Assuming, as Ricardo does, that the depreciated gold currency remains in circulation, the prices of commodities would then rise – inflation. In terms of these commodities, the amount of currency is now at an appropriate level, but what about the value of gold? As a commodity, its value now differs from its value as coin. So, as with Gresham's Law, anyone with full weight gold coins will take them from circulation and convert them to bullion. Ricardo's argument was that if the price of gold rose above its exchange-value, it would stimulate additional production, the increased supply reducing the market-price of gold. But, there is no reason increased supply would reduce the exchange-value of gold. It might rise if it required more expensive production.
On this basis, Ricardo equated the laws relating to precious metal currency with those for paper currency.
“According to Ricardo's general theory of exchange-value, the rise of gold above its exchange-value, in other words above the value which is determined by the labour-time it contains, would lead to an enlarged output of gold until the increased supply reduced it again to its proper value. Conversely, a fall of gold below its value would lead to a decline in the output of gold until its value rose again to its proper level. These opposite movements would resolve the contradiction between the metallic value of gold and its value as a medium of circulation; the amount of gold in circulation would reach its proper level and commodity-prices would once more be in accordance with the standard of value. These fluctuations in the value of gold would in equal measure affect gold bullion, since according to the assumption all gold that is not used as luxury articles is in circulation. Seeing that even gold in the form of coin or bullion can become a value-token representing a larger or smaller value than its own, it is obvious that any convertible bank-notes that are in circulation must share the same fate. Although bank-notes are convertible and their real value accordingly corresponds to their nominal value, “the aggregate currency consisting of metal and of convertible notes” may appreciate or depreciate if, for reasons described earlier, the total quantity either rises above or falls below the level which is determined by the exchange-value of the commodities in circulation and the metallic value of gold. According to this point of view, inconvertible paper money has only one advantage over convertible paper money, i.e., it can be depreciated in two ways. It may fall below the value of the metal which it professes to represent, because too much of it has been issued, or it may fall because the metal it represents has fallen below its own value. This depreciation, not of notes in relation to gold, but of gold and notes taken together, i.e., of the aggregate means of circulation of a country, is one of Ricardo's main discoveries, which Lord Overstone and Co. pressed into their service and turned into a fundamental principle of Sir Robert Peel's bank legislation of 1844 and 1845.” (p 174)
What Ricardo needed to prove was that any amount of gold thrown into circulation, whatever its value, stays there, and is, thereby, devalued as coin, causing prices to rise – inflation – and that the same applies with convertible paper notes. But, whilst this is true in relation to inconvertible notes, it is not true for gold or convertible paper notes, for the reasons already described. So, Ricardo, and his supporters, could not prove this, and instead, simply asserted what had to be proved, as being “incontrovertible”. Ricardo writes,
““That commodities would rise or fall in price, in proportion to the increase or diminution of money, I assume as a fact which is incontrovertible.”” (Note *, p 174)
It is incontrovertible in relation to fiat currency, i.e. to non-convertible paper notes, but it is not true for gold or convertible notes. A 1 ounce gold coin whose value falls below the value of an ounce of gold will be melted down into bullion, a convertible note, whose value falls below the ounce of gold it represents, will be redeemed for an ounce of gold.
Forward To Part 12
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