The Division of Labour is the precondition for exchange. In primitive co-operative communities the Division of Labour arises (firstly between men and women) and production is increased accordingly, but without trade occurring. The male hunters do not trade their products with those of the females, but the whole produce is a collective produce to be shared out equally. Trade only begins as a peripheral activity between tribes rather than within them. However, once trade between tribes commences, then, together with the establishment of classes within society, trade begins to take place within the society too. A precondition for trade within the society is the establishment of private property as a replacement for communal or collective property.
With trade of goods being peripheral, often it amounts to little more than bridal gifts, there is no need to consider in depth the question of exchange values of the goods exchanged. At best all that is required is a rudimentary system of barter. However, when trade begins to develop within each society rather than between different societies, and when the goods exchanged begin to be produced for the purpose of exchange rather than simply being surplus production i.e. they become commodities, the question of how much of one commodity should exchange for another becomes an issue. All historical record, from societies all over the world, demonstrates that the basis of this calculation was the amount of time required to produce each commodity.
This basis of calculating the rate of exchange also provides the basis for setting aside one commodity, which can act as a universal equivalent. If I take the sequence A = 2B, B = 3C, C = 2D I can replace these individual rates of exchange with the single A = 2B, 6C, 12D. The underlying relationship of each commodity based on the labour-time required for its production can now be subsumed under the relationship of each commodity to the universal equivalent A. The exchange value of each commodity can now be expressed as so much A. A does not have to be physically present for this calculation to occur it is merely an abstraction – it has become a unit of account. This is the first stage in the development of money.
Benjamin Franklin described the situation,
“By labour may the value of silver be measured as well as other things. As, suppose one man is employed to raise corn, while another is digging and refining silver; at the year’s end, or at any other period of time, the complete produce of corn, and that of silver, are the natural price of each other; and if one be twenty bushels, and the other be twenty ounces, then an ounce of that silver is worth the labour of raising a bushel of that corn. Now if by the discovery of some nearer, more easy or more plentiful mines, a man may get forty ounces of silver as easily as formerly he did twenty, and the same labour is still required to raise twenty bushels of corn, then two ounces of silver will be worth no more than the same labour of raising one bushel of corn, and that bushel of corn will be as cheap at two ounces, as it was before at one ceteris paribus. Thus the riches of a country are to be valued by the quantity of labour its inhabitants are able to purchase.”
And “trade in general being nothing else but the exchange of labour for labour, the value of all things is, as I have said before, most justly measured by labour.”
Ben Franklin “A Modest Inquiry into the Nature and Necessity of a Paper Currency” pp 265 and 267.
Franklin should have pointed out that, of course, the particular labour of the silver miner and the grain farmer are as different as the silver and the grain they each produce. It is not this particular labour that is the measure, but generalised social labour in the abstract. And what determines the average amount of this labour that is socially necessary – competition.
Once commodity A is accepted as the unit of account it is a simple step forward for this unit to become universally accepted in exchange for any other commodity, in other words, for it to become the medium of exchange. The process does not require the intervention of the State or government to bring this about it arises naturally in the course of development of exchange. This did not always happen e.g. using gold as the standard of value, but silver as the medium of exchange. Only when the standard of value, and the medium of exchange are the same can it truly be considered money. The introduction of a medium of exchange abolishes all the limitations on trade imposed by barter, and in its turn provides a great stimulus to the development of trade.
The question then arises how much of this medium of exchange is required. This depends upon the amount of commodities being traded, their prices, and the relation of these prices to the value of the medium of circulation.
The Economist July 10th 1858 gives the output of the mint as 1855 £9,245,000; 1856 £6,476,000; 1857 £5,298,858, and says that during 1858 the mint had scarcely anything to do. The different figures were due to the varying quantities of commodities in circulation in each year.
“Much will be manufactured when it is wanted; and little when little is wanted.” it said.
(A Contribution to the Critique of Political Economy, Karl Marx p 106.)
And in Holland, after the discovery of gold in California, its gold currency was replaced with silver currency which meant that 15 times more silver was required than gold. Although, the velocity of circulation of the medium of exchange will affect how much needs to be put into circulation, and different denominations circulating in different spheres will have different velocities – an increase in velocity reducing the amount and vice versa – changes in the velocity are determined by technical considerations, which mean that this does not have a marked effect in the short term. In short the quantity of gold or silver coins put into circulation is determined by the quantity of commodities to be circulated, and the relative values of those commodities. So, for example, after the discovery of new gold mines, the relative value of gold fell and consequently more had to be put into circulation.
And in Holland, after the discovery of gold in California, its gold currency was replaced with silver currency which meant that 15 times more silver was required than gold. Although, the velocity of circulation of the medium of exchange will affect how much needs to be put into circulation, and different denominations circulating in different spheres will have different velocities – an increase in velocity reducing the amount and vice versa – changes in the velocity are determined by technical considerations, which mean that this does not have a marked effect in the short term. In short the quantity of gold or silver coins put into circulation is determined by the quantity of commodities to be circulated, and the relative values of those commodities. So, for example, after the discovery of new gold mines, the relative value of gold fell and consequently more had to be put into circulation.
Once in circulation coins made from precious metals soon begin to deteriorate either as a result of normal wear and tear or from clipping. This has caused some considerable problem and debate because it means that a contradiction arises between the coin as unit of account, and as medium of exchange. As unit of account a 1 oz. gold coin has a relative value as against other commodities based upon its weight. This value, as has been demonstrated, is based upon the labour time required to produce an ounce of gold, and the labour time required to produce the commodity against which it is being exchanged, say a bushel of wheat. But if the nominal value of this coin is set at 1 bushel of wheat, but as a result of clipping or wear and tear its weight is reduced to .8 ounces then clearly the actual value of the coin in gold is less and should in terms of its actual gold value only buy .8 bushels of wheat rather than 1. If the coin continues to purchase goods at its nominal value rather than the value of the gold it now contains then in effect the coin has become nothing more than a token for the nominal value of the gold it is supposed to represent. But despite the fact that these coins had become mere tokens whose actual value was much less than their nominal value they continued to circulate, which then provided the basis for replacing coins made from gold, and silver first with coins made from copper and other metals, and subsequently with paper. As Benjamin Franklin put it again,
“At this very time, even the silver money in England is obliged to the legal tender for part of its value; that part which is the difference between its real weight and its denomination. Great part of the shillings and sixpences now current are by wearing become 5,10, 20 and some sixpences even 50% too light. For this difference between the real and the nominal you have no intrinsic value; you have not so much as paper, you have nothing. It is legal tender with the knowledge that it can easily be repassed for the same value, that makes three pennyworth of silver pass for a sixpence.” (Remarks and Facts Relative to the American Paper Money, 1764 p 348)
The determining factor was not the actual metal value of the coin vis a vis its nominal value, but the quantity of coins put into circulation. Provided no increase in the coins put into circulation occurred the debased coins would continue to operate as tokens of the full value. The important point here is that it was not the coin, which constituted money, but the gold, which the token represented. The value of money i.e. gold (or silver if silver was the money commodity) remained the same provided its cost of production did not vary, and consequently provided the coins issued as tokens representing this gold were not increased the value of the tokens would remain the same. If however the number of tokens (even gold tokens of less weight than their nominal value) was increased then the value of these tokens would be decreased proportionately. The Bank of England took action to ensure that coins of inadequate weight were withdrawn. By law a sovereign, which had lost more than 0.747 grains of weight ceased to be legal tender.
“When the decline of the metal content has affected a sufficient number of sovereigns to cause a permanent rise of the market price of gold over the mint price, the coins retain the same names of account but these henceforth stand for a smaller quantity of gold. In other words, the standard of money will be changed, and henceforth gold will be minted in accordance with this new standard. Thus, in consequence of its idealisation as a medium of circulation, gold in its turn will have changed the legally established relation in which it functioned as the standard of price. A similar revolution would be repeated after a certain period of time: gold both as the standard of price and the medium of circulation in this way being subject to continuous changes so that a change in the one aspect would cause a change in the other and vice versa.”
(A Contribution to the Critique of Political Economy, Karl Marx p 110.)
“Thus the English pound sterling denotes less than one-third of its original weight, the pound Scots before the Union only 1/36, the French Livre 1/74, the Spanish Maravedi less than 1,000th, and the Portuguese Rei an even smaller proportion. Historical development thus led to a separation of the money names of certain weights of metals from the common names of these weights.” (ibid p 72)
The inflation of prices does not arise as a result of an increase in the supply of money, but from an increase in the number of tokens circulating which represent money. A confusion exists because of the nature of theories concerning the determination of value, and because of a concentration on the role of money merely as a means of circulation. Suppose the value of gold remains constant i.e. its cost of production does not change. More gold coins are put into circulation than are required to circulate the given amount of commodities in the economy at their given values. This increased money supply does not result in an inflation of prices because if it did the value of gold as a commodity would itself rise above the value of gold as medium of exchange – 1 ounce of gold would trade for more than a 1 ounce gold coin.
This is because the value of gold both as commodity and as money is determined not by demand and supply (though its price may be in the short term) as the neo-classical school maintain, but by the labour time required for its production. A surplus of gold coins would consequently not result in an increase in the prices of other commodities, but in the surplus of those coins being withdrawn from circulation and hoarded as stores of value either in the form of coins, or by being melted down and sold as bullion.
Ricardo who began by correctly defining the value of money in terms of its cost of production fell into this trap because he equated the total amount of gold with the total issue of currency forgetting that gold has a separate life as a commodity to that as coin. It is this separate life, which makes it different to paper. Unfortunately, on the basis of Ricardo’s incorrect analysis and evidence to Parliament the 1844 Bank Acts were passed which exacerbated the crisis of 1857, and the crisis in its turn led to these Acts being suspended. The analysis of paper currency has been read back on to gold currency incorrectly so that the correct concept that an increase in tokens causes inflation has been interpreted as an increase in real money causes inflation. As Marx put it,
“It is thus evident that a person who restricts his studies of monetary circulation to an analysis of the circulation of paper money with a legal rate of exchange must misunderstand the inherent laws of monetary circulation. These laws indeed appear not only to be turned upside down in the circulation of tokens of value but even annulled; for the movements of paper money, when it is issued in the appropriate amount, are not characteristic of it as token of value, whereas its specific movements are due to infringements of its correct proportion to gold, and do not directly arise from the metamorphosis of commodities.”
(ibid p 122)
Marx demonstrates what really happens with the issue of coins as opposed to paper money.
“Thus for example in England copper is legal tender for sums up to 6d. and silver for sums up to 40s. The issue of silver and copper tokens in quantities exceeding the requirements of their spheres of circulation would not lead to a rise in commodity prices but to the accumulation of these tokens in the hands of retail traders, who would in the end be forced to sell them as metal. In 1798, for instance, English copper coins to the amounts of £20, £30 and £50, spent by private people, had accumulated in the tills of shopkeepers and since their attempts to put the coins again into circulation failed, they finally had to sell them as metal on the copper market.”(A Contribution to a Critique of Political Economy, Karl Marx p 113)
“The circulation of commodities can absorb only a certain amount of gold currency, the alternating contraction and expansion of the volume of money in circulation manifesting itself accordingly as an inevitable law, whereas any amount of paper seems to be absorbed by circulation.”
(ibid p 122)
“Gold circulates because it has value, whereas paper has value because it circulates. If the exchange value of commodities is given, the quantity of gold in circulation depends on its value, whereas the value of paper tokens depends on the number of tokens in circulation. The amount of gold in circulation increases or decreases with the rise or fall of commodity prices, whereas commodity prices seem to rise or fall with the changing amount of paper in circulation.”(ibid p 121-2)
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