CHAPTER VIII

INFLATION AND CONTRACTION. DEPRECIATION.

MULTIPLE TENDER

I. INFLATION AND CONTRACTION

Inflation. As has already been mentioned, a certain amount of money is needed in a state to carry on all its commercial transactions. There should be no more and no less than is

needed for this purpose. But it may happen that the amount of money in circulation will be far greater than is needed for commercial exchanges. In that case there will be inflation and inflated prices.

The value of money depending inversely on the supply, when the supply is greater than needed, the value of money will decrease, and, as a consequence, the prices of commodities will rise.

This increase of the amount of money beyond the commercial need may happen in various ways:

I.

1. There may be an increased output of gold and silver from the mines; the metal so mined may be coined by the government and thrown into circulation.

2. The government may give legal tender power to silver coins, coined at a ratio that gives them a smaller bullion value than gold coins. Much of our silver money has been coined under such conditions. The silver dollar has 371.25 grains of pure silver, worth by weight about 50 cents. The government can buy for about 50 cents 371.25 grains of silver and coin it into a silver dollar having the legal tender value of 100 cents. The government makes nearly 50 cents on

each dollar. The temptation for a government to make such profits from its mints has sometimes been very great, and when the government yields to the temptation and does so, it may overstock the money market. The result will be inflation, a depreciation of money, and a rapid rise in prices.

3. Again, the government may issue paper money and give it legal tender power. This was done by the United States during the Civil War. One issue of "greenbacks" succeeded another, until the amount of paper money on the market was enormous, with the result that a paper dollar was worth only about 50 cents, as compared to gold. There was inflation, and there resulted the high prices of the war time.

4. Trade depression may follow on a period of commercial activity, and the stock of money may be greater than is needed. Inflation always works injustice to creditors on long-term contracts, whereas it is advantageous to debtors. Thus, if Smith owes Brown $1000 in 1860, said amount to be paid five years later, Smith may discharge his debt in 1865 by the payment of 1000 paper dollars, since they are legal tender. But Brown practically receives but $500, because of the depreciated value of the paper dollar, equal to but one half the value of the dollar at the time the debt was contracted.

Contraction. - When there is less money in circulation than is needed for the commercial exchanges of the country, there is contraction. This may also be brought about through various

causes:

1. The output from the gold and silver mines may be reduced. A certain amount of coin and bullion is lost through accident and abrasion, and the stock may not be replenished.

2.

3. Commercial activity may increase proportionately more than the increase of money.

The effect of each of these causes may be that there will be less money in circulation than is needed. The scarcity of money will produce an appreciation of money, i.e. money will have more value. The result will be a fall in prices.

Just as inflation works injustice to the creditor class, so con

traction will work injustice to the debtor class in long-term contracts. Thus, if Smith owes Brown $1000, a debt entered into before contraction, and pays him in the appreciated money of the period of contraction, he practically pays more than the amount originally called for.

Effects on Productive Industries. The variation in money values has an important effect on productive industries. A great part of the money invested in business is borrowed capital. If a contraction is foreseen, producers will refuse to borrow, because of the greater amount they will have to pay their creditors, or, if they do borrow, they will be forced to produce a greater amount of commodities in order to be able to pay their debts. All this will have the effect of restricting production.

Our history furnishes an instance of contraction in the years 1873-1879. It was due principally to the endeavor of the government to pay off the principal of the debt incurred in the Civil War. Between 1869 and 1873, bonds to the value of hundreds of millions of dollars were redeemed. "When the crop-moving period came, a sharp stringency in money manifested itself, a severe panic involving a large number of important concerns and spreading over the entire country followed." (Hepburn, Contest for Sound Money, p. 221.)

In this instance, contraction " brought a period of falling prices extending over all sorts of commodities, and continuing almost uninterruptedly for seven years, with the effect of checking production and causing apprehension and great caution, with frequent closing of large factories and workshops, some suffering, and much agitation among wage earners.' (Denslow, Principles of Economic Philosophy, p. 390.)

While some claim that inflation and a rise in prices will prove beneficial to productive industries, because there will be a greater amount of money for investment, yet it must be observed that rising prices have the effect of stimulating speculation. New enterprises will be established, some wisely, some unwisely. There will be overproduction of certain commodities. Business failures result. Failures are a necessary concomitant of

POL. ECON. — IO

commercial enterprises, but inflation intensifies the forces which tend to bring them about.

The following table gives the commercial failures that occurred in the United States since 1899:

(Statistical Abstract of U. S. Dep't Com. & Labor, 1912, p. 705.)

Crises. - Inflation and contraction may be the causes of financial crises. A financial crisis is a violent state of unrest in a financial center, causing restriction of credit, and the failure of merchants and bankers. The financial crisis that occurred in the United States in 1837 and that also of 1857 were due to inflation of the currency through the immense issues of state bank notes. These notes became greatly depreciated in value, as we have already seen. The effects produced in both crises were great prostration of business, the cessation of manufactures and agriculture, and much suffering among the laboring classes. (Cf. Denslow, Principles of Economic Philosophy, pp. 382, 385.) The crisis of 1873 was due to contraction. Says Denslow (p. 390), in speaking of this crisis: "The causes were national, and grew out of a large contraction in the volume of transferable

credits, occasioned partly by the policy of rapidly paying off the principal of the United States war debt, and partly by the fall in the value of silver relatively to gold, which set in in 1873, and culminated in the spring of 1876."

The crises of 1893 and of 1907 were also due to contraction. The former was brought about by the disappearance of gold from the country through the disturbing influence of the silver agitation. The latter was brought on by many remote causes, all no doubt affecting the situation in various degrees, but the immediate causes were the withdrawal of deposits, the hoarding of money, the inability of banks to continue bank credits, and the inelasticity of the currency system in use.

Remedy in Long-Term Contracts. To remedy the evils to creditors and debtors resulting from the fluctuation of the monetary value, several plans have been suggested. Two of them are as follows:

1. The government should so regulate the amount of money in circulation that there would be a general level of prices.

2. The contracts should stipulate that the amount of money called for shall be determined by the value of money at the time of payment, and shall be greater or less according as there is a depreciation or an appreciation of money. The fact of depreciation or appreciation will be found by taking the sum of the prices of one hundred different commodities at the time of making the contract and of payment, comparing the two sums, and arriving at a tabular unit. This plan is more fully stated on pages 157-158.

Some believe that the difficulty would be obviated if some staple which does not vary in value as much as money should be taken as the standard in which to pay long-term contracts. Such a staple is grain. The fluctuations in the price of grain have been much less than the fluctuations of gold and silver during the past centuries. As a matter of fact, Oxford University for centuries has received and does still receive its rental from its lands in grain valuation. Hitherto no plan has actually been adopted.