The reader will recall from a previous post on Ricardo’s criticisms of Bentham’s argument that the production of paper money would lead to increased output. Ricardo’s argument was based on what he himself called his key economic principle – the purchasing power of money was regulated by its cost of production. Although we often now talk of the ‘classical dualism’ of prices of goods and prices of money being determined by different laws this is reality is a monetarist dualism as Ricardo was very clear that the same principles of value theory determined both.
It struck me after writing the last letter that Ricardo missed a very good example which showed a serious weakness and necessary correction in his argument. This arose from Malthus’s well known ‘silver gathered on a sea shore’ argument in his letter to Ricardo of the 10th Sept 1819 , answered here , leading to a debate which continued to the end of Ricardo’s life.
If we suppose half an ounce of silver on an average to be picked up by a days search on the sea shore, money would then always retain most completely the same value. It would always on an average both cost, and command the same quantity of labour. The money price of labour could never permanently either rise or fall.
This scenario is oddly similar to Keynes parable of digging for money hidden in bottles and I guess was probably its source.
What Malthus was doing here was deliberately contriving a model with no fixed capital, no rent and no capital advances, other than the need to provide food to feed the laborer one day in advance. This was designed to produce a scenario where the money wages of labour was the same in Malthus’s measure of value (labour commanded) and Ricardo’s (labour embodied) to take these arguments out of the discussion and solely consider the issue of how the rate of profit and price of wages goods was regulated.
Ricardo called Malthus’s assumptions ‘extreme’ and ‘contrived’. The arguments subsequently took as read that the ‘value’ of the money produced would be of the same value and that any price effects would be due to the shifting of labour from production of wages goods to production of money. Both authors also occasionally touched on the nominal and real issues involved and the consequences to prices of the variations in production of money.
Its seems however that both missed something important. That given that prices are expressed in the nominal unit of exchange any increase in production of money would have a denominator effect on the purchasing power of the money produced. Take an extreme example of 10 labourers producing corn the other 2 gathering silver. If silver is rare to begin with and the quantities of silver gathered high then the circulation of money would rapidly increase and prices would rise. Labour would be attracted from corn to silver gathering further increasing the production of money, and leading to diminishing returns and further increasing the price of corn due to reduced supply. Eventually the profits from producing corn would rise to the same as those from producing silver and we would have an equilibrium. On the way though we have a disequilibrium process caused by increasing the stock of money. We also have an strong incentive to invest capital in corn to increase productivity due to increased corn wages. Hence the value of money in the short term is not simply to be measured in terms of cost of production but the cost of production discounted by the increase in circulation. Ricardo is right however that in the long term if we get to equilibrium the real economy adjust (and in our terms the discounting vanishes) as production changes and rates of profit are equalised.
Here we can see a fundamental modification to the law of markets which I think is equivalent to Keen’s Schumpeter-Minksy law if we break down algebraically the components of change arising from income from production and income from the effect of the change in the circulation of money.
Of course today we don’t have metallic money but money has a cost of production, and that cost is the opportunity cost, either from Crusoe type savings or from reductions in future income to pay back debt. Therefore you can extend the same silver-corn model to todays economy between those producing to increase the production of money to pay off debt and those producing for consumption. The effect is the same. The more we produce for the former the higher wages rise but always offset by the reduced purchasing power of those wages due to higher prices of wage goods. This assumes free entry. If we allow for rents from those holding the resources producing the unit of exchange real wages will not necessarily stay the same. Also if those producing for paying back debt and those producing consumer goods are the same people for different part of the working day wages will not rise but prices would, so we have a business cycle as real wages would be squeezed more and more as debt rises until debt becomes unpayable.
Malthus’s response in producing his ‘constant value of labour’ theory to rescue as he saw it this labour commanded theory deserves its own post no least because it was highly influential to Sraffa.
Regular readers of this blog will also know that it was discovered after Ricardo’s death that introducing fixed capital into the equation makes no difference (the Mill-Longfield recalculation approach – acknowledged by Torrens and JS Mill to remove objections to the theory of value). If I have time I hope to write an extended piece on what to may mind was possibly the key discovery of classical economics after the death of Ricardo was almost completely forgotten.