IV The monetary system

Enough has been said to show that the use of money causes certain delays in the manner in which commodities and services are exchanged and circulated, which delays react upon the value of existing supplies in the market and upon the production of further supplies. It is not pretended that these delays and their reactions upon production would not be greater without any monetary system at all; but it is necessary to ascertain whether these delays are really inevitable or not, and this can only be done by an exact understanding of the manner in which they are caused by the monetary system. In a modern state the effective demand normally operates through the monetary system, for people can only demand commodities and services effectively by giving money for them. Thus, unless the total supply of cash and credit money contracts and expands at all times in a manner proportionate to the production of commodities and services, the quantity of them effectively demanded cannot contract and expand in the same manner as the quantity produced without a rise or fall in the general price level. These variations in the price level, however, do not give the effective demand the required elasticity. Let us consider separately, for a moment: (a) A continuous rise in the general level of prices accompanied by a contraction in the effective demand; (b) a continuous rise in the general level of prices accompanied by an expansion in the effective demand; (c) a continuous fall in the general price level accompanied by an expansion in the effective demand; and, (d ) a continuous fall in the general level of prices accompanied by a contraction in the effective demand. (a) A continuous rise in the general level of prices accompanied by a contraction in the effective demand is an occurrence which is practically limited to States of which the natural resources are being exhausted, or where production is restricted or over-penalised in some way or another. It is rather an abnormal occurrence which carries its own remedy or lack of remedy in a very obvious manner. (b) A continuous rise in the general level of prices accompanied by an expansion in the effective demand indicates that the total supply of cash and credit money is expanding in a manner proportionately more rapid than the production of commodities and services for sale. In such circumstances production is meeting with no impediment from the monetary system, and, other things equal, is taking

place to an extent proportionate to human inclination to develop natural resources. We must observe, however, that such an expansion in the total supply of cash and credit money can only be due to continuous excessive borrowing or issue of Paper Money by a government and, in certain circumstances,2 in countries where the issue of Paper Money is not restricted to the government, by the issue of Paper Money by banks; and we must also observe that prices cannot rise for ever to any perceptible extent without destroying the currency concerned as a standard and stable means of measuring and exchanging value and wealth. (c) A continuous fall in the general price level accompanied by an expansion in the effective demand can only take place gradually over long periods in two ways. (1) By a reduction in the cost of production arising from progress in the arts of production and distribution. Notice that lower costs of production obtained by means of reductions in the total monetary earnings of labour, land, capital or entrepreneurs’ profi ts, other things equal, do not cause an expansion in the effective demand, but reduce the effective demand to more or less the same extent as the quantity of earnings economised. (2) By a permanent rise in the value of money due to the total quantity of cash and credit money having become permanently smaller in proportion to the total quantity of commodities and services for sale. Such a rise in the value of money is always resisted, and rightly so, by producers and distributors, who are losers thereby through no fault of their own. We know that, whilst prices are visibly moving down, an expansion in the effective demand never takes place owing to the disinclination of both buyers and sellers to operate, production and distribution are meanwhile slowed down until either the quantity of commodities and services for sale has been reduced to a point which enables producers to hold their own against consumers and money merchants, or until producers and distributors have cut all their losses, and prices are on a lower basis all round.3 A rise in the general price level accompanied either by a contraction or an expansion in the effective demand and a fall in the general price level accompanied by an expansion in the effective demand, are not the main subject of our enquiry. What we must examine closely is a fall in the general level of prices accompanied by a contraction in the effective demand, for this is trade depression as we know it so well. Prices falling through abundance of supplies of commodities and services; but the effective demand diminishing because consumers are either unable or unwilling to buy. A rise in the general level of prices may be a useful method of checking the rate of consumption when required, but it does not necessarily do so. During the great world war the only check on consumption was the rate of production, not the price level; and after the war in many countries the only check on consumption was home production plus what could be borrowed from abroad. No existing monetary system has yet stood up to man’s fi xed determination to consume all there is to consume, when the determination to do so regardless of price exists. Normally, however, this aspect of the matter does not arise. The aspect that does arise potently, and is more or less always with us, is the diffi culty of marketing the production of commodities and services as fast as it

takes place, and the fact that a fall in the price level, so far as it adjusts things, does so, not by increasing consumption, but merely by holding back the production of further supplies. Briefl y, then, the monetary system is such that the total quantity of commodities and services produced and distributed for sale cannot be continuously marketed after any increase in the total quantity continuously produced unless, either the expansion of the total supply of cash and credit money is continuously maintained to the same extent, or, unless the total monetary value of the increased supply of commodities and services continuously produced for sale is reduced in a manner proportionate to the total value of the existing supply of cash and credit money by means of a fall in prices. If, however, a fall in the price level merely holds back production instead of increasing the effective demand, the only alternative is for the expansion of the total supply of cash and credit money to be governed by, and maintained continuously in the same proportion to, the total supply of commodities continuously produced for sale; for, if this expansion is governed by narrower factors, the expansion of the effective demand is narrowed to the same extent4 together with production and development in the area affected. We must, therefore, examine the nature of the total supply of cash and credit money in order to ascertain whether its expansion and contraction is governed by narrower factors than variations in the rate of production and distribution.