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Friday, July 19, 2013

 The theory of money

Say's excellent discussion of money, like most of the rest of his doctrine, has been grievously neglected by historians of thought. He begins by setting forth a theory of how money originates that was later to be developed in a famous article by Carl Menger and would form the basis of the first chapter in every money and banking text for generations. Money, he pointed out, originates out of barter. To facilitate exchanges and overcome the difficulties of barter, people on the market begin to use particularly marketable commodities as media of exchange. Specifically, under barter everyone, in order to buy a product, must find someone who desires his own specific product, and this soon becomes very difficult. Thus: ‘The hungry cutler must offer the baker his knives for bread; perhaps, the baker has knives enough, but wants a coat; he is willing to purchase one of the tailor's with his bread but the tailor wants not bread, but butcher's meat; and so on to infinity’.

How to overcome this problem of what later came to be called the ‘double coincidence of wants?’ By finding a more generally marketable commodity which the seller will take in exchange:

By way of getting over this difficulty, the cutler, finding he cannot persuade the baker to take an article he does not want, will use his best endeavours to have a commodity to offer, which the baker will be able readily to exchange again for whatever he may happen to need. If there exist in the society any specific commodity that is in general request, not merely on account of its inherent utility, but likewise on account of the readiness with which it is received in exchange for the necessary articles of consumption... that commodity is precisely what the cutler will try to barter his knives for; because he has learnt from experience, that its possession will procure him without any difficulty, by a second act of exchange, bread or any article he may wish for.

That commodity is precisely the money in that society.
Say then goes into a by now familiar analysis of which commodities are most likely to be chosen on the market as monies. A money commodity must have a high inherent value – this is, value in its pre-monetary use. It must also be physically easily divisible, preserving a proportionate quota of its value when divided; it should have a high value per unit weight, so that it will both be scarce and valuable, and easily portable; and it must be durable, so it can be retained as value for a long time. Of course, once a commodity is chosen as a general medium of exchange, its value becomes much higher than it had been in the pre-monetary state.

Say follows the continental tradition of assimilating money to all other commodities; i.e., the value of money, as of all other commodities, is determined by the interaction of its supply and its demand. Its value, its purchasing power on the market – moves directly with its demand and inversely with its supply. While he lacked the marginal approach, Say pointed the way to the eventual integration of a utility theory of goods with money. Since money, too, is an object of desire, its utility is the basis for its demand on the market. Say also criticized Ricardo and the British classical school for attempting to explain the value of money, not by utility or supply and demand, but, as in the case of all other goods, by its cost of production. In the case of money, only the supply of money and not the demand was considered important and the supply was supposedly governed by the cost of mining gold or silver.
Say was a hard-money man, insistent that all paper must be instantly convertible into specie. Irredeemable paper expands rapidly in quantity and depreciates the value of the currency, and Say pointed to the recent issue by the revolutionary French government of the assignats, inconvertible paper that depreciated eventually to zero. Say was thus able to analyse one of the first examples of runaway inflation.

If the national money is deteriorated, it becomes an object to get rid of it in any way, and exchange it for commodities. This was one of the causes of the prodigious circulation that took place during the progressive depreciation of the French assignats. Everybody was anxious to find some employment for a paper currency, whose value was hourly depreciating; it was only taken to be re-invested immediately, and one might have supposed it burnt the fingers it passed through.

Say also pointed out that inflation systematically injures creditors for the benefit of debtors.
Say was highly critical of the Smith-Ricardo yen to find an absolute and invariable measure of the value of money. He pointed out that while the relative values of money to other prices can be estimated, they are not susceptible to measurement. The value of gold or silver or coin is not fixed but variable as is that of any commodity.

One of the splendid parts of Say's theory of money was his trenchant critique of bimetallism. He was insistent that the government's fixing the ratio of the weights of the two precious metals was doomed to failure, and only caused perpetual fluctuations and shortages of one or the other metals. Say called for parallel standards, that is, for freely fluctuating exchange rates between gold and silver. As he pointed out: ‘gold and silver must be left to find their own mutual level, in the transactions in which mankind may think proper to employ them’. And again, the relative value of gold and silver ‘must be left to regulate itself, for any attempt to fix it would be in vain’.

While at one point Say inconsistently looks with favour on Ricardo's plan for a central bank redeeming its notes only in gold bullion and not even coin, the general thrust of his discussion is for ultra-hard money. On the whole, Say comes out for 100 per cent specie money, for a money where paper is only a ‘certificate’ backed fully by gold or silver, ‘A medium composed entirely of either silver or gold, bearing a certificate, pretending to none but its real intrinsic value, and consequently exempt from the caprice of legislation, would hold out such advantages to every department of commerce’ that it would be adopted by all nations. So insistent was Say on separating money from government that he called for changing the national names of monies to actual units of weight of gold or silver e.g. grams instead of francs. In that way, there would be a genuinely worldwide commodity money, and the government could not impose legal tender laws for paper money or debase currency standards. The entire current monetary system, Say writes happily, ‘would thenceforth fall to the ground; a system replete with fraud, injustice, and robbery, and moreover so complicated, as rarely to be thoroughly understood, even by those who make it their profession. It would ever after be impossible to effect an adulteration of the coin...’. In short, Say concludes eagerly, ‘the coinage of money would become a matter of perfect simplicity, a mere branch of metallurgy’.

Indeed, the only role that Say would, inconsistently, reserve for government is a monopoly of the coinage, since that coinage was to be this simple ‘branch of metallurgy’ that government could presumably not cripple or destroy.

There is not a great deal of analysis of banking in Say's Treatise. But despite his aberration in being favourable to the Ricardo plan for a central bank bullion standard, the main thrust of his discussion is, once, again, to separate government from bank credit expansion, either by a 100 per cent reserve banking system, or by freely competitive banking, which would presumably approximate that condition. Thus Say writes highly favourably of the 100 per cent reserve banks of Hamburg and Amsterdam. Free banks of circulation (issuing bank notes) he holds to be far better than a monopoly central bank, for ‘the competition obliges each of them to court the public favour, by a rivalship of accommodation and solidity’. And if these banks are not to be based on 100 per cent specie reserve, which Say indicates would be the best system, competition would keep them investing in sound, very short-term credit which could easily be used to redeem their bank notes.

Austrian Perspective on the History of Economic Thought (2 volume set)

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