Money and economic crises
Say’s monetary thinking is based on the idea that the value of money is determined by supply and demand. This implies that money supply can differ from money demand. In other words, individuals are susceptible to increase or decrease their money holdings.
Money is not neutral. Say’s monetary theory of crises shows that monetary changes could affect the real economy.Say identifies two types of circulating medium: money stricto sensu (hereafter “money”), and monetary substitutes (“signes representatifs”). Money took the form of metal (gold and silver) or consisted of inconvertible paper money (“papier-monnaie”). Inconvertible paper money differs from banknotes, which can be converted into gold and silver. It is “a real money made of paper which does not stipulate its refund, or which stipulates a merely illusory refund which is not made” (Say 1826, 503). The circulation of inconvertible paper money
is drawn upon the fact that the government authorises its use to pay debts, and not on trust in the possibility of being converted into metallic money. It is thus “a true money, and not the representative sign of money” (Say 1826, 505). On the other hand, monetary substitutes - banknotes, bills of exchange and promissory notes - are not considered to be money but instead instruments of credit: they are convertible monetary substitutes that have no value other than to give the bearer the right to receive a sum of money, on par and on demand for banknotes or in function of asset maturity and uncertainty of payment for the other substitutes (Say 1826, 517).
In Say’s mind, the quantity of money and its value were intrinsically related. Like any other commodity, the value of money derives from its uses. The value of money is inversely related to its quantity: “[E]very time the number of monetary units has been increased, their value decreased proportionally, and...
it has increased as their number has been lowered” (Say 1828-29, 402). This inverse relationship between value and quantity is applicable to inconvertible paper money, as Say (1826, 511) explained.Individuals can alter their money holdings. In the first edition of Traite, Say observed that these holdings remained more or less unchanged during the course of a year, but he did not mean that it was always and necessarily the case:
Money is used [for trading] almost like posters and handbills that, in a large city, facilitate the intercourse of people who may want to do business together. At the end of the year, each producer used a very large amount of money, but except for a few insignificant balances, generally there is no more money in his hands at the end of the year than he had at the beginning. What matters is what he purchases with this money, in other words the products sold by others that he traded for his own In the end, [when] the exchanges have
been completed, it turns out that one has paid for products with products.
(Say 1803, 244-6; emphasis added)
Say only stressed an empirical fact without drawing any definite conclusion. His formulation was later interpreted as “Say’s identity” (Becker and Baumol 1952, 357), that is, the sum of the excess demands, money excluded, is identically nil. In the second edition of his Traite, however, Say claimed that individuals can increase their holdings using monetary expedients to substitute for the lack of cash: money holdings can thus change, because market forces respond to any increased demand for money by making available substitutes for specie - bills of exchange, banknotes, or other credit instruments:
[A]ny shortage of cash... can easily be overcome.... The intermediary merchandise that facilitates exchanges (money) is in those cases quite easily replaced by [other] means used by the merchants; and soon money begins to flow, because any sort of merchandise is directed toward places where one needs it.
Say later emphasised that the circular flow of output and income could be disrupted by dis-coordination between the suppliers and demanders of factor services, thus causing changes in the holdings of money.
Therefore, money demand was not constant. In Cours, he pointed out that money demand depends on immediate cash constraints and expectations of future needs: individuals consider how long they would hold cash but, at the same time, they have to consider the opportunity cost of holding idle sums of money, as this would entail losing out on interest.More precisely, three motives lie behind the desire to hold money: transaction, precaution and finance. First, Say described an income-elastic demand for money for transaction purposes: “What quantity of money will I need? The more sales and purchases I will have to carry out, the more money I will need” (Say 182829, 400). Say then refers to a money demand to cope with unexpected expenses: “[T]here are some types of occupation and consumption that always require to keep... a certain sum to deal with unforeseen expenses” (Say 1828-29, 401). Finally, he writes that “as one loses interest in holding money, I assume that no one holds more [money] than one expects to use” (Say 1828-29, 401), and adds that “the money used... to cover expenses inherent to the movement of business, is part of the capital of the firm; and the portion of money that remains idle... is unproductive capital” (Say 1828-29, 401n1). These assertions logically imply that a higher interest rate induces people to lower their money holdings.
Say’s approach brings to mind modern contributions which postulate that money is one of the components included in the asset portfolio of individuals. Simply put, the demand for money depends on the nominal income and on the velocity of circulation of money, the latter being a function of the interest rate. It is clear that for Say money is more than just a medium of exchange. He did consider long-term and short-term hoarding, and more generally, he explained that money could serve as a store of value (Numa 2020).
Finally, a last point has to be stressed. Say did not deny that economic crises could take place, but he rejected Malthus and Sismondi’s thesis, which held that crises resulted from too rapid a capital accumulation inducing a possible excess supply of goods.
In his framework, crises could indeed happen, in two ways. In the first four editions of Traite (1803-1819), Say argued - like David Ricardo (1817-21) and Robert Torrens (1819, 1821) - that crises were caused by a disproportion between supply and demand: too many goods were produced in some sectors and not enough in others. But he later developed a monetary theory of crises (Say 1826), which held that economic disturbances were caused by poor decisions on the part of banking institutions. In his analysis of the 1825 crisis in England, Say indicated that by discounting too many bills issued by merchants, country banks spurred reckless speculation. The abundance of monetary instruments in circulation led to a decline in the value of money compared with bullion, and holders of banknotes issued by the Bank of England rushed to country banks in order to redeem their notes into specie. Constrained by the obligation of convertibility and facing exhausted metallic reserves, country banks were forced to interrupt their discounting operations. As a result, entrepreneurs could no longer issue bills and thus failed to fulfil their commitments, leading to a spike in bankruptcies. Monetary crises are “public calamities”; therefore, public authorities should intervene to contain them. For this reason, it is necessary to limit the individual faculty to issue banknotes. Say (1828-29, 488-9) suggested that governments should prohibit the circulation of small denominations so that banknotes could only be used to settle transactions between merchants. In Say’s mind, this could help limit the losses endured by the poor during financial crises.Say explicitly acknowledged that his analysis of the effects of monetary changes led him to reconsider some of the positions he previously held. If monetary changes affect the level of economic activity, then one cannot argue that money is only a medium of exchange and that products are ultimately bought with products:
in spite of the principles that teach us that money plays only the role of a simple intermediary, and that products can ultimately be purchased only with products, more abundant money fosters all sales and the reproduction of new values.
(Say 1828-29, 479)
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