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The Epistemological Import of Carl Menger’s Theory of the Origin of Money - Ludwig von Mises, Human Action: A Treatise on Economics, vol. 2 (LF ed.) [1996]

Edition used:

Human Action: A Treatise on Economics, in 4 vols., ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007). Vol. 2.

Part of: Human Action: A Treatise on Economics, in 4 vols. (LF ed.)

About Liberty Fund:

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.


The Epistemological Import of Carl Menger’s Theory of the Origin of Money

Carl Menger has not only provided an irrefutable praxeological theory of the origin of money. He has also recognized the import of his theory for the elucidation of fundamental principles of praxeology and its methods of research.5

There were authors who tried to explain the origin of money by decree or covenant. The authority, the state, or a compact between citizens has purposively and consciously established indirect exchange and money. The main deficiency of this doctrine is not to be seen in the assumption that people of an age unfamiliar with indirect exchange and money could design a plan of a new economic order, entirely different from the real conditions of their own age, and could comprehend the importance of such a plan. Neither is it to be seen in the fact that history does not afford a clue for the support of such statements. There are more substantial reasons for rejecting it.

If it is assumed that the conditions of the parties concerned are improved by every step that leads from direct exchange to indirect exchange and subsequently to giving preference for use as a medium of exchange to certain goods distinguished by their especially high marketability, it is difficult to conceive why one should, in dealing with the origin of indirect exchange, resort in addition to authoritarian decree or an explicit compact between citizens. A man who finds it hard to obtain in direct barter what he wants to acquire renders better his chances of acquiring it in later acts of exchange by the procurement of a more marketable good. Under these circumstances there was no need of government interference or of a compact between the citizens. The happy idea of proceeding in this way could strike the shrewdest individuals, and the less resourceful could imitate the former’s method. It is certainly more plausible to take for granted that the immediate advantages conferred by indirect exchange were recognized by the acting parties than to assume that the whole image of a society trading by means of money was conceived by a genius and, if we adopt the covenant doctrine, made obvious to the rest of the people by persuasion.

If, however, we do not assume that individuals discovered the fact that they fare better through indirect exchange than through waiting for an opportunity for direct exchange, and, for the sake of argument, admit that the authorities or a compact introduced money, further questions are raised. We must ask what kind of measures were applied in order to induce people to adopt a procedure the utility of which they did not comprehend and which was technically more complicated than direct exchange. We may assume that compulsion was practiced. But then we must ask, further, at what time and by what occurrences indirect exchange and the use of money later ceased to be procedures troublesome or at least indifferent to the individuals concerned and became advantageous to them.

The praxeological method traces all phenomena back to the actions of individuals. If conditions of interpersonal exchange are such that indirect exchange facilitates the transactions, and if and as far as people realize these advantages, indirect exchange and money come into being. Historical experience shows that these conditions were and are present. How, in the absence of these conditions, people could have adopted indirect exchange and money and clung to these modes of exchanging is inconceivable.

The historical question concerning the origin of indirect exchange and money is after all of no concern to praxeology. The only relevant thing is that indirect exchange and money exist because the conditions for their existence were and are present. If this is so, praxeology does not need to resort to the hypothesis that authoritarian decree or a covenant invented these modes of exchanging. The étatists may if they like continue to ascribe the “invention” of money to the state, however unlikely this may be. What matters is that a man acquires a good not in order to consume it or to use it in production, but in order to give it away in a further act of exchange. Such conduct on the part of people makes a good a medium of exchange and, if such conduct becomes common with regard to a certain good, makes it money. All theorems of the catallactic theory of media of exchange and of money refer to the services which a good renders in its capacity as a medium of exchange. Even if it were true that the impulse for the introduction of indirect exchange and money was provided by the authorities or by an agreement between the members of society, the statement remains unshaken that only the conduct of exchanging people can create indirect exchange and money.

History may tell us where and when for the first time media of exchange came into use and how, subsequently, the range of goods employed for this purpose was more and more restricted. As the differentiation between the broader notion of a medium of exchange and the narrower notion of money is not sharp, but gradual, no agreement can be reached about the historical transition from simple media of exchange to money. Answering such a question is a matter of historical understanding. But, as has been mentioned, the distinction between direct exchange and indirect exchange is sharp and everything that catallactics establishes with regard to media of exchange refers categorially to all goods which are demanded and acquired as such media.

As far as the statement that indirect exchange and money were established by decree or by covenant is meant to be an account of historical events, it is the task of historians to expose its falsity. As far as it is advanced merely as a historical statement, it can in no way affect the catallactic theory of money and its explanation of the evolution of indirect exchange. But if it is designed as a statement about human action and social events, it is useless because it states nothing about action. It is not a statement about human action to declare that one day rulers or citizens assembled in convention were suddenly struck by the inspiration that it would be a good idea to exchange indirectly and through the intermediary of a commonly used medium of exchange. It is merely pushing back the problem involved.

It is necessary to comprehend that one does not contribute anything to the scientific conception of human actions and social phenomena if one declares that the state or a charismatic leader or an inspiration which descended upon all the people have created them. Neither do such statements refute the teachings of a theory showing how such phenomena can be acknowledged as “the unintentional outcome, the resultant not deliberately designed and aimed at by specifically individual endeavors of the members of a society.”6

4

The Determination of the Purchasing Power of Money

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its “price” as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange. If people stop using the good in question as a medium of exchange, this additional specific demand disappears and the “price” drops concomitantly.

Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange.7 With regard to modern metallic money one speaks of the industrial demand and of the monetary demand. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.

Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble so that they abstained from following farther along this line of reasoning. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power.

The difficulty is, however, merely apparent. The purchasing power which we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle.8

But, say the critics, this is tantamount to merely pushing back the problem. For now one must still explain the determination of yesterday’s purchasing power. If one explains this in the same way by referring to the purchasing power of the day before yesterday and so on, one slips into a regressus in infinitum [(Latin) process of going back endlessly]. This reasoning, they assert, is certainly not a complete and logically satisfactory solution of the problem involved. What these critics fail to see is that the regression does not go back endlessly. It reaches a point at which the explanation is completed and no further question remains unanswered. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday’s exchange value is exclusively determined by the nonmonetary—industrial—demand which is displayed only by those who want to use this good for other employments than that of a medium of exchange.

But, the critics continue, this means explaining that part of money’s purchasing power which is due to its service as a medium of exchange by its employment for industrial purposes. The very problem, the explanation of the specific monetary component of its exchange value, remains unsolved. Here too the critics are mistaken. That component of money’s value which is an outcome of the services it renders as a medium of exchange is entirely explained by reference to these specific monetary services and the demand they create. Two facts are not to be denied and are not denied by anybody. First, that the demand for a medium of exchange is determined by considerations of its exchange value which is an outcome both of the monetary and the industrial services it renders. Second, that the exchange value of a good which has not yet been demanded for service as a medium of exchange is determined solely by a demand on the part of people eager to use it for industrial purposes, i.e., either for consumption or for production. Now, the regression theorem aims at interpreting the first emergence of a monetary demand for a good which previously had been demanded exclusively for industrial purposes as influenced by the exchange value that was ascribed to it at this moment on account of its nonmonetary services only. This certainly does not involve explaining the specific monetary exchange value of a medium of exchange on the ground of its industrial exchange value.

Finally it was objected to the regression theorem that its approach is historical, not theoretical. This objection is no less mistaken. To explain an event historically means to show how it was produced by forces and factors operating at a definite date and a definite place. These individual forces and factors are the ultimate elements of the interpretation. They are ultimate data and as such not open to any further analysis and reduction. To explain a phenomenon theoretically means to trace back its appearance to the operation of general rules which are already comprised in the theoretical system. The regression theorem complies with this requirement. It traces the specific exchange value of a medium of exchange back to its function as such a medium and to the theorems concerning the process of valuing and pricing as developed by the general catallactic theory. It deduces a more special case from the rules of a more universal theory. It shows how the special phenomenon necessarily emerges out of the operation of the rules generally valid for all phenomena. It does not say: This happened at that time and at that place. It says: This always happens when the conditions appear; whenever a good which has not been demanded previously for the employment as a medium of exchange begins to be demanded for this employment, the same effects must appear again; no good can be employed for the function of a medium of exchange which at the very beginning of its use for this purpose did not have exchange value on account of other employments. And all these statements implied in the regression theorem are enounced apodictically as implied in the apriorism of praxeology. It must happen this way. Nobody can ever succeed in constructing a hypothetical case in which things were to occur in a different way.

The purchasing power of money is determined by demand and supply, as is the case with the prices of all vendible goods and services. As action always aims at a more satisfactory arrangement of future conditions, he who considers acquiring or giving away money is, of course, first of all interested in its future purchasing power and the future structure of prices. But he cannot form a judgment about the future purchasing power of money otherwise than by looking at its configuration in the immediate past. It is this fact that radically distinguishes the determination of the purchasing power of money from the determination of the mutual exchange ratios between the various vendible goods and services. With regard to these latter the actors have nothing else to consider than their importance for future want-satisfaction. If a new commodity unheard of before is offered for sale, as was, for instance, the case with radio sets a few decades ago, the only question that matters for the individual is whether or not the satisfaction that the new gadget will provide is greater than that expected from those goods he would have to renounce in order to buy the new thing. Knowledge about past prices is for the buyer merely a means to reap a consumer’s surplus. If he were not intent upon this goal, he could, if need be, arrange his purchases without any familiarity with the market prices of the immediate past, which are popularly called present prices. He could make value judgments without appraisement. As has been mentioned already, the obliteration of the memory of all prices of the past would not prevent the formation of new exchange ratios between the various vendible things. But if knowledge about money’s purchasing power were to fade away, the process of developing indirect exchange and media of exchange would have to start anew. It would become necessary to begin again with employing some goods, more marketable than the rest, as media of exchange. The demand for these goods would increase and would add to the amount of exchange value derived from their industrial (nonmonetary) employment a specific component due to their new use as a medium of exchange. A value judgment is, with reference to money, only possible if it can be based on appraisement. The acceptance of a new kind of money presupposes that the thing in question already has previous exchange value on account of the services it can render directly to consumption or production. Neither a buyer nor a seller could judge the value of a monetary unit if he had no information about its exchange value—its purchasing power—in the immediate past.

The relation between the demand for money and the supply of money, which may be called the money relation, determines the height of purchasing power. Today’s money relation, as it is shaped on the ground of yesterday’s purchasing power, determines today’s purchasing power. He who wants to increase his cash holding restricts his purchases and increases his sales and thus brings about a tendency toward falling prices. He who wants to reduce his cash holding increases his purchases—either for consumption or for production and investment—and restricts his sales; thus he brings about a tendency toward rising prices.

Changes in the supply of money must necessarily alter the disposition of vendible goods as owned by various individuals and firms. The quantity of money available in the whole market system cannot increase or decrease otherwise than by first increasing or decreasing the cash holdings of certain individual members. We may, if we like, assume that every member gets a share of the additional money right at the moment of its inflow into the system, or shares in the reduction of the quantity of money. But whether we assume this or not, the final result of our demonstration will remain the same. This result will be that changes in the structure of prices brought about by changes in the supply of money available in the economic system never affect the prices of the various commodities and services to the same extent and at the same date.

Let us assume that the government issues an additional quantity of paper money. The government plans either to buy commodities and services or to repay debts incurred or to pay interest on such debts. However this may be, the treasury enters the market with an additional demand for goods and services; it is now in a position to buy more goods than it could buy before. The prices of the commodities it buys rise. If the government had expended in its purchases money collected by taxation, the taxpayers would have restricted their purchases and, while the prices of goods bought by the government would have risen, those of other goods would have dropped. But this fall in the prices of the goods the taxpayers used to buy does not occur if the government increases the quantity of money at its disposal without reducing the quantity of money in the hands of the public. The prices of some commodities—viz., of those the government buys—rise immediately, while those of the other commodities remain unaltered for the time being. But the process goes on. Those selling the commodities asked for by the government are now themselves in a position to buy more than they used previously. The prices of the things these people are buying in larger quantities therefore rise too. Thus the boom spreads from one group of commodities and services to other groups until all prices and wage rates have risen. The rise in prices is thus not synchronous for the various commodities and services.

When eventually, in the further course of the increase in the quantity of money, all prices have risen, the rise does not affect the various commodities and services to the same extent. For the process has affected the material position of various individuals to different degrees. While the process is under way, some people enjoy the benefit of higher prices for the goods or services they sell, while the prices of the things they buy have not yet risen or have not risen to the same extent. On the other hand, there are people who are in the unhappy situation of selling commodities and services whose prices have not yet risen or not in the same degree as the prices of the goods they must buy for their daily consumption. For the former the progressive rise in prices is a boon, for the latter a calamity. Besides, the debtors are favored at the expense of the creditors. When the process once comes to an end, the wealth of various individuals has been affected in different ways and to different degrees. Some are enriched, some impoverished. Conditions are no longer what they were before. The new order of things results in changes in the intensity of demand for various goods. The mutual ratio of the money prices of the vendible goods and services is no longer the same as before. The price structure has changed apart from the fact that all prices in terms of money have risen. The final prices to the establishment of which the market tends after the effects of the increase in the quantity of money have been fully consummated are not equal to the previous final prices multiplied by the same multiplier.

The main fault of the old quantity theory as well as the mathematical economists’ equation of exchange is that they have ignored this fundamental issue. Changes in the supply of money must bring about changes in other data too. The market system before and after the inflow or outflow of a quantity of money is not merely changed in that the cash holdings of the individuals and prices have increased or decreased. There have been effected also changes in the reciprocal exchange ratios between the various commodities and services which, if one wants to resort to metaphors, are more adequately described by the image of price revolution than by the misleading figure of an elevation or a sinking of the “price level.”

We may at this point disregard the effects brought about by the influence on the content of all deferred payments as stipulated by contracts. We will deal later with them and with the operation of monetary events on consumption and production, investment in capital goods, and accumulation and consumption of capital. But even in setting aside all these things, we must never forget that changes in the quantity of money affect prices in an uneven way. It depends on the data of each particular case at what moment and to what extent the prices of the various commodities and services are affected. In the course of a monetary expansion (inflation) the first reaction is not only that the prices of some of them rise more quickly and more steeply than others. It may also occur that some fall at first as they are for the most part demanded by those groups whose interests are hurt.

Changes in the money relation are not only caused by governments issuing additional paper money. An increase in the production of the precious metals employed as money has the same effects although, of course, other classes of the population may be favored or hurt by it. Prices also rise in the same way if, without a corresponding reduction in the quantity of money available, the demand for money falls because of a general tendency toward a diminution of cash holdings. The money expended additionally by such a “dishoarding” brings about a tendency toward higher prices in the same way as that flowing from the gold mines or from the printing press. Conversely, prices drop when the supply of money falls (e.g., through a withdrawal of paper money) or the demand for money increases (e.g., through a tendency toward “hoarding,” the keeping of greater cash balances). The process is always uneven and by steps, disproportionate and asymmetrical.

It could be and has been objected that the normal production of the gold mines brought to the market may well entail an increase in the quantity of money, but does not increase the income, still less the wealth, of the owners of the mines. These people earn only their “normal” income and thus their spending of it cannot disarrange market conditions and the prevailing tendencies toward the establishment of final prices and the equilibrium of the evenly rotating economy. For them, the annual output of the mines does not mean an increase in riches and does not impel them to offer higher prices. They will continue to live at the standard at which they used to live before. Their spending within these limits will not revolutionize the market. Thus the normal amount of gold production, although certainly increasing the quantity of money available, cannot put into motion the process of depreciation. It is neutral with regard to prices.

As against this reasoning one must first of all observe that within a progressing economy in which population figures are increasing and the division of labor and its corollary, industrial specialization, are perfected, there prevails a tendency toward an increase in the demand for money. Additional people appear on the scene and want to establish cash holdings. The extent of economic self-sufficiency, i.e., of production for the household’s own needs, shrinks and people become more dependent upon the market; this will, by and large, impel them to increase their holding of cash. Thus the price-raising tendency emanating from what is called the “normal” gold production encounters a price-cutting tendency emanating from the increased demand for cash holding. However, these two opposite tendencies do not neutralize each other. Both processes take their own course, both result in a disarrangement of existing social conditions, making some people richer, some people poorer. Both affect the prices of various goods at different dates and to a different degree. It is true that the rise in the prices of some commodities caused by one of these processes can finally be compensated by the fall caused by the other process. It may happen that at the end some or many prices come back to their previous height. But this final result is not the outcome of an absence of movements provoked by changes in the money relation. It is rather the outcome of the joint effect of the coincidence of two processes independent of each other, each of which brings about alterations in the market data as well as in the material conditions of various individuals and groups of individuals. The new structure of prices may not differ very much from the previous one. But it is the resultant of two series of changes which have accomplished all inherent social transformations.

The fact that the owners of gold mines rely upon steady yearly proceeds from their gold production does not cancel the newly mined gold’s impression upon prices. The owners of the mines take from the market, in exchange for the gold produced, the goods and services required for their mining and the goods needed for their consumption and their investments in other lines of production. If they had not produced this amount of gold, prices would not have been affected by it. It is beside the point that they have anticipated the future yield of the mines and capitalized it and that they have adjusted their standard of living to the expectation of steady proceeds from the mining operations. The effects which the newly mined gold exercises on their expenditure and on that of those people whose cash holdings it enters later step by step begin only at the instant this gold is available in the hands of the mine owners. If, in the expectation of future yields, they had expended money at an earlier date and the expected yield failed to appear, conditions would not differ from other cases in which consumption was financed by credit based on expectations not realized by later events.

Changes in the extent of the desired cash holding of various people neutralize one another only to the extent that they are regularly recurring and mutually connected by a causal reciprocity. Salaried people and wage earners are not paid daily, but at certain pay days for a period of one or several weeks. They do not plan to keep their cash holding within the period between pay days at the same level; the amount of cash in their pockets declines with the approach of the next pay day. On the other hand, the merchants who supply them with the necessities of life increase their cash holdings concomitantly. The two movements condition each other; there is a causal interdependence between them which harmonizes them both with regard to time and to quantitative amount. Neither the dealer nor his customer lets himself be influenced by these recurrent fluctuations. Their plans concerning cash holding as well as their business operations and their spending for consumption respectively have the whole period in view and take it into account as a whole.

It was this phenomenon that led economists to the image of a regular circulation of money and to the neglect of the changes in the individuals’ cash holdings. However, we are faced with a concatenation which is limited to a narrow, neatly circumscribed field. Only as far as the increase in the cash holding of one group of people is temporally and quantitatively related to the decrease in the cash holding of another group and as far as these changes are self-liquidating within the course of a period which the members of both groups consider as a whole in planning their cash holding, can the neutralization take place. Beyond this field there is no question of such a neutralization.

5

The Problem of Hume and Mill and the Driving Force of Money

Is it possible to think of a state of affairs in which changes in the purchasing power of money occur at the same time and to the same extent with regard to all commodities and services and in proportion to the changes effected in either the demand for or the supply of money? In other words, is it possible to think of neutral money within the frame of an economic system which does not correspond to the imaginary construction of an evenly rotating economy? We may call this pertinent question the problem of Hume and Mill.

It is uncontested that neither Hume nor Mill succeeded in finding a positive answer to this question.9 Is it possible to answer it categorically in the negative?

We imagine two systems of an evenly rotating economy A and B. The two systems are independent and in no way connected with one another. The two systems differ from one another only in the fact that to each amount of money m in A there corresponds an amount n m in B, n being greater or smaller than 1; we assume that there are no deferred payments and that the money used in both systems serves only monetary purposes and does not allow of any nonmonetary use. Consequently the prices in the two systems are in the ratio 1:n. Is it thinkable that conditions in A can be altered at one stroke in such a way as to make them entirely equivalent to conditions in B?

The answer to this question must obviously be in the negative. He who wants to answer it in the positive must assume that a deus ex machina [(Latin) providential, god-like, intervention] approaches every individual at the same instant, increases or decreases his cash holding by multiplying it by n, and tells him that henceforth he must multiply by n all price data which he employs in his appraisements and calculations. This cannot happen without a miracle.

It has been pointed out already that in the imaginary construction of an evenly rotating economy the very notion of money vanishes into an unsubstantial calculation process, self-contradictory and devoid of any meaning.10 It is impossible to assign any function to indirect exchange, media of exchange, and money within an imaginary construction the characteristic mark of which is unchangeability and rigidity of conditions.

Where there is no uncertainty concerning the future, there is no need for any cash holding. As money must necessarily be kept by people in their cash holdings, there cannot be any money. The use of media of exchange and the keeping of cash holdings are conditioned by the changeability of economic data. Money in itself is an element of change; its existence is incompatible with the idea of a regular flow of events in an evenly rotating economy.

Every change in the money relation alters—apart from its effects upon deferred payments—the conditions of the individual members of society. Some become richer, some poorer. It may happen that the effects of a change in the demand for and supply of money encounter the effects of opposite changes occurring by and large at the same time and to the same extent; it may happen that the resultant of the two opposite movements is such that no conspicuous changes in the price structure emerge. But even then the effects on the conditions of the various individuals are not absent. Each change in the money relation takes its own course and produces its own particular effects. If an inflationary movement and a deflationary one occur at the same time or if an inflation is temporally followed by a deflation in such a way that prices finally are not very much changed, the social consequences of each of the two movements do not cancel each other. To the social consequences of an inflation those of a deflation are added. There is no reason to assume that all or even most of those favored by one movement will be hurt by the second one, or vice versa.

Money is neither an abstract numéraire nor a standard of value or prices. It is necessarily an economic good and as such it is valued and appraised on its own merits, i.e., the services which a man expects from holding cash. On the market there is always change and movement. Only because there are fluctuations is there money. Money is an element of change not because it “circulates,” but because it is kept in cash holdings. Only because people expect changes about the kind and extent of which they have no certain knowledge whatsoever, do they keep money.

While money can be thought of only in a changing economy, it is in itself an element of further changes. Every change in the economic data sets it in motion and makes it the driving force of new changes. Every shift in the mutual relation of the exchange ratios between the various nonmonetary goods not only brings about changes in production and in what is popularly called distribution, but also provokes changes in the money relation and thus further changes. Nothing can happen in the orbit of vendible goods without affecting the orbit of money, and all that happens in the orbit of money affects the orbit of commodities.

The notion of a neutral money is no less contradictory than that of a money of stable purchasing power. Money without a driving force of its own would not, as people assume, be a perfect money; it would not be money at all.

It is a popular fallacy to believe that perfect money should be neutral and endowed with unchanging purchasing power, and that the goal of monetary policy should be to realize this perfect money. It is easy to understand this idea as a reaction against the still more popular postulates of the inflationists. But it is an excessive reaction, it is in itself confused and contradictory, and it has worked havoc because it was strengthened by an inveterate error inherent in the thought of many philosophers and economists.

These thinkers are misled by the widespread belief that a state of rest is more perfect than one of movement. Their idea of perfection implies that no more perfect state can be thought of and consequently that every change would impair it. The best that can be said of a motion is that it is directed toward the attainment of a state of perfection in which there is rest because every further movement would lead into a less perfect state. Motion is seen as the absence of equilibrium and full satisfaction, as a manifestation of trouble and want. As far as such thoughts merely establish the fact that action aims at the removal of uneasiness and ultimately at the attainment of full satisfaction, they are well founded. But one must not forget that rest and equilibrium are not only present in a state in which perfect contentment has made people perfectly happy, but no less in a state in which, although wanting in many regards, they do not see any means of improving their condition. The absence of action is not only the result of full satisfaction; it can no less be the corollary of the inability to render things more satisfactory. It can mean hopelessness as well as contentment.

With the real universe of action and unceasing change, with the economic system which cannot be rigid, neither neutrality of money nor stability of its purchasing power are compatible. A world of the kind which the necessary requirements of neutral and stable money presuppose would be a world without action.

It is therefore neither strange nor vicious that in the frame of such a changing world money is neither neutral nor stable in purchasing power. All plans to render money neutral and stable are contradictory. Money is an element of action and consequently of change. Changes in the money relation, i.e., in the relation of the demand for and the supply of money, affect the exchange ratio between money on the one hand and the vendible commodities on the other hand. These changes do not affect at the same time and to the same extent the prices of the various commodities and services. They consequently affect the wealth of the various members of society in a different way.

6

Cash-Induced and Goods-Induced Changes in Purchasing Power

Changes in the purchasing power of money, i.e., in the exchange ratio between money and the vendible goods and commodities, can originate either from the side of money or from the side of the vendible goods and commodities. The change in the data which provokes them can either occur in the demand for and supply of money or in the demand for and supply of the other goods and services. We may accordingly distinguish between cash-induced and goods-induced changes in purchasing power.

Goods-induced changes in purchasing power can be brought about by changes in the supply of commodities and services or in the demand for individual commodities and services. A general rise or fall in the demand for all goods and services or the greater part of them can be effected only from the side of money.

Let us now scrutinize the social and economic consequences of changes in the purchasing power of money under the following three assumptions: first, that the money in question can only be used as money—i.e., as a medium of exchange—and can serve no other purpose; second, that there is only exchange of present goods and no exchange of present goods against future goods; third, that we disregard the effects of changes in purchasing power on monetary calculation.

Under these assumptions all that cash-induced changes in purchasing power bring about are shifts in the disposition of wealth among different individuals. Some get richer, others poorer; some are better supplied, others less; what some people gain is paid for by the loss of others. It would, however, be impermissible to interpret this fact by saying that total satisfaction remained unchanged or that, while no changes have occurred in total supply, the state of total satisfaction or of the sum of happiness has been increased or decreased by changes in the distribution of wealth. The notions of total satisfaction or total happiness are empty. It is impossible to discover a standard for comparing the different degrees of satisfaction or happiness attained by various individuals.

Cash-induced changes in purchasing power indirectly generate further changes by favoring either the accumulation of additional capital or the consumption of capital available. Whether and in what direction such secondary effects are brought about depends on the specific data of each case. We shall deal with these important problems at a later point.11

Goods-induced changes in purchasing power are sometimes nothing else but consequences of a shift of demand from some goods to others. If they are brought about by an increase or a decrease in the supply of goods they are not merely transfers from some people to other people. They do not mean that Peter gains what Paul has lost. Some people may become richer although nobody is impoverished, and vice versa.

We may describe this fact in the following way: Let A and B be two independent systems which are in no way connected with each other. In both systems the same kind of money is used, a money which cannot be used for any nonmonetary purpose. Now we assume, as case 1, that A and B differ from each other only in so far as in B the total supply of money is n m, m being the total supply of money in A, and that to every cash holding of c and to every claim in terms of money d in A there corresponds a cash holding of n c and a claim of n d in B. Inevery other respect A equals B. Then we assume, as case 2, that A and B differ from each other only in so far as in B the total supply of a certain commodity r is n p, p being the total supply of this commodity in A, and that to every stock v of this commodity r in A there corresponds a stock of n v in B. In both cases n is greater than 1. If we ask every individual of A whether he is ready to make the slightest sacrifice in order to exchange his position for the corresponding place in B, the answer will be unanimously in the negative in case 1. But in case 2 all owners of r and all those who do not own any r, but are eager to acquire a quantity of it—i.e., at least one individual—will answer in the affirmative.

The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power. As the operation of the market tends to determine the final state of money’s purchasing power at a height at which the supply of and the demand for money coincide, there can never be an excess or a deficiency of money. Each individual and all individuals together always enjoy fully the advantages which they can derive from indirect exchange and the use of money, no matter whether the total quantity of money is great or small. Changes in money’s purchasing power generate changes in the disposition of wealth among the various members of society. From the point of view of people eager to be enriched by such changes, the supply of money may be called insufficient or excessive, and the appetite for such gains may result in policies designed to bring about cash-induced alterations in purchasing power. However, the services which money renders can be neither improved nor repaired by changing the supply of money. There may appear an excess or a deficiency of money in an individual’s cash holding. But such a condition can be remedied by increasing or decreasing consumption or investment. (Of course, one must not fall prey to the popular confusion between the demand for money for cash holding and the appetite for more wealth.) The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.

From the point of view of this insight one may call wasteful all expenditures incurred for increasing the quantity of money. The fact that things which could render some other useful services are employed as money and thus withheld from these other employments appears as a superfluous curtailment of limited opportunities for want-satisfaction. It was this idea that led Adam Smith and Ricardo to the opinion that it was very beneficial to reduce the cost of producing money by resorting to the use of paper printed currency. However, things appear in a different light to the students of monetary history. If one looks at the catastrophic consequences of the great paper money inflations, one must admit that the expensiveness of gold production is the minor evil. It would be futile to retort that these catastrophes were brought about by the improper use which the governments made of the powers that credit money and fiat money placed in their hands and that wiser governments would have adopted sounder policies. As money can never be neutral and stable in purchasing power, a government’s plans concerning the determination of the quantity of money can never be impartial and fair to all members of society. Whatever a government does in the pursuit of aims to influence the height of purchasing power depends necessarily upon the rulers’ personal value judgments. It always furthers the interests of some groups of people at the expense of other groups. It never serves what is called the commonweal or the public welfare. In the field of monetary policies too there is no such thing as a scientific ought.

The choice of the good to be employed as a medium of exchange and as money is never indifferent. It determines the course of the cash-induced changes in purchasing power. The question is only who should make the choice: the people buying and selling on the market, or the government? It was the market which in a selective process, going on for ages, finally assigned to the precious metals gold and silver the character of money. For two hundred years the governments have interfered with the market’s choice of the money medium. Even the most bigoted étatists do not venture to assert that this interference has proved beneficial.

[5. ]Cf. Carl Menger’s books Grundsätze der Volkswirtschaftslehre (Vienna, 1871), pp. 250 ff.; ibid. (2d ed. Vienna, 1923), pp. 241 ff.; Untersuchungen über die Methode der Sozialwissenschaften (Leipzig, 1883), p. 171 ff. [Menger’s Grundsätze . . . was translated into English by James Dingwall and Bert F. Hoselitz and published with an Introduction by Frank H. Knight, as Principles of Economics (Glencoe, Ill.: The Free Press, 1950). The section on money (pp. 250 ff. in the German edition) is on pp. 257 ff. in the English translation. Untersuchungen . . . was translated into English by Francis J. Nock, edited and published with an Introduction by Louis Schneider, as Problems of Economics and Sociology (Urbana: University of Illinois Press, 1963); pp. 171 ff. in the German edition are pp. 152 ff. in the English version.]

[6. ]Cf. Menger, Untersuchungen, l.c., p. 178. [The quotation on p. 178 of the German Untersuchungen appears in Problems of Economics and Sociology (1963) on p. 133 of the English translation.]

[7. ]The problems of money exclusively dedicated to the service of a medium of exchange and not fit to render any other services on account of which it would be demanded are dealt with below in section 9.

[8. ]The present writer first developed this regression theorem of purchasing power in the first edition of his book Theory of Money and Credit, published in 1912 (pp. 97–123 of the English-language translation; pp. 117–44 in Liberty Fund’s 1980 edition). His theorem has been criticized from various points of view. Some of the objections raised, especially those by B. M. Anderson in his thoughtful book The Value of Money, first published in 1917 (cf. pp. 100 ff. of the 1936 edition), deserve a very careful examination. The importance of the problems involved makes it necessary to weigh also the objections of H. Ellis (German Monetary Theory 1905–1933 [Cambridge, 1934], pp. 77 ff.). In the text above, all objections raised are particularized and critically examined.

[9. ]Cf. Mises, Theory of Money and Credit, pp. 140–42; Liberty Fund edition, 1980, pp. 162–64.

[10. ]Cf. above, p. 249.

[11. ]Cf. below, Chapter 20.