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• Foreword
• On the Manipulation of Money and Credit Three Treatises On Trade-cycle Theory
• Stabilization of the Monetary Unit— From the Viewpoint of Theory
• Introduction *
• I: The Outcome of Inflation
• II: The Emancipation of Monetary Value From the Influence of Government
• III: The Return to Gold
• IV: The Money Relation
• V: Comments On the “balance of Payments” Doctrine
• VI: The Inflationist Argument
• VII: The New Monetary System
• VIII: The Ideological Meaning of Reform
• Appendix: Balance of Payments and Foreign Exchange Rates *
• Monetary Stabilization and Cyclical Policy
• Preface *
• Part I: Stabilization of the Purchasing Power of the Monetary Unit
• I: The Problem
• II: The Gold Standard
• III: The “manipulation” of the Gold Standard
• IV: “measuring” Changes In the Purchasing Power of the Monetary Unit
• V: Fisher’s Stabilization Plan
• VI: Goods-induced and Cash-induced Changes In the Purchasing Power of the Monetary Unit
• VII: The Goal of Monetary Policy
• Part II: Cyclical Policy to Eliminate Economic Fluctuations
• I: Stabilization of the Purchasing Power of the Monetary Unit and Elimination of the Trade Cycle
• II: Circulation Credit Theory
• III: The Reappearance of Cycles
• IV: The Crisis Policy of the Currency School
• V: Modern Cyclical Policy
• VI: Control of the Money Market
• VII: Business Forecasting For Cyclical Policy and the Businessman
• VIII: The Aims and Method of Cyclical Policy
• The Causes of the Economic Crisis an Address
• I: The Nature and Role of the Market
• II: Cyclical Changes In Business Conditions
• III: The Present Crisis
• A.: Unemployment
• B.: Price Declines and Price Supports
• C.: Tax Policy
• D.: Gold Production
• IV: Is There a Way Out?
• The Current Status of Business Cycle Research and Its Prospects For the Immediate Future
• 1.: The Acceptance of the Circulation Credit Theory of Business Cycles *
• 2.: The Popularity of Low Interest Rates
• 3.: The Popularity of Labor Union Policy
• 4.: The Effect of Lower Than Unhampered Market Interest Rates
• 5.: The Questionable Fear of Declining Prices
• The Trade Cycle and Credit Expansion: the Economic Consequences of Cheap Money
• 1.: Introductory Remarks *
• 2.: The Unpopularity of Interest
• 3.: The Two Classes of Credit
• 4.: The Function of Prices, Wage Rates and Interest Rates
• 5.: The Effects of Politically Lowered Interest Rates
• 6.: The Inevitable Ending

II

The Gold Standard

1.

The Demand for Money

Under the gold standard, the formation of the value of the monetary unit is not directly subject to the action of the government. The production of gold is free and responds only to the opportunity for profit. All gold not introduced into trade for consumption or for some other purpose flows into the economy as money, either as coins in circulation or as bars or coins in bank reserves. Should the increase in the quantity of money exceed the increase in the demand for money, then the purchasing power of the monetary unit must fall. Likewise, if the increase in the quantity of money lags behind the increase in the demand for money, the purchasing power of the monetary unit will rise.1

There is no doubt about the fact that, in the last generation, the purchasing power of gold has declined. Yet earlier, during the two decades following the German monetary reform and the great economic crisis of 1873, there was widespread complaint over the decline of commodity prices. Governments consulted experts for advice on how to eliminate this generally prevailing “evil.” Powerful political parties recommended measures for pushing prices up by increasing the quantity of money. In place of the gold standard, they advocated the silver standard, the double standard [bimetallism] or even a paper standard, for they considered the annual production of gold too small to meet the growing demand for money without increasing the purchasing power of the monetary unit. However, these complaints died out in the last five years of the nineteenth century, and soon men everywhere began to grumble about the opposite situation, i.e., the increasing cost of living. Just as they had proposed monetary reforms in the 1880’s and 1890’s to counteract the drop in prices, they now suggested measures to stop prices from rising.

The general advance of the prices of all goods and services in terms of gold is due to the state of gold production and the demand for gold, both for use as money as well as for other purposes. There is little to say about the production of gold and its influence on the ratio of the value of gold to that of other commodities. It is obvious that a smaller increase in the available quantity of gold might have counteracted the depreciation of gold. Nor need anything special be said about the industrial uses of gold. But the third factor involved, the way demand is created for gold as money, is quite another matter. Very careful attention should be devoted to this problem, especially as the customary analysis ignores most unfairly this monetary demand for gold.

During the period for which we are considering the development of the purchasing power of gold, various parts of the world, which formerly used silver or credit money (“paper money”) domestically, have changed over to the gold standard. Everywhere, the volume of money transactions has increased considerably. The division of labor has made great progress. Economic self-sufficiency and barter have declined. Monetary exchanges now play a role in phases of economic life where earlier they were completely unknown. The result has been a decided increase in the demand for money. There is no point in asking whether this increase in the demand for cash holdings by individuals, together with the demand for gold for non-monetary uses, was sufficient to counteract the effect on prices of the new gold flowing into the market from production. Statistics on the height and fluctuations of cash holdings are not available. Even if they could be known, they would tell us little because the changes in prices do not correspond with changes in the relationship between supply and demand for cash holdings. Of greater importance, however, is the observation that the increase in the demand for money is not the same thing as an increase in the demand for gold for monetary purposes.

As far as the individual’s cash holding is concerned, claims payable in money, which may be redeemed at any time and are universally considered safe, perform the service of money. These money substitutes—small coins, banknotes and bank deposits subject to check or similar payment on demand (checking accounts)—may be used just like money itself for the settlement of all transactions. Only a part of these money substitutes, however, is fully covered by stocks of gold on deposit in the banks’ reserves. In the decades of which we speak, the use of money substitutes has increased considerably more than has the rise in the demand for money and, at the same time, its reserve ratio has worsened. As a result, in spite of an appreciable increase in the demand for money, the demand for gold has not risen enough for the market to absorb the new quantities of gold flowing from production without lowering its purchasing power.

2.

Economizing on Money

If one complains of the decline in the purchasing power of gold today, and contemplates the creation of a monetary unit whose purchasing power shall be more constant than that of gold in recent decades, it should not be forgotten that the principal cause of the decline in the value of gold during this period is to be found in monetary policy and not in gold production itself. Money substitutes not covered by gold, which we call fiduciary media, occupy a relatively more important position today in the world’s total quantity of money2 than in earlier years. But this is not a development which would have taken place without the cooperation, or even without the express support, of governmental monetary policies. As a matter of fact, it was monetary policy itself which was deliberately aimed at a “saving” of gold and which created, thereby, the conditions that led inevitably to the depreciation of gold.

The fact that we use as money a commodity like gold, which is produced only with a considerable expenditure of capital and labor, saddles mankind with certain costs. If the amount of capital and labor spent for the production of monetary gold could be released and used in other ways, people could be better supplied with goods for their immediate needs. There is no doubt about that! However, it should be noted that, in return for this expenditure, we receive the advantage of having available, for settling transactions, a money with a relatively steady value and, what is more important, the value of which is not directly influenced by governments and political parties. However, it is easy to understand why men began to ponder the possibility of creating a monetary system that would combine all the advantages offered by the gold standard with the added virtue of lower costs.

Adam Smith drew a parallel between the gold and silver which circulated in a land as money and a highway on which nothing grew, but over which fodder and grain were brought to market. The substitution of notes for the precious metals would create, so to speak, a “waggonway through the air,” making it possible to convert a large part of the roads into fields and pastures and, thus, to increase considerably the yearly output of the economy. Then in 1816, Ricardo devised his famous plan for a gold exchange standard. According to his proposal, England should retain the gold standard, which had proved its value in every respect. However, gold coins should be replaced in domestic trade by banknotes, and these notes should be redeemable, not in gold coins, but in bullion only. Thus the notes would be assured of a value equivalent to that of gold and the country would have the advantage of possessing a monetary standard with all the attributes of the gold standard but at a lower cost.

Ricardo’s proposals were not put into effect for decades. As a matter of fact, they were even forgotten. Nevertheless, the gold exchange standard was adopted by a number of countries during the 1890’s—in the beginning usually as a temporary expedient only, without intending to direct monetary policy on to a new course. Today it is so widespread that we would be fully justified in describing it as “the monetary standard of our age.”3 However, in a majority, or at least in quite a number of these countries, the gold exchange standard has undergone a development which entitles it to be spoken of rather as a flexible gold exchange standard. Under Ricardo’s plan, savings would be realized not only by avoiding the costs of coinage and the loss from wearing coins thin in use, but also because the amount of gold required for circulation and bank reserves would be less than under the “pure” gold standard.

Carrying out this plan in a single country must obviously, ceteris paribus, reduce the purchasing power of gold. And the more widely the system was adopted, the more must the purchasing power of gold decline. If a single land adopts the gold exchange standard, while others maintain a “pure” gold standard, then the gold exchange standard country can gain an immediate advantage over costs in the other areas. The gold which is surplus under the gold exchange standard, as compared with the gold which would have been called for under the “pure” gold standard, may be spent abroad for other commodities. These additional commodities represent an improvement in the country’s welfare as a result of introducing the gold exchange standard. The gold exchange standard renders all the services of the gold standard to this country and also brings an additional advantage in the form of this increase of goods.

However, should every country in the world shift at the same time from the “pure” gold standard to a similar gold exchange standard, no gain of this kind would be possible. The distribution of gold throughout the world would remain unchanged. There would be no country where one could exchange a quantity of gold, made superfluous by the adoption of the new monetary system, for other goods. Embracing the new standard would result only in a universally more severe reduction in the purchasing power of gold. This monetary depreciation, like every change in the value of money, would bring about dislocations in the relationships of wealth and income of the various individuals in the economy. As a result, it could also lead indirectly, under certain circumstances, to an increase in capital accumulation. However, this indirect method will make the world richer only insofar as (1) the demand for gold for other uses (industrial and similar purposes) can be better satisfied and (2) a decline in profitability leads to a restriction of gold production and so releases capital and labor for other purposes.

3.

Interest on “Idle” Reserves

In addition to these attempts toward “economy” in the operation of the gold standard, by reducing the domestic demand for gold, other efforts have also aimed at the same objective. Holding gold reserves is costly to the banks of issue because of the loss of interest. Consequently, it was but a short step to the reduction of these costs by permitting non-interest-bearing gold reserves in bank vaults to be replaced by interest-bearing credit balances abroad, payable in gold on demand, and by bills of exchange payable in gold. Assets of this type enable the banks of issue to satisfy demands for gold in foreign trade just as the possession of a stock of gold coins and bars would. As a matter of fact, the dealer in arbitrage who presents notes for redemption will prefer payment in the form of checks, and bills of exchange—foreign financial paper—to redemption in gold because the costs of shipping foreign financial papers are lower than those for the transport of gold. The banks of smaller and poorer lands especially converted a part of their reserves into foreign bills of exchange. The inducement was particularly strong in countries on the gold exchange standard, where the banks did not have to consider a demand for gold for use in domestic circulation. In this way, the gold exchange standard [Goldkernwährung] became the flexible gold exchange standard [Golddevisenkernwährung], i.e., the flexible standard.

Nevertheless, the goal of this policy was not only to reduce the costs involved in the maintenance and circulation of an actual stock of gold. In many countries, including Germany and Austria, this was thought to be a way to reduce the rate of interest. The influence of the Currency Theory had led, decades earlier, to banking legislation intended to avoid the consequences of a paper money inflation. These laws, limiting the issue of banknotes not covered by gold, were still in force. Reared in the Historical-Realistic School of economic thinking, the new generation, insofar as it dealt with these problems, was under the spell of the Banking Theory, and thus no longer understood the meaning of these laws.

Lack of originality prevented the new generation from embarking upon any startling reversal in policy. In line with currently prevailing opinion, it abolished the limitation on the issue of banknotes not covered by metal. The old laws were allowed to stay on the books essentially unchanged. However, various attempts were made to reduce their effect. The most noteworthy of these measures was to encourage, systematically and purposefully, the settlement of transactions without the use of cash. By supplanting cash transactions with checks and other transfer payments, it was expected not only that there would be a reduction in the demand for banknotes but also a flow of gold coins back to the bank and, consequently, a strengthening of the bank’s cash position. As German, and also Austrian, banking legislation prescribed a certain percentage of gold cover for notes issued, gold flowing back to the bank meant that more notes could be issued—up to three times their gold value in Germany and two and a half times in Austria. During recent decades, the banking theory has been characterized by a belief that this should result in a reduction in the rate of interest.

4.

Gold Still Money

If we glance, even briefly, at the efforts of monetary and banking policy in recent years, it becomes obvious that the depreciation of gold may be traced in large part to political measures. The decline in the purchasing power of gold and the continual increase in the gold price of all goods and services were not natural phenomena. They were consequences of an economic policy which aimed, to be sure, at other objectives, but which necessarily led to these results. As has already been mentioned, accurate quantitative observations about these matters can never be made. Nevertheless, it is obvious that the increase in gold production has certainly not been the cause, or at least not the only cause, of the depreciation of gold that has been observed since 1896. The policy directed toward displacing gold in actual circulation, which aimed at substituting the gold exchange standard and the flexible standard for the older “pure” gold standard, forced the value of gold down or at least helped to depress it. Perhaps, if this policy had not been followed, we would hear complaints today over the increase, rather than the depreciation, in the value of gold.

Gold has not been demonetized by the new monetary policy, as silver was a short time ago, for it remains the basis of our entire monetary system. Gold is still, as it was formerly, our money. There is no basis for saying that it has been de-throned, as suggested by scatterbrained innovators of catchwords and slogans who want to cure the world of the “money illusion.” Nevertheless, gold has been removed from actual use in transactions by the public at large. It has disappeared from view and has been concentrated in bank vaults and monetary reserves. Gold has been taken out of common use and this must necessarily tend to lower its value.

It is wrong to point to the general price increases of recent years to illustrate the inadequacy of the gold standard. It is not the old style gold standard, as recommended by advocates of the gold standard in England and Germany, which has given us a monetary system that has led to rising prices in recent years. Rather these price increases have been the results of monetary and banking policies which permitted the “pure” or “classical” gold standard to be replaced by the gold exchange and flexible standards, leaving in circulation only notes and small coins and concentrating the gold stocks in bank and currency reserves.

[1. ]This is not the place to examine further the theory of the formation of the purchasing power of the monetary unit. In this connection, see The Theory of Money and Credit [(Yale, 1953) pp. 97–165 and (Liberty Fund, 1981), pp. 117–189.—Ed.].

[2. ]The quantity of “money in the broader sense” is equal to the quantity of money proper [i.e., commodity money] plus the quantity of fiduciary media [i.e., notes, bank deposits not backed by metal, and subsidiary coins.]

[3. ]Machlup, Fritz. Die Goldkernwährung. Halberstadt, 1925, p. xi.