It is interesting to note, in this connection, that some striking contradictions in quantity theory reasoning on any formulation, whether connected with the notions of supply and demand or not, are involved in this hypothesis. The illustration above gives a case where a lowered price level leads money to flow away from your country. But, on the quantity theory explanation of foreign exchange, it is _rising_ price levels which drive gold away, and _falling_ price levels which attract gold![53]
Mill's effort to apply the notion of demand and supply to the value of money is, then, (1) not an application of his formal doctrine of supply and demand, and (2), is a failure, leads to results contradictory to the general law of supply and demand, as soon as we take account of the peculiarities of individual commodities, and cease to look at commodities in one huge lump. Psychological forces, rather than physical quantities, are what count. Whether or not the supply and demand notion of Cairnes, reinterpreted by putting a quantitative value concept into it, could serve as a means of approach to the value of money, I shall not here argue. No one so far as I know has attempted to do the thing that way, and my own theory is best developed by another method. It is interesting to note, however, another somewhat different effort to apply the supply and demand formula. General Walker does so, including among the factors determining the demand for money, not only the quantity of goods to be exchanged, but also the _prices_[54] prevailing. Since by value of money Walker means merely the reciprocal of the price-level, this is the clearest possible case of a vicious circle. It would be a circle even if he were trying to explain the absolute value of money, as distinguished from the reciprocal of the price-level, since the former is one of the determinants of the latter. Value of money and values of goods determine prices; prices and quantity of goods determine demand for money; demand and supply of money determine value of money,--a hopeless circle.
I know no sense in which the terms, demand and supply of money, can have relevance to the problem of the value of money. There is one sense in which the terms can be used which fits in with the modern supply and demand-curves, and that is the sense in which they are used in the money market. Demand for money comes from borrowers; supply of money from lenders. The price paid is a money-price, the curves express the short time money-rates, the rental of money, in terms of money, for stated periods of time. There is a relation, later to be investigated, between the rental of money, the money-rate, and the value of money, but the two are in no sense the same. It should be noted, too, that we are here concerned with "money-funds" rather than with money in the strict sense,--distinctions and relations in this connection properly belong at another stage of our inquiry. Whenever the terms, demand and supply of money, appear in the following pages, they will be used in the sense developed in this paragraph.