half the production of the land. This debt would always exceed one-half if all property owners lived in the city, but because most owners with less significant land holdings live in the country, I suppose that the balance or debt, which continually returns from the country to the city, is equal to half the production of the land and is paid to the city with half of the commodities transported from the countryside and sold to pay this debt.
The countryside of a state or kingdom owes a constant balance to the capital to pay rents to the great property owners who reside there, and to pay taxes to the State or crown, most of which are spent in the capital. All the provincial cities owe a constant balance to the capital, for the State’s property and consumption taxes, and for the different goods that they obtain from the capital. It is also the case that several individuals and property owners, who live in the provincial cities, will spend some time in the capital for pleasure, or for the judgment of their lawsuits in final appeal, or because they send their children there for an elite education. Consequently, all these expenses incurred in the capital are drawn from the provincial cities.
It may therefore be said that all the countryside and cities of a state regularly owe an annual balance or debt to the capital. However, because such payments are made in money, it is clear that the provinces always owe considerable sums to the capital. The products and commodities that the provinces send to the capital are sold to pay for these debts and balances.
Now assume that the circulation of money in the provinces and in the capital is equal both in terms of the quantity of money and the speed of circulation. The balance will be first sent to the capital in cash and this will decrease the quantity of money in the provinces and increase it in the capital. Consequently, products and goods will be more expensive in the capital than in the provinces because of the greater abundance of money in the capital. The difference between the prices in the capital and the provinces must pay for the costs and risks of transport, otherwise cash will be sent to the capital to pay the balance and this will continue until the differences in prices between the capital and the provinces cover the costs and risks of transport. Then the merchants and entrepreneurs of the market towns will buy the products of the villages at a low price and will have them transported to the capital to be sold at a higher price. This difference in price will of necessity pay for the maintenance of the horses and employees of the entrepreneur, plus profit, or else he would cease his enterprise.
As a result, the price of farm products of equal quality will always be higher in areas that are closer to the capital than in those more distant in proportion to the costs and risks of transport. In addition, areas that are adjacent to seas and rivers flowing into the capital will get a better price for their products relative to those which are distant (other things being equal), because water transport is considerably less expensive than land transport. On the other hand, there are certain foods and goods that cannot be consumed in the capital because they are not suitable or cannot be sent there on account of their bulk, or because they would be spoiled on the way. These will be infinitely cheaper in the country and distant provinces than in the capital, because of the much smaller amount of money in circulation in the distant provinces.
Therefore fresh eggs, game, fresh butter, firewood, etc., will generally be much cheaper in the province of Poitou,73 while wheat, cattle and horses will be more expensive in Paris, the difference being the cost and risk of transport, and the fees for entering the city.
It would be easy to make an infinite number of inductions of the same kind to justify by experience the necessity of an inequality in the circulation of money in the different provinces of a great state or kingdom, and to show that this inequality is always relative to the balance or debt, which belongs to the capital.
If we assume that the balance owed to the capital amounts to one-fourth of the production of the land of all the provinces of the state, the best use that can be made of the land would be to employ the country bordering on the capital to produce the kinds of products which could not be drawn from distant provinces without much expense or deterioration. This is in fact what always takes place. The market prices in the capital regulate how the farmers employ the land for this or that purpose. They use the closest lands, when suitable, for market gardens, pasture, etc.
Therefore, when possible, factories for cloth, linen, lace, etc., ought to be set up in remote provinces and factories to make tools of iron, tin, copper, etc., should be located in the neighborhood of coal mines or forests, which are otherwise useless because of their distance. In this way, finished manufactured goods could be sent to the capital with much lower transportation cost than by sending the raw materials to be manufactured in the capital, as well as the subsistence of the artisans who manufacture them. This would save a large quantity of horses and transport workers who could be better employed for the benefit of the state. The land could serve to maintain the nearby workmen and useful artisans and a multitude of horses could be saved that are now used for unnecessary transportation. In this way, the remote areas would yield higher rents to property owners and the inequality of circulation between the provinces and the capital would be considerably less and better proportioned.
Nevertheless, to set up manufacturing in this way requires not only much encouragement and capital funds, but also some way to ensure a regular and constant demand, either in the capital itself or in foreign countries. Exports to foreign countries serve the capital by either paying for the goods it imports, or with the money it gets in return.
When these factories are established, perfection is not attained immediately. If some other province produces the goods better or cheaper, or has an advantage in transportation costs because it is closer to the capital or can resort to river and sea transportation, the new manufactures will not succeed. All these circumstances have to be considered when setting up a factory. My intention in this essay is not to explain these issues, but only to suggest that so far as practicable, significant manufacturing should be set up in provinces far from the capital to produce a less unequal distribution of money between rural areas and the capital.74
For when a distant province has no factories and produces only ordinary foodstuffs and is without water communication to the capital or the ocean, it is surprising how scarce money is compared to that which circulates in the capital, and how little revenue the prince and the property owners who reside in the capital receive from even their best lands.
The wines of Provence and Languedoc75 that are sent to the north, must be sent on the long and difficult route around the Straits of Gibraltar and after having passed through the hands of several entrepreneurs, yield very little to the property owners living in Paris.
However, these distant provinces must send their commodities to the capital or elsewhere (either within the state or to foreign countries), despite all the disadvantages of transport and distance, in order to pay the balance owed to the capital. If there were rural factories to pay this balance, the commodities would be mostly consumed locally and in that case, the rural population would be much larger.
When a province pays its balance only with commodities that yield little in the capital because of transport costs, it is clear that the property owners living in the capital give up the production of a large amount of land in the country to receive little in the capital. This arises from the inequality of money, and this inequality results from the constant balance owed to the capital by the province.
Currently, if a state or kingdom supplies foreign countries with goods from its own factories and does enough of this commerce to draw in a constant balance of money from abroad every year, money will be more plentiful and the circulation will become more substantial than in foreign countries, and consequently, land and labor will gradually command a higher price. It therefore follows that in all the branches of commerce, this state will exchange a smaller amount of land and labor with the foreigner for a larger amount, so long as these circumstances continue.76
But if a foreigner resides in the state in question, he will be in roughly the same situation and circumstances as the citizen of Paris who owns land in distant provinces.
Beginning in 1646,77 factories for making cloth and other goods were built in France and it appeared to trade, at least in part, in the way I described. Since the decay of France, England has taken possession of this trade, and all states appear to flourish by it to a larger or lesser extent. The inequality of the circulation of money in the different states represents the inequality of their comparative power, other things being equal, and this inequality of circulation is always related to the balance of foreign trade.78
It is easy to judge from what has been said in this chapter that the assessment of taxes by the royal tithe, as suggested by Mr. de Vauban, would be neither advantageous, nor practicable. If taxes on land were levied in money, in proportion to the rents of the property owners, it would be fairer. But I must not stray from my subject to show the inconveniences and impossibility of Mr. de Vauban’s proposal.

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Further Reflection on the Rapidity or Slowness of the Circulation of Money in Exchange

Large transactions can be accomplished with the use of bills of exchange or barter, which reduces the demand for money. Ordinary transactions by people require actual coin money in circulation. A variety of factors, therefore, affect the flow of money in circulation and this in turn affects the amount of money in circulation.


LET US ASSUME THAT THE FARMER pays 1,300 ounces of silver every quarter to the property owner, who pays, every week, 100 ounces to the baker, butcher, etc., and that these, in turn, pay the farmer 100 ounces every week, so that the farmer collects every week as much money as the property owner spends. In this case there will be only 100 ounces in constant circulation; the other 1,200 ounces will remain held partly by the property owner and partly by the farmer.
However, it rarely happens that the property owners spend their rents in a fixed and regular proportion. In London, as soon as a property owner receives his rent, he deposits most of it with a goldsmith or banker, who lends it at interest, so that this part is in circulation. Or else the property owner spends a large part of it on the many things he needs for his household. He may even borrow money before he gets his next quarter’s rent. Thus the money of the first quarter’s rent will circulate in a thousand ways before it is accumulated by the farmer to make his second-quarter payment.
When it comes time to pay the second quarter rent, the farmer will sell his products in large amounts. Those who buy his cattle, wheat, hay, etc., will already have collected the price of these goods from their retail sales. Thus, the money of the first quarter will have circulated in the retail trade for nearly three months before being collected by the retail dealers, and given to the farmer who will use it to make his second-quarter payment. It would seem from this that less money would suffice for the circulation in a state than we have assumed.
Barter does not require much cash because goods can be evaluated at the market price on the day of delivery. If a brewer supplies a tailor with beer for his family, and if the tailor in turn supplies the brewer with the clothes he needs, the only cash needed between these two traders is the amount of the difference between the two transactions.
If a merchant in a market town sends commodities to an entrepreneur in the city, and in return the entrepreneur sends the merchant products from the city to be consumed in the country, throughout the year, business between these two dealers and mutual confidence leads them to account for their commodities and merchandise at their respective market prices, and the only money needed for this commerce will be the balance that one owes to the other at the end of the year. Even then, this balance may be carried forward to the next year, without the actual payment of any money. All the entrepreneurs of a city who continually do business with each other may practice this method. Barter exchange by valuation does seem to reduce the cash in circulation, or at least to accelerate its movement by making it unnecessary when people have confidence in each other and can use this method of exchange by valuation. It is not without reason, as is commonly said, that trust in commerce makes money less scarce.
Goldsmiths and bankers, whose tickets71 serve as payment like coin money, also add to the speed of circulation, which would be retarded if money was required for payments where tickets now suffice. And although these goldsmiths and bankers always keep on hand a large part of the coin money they have received for their tickets, they also put into circulation a considerable amount of this effective money, as I shall explain later when dealing with public banks.
All these reflections seem to prove that the circulation in a state could be conducted with much less coin money than what I previously assumed was necessary. However, the following inductions appear to counterbalance them and to contribute to the slowing down of circulation.
I will first observe that all commodities are produced by labor that may possibly—strictly speaking—be carried on with little or no actual money, as I have often suggested. But the workers who make goods in cities or market towns must be paid in coin money. If a house has cost 100,000 ounces of silver to build, all this sum or most of it, must have been paid in small amounts on a weekly basis to the brick maker, masons, carpenters, etc., directly or indirectly. The expenditures of small families, which are always more numerous in cities, must be made with coin money. With such small purchases, credit, barter, and tickets, like banknotes do not work. Merchants and entrepreneurs demand cash for the things they supply, and if they give credit to a family for a few days or months, they require a substantial down payment. A wagon builder, who sells a wagon for 400 ounces of silver in notes, will have to convert them into coin money to pay for all the materials and the men who have worked on the wagon if they have worked on credit. If he has paid them already, the money will be used to pay them to start working on a new one. The sale of the wagon will leave him the profit of his enterprise and he will spend this profit to maintain his family. He could not be satisfied with notes, unless he can afford to put something aside or deposit it to earn interest.
The consumption of the inhabitants of a state is, in a sense, entirely for food. Lodging, clothing, furniture, etc., correspond to the food of the men who have worked upon them, and in the cities, all beverages and food are necessarily paid for in coin money. In the families of landowners, who live in the city, food is paid for every day or every week. In their families, wine is paid for every week or every month; hats, stockings, shoes, etc. are ordinarily paid for in coin money, at least the payments correspond to cash for the men who have worked upon them. All the sums used to make large payments are divided, distributed, and spread in small payments corresponding to the maintenance of the workmen, servants, etc., and all these sums are necessarily collected and reunited by the entrepreneurs and retailers, who are employed in providing the subsistence of the inhabitants, to make large payments when they buy commodities from the farmers. An alehouse keeper collects by sols and livres the sums he pays to the brewer, who uses them to pay for all the grain and materials he buys from the country. One cannot imagine that anything could be purchased for cash in a state, like furniture, merchandise, etc., at a value that does not correspond to the maintenance of those who have produced it.
Circulation in the cities is carried out by entrepreneurs and always corresponds, directly or indirectly, to the subsistence of the servants, workmen, etc. It is inconceivable that the circulation in small retail businesses could be conducted without cash. Notes may serve as counters in large payments for a certain time, but when the large sums come to be distributed and spread into small transactions, as is always the case sooner or later in the course of circulation in a city, notes cannot serve this purpose and cash is needed.
All this presupposes that all the classes in a state who practice some economy, save and keep out of circulation small amounts of cash until they have enough to invest at interest or profit.

Many miserly and timid people will bury and hoard cash for considerable periods of time.
Many property owners, entrepreneurs and others, always keep some cash in their pockets or safes so that they do not run out of money and to protect them against unforeseen emergencies. If a gentleman says that he never had less than 20 louis72 in his pocket throughout the whole year, it may be said that this pocket has kept 20 louis out of circulation for a year. No one likes to spend to their last penny or to be completely without money. People like to receive a new payment before paying debt, even if they have the money.
The funds of minors and of litigants are often deposited in cash and kept out of circulation.
Beside the large quarterly payments that pass through the hands of the farmers, there are wholesale transactions between entrepreneurs and payments from borrowers to lenders that occur at different times. All these sums are collected in the retail trade, are dispersed again, only to come back to the farmer sooner or later. However, they would seem to require a larger amount of cash for circulation than if these large payments were made at times different from those when the farmers are paid for their commodities.
In conclusion, there is such a great a variety in the organization of the inhabitants in the state, and in the corresponding circulation of coin money, that it seems impossible to lay down anything precise or exact about the proportion of money sufficient for circulation. I have produced so many examples and inductions which make it clear that I am not far from the truth in my conclusion “that the actual money necessary for the circulation of the state corresponds nearly to the value of the third of all the annual rents of the property owners.” When the owners have a rent that amounts to half the production, or more than a third, a greater quantity of coin money is needed for circulation, other things being equal. When there is great confidence in the banks and in book credits, or when the speed of circulation is accelerated in any way, less money will suffice. However, I shall show later that public banks do not bring as many advantages as is usually assumed.

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From the Independent Institute

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The Circulation of Money

Farm production produces three rents, one of which sustains the farm workers, while the other two can be sold at wholesale to entrepreneurs who in turn provide property owners and farmers with goods and merchandise. This is the circular flow model of the economy. Money facilitates the flow and timing of rent payments (i.e., “velocity”) and the rate of the monetary flow determines the ratio between the quantity of money and the value of annual production. This model is then used to explain the implications of international trade.

IT IS THE GENERAL OPINION in England that a farmer must make three rents. The first is the principal and true rent that he pays to the property owner, which is assumed to be equal in value to one-third of the farm’s output. A second rent goes for his maintenance and that of the men and horses he employs to operate the farm, and a third rent that he keeps for making the business profitable.
The same idea generally is the norm in other countries of Europe, though in some states, like Milan, the farmer gives up half the product instead of a third. It is also true that many landlords in all countries try to lease their farms at the highest price they can; but when it is above one-third of the product, the farmers generally are very poor. I do not doubt that the Chinese landowner extracts from his farmer more than three-fourths of the product of the land.
However, when a farmer has some capital to carry on the management of this farm, the owner who leases him the farm for one-third of the product will be sure of payment and will be better off by such a deal than if he leases his land at a higher rate to a poor farmer and faces the risk of losing all his rental income. The larger the farm, the better off the farmer will be. This is seen in England where farmers are generally more prosperous than in other countries where farms are small.
The assumption I shall make in this inquiry of the circulation of money is that farmers earn three rents and they spend the third rent to live more comfortably, instead of saving it. This is indeed the case with most farmers in all countries.
All the products in the state come directly or indirectly from the hands of the farmers, as well as all the materials from which commodities are made. The land produces everything but fish, and even then, the fishermen who catch the fish must be maintained by the products of the land.
The three rents of the farmer must therefore be considered the principal sources or, so to speak, the mainspring of circulation in the state. The first rent must be paid to the property owner in cash. For the second and third rents, cash is needed for the iron, tin, copper, salt, sugar, cloth, and generally all the products from the city that are consumed in the countryside. However, all that hardly exceeds one-sixth of the total of the three rents. As for the food and drink of the country folks, cash is not always necessary to obtain them.
The farmer may brew his beer or make his wine without spending money. He can make his bread, slaughter the oxen, sheep, pigs, etc., that are eaten in the country. He can pay most of his assistants in wheat, meat, and drink, not only laborers, but country artisans as well, by valuing products at the prices of the nearest markets, and labor at local wage rates.
The things necessary to life are food, clothing, and housing. There is no need for cash to obtain food in the country, as I have just explained. If coarse linen and cloths are made there70 and if houses are built there, as is often the case, the labor may be paid in barter by valuation without cash being needed.
The only cash needed in the countryside is for the rent payment to the property owner and for the goods obtained from the city, such as knives, scissors, pins, needles, cloths for some farmers or other well-to-do people, kitchen utensils, plates, and generally all that is obtained from the city for use in the countryside.
I have already noted that it has been estimated that half the inhabitants of a state live in the cities, and that consequently, those who live in the city consume more than half the production of the land. Cash is therefore necessary, not only for the rent payment to the owner, corresponding to one-third of the product of the land, but also for the city merchandise consumed in the country, which may amount to something more than one-sixth of the product of the soil. However, one-third and one-sixth amount to half the product. The cash circulating in the country must therefore be equal to at least one-half the product of the land, while the other half, or somewhat less, may be consumed in the country without need for cash.
The circulation of this money takes place when the property owners spend the rents they collected in lump sums from the farmers on retail purchases in the city. The entrepreneurs of the cities (e.g., butchers, bakers, brewers, etc.) then collect this same money, little by little, in order to buy goods from the farmers, such as cattle, wheat, barley, etc. In this way, all the large sums of money are distributed in small amounts, and all the small amounts are then collected to make payments in large amounts, directly or indirectly, to the farmers. Therefore this money serves both in wholesale and retail.
When I stated that the necessary quantity of money for circulation in the countryside is often equal to half the product of the land, this is the minimum. For the circulation in the countryside to be easily conducted, I will suppose that the cash needed is equal in value to two-thirds of the farmers’ income, or two-thirds of the product of the land. It will be seen later that this assumption is not far from the truth.
Let us now imagine that the money conducting the whole circulation in a small state is equal to 10,000 ounces of silver, and that all the payments made with this money, country to city, and city to country, are made once a year. In addition, these 10,000 ounces of silver are equal in value to two of the farmers’ rents, or two-thirds of the product of the land. The rents collected by the property owners will correspond to 5,000 ounces, and the whole circulation of the remaining silver between the people of the countryside and those of the city, made by annual payments, also will correspond to 5,000 ounces.
However, if the owners stipulate that their farmers make payments every six months instead of once a year, and if the other debtors also make their payments every six months, this will alter the pace of circulation. While 10,000 ounces were needed to make the annual payments, only 5,000 will now be required because 5,000 ounces paid twice over will have the same effect as 10,000 ounces paid once.
Furthermore, if the owners stipulate that their farmers make quarterly payments, or if they are satisfied to receive payments from the farmers as the four seasons enable them to sell their products, and if all other payments are made quarterly, only 2,500 ounces will be needed for the same circulation that would have required 10,000 ounces paid annually. Therefore, supposing that all payments are made quarterly in the small state in question, the proportion of the value of the money needed for the circulation is to the annual product of the soil (or the three rents), as 2,500 livres is to 15,000 livres, or 1 to 6, so that money would correspond to a one-sixth of the annual production.

However, considering that each branch of the circulation [i.e., the economy] in the cities is carried out by entrepreneurs, and that the consumption of food is paid for daily, weekly, or monthly, and that clothing purchased once or twice a year by families is paid for at different times by different people; and considering also that the expenditure on beverages is usually made daily, and that payment for beer, coal, and a thousand other articles of consumption is very prompt, then it would seem that the proportion we have established for quarterly payments would be too high and that the circulation of products estimated at 15,000 ounces of silver in value could be conducted with much less than 2,500 ounces of silver coins.
However, because farmers have to make large payments to the owners at least every quarter and that the taxes collected by the prince or the State upon consumption goods are accumulated by the tax collectors to make large payments to the Receivers-General, there must be enough cash in circulation to make these large payments without difficulty, and without hindering the circulation of currencies for the food and clothing of the people.
It will be understood from this that the proportion of the amount of money needed for circulation in a state is not incomprehensible, and that this amount may be greater or less in a state depending on the mode of living and the speed of payments. It is very difficult to lay down anything definite about this quantity in general, as the proportion may vary in different countries. Therefore, it is only conjectural when I say that generally, “the cash or money necessary to carry on the circulation and exchange in a state is roughly equal in value to one-third of all the owners’ annual rents of the said state.”
Whether money is scarce or plentiful in a state, this proportion will not change much, because where money is abundant, land is leased at higher rates and at lower rates where money is scarce. This rule will always be true, at all times. In states where money is scarcer, there usually is more barter by valuation, than in those where money is plentiful, and circulation is more prompt and less sluggish than in those where money is not so scarce. Thus it is always necessary, when estimating the amount of money in circulation, to take into account the speed of its circulation.
Assuming that the money in circulation is equal to one-third of all the owners’ rents and that these rents equal to one-third of the annual product of the land, it follows that “the money circulating in a state is equal in value to the one-ninth of all the annual product of the land.”
Sir William Petty, in a 1685 manuscript, frequently assumes that the money in circulation is equal to one-tenth of the product of the land without explaining his reasoning. I believe he formed this opinion from experience and from his practical knowledge of both the money circulating in Ireland (a country he had measured as a surveyor) and of production, which he estimated from observation. I am not far removed from his idea, however, I chose to compare the money circulating to the owners’ rents, which are ordinarily paid in cash and easily ascertainable by a uniform land tax, rather than to the products of the land because of their daily price variations in the markets, and the fact that a large part of the product is consumed without ever entering the markets. In the next chapter, I shall give several reasons, supported by examples, to strengthen my conclusion. I think this rule is useful, even if it is not mathematically exact in any country. It is sufficient if it is near the truth and if it prevents governors of states from forming extravagant ideas about the amount of money in circulation. There is no branch of knowledge in which one is more subject to error than statistics when they are based on one’s imagination, and none is more informative when they are based upon detailed facts.
Some cities and states, which have no land to call their own, subsist by exchanging their labor and manufactured goods for the products of other lands. For example, in Hamburg, Dantzig, several other cities of the Empire, and even part of Holland, it seems more difficult to estimate the amount of cash in circulation. However, if we could estimate the amount of foreign land used for their subsistence, the calculation would probably not differ from the one I made for the other states that chiefly subsist on their own products, and which are the subject of this essay.
As to the cash needed to carry on foreign trade, it seems that no more is required than what is in circulation in the state when the balance of foreign trade is equal, that is when the products and merchandise sent abroad are equal in value to those imported.
If France sends cloth to Holland and receives spices of equal value in return, the property owner who consumes these spices pays their value to the grocer, who pays the same amount to the cloth maker, to whom the same amount is due in Holland for the cloth he sent there. This is done using bills of exchange, which I will explain later. These two payments take place in France, unconnected to the rent of the property owner, and no money leaves France because of these transactions. All other classes of society consuming Dutch spices similarly pay the grocer. Those living on the first rent, that is the property owners, pay from this rent, and those who live on the other two rents, in the country or the city, pay the grocer, directly or indirectly, out of the money that conducts the circulation of these rents. The grocer again pays this money to the manufacturer in Holland for his bill of exchange and when the balance is equal, no increase of money is needed for circulation in the state due to foreign trade. But if it is not equal, if more merchandise is sold to Holland than is bought back, or vice versa, money is needed for the surplus that Holland must send to France or France to Holland. This will increase or diminish the amount of money circulating in France.
It may even occur that when the balance with the foreigner is equal to the trade with him, commerce with this foreigner may slow down the circulation of currencies, and consequently, a greater quantity of money is required because of this commerce.
For example, if the French ladies who wear French fabrics wish to wear Dutch velvets paid for by the cloth sent to Holland, they will buy these velvets from the merchants who imported them from Holland, and these merchants will pay the cloth manufacturers. The money thus passes through more hands than if these ladies took their money to the cloth manufacturers and contented themselves with French fabrics. When the same money passes through the hands of several entrepreneurs, the rapidity of circulation is slowed down. But it is difficult to make an exact estimate of this sort of delay, which depends upon various circumstances. Thus, in the present example, if the ladies pay the merchant for the velvet today, and the merchant pays his bill with the manufacturer in Holland tomorrow, and if the manufacturer pays the wool merchant the next day, and this last pays the farmer the day after, it is possible that the farmer will keep the money in hand more than two months to make up the quarter’s rent he owes to his landlord. This money might, in two months, have circulated through the hands of a hundred entrepreneurs without slowing down the circulation needed in the state.
After all, we must consider the rent collected by the property owner as the most necessary and considerable part of the money in circulation. If the owner lives in the city and the farmer sells all his production and buys all the goods needed in the country in the same city, the money may always remain in the city. The farmer will sell products there exceeding half the output of his farm and will pay his landlord the money value of one-third of his product and the rest to merchants or entrepreneurs for goods to be consumed in the country. Even here, however, as the farmer sells his products for lump sums, which are subsequently distributed in retail purchases, and are again collected to serve for lump payments to the farmers, the circulation always has the same effect (subject to its rapidity) as if the farmer took the money received for his products to the country, and sent it back again to the city.
The circulation always consists of the large sums, received by the farmer for his products, being distributed at retail, and being brought together again to make large payments. Whether part of this money leaves the city, or remains there entirely, may be regarded as the circulation between city and country. All the circulation takes place between the inhabitants of the state, and they are all fed and maintained in any event from the product of the land and raw materials of the country.
It is true that the wool, for example, which is brought from the country, is worth four times its former value when made up into cloth in the city. However, this increase of value, which is the price of the workmen’s labor and manufactures in the city, is again exchanged for the country products that serve for the laborer’s maintenance.

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