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same place. Sec. 263.

Domestic exchange is the difference in money values of checks on
banks from different parts of the country. This difference may
equal the cost of shipment of bullion. The bank, with regular de-
positors, pays the loss. Sec. 263.

In foreign exchange the cost of shipment is greater, giving a wider
margin of profit and loss. The business of foreign exchange is
unlike domestic exchange in that it is used as a source of income.
Sec. 264.

When exchange is most favorable it is at $ 4.83. When most un-
favorable it is at $ 4.89. It will hardly exceed these since the bul-
lion would be transported at a higher rate. Sec. 265.

The limits of variation in foreign exchange are largely affected by
the rate of discount in both countries. Sec. 266.

Bills of exchange are sold ahead of time. The buyer may reap a
profit by prophesying which way exchange will run when the bill is
due. It would be economical if we could stall the constant flow of
gold by giving and receiving rights of money instead of sending it
across. Sec. 267.

It is not necessajy to receive money from the country to which
we sent it. We may receive it from any where. Sec. 268.

This credit system, by which less bullion actually flows than would
flow if we settled separately with each country, has two advantages.
I. It avoids the risk of actual transmission. 2. It saves the wear


on metallic money and saves the interest on the capital which would
be represented by so much coin. The money which is thus saved
may be used for investment which would yield a profit besides that
already gained from exchange. Sec. 269.

The amount of reserves depends on the kind of business the bank
does. The city bank has 25 per cent, while the country bank has
only fifteen per cent. Sec. 270.

Commercial banks have many of their investments in discounted
commercial paper. Sec. 271.

When parties draw accommodation paper — accepted bills on the
basis of fictitious transportation — the bank refuses to do business
with them. Sec. 272.

Banking does the same service that speculating does. It allows
the stock of money to be better utilized and insures credit. The use
of bank deposit gives elasticity to the currency. Sec. 273.

If it is easy to get accommodation at the bank, prices rise. This
goes on until the liabilities become disproportionate to the reserves.
When the public perceives this, accommodation is withdrawn. This
causes greater distress than would have resulted had the facilities of
payment by credit been less elastic. Sec. 274.

This danger is greater when credit takes the form of bank notes
instead of checks. The credit of the bank notes is outstanding for
a long time. The inflation is apt to be too large and the reserve too
small. Sec. 275.

As prices rise, the notes are increased. This continues until there
is some shock to the confidence of the people, such as may be
caused by a bank failure. Sec. 276.

Bank note inflation may be stopped before a crisis comes. When
inflation is weak, the movement of coin may give warning. Sec. 277.

No method of banking will avoid these evils. All banks tend to
inflate at the same time. The local character of the currency may
prove an actual advantage. Pride or custom may prevent people
from redemption of notes. This tends to let the notes circulate
freely. Sec. 278.

Centralized control of banking and note issues has worked better.
But that is not eminently successful. Sec. 279.

The choice between one great bank and many small ones has been
political, not economic. Sec. 280.

Sir Robert Peel's Act of 1884, to compel the volume of currency
depend on coin and bullion was, for the most part, good. Sec. 218.


In Scotland and Canada the notes are convertible. Sec. 282.

The Bank of France is not governed by legislation as to the
amount of its note issues. It has issued its notes wisely. Sec. 283.

In Germany one-third of the issue must be protected by coin. If
the difference between the reserve and the issue exceeds $70,000,000
an annual tax of 5 per cent, is levied on the excess. More stress is
laid on supervision than on specific instructions. Sec. 279.

A United States bank was established twice, chiefly to help the
government. It did not prevent the issue of notes by state banks.
Both times it expired, but the issues of notes by state banks con-
tinued until the Civil War. Sec. 285.

In Massachusetts a number of banks established a common agency
for the redemption of notes, to prevent irresponsible issues. In
New York, a law compelled banks to hold United States bonds,
state securities, or real estate mortgages to the amount of the notes
issued, and to deposit them with the state treasurer as a pledge of
redemption. Sec, 286.

During the war a tax of ten per cent, was levied on State Bank
notes in order to place the government notes. State Banks then
became national. They deposited one-third of their capital in United
States bonds in the Treasury, and on this they could issue 90 per
cent, of the face value of the bonds. The price of bonds later rose,
so that the maintenance of the circulation was unprofitable, and a
large amount was surrendered. Sec. 287.

It is urged that the financial systems of both the United States
and England are based on no economic law, but on a somewhat
arbitrary principle. In England, the circulation is increased by sus-
pending Sir Robert Peel's Act of 1844. Ii^ the United States the
circulation is increased by the issue of clearing house loan certifi-
cates. These certificates are allowed the members of the New York
Clearing House Association in return for deposits of securities, 75
per cent, of their par value. At the Clearing House they are ac-
cepted in lieu of cash payments. This, of course, sets free so much
extra cash. Sec. 288.

The bank notes should not equal the wants of business in ordinary
times. It should not be so elastic that in times of emergency it will
not take additional strain. Sec. 289.

Some think the government should take into its hands the issue
of notes. They urge that it would be a profit to the treasury and a
protection to the people. Sec. 290.


Much of the profit is more apparent than real. The proof is that
some banks have given up the circulation of notes. If the govern-
ment took it, its credit would diminish, and the rate of interest on
the debt would increase. This would counter-balance all the gain
Sec. 291.

The treasury is not well fitted for a banking business. It has no
means of swelling or shrinking the currency. A bank may use its
assets for this. The government cannot, because quick inflation
will ensue. Besides, the assets of the government furnish no indi-
cation of the volume of the currency needed. Sec. 292.

The Farmers' Alliance wants the government to issue notes on
the basis of products entrusted to the government ; the notes to be
retired as soon as the products are withdrawn, and the proportion
of such notes to the value of the product deposited to be kept low
enough to ensure the government against loss and stimulate the
owner to sell goods as soon as possible. Such a plan would do
little good or harm if it were properly carried out. If safe action on
the part of the government does not make the currency larger than
it is with safe action on the part of the banks, the whole reason of
the scheme falls through. It involves the existence of a system of
governmental machinery which, with slight changes in the law,
could be made to inflate the currency under the guise of promoting
credit. This would be a perpetual menace to the stability of the
country. Sec. 293.


More than normal profits in any business attracts capitalists to it.
This will increase the demand for labor and wages will rise.
Sec. 295.

The rate of profit is extremely variable, due (i) to the difference
of time production (2) to superior foresight. Sec. 296.

Payment for capital is interest. Payment for location is rent.
Sec. 297.

Interest is not a natural return independent of skill in investment.
There is a conformity between the borrower's estimate for the future
and the actual experience of the past. Sec. 298.

The system of interest was approved because it increased public
wealth. The rate of interest is detrimental by the skill of the in-
vestor. Sec. 299.


The rate of interest depends on the law of demand and supply of
loanable funds. It is paid for the control of capital. It represents
commuted profit. Sec. 300.

The rate of interest is a competitive rate of commutation. It
tends to a point where the demand for capital, on the part of those
who think their profit will exceed that rate, equals the supply fur-
nished by those who think their profit will not exceed that rate.
Sec. 301.

In point of fact the interest is a little below this point. The
lender is willing to let his capital a little cheaper in order to lose the
care of it. Sec. 302.

There are two sources of capital. One is the business men who
might be borrowers instead of lenders. The other is the people who
insure themselves, by lending, a steady return in the future. The
amount of the first kind of capital varies. The capital from the
latter source does not vary with the rate offered. It would be
better to say the rate varied with the amount offered. Sec. 303.

The amounts of capital which people are willing to convert into
income (interest) correspond to the amounts of income people
are willing to convert into capital. Sec. 304.

The general fund of loanable capital owned by people who wish
neither capital nor risk tends to equalize interest rates in different
lines. Sec. 305.

This process is never fully accomplished, partly for lack of time,
chiefly to lack of knowledge. It takes a long time for the public to
find out where profits are really highest and to transfer their income
to them in amounts sufficient to reduce the rate of profit to the
general level. Sec. 306.

There is a general rate of interest fixed by demand and supply.
This is influenced in three ways : by changes in the money supply,
by changes in the supply of products, and by changes in the degree
of economical security. The effects of the first are trifling as com-
pared to the last. Sec. 307.

The rate of interest is not lowered by an increase in the currency.
The resulting insecurity of such an inflation really tends to raise it
higher. But if the currency is increased through the banks as loan-
able funds, the interest will be lowered. This must be immediately
retired in order to prevent the subsequent rise which would follow
the increased speculation and increased security which such excess
of currency engenders. Sec. 308.


The idea that the rate of interest can be lowered by increasing the
supply of products is a fallacy. If capital is increased interest will
fall. The value of each product has decreased with the interest, due
tolthe great supply of products, so that the ratio of the lower inter-
est to the lower value is just about the same as the old rate of
interest. Sec. 8io.

The rate of interest is influenced more by the degree of security
than value of money products. The best guarantee of security is
given by the character of the capitalists. The clearest evidence of
this is to be found in conservative government. Sec. 311.

Risk is incident to progress. So far as insecurity results from
activity in industrial enterprise rather than from lack of enforce-
ment of laws, it is good. Sec. 312.

The tendency of profits and of interests to fall as security ad-
vances has been overestimated. The high rate of profit in new
countries is more apparent than real. The new country offers more
fields of exceptional profit, but it involves more risk. This idea
is due to the glowing reports of the new country and to the promi-
nence of the few cases of exceptional profit. .Sec. 313.

The rate of interest tends to fall. But it does not fall so much as
it is commonly thought. As society becomes more secure there are
fewer cases of high nominal interest on risky contracts and invest-
ments which make it seem as if the interest had fallen from a greater
height than it really has. Sec. 314.

There still is difference in the real rate, which is due to the follow-
ing :

1. In new communities there is an insecurity of tenure and a
chance for adverse legislation which make future rights less valuable.

2. The high rate of fake interest attracts into illegitimate invest-
ments a certain amount of capital which would otherwise be used in
legitimate ones. This lowers the supply for the legitimate invest-
ments and raises the rate.

3. In new countries people want to control their own capital.
This raises the rate by decreasing the supply of loanable funds.
Sec. 315.

The rate of profits seeks a level, because as interest goes down
while profit remains stationary, the borrowers invest more. This
creates a demand for labor. Wages rise. More products result.
Prices go down and profits go down. Sec. 316.

There are two causes which make this adjustment incomplete.


I. When all the business men in one industry combine to prevent
an increase of investment. 2. When each man acts separately and
competes with others, but where some have advantages of method
or location over the others. Both may be called monopoly. In the
second case the one has a differential advantage over the others.
Sec. 317.

Exceptional profits of a true monopoly are generally transient. If
they are due to a patent, it expires. Rival processes fear of
public opinion and legislation reduce them. Sec. 318.

We see differential gains if the demand for the products of indus-
try is too large to be met by a single organized source of supply.
Sec. 319.

When individual gains are personal (that is, due to individual
capacity), they are known as net profits. When they are due to ad-
vantages of location they are known as economic rent. Economic
rent is generally due to foresight in investment. Net profit is due
to skill in management. Sec. 320.

Commercial rent is the price paid for the use of the land and its
improvements. A large part of this is interest. Commercial rent
must not be confounded with economic rent. Sec. 321.

Economic rent and net profit resemble producers' and consumers'
gains in being differential gains. They are unlike them in being
habitually measured in money and, therefore, more observable ; and,
second, they are offset by differential losses which often more than
neutralize the gains. Economic rent and net profits are really com-
pensations for risk. This justifies the private ownership of property
and the present industrial system. Sec. 322.

Profits are the charges which the capitalists make for insuring
I society against the loss incident to industrial experiments. Sec. 323.
\ ' The prevailing theory of ecenomic rent ignores the extent of these
losses. It assumes that future prices can be foreseen, and that
the marginal laborer and the marginal unit of capital do contribute
to an amount equal to the valuation of their services. This is not
true. The marginal laborer is employed at wages which exceed the
total amount that the consumer ever pays for the product of his
labor. The marginal unit of capital receives a return in the form
of interest which is often in excess of the advantage which the
speculator gets from its use. If the product of the laborer and
capital were immediately available for consumption, such mistakes
would not be made. The number of these errors is very great.
Sec. 324.


Ricardo thought that, if for any reason profits were low, the capi-
tal would be immediately withdrawn, for two reasons : In his day
there were no great companies which can't get tiieir capital out, once
it is in a business. He was a banker and landlord. He was ac-
quainted with investments that could be easily transferred. Today
there is much fi.xed capital. The returns to labor are distant. A
thing once made cannot be unmade without great sacrifice. The
positive rent and positive profits are counter-balanced by losses,
both on real estate and personal property, which perhaps are greater
than the aggregate amount of differential gains made by the more
successful inventors. Sec. 325.

Four circumstances may cause sucli loss. i. Technical failure.
The capital does not yield expected result. 2. Industrial progress.
The investment of capital in an industry is replaced by a belter one
before the accumulated profits have paid the original cost. 3. Over
competition. This makes low prices and low profits. 4. Contrac-
tion of credit. This lowers prices and makes investment unreniu-
nerative, even though it be otherwise perfectly adapted to the needs
of society. Sec. 326.

Technical failure is the least important cause. Sec. 327.
The losses from industrial progress are less evident but more
widespread. Few make allowances for the danger of the introduc-
tion of new processes in determining the depreciation of stock. It
represents a great reduction in the profits earned by the owners of
fixed capital as a class. Sec. 328.

Land owners are not exempt from these losses. They are likely to
lose all tlieir fixed capital as industry progresses. Sec. 329.

Over-production means that more goods are produced than can be
consumed at the prices which cover the expense to the producers.
Sec. 330.

This will take place in any industry involving large fixed capital.
When it occurs in only one line it is called disproportionate produc-
tion. Over-production is more often due to a collapse of demand in
a number of lines simultaneously. Such a contraction is the central
figure of a crisis. Sec. 331.

If the banks are compelled to reduce the accommodation of credit,
the men who wish to pay money cannot pay as much, and the men
who wish to receive money cannot oljtain as much. This decreases
the volume of business by decreasing the effective circulation of
money. Transactions must decrease in number or prices must fall*


Both singly cause a crisis. A fall in price prevents the fulfillment of
contracts. A fall in the number of transactions prevents some from
getting what they used or consumed and selling their surplus to pro-
ducers. Here is congestion in trade and apparent over-production
Sec. 332.

The order of events of a crisis is this :

1 . The shock to public confidence in a period of liberal, not to
Bay, inflated credit, creates a demand for money.

2. This increases the interest. To raise money people sell their
goods at a sacrifice. The fall of prices is further increased, because
those who would buy can't borrow the money easily.

3. The fall of prices lowers profits. This makes it impossible to
pay interest, notes, etc. Readjustments and foreclosures follow.
The loss falls on the borrowers if the security is good. If it is de-
lusive, they assent to a reduction of the interest.

4. When the interest contracts have been readjusted the chief
effect on wages begins to be felt. During the early stages of the
crisis the employer wanted his laborers to make products. After
the readjustment the demand for labor diminishes and wages fall.
Soon the laborers strike. This is the beginning of the end.
Sec. 333.

Strikes do not help those who try to depress the price of securities.
The strikes cut down the number of producers, so that the com-
peting producers can dispose of their products easily. Strikes indi-
cate that interest contracts have been adjusted to the prevailing
price conditions, and that speculators can make arrangements for
the future, with the assurance that the marginal price charged by
labor and capital do not exceed the market price which the con-
sumers are likely to pay for the results of such service. Sec. 333.

Until this process is substantially complete the price which con-
sumers pay for products is less than the marginal expense of those
products — including, as we must, a return on capital invested.
Sec. 334.

The competition of capitalists leads them to advance wages, which
are equal to the expected price of the product. Any excess consti-
tutes profits. Sec. 335.

The income for the use of capital is guaranteed, not advanced.
This is interest. The remaining profit is either net profit or econo-
mic rent. To separate them is to divide the reward for waiting from
the reward for risk and foresight. Wages are advanced and guaran-


teed. Interest is not advanced but guaranteed. The justice of the
charge made for such guarantees is justified, because society finds
itself best served by them. Sec. 335.


Wages are the discounted product of industry. The expected
value of the product, less the discount, gives the labor cost per unit
of product, or piece wage. This times the number of pieces per
day constitute the day's earnings or nominal wage. The amount of
commodities represented by the nominal wage is the real wage.
Nominal wages and real wages should be estimated by the year
rather than by the day. Sec. 336.

The system of wages by time or piece is determined by the nature
of the work. Sec. 337.

Differences in the rate of wages among producers are due far more
to variations in efficiency than to variations in piece wages. Com-
petition makes this. Sec. 338.

There are two exceptions possible.

1. When different competitors use different methods, interest may
take a larger share of the return, thus leaving an unequal return for

2. When the operation of low-cost labor is restricted to land of
exceptional advantage or otherwise limited by monopoly, there may
not be enough competition of capital to give the low-cost laborer
the advantage of his superior economy. Sec. 339.

The wages of services must correspond to what their efficiency
would secure if they were engaged in the production of goods for
market. Sec. 340.

If wages fall the supply of labor diminishes, and vice versa. Sec.


The demand for labor is measured by the piece ; the supply by
the day. Sec. 342.

When there is little competition there is a tendency to pay the
laborer the minimum wage. Under this system we find —

1. A large body of peasants producing food and receiving the
bare necessaries of life. Diminution of labor will give this labor a
scarcity value.

2. A body of craftsmen who receive enough to keep their station
and who can resist a cutting down of wages.


3- The privileged classes, controlling property and politics, who
use surplus food unproductively. Sec. 343.

It is the theory of most Socialists that this state of affairs prevails
to-day. Many remedies have been offered. Sec. 344.

The rich man benefits the poor in his productiveness by increasing
public wealth. The spendthrift uses up the useful things. The
miser merely hoards them. Sec 345.

Increased production accrues to the laborers. A destruction of
capital diverts capital from one group of laborers to another. It is
no blessing to humanity. The wage fund is the demand, the labor-
ing population the supply of labor, under the wage fund theory.
The price of labor is thus fixed by demand and supply. Sec. 346.

MacCulloch's definition of capital, as composing all products em-
ployed for sustenance or facilitation of production, is inadequate.
Not all the things that may be employed for this are thus used.
The amount of capital used bears no fixed proportion to the pro-
ducts that might be used. Laborers are better off when there is a
small surplus of products effectively used than when a large
surplus is ineffectively used. Wages are a flow and not a fund.
Sec. 348.

This fact is seen in new countries which have recently suffered
from a war or a crisis. The capital in these cases is the same, yet
the wages are higher than before. Sec. 349.

Industry is not accurately limited by capital, when limited means
that the first habitually comes up to the second and that it cannot
exceed it. Sec. 350.

Wages are the residual share of the product of industry. This is
true of industry, as a whole, in the long run. Sec. 351.

This explains high wages, where labor is efBcient. It makes
them depend on a flow of capital rather than on a fund. Part of
the gain from low profits goes to the laborer. All of the gain from
low wages goes to the consumers. Sec. 352.

Since most improvements are in manufactured articles, the gain is
mostly the laborer's. Sec. 353.

An improvement in production does not affect the consumption of
the rich, but it does affect that of the poor. Sec. 354.

Four possibilities are now open to the laborer.

1. He may increase his numbers.

2. He may shorten his hours of labor.

3. He may enlarge his consumption of products.

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Online LibraryArthur Twining HadleyEconomics I → online text (page 3 of 5)