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CHAPTER 7: The General Rise in Prices in the Light of Economic Theory 1 - Ludwig von Mises, Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War [2012]

Edition used:

Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War, edited and with an Introduction by Richard M. Ebeling (Indianapolis: Liberty Fund, 2012).

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.


CHAPTER 7

The General Rise in Prices in the Light of Economic Theory1

The problem of rising prices, which has for many years occupied the attention of our best minds, cannot be dealt with in the usual statistical-empirical manner. The collection and comparison of price data is not a substitute for the intellectual work of theoretical economists; nor can it lead to clear thinking and a correct understanding of the interrelationships involved. The multivolume publications of the statistical bureaus, with a wealth of figures and tables, have not brought the problem one step closer to a solution. What we know about the origin, nature, and significance of fluctuations in prices has not resulted from the processing of statistical materials. On the whole, statistical material is valuable only insofar as it can be used in conjunction with the findings of economic theory. Those who seek to find their way through the darkness of statistical figures will succeed only where economic theory lights the way.

Once the work of gathering the numbers is completed, the statistician has finished his job. The conclusions drawn from the assembled material are determined by economic theory. The conclusions are not strengthened by being linked to a statistical apparatus. They do not follow with the force of logical deduction from the study of the statistical material. Contradictory conclusions can easily be drawn from the profusion of complementary and opposing economic factors, the relative significance of which the observer must determine by means of abstract reasoning for the purposes of his investigation. Apart from a few trivial matters of detail, it is impossible to ascribe to price statistics any role other than that of illustrating the sound results of price theory. If we look more closely we can easily see that every writer who did not limit himself to the assembling of data but also tried to study causal relationships started out from certain theoretical conceptions that guided his thinking. The literature on inflation is completely dominated by the premises of price theory, and these form the basis of the various articles on the subject.

Nowadays, these articles are not always of the highest caliber. Very often—insofar as we are speaking about German writings, it would unfortunately be more correct to say nearly always—we find lines of reasoning that have long since been surpassed by more recent scholarly developments. The basic theory of supply and demand and the quantity theory of money are referred to and challenged in these articles in a manner similar to what one would expect to find one or two hundred years ago. But this is only a minor problem. The cost of production theory is presented in a naïve manner as well; and frequently we even run into the layman’s favorite theories presented with ethical and political commentaries that seek to make commodity speculation and usury responsible for all our economic ills. The forty-year-long development of the theory of subjective value has made hardly any impact at all in Germany.2

In addition to these “internal” difficulties, there are equally great “external” ones that confront the scholarly treatment of the problem of inflation. Rising prices are now one of our most important political problems. Every political party is committed to a specific theory about the causes of inflation, and each has a specific prescription for combating it. Whoever tries to examine the problem runs the risk of falling out with all the parties at the same time. Such a person would be getting off lightly if either the “political pragmatists” merely ignored his explanation as the work of a “theoretician alienated from the real world” or if the attacks directed against his scholarly efforts remained within the bounds of civil decency. Anyone daring to question the popular dogmas on the causes of and the cures for inflation must be prepared for rough treatment.3

General Price Increases and Particular Price Increases

When a general rise in prices, or simply higher prices, is referred to, this means a decline in the purchasing power (or the objective exchange value) of money. In an economy in which a general medium of exchange is not used, if the exchange relationship between one economic good and another changes, this refers to a rise in the price of one good relative to another. In this case, a higher or lower price cannot be discussed without more detail. If we set aside the use of money, it is clear that one good cannot become more expensive without all other goods becoming less expensive.

The problem that exclusively concerns us is a general rise in prices. We certainly do not claim that this is the only problem that is of interest in terms of increases in prices. Besides those changes in the exchange relationship between money and all other economic goods that originate from the side of money, there is also the issue of changes in the relative price relationships among different economic goods. It has to be recognized that a general increase in the level of prices does not affect the prices of all goods proportionally. The prices of some goods may rise more than others, and the prices of some goods may, on the contrary, actually decline.

This phenomenon is by no means attributable solely to the fact that the changes in the value of money always bring with them changes in the distribution of wealth and income, and therefore lead to changes in consumption, which then influence supply and demand and through them the prices of consumer goods. A number of independent causes lead to this phenomenon, and in the majority of cases it is not difficult to discover them. If it is in reference to the prices of meat, of milk, or of housing, the causes are seldom hard to find. Even the efforts of interested parties cannot succeed for very long in misleading the public about it. It is abundantly clear that the problem of general inflation (the general rise in the prices of goods) and the increase in the price of a particular good (the rise in the prices of individual goods or services) must be strictly separated. There is much confusion in journalistic discussions due to the failure to distinguish between the two.

The prices of individual commodities can rise or fall at the international level, though it is not always the case. It can happen that such changes are limited to the local level. If, for example, the price of brandy rises in Austria because the tax on brandy is increased, or if the price of meat goes up because the importation of cattle and meat is prohibited, this has no direct effect on the prices of brandy and meat in other countries. Foreign prices are not directly changed due to these taxes or regulations; if there is any indirect influence that takes place, it tends to work in the opposite direction. For example, it can lower the price of meat in Romania because exports to Austria have been banned, and therefore Austrian demand for Romanian meat has been stopped. To the extent that there is a general rise in prices, it is international in character. This results from the fact that at the present time gold is the international money. Gold is the world’s money, nowadays, and not only the money of a particular region or nation; therefore a lowering in its value always occurs at the international level.

The Quantity of Money and the Value of Money

The exchange relationship that exists between money and other economic goods must experience a change if individuals in the economy have a change in their demand for or supply of money. Ceteris paribus, the purchasing power of the monetary unit must decline if the quantity of money is increased and, conversely, the purchasing power of the monetary unit must rise if the quantity of money is decreased. This is the essence of the quantity theory, the oldest and most unchallengeable conclusion in the theory of money.4

The demands for money by individuals are not only satisfied by money alone. The same service can be provided by money substitutes, that is, generally recognized and secure claims to money that are payable on demand (e.g., banknotes, cashier’s checks, small coins, and the like). Money substitutes may or may not be “covered” by money. When they are covered by money, we call them “money certificates,” and when they are not covered they are called “fiduciary media.”5 It is clear that an increase or decrease in the quantity of fiduciary media must result in the same effect on the value of the monetary unit that is caused by an increase or decrease in the quantity of money.

If the supply of money (in the wider sense, including the supply of fiduciary media) is increased while the demand for money (in the wider sense, including the demand for fiduciary media) remains unchanged, then the objective exchange value of money will decline. This decline is, however, by no means inversely proportional to the increase in the supply of money; in addition, the change in the value of money does not occur simultaneously in the entire economy to the same extent with respect to all goods. It is not necessary to justify and explain this further, since I have done this elsewhere.

All attempts to use the quantity theory of money for statistical investigations into the causes and degree of change in the objective exchange value of money must always remain a failure. Of the two factors whose interactions determine changes in the value of money, only one, the supply of money, can be determined. The other one, demand for money, is one whose size is dependent upon subjective factors that in the best of cases only can be approximately estimated.6

But even were it possible to quantitatively determine the changes in both the supply of and demand for money, this would still be very far from being able to reach any quantitative conclusions about changes in the value of money. As was already pointed out, movements in the objective exchange value of money are not inversely proportional to those that take place in the relationship between the supply of and the demand for money. Furthermore, we lack the ability to precisely measure changes in the objective exchange value of money.

All index number methods, even the most ingenious and complete, can make no claim to such precision.7 Usually, statistical investigations into the value of money ignore all of this. They quietly assume that the changes in the quantity of money (in the narrower sense, not including fiduciary media) indirectly cause proportional changes in the purchasing power of the monetary unit—and that such changes simultaneously affect the prices of all goods throughout the entire economy.

While index numbers are considered a method for precisely measuring changes in the purchasing power of money, this view is no more justifiable even when they are constructed by combining several different principles and procedures. These procedures turn an allegedly scientific work into a meaningless juggling of numbers and words. The errors in this approach end up damaging the reputation of economics as a science, since the general public always tends to blame economic theory for the “failures” of those providing economic information through the collecting and manipulating of the statistical data.

In general, economic theory is not likely to lead to blunders in economic policy. In only one area is there an incomplete theoretical understanding which can lead to questionable conclusions for purposes of policy. It is customary to ignore the fact that fiduciary media have the same effect on determining the objective exchange value of money as money itself. Ceteris paribus, an increase in the quantity of fiduciary media will lead to the same decline in the purchasing power of the monetary unit as will an increase in the quantity of money proper.

In a complete reversal of all that economic theory demonstrated five generations ago, it is now again believed that it is possible to reduce the rate of interest by increasing the quantity of fiduciary media in circulation. This has generated very strange results. On the one hand, a battle is undertaken against inflation, though certainly with more pretension than with any serious intention behind it. On the other hand, there is an attempt to increase the number of unbacked banknotes in circulation, including efforts to artificially expand the supply of fiduciary media through the use of checks. This generates a tendency for a decline in the purchasing power of money.8

Recently an argument has been made that opposes what has been said above about the influence of changes in the relationship between the demand for and the supply of money on the purchasing power of money. Othmar Spann9 considers as more or less useless a theory that explains inflation as being due to the increase in gold production, as an attempt to employ one underlying concept for explaining the phenomena of rising prices.

Therefore, “everyone who has a good instinct for inductive analysis of economic relationships becomes distrustful of a theory which tries to explain increases in prices and finally the whole history of prices, with its great rising and falling price curves, according to a surplus or a shortage in the media of exchange, rather than by the ‘inner progress’ of the economy, itself.” The older Physiocratic10 attempt to understand economic processes by basically assuming the absence of money should be reintroduced and viewed with greater respect than it has enjoyed up until now. For analyzing general movements in prices, this method allegedly would be especially useful in order to be able to precisely separate the effects caused by money in circulation from those effects that are inherent in the underlying economic processes.11

One of Spann’s claims does entirely agree with our own view: an explanation of inflation not by one principle but—as the next section will show—by two different principles which interact in their effect. For the rest, however, Spann’s remarks must be rejected as being wrong.

For a long time, it has been customary in economics to first discuss the problem of the formation of prices (the prices of goods, wages, real estate rents, interest on capital, etc.) under the assumption that it was as if there was direct exchange. Not only did the Physiocrats assume this, as Spann mentions, but so did all economic theorists; a glance at the works of the classical or modern writers on economics will easily convince anyone of this. The knowledge that can be gained by this method, and by this method alone, then needs to be completed by a study into how the result is affected by the use of money and fiduciary media.

In addition to the theory of direct exchange, there is the theory of indirect exchange—the theory of money and of fiduciary media (that is, money and banking theory). If a criticism were to be raised against economic theory during the last several decades, it would certainly not be that this distinction between direct and indirect exchange has been neglected. Quite to the contrary! Though the study of direct exchange logically must precede the study of indirect exchange, the problems of the former have so thoroughly claimed the attention of economists that the problems of the latter have been passed over. Among those that have suffered severe neglect, for example, is the problem of economic crises, the complete understanding of which can be provided only by the theory of indirect exchange.12

Among the economic processes that can and should be studied under the assumption of direct exchange, the problem of a general rise in prices is not one. A general rise in prices means a change in the existing exchange relationship between money and other economic goods. In an economy in which money is not used, a general inflation of prices is not possible.

How can money be excluded from the investigation? Spann, of course, attempts this obviously hopeless task. If he presumes to explain “a higher price level” on the basis of natural [barter] exchange, he demonstrates a misunderstanding of what in everyday speech is called, for the sake of brevity and convenience, “price,” but what more fully and correctly should be called the “exchange relationship between money and goods.” If the following exchange relationship prevails today: 5 kilos of A = 7 kilos of B = 9 kilos of C = 16 crowns; and tomorrow 5 kilos of A = 7 kilos of B = 9 kilos of C = 18 crowns, then the change that has occurred overnight can never be explained from causes which lie in the relationship between A, B, and C.

Devaluation as a Consequence of Certain Characteristics of Indirect Exchange

A change in the objective exchange value of money does not occur only due to a change in the relationship between the demand for and the supply of money. There is another reason for such changes, and it is to be found in certain characteristics of indirect exchange. There is a fundamental distinction between the exchange relationships existing between money and the other economic goods and the structure of exchange relationships among the other economic goods themselves.

In direct (or barter) exchange, an exchange can be carried out only if each of the two parties in the transaction values less highly the quantity of goods that he is to give up than the goods he is to receive in exchange. If this assumption does not hold, there will be no exchange. This holds for indirect exchange facilitated by money only with an important modification. The willing buyer can decide to pay the price demanded by the seller on the presumption that, even if the price is beyond his appraisement of the value of the goods, he hopes that he will be able to obtain a higher price for the goods and services he brings to market because he has paid higher prices for the goods and services that he purchased.

The higher money price does not at all have to mean also a higher “own price”; it can very well be the case that in terms of barter relationships the exchange relationships among goods themselves (with the exception of money) has remained unchanged. The only change that has occurred is in the exchange relationship between money and all other goods.

If workers demand higher money wages and the entrepreneurs give in to their demand, this does not by any means signify that there has been an increase in real wages. It can happen that the entrepreneurs succeed in passing the wage increase on to the consumers, so that the prices of goods also rise, with the result that real wages remain the same or do not rise to the same extent as money wages have gone up. If the producers of a certain product push through an increase in its price, this also does not have to mean an increase in the “own price”; in this case, too, the price increase may be only a nominal one.

This can also sometimes happen due to the type of information possessed by the producer and the consumer when they are in a face-to-face relationship with each other. This is, however, by no means necessarily the case. Market conditions are more clearly and easily understood and compared when consumption and production are more directly connected.

The situation is different in the more developed stages of a national and, especially, the global economy. The lay of the land in the market is not as easily surveyed as it was when the market was smaller and exchange relationships were more direct. The producer no longer comes into direct contact with the consumer. The product is “taken up by the market,” which means that the evaluation of the good by consumers may not be the same as the one upon which the producer based his calculations.

Producers and traders face an unknown factor; they can anticipate the future decisions of consumers with only a greater or lesser degree of skill; but, of course, they cannot talk about it with any degree of certainty. For the majority of ready-made consumer goods, dealing with individual consumers is impossible. The producer and the trader must set “fixed” prices, which the consumer either accepts by paying the money prices asked or refrains from buying and not paying the money prices being asked. This either maintains or alters the purchasing power of money.

In order for there to be a tendency for a decline in the objective exchange value of money that encompasses the entire economy due to an exchange process mediated by money, significant disturbances must occur in the relationships between production and consumption. In a static, or more or less static economy, reciprocal exchange relationships between economic goods (excluding money) experience no or only minor changes. Under such conditions businessmen and workers do not have an incentive to push for increases in their prices and wages.

It is otherwise during times of significant change in production and consumption, if there are also significant changes in the reciprocal exchange relationships. Then sellers (including the sellers of labor services) are groping and feeling their way, trying to establish new prices for the goods and services that they are bringing to market. They set prices that, according to their perspective, are prices at which their goods and services can be sold; but they can easily aim too high. If they have aimed too low, that is, asked for too low a price, they will quickly become aware of their mistake as soon as the demand exceeds the supply.

In the opposite case the error is not so quickly recognized. If the sellers demand too high a price, then, as the law of price teaches us, quantity demanded will be less than quantity supplied. The unwillingness of buyers to purchase the good will finally force the sellers to reduce the price they are asking. But here the special characteristics of indirect exchange come into play. The willing buyer does not hold back from buying the product even if the price asked exceeds his valuation of the good by only a small amount because he, on his part, also hopes to get more money from the sale of the goods and services that he brings to market. The seller has raised his price and he sees that the buyers accept it; and for the same reason that the buyers paid higher prices for his product, he, in turn, also pays them. Everyone expects that their higher monetary costs will be balanced by their earning higher money incomes; they expect a decline in the purchasing power of money which their own behavior in fact brings about.

Because of the particular ways in which markets are organized, upon which money facilitates transactions, major changes in the reciprocal exchange relationships among economic goods create a tendency for declines in the purchasing power of the monetary unit.13

The Social Effects from General Inflation

Before we use an important example to explain what we have said, it seems appropriate to add a few words about the social significance resulting from a general rise in prices. If changes in the objective exchange value of money were to appear simultaneously and to the same degree in the entire global economy, if the prices of all goods and services were to rise or fall simultaneously and proportionally, the social effects on the structure of contractual obligations fulfilled through the use of money would be very limited. All deferred payments are affected if money rises or falls in value. If the purchasing power of money declines, debtors gain while creditors lose. The assumption here, of course, is that when debtors and creditors entered into their contracts they did not anticipate and incorporate into the contract future changes in the objective exchange value of money. This is a reasonable assumption, since for various reasons it is impossible to foresee the extent to which there may be changes in the purchasing power of money.

If changes in the purchasing power of money really occurred simultaneously and proportionally throughout the entire economy, then complaints about inflation nowadays would not be so loud and would hardly result in governments undertaking anti-inflationary policy measures. Creditors who have binding contracts specifying particular sums of money to be paid would most probably not calmly accept the damages they would suffer. No doubt they would attempt to bring about changes in prices more favorable to their situation. However, it is highly unlikely that they would succeed in this attempt. Their complaints would hardly be likely to bring any positive response from the majority of the population. The numbers of people whose incomes are mainly or exclusively derived from invested capital is much too small in most countries for their desires and interests to significantly influence the direction of economic policy.

The detrimental effect that is experienced by most people from a monetary devaluation is not due to the fact that it hurts the interests of creditors; rather it is due to the fact that it only appears gradually throughout the economy. The prices of various goods do not rise proportionally all at once. Inflation first appears in some particular part of the economy, affecting only some goods, and then gradually spreads out from there. Let us first consider the case of a monetary devaluation that comes about due to an increase in the quantity of money or fiduciary media, while the demand for money remains the same, or does not rise at the same rate in the broader sense as the money supply has increased.14

Let us suppose, for example, that a new gold mine has been opened. The new gold first pours into the hands of the gold producers; it increases their income, reduces their subjective valuation of the monetary unit, and so intensifies their desire to purchase goods on the market. They now express on the market their demand for those goods that they now more intensely desire than before; they can offer more money for the goods they wish to acquire. These are the goods that first rise in price, and the objective exchange value of money declines first in terms of these goods. This is the point at which the monetary devaluation begins. The next step in this process is that those who sold the goods that were purchased by the first possessors of the new money now, in turn, have an increased buying power and are able to express a greater demand for the goods that they desire to buy, so the prices of these goods rise, as well. The rise in prices continues until, to one degree or another, the prices of all goods are included in the process.

This gradual progression of rising prices causes its associated effects. The particular social groups who first receive the new quantity of money benefit from the process, while those are harmed who receive the money only later in the process. So long as the monetary depreciation has not yet worked its way through the entire economy, those who already receive a higher money income reflecting the eventual decline in the value of money are able to purchase all or some of the goods they desire at prices that do not yet fully incorporate the devaluation of the monetary unit. On the other hand, those whose money incomes do not yet reflect the new situation pay for the goods they demand at prices that have already adjusted to the higher price level.

The exact same process is at work, of course, with those changes in the value of money that, as was described earlier, arise from sellers raising their prices. Here again, the increase in prices starts at some point in the economy and gradually spreads out from there. That group of sellers who begin the process of raising prices also benefit even if, over time, the prices of the goods they buy increase in proportion to the prices of the goods they sell. For while the process is continuing that leads to a general devaluation throughout the entire economy, they enjoy an advantage they will no longer have when prices will have fully adjusted to the new situation.

It is precisely this circumstance that provides an explanation of the practices followed by the groups that initiate the rise in prices. This applies to actions of cartels and trusts—insofar as they are not monopolistic practices—and also the methods employed by trade unions. The latter now require some further comments.

Increasing Wages and Inflation

It can hardly be denied that reciprocal effects exist between the movements of money wages and movements in the money prices of finished goods. Modern economic theory is distinct from the widely popular older theory of value that tried to explain a rise in prices of finished goods in terms of a rise in the cost of the factors of production. It is an anachronism to explain those movements in the objective exchange value of money that are caused by changes in the relationship between the supply of and the demand for money, by referring to the labor time in production and the influence of the money prices of the factors of production as the basis for the prices of consumer goods.

This customary way of analyzing the problem is seen to be untenable without much difficulty. Any useful result will require a different chain of reasoning. One thing that is common in all economic theories of wages is that they consider the determination of the level of wages to be a part of the theory of value. The different answers that were given over time to the problem of explaining the value of goods also led to different attempted answers to the problem of explaining wages. The objective theories of value followed paths different from those of the modern theory of value.

The modern theory of value was the first one to fully appreciate the significance of the problem. The theory of imputation developed by Böhm-Bawerk,15 Clark,16 and Wieser17 demonstrates how the individual complementary factors of production factors are evaluated; it forms the indispensable logical link between any theory of the formation of the prices of the factors of production and the distribution of the product among the factors of production.

The only interventions that can influence the level of market-determined wages are those that work within the laws of the market. Any wage policy that wishes to change the level of wages from the one that tends to form on the unhampered market, and which we can call the “natural wage,” must modify the factors whose interactions jointly determine the actual level of wages prevailing on the market. For example, it is possible to lower wages if one encourages the immigration of foreign workers, and one can push wages up if one restricts the influx of workers. The market price for labor is indirectly influenced by the use of these methods; the market wage that is formed under the influence of these changed conditions is the “natural wage” in this new state of affairs.18

Any direct influence on wages is as unworkable as with any other price on the market. It necessarily leads to a reaction that reestablishes the “natural” market situation. This is equally true for tax rates as it is for the wage policy of organized labor through trade unions. The older Classical School already understood this, even though it was based on an untenable theory of value.

We set aside for any further consideration the role organized labor may play for economic life, in politics, for law and social customs, or for national identity. We have only one question before us: whether or not organized labor can raise wages above their natural level. This question is immediately answered in the affirmative for all those cases in which labor unions can succeed in influencing the conditions of the labor market. As for influencing the demand side, in general the answer is no. More often the unions can succeed in influencing supply according to their wishes. If this influence is limited to individual industries, it always comes down to a question of advantages for the workers in one branch of production at the expense of all other workers. Artificially reducing the supply of labor in one or more branches of production results in an increased supply of labor in all other branches of industry; if the wages are pushed up in the former, then they must fall in the latter.

This by no means exhausts the consequences from such monopolies of the labor force in particular branches of industry; their effects go further than this. They also prevent the optimal combination of the factors of production, and as a result reduce the value of the total product. This second effect shows itself most clearly when the supply of labor is restricted not in one but in all branches of production. Two cases are conceivable: a decrease in the availability of new workers through a reduction in the total population (a reduction in fertility, for example), or a decrease in the supply of labor with no change in the total number of workers by shortening the number of work hours. The latter can be brought about either through legislation (a limit on the work-day), or through the actions of labor unions, or due to a restriction in the output of the workers (passive workers’ resistance, or a “ca’ canny” policy).19 If, however, the factors underlying the formation of wages are left unchanged, then a permanent deviation of the level of wages from its natural level cannot be achieved. That is generally true for almost all labor unions. Labor unions cannot permanently raise the level of wages because they cannot also change the underlying conditions of the overall labor market.

The last several decades seem to contradict this conclusion. We see organized labor move forward from one success to another; wages keep rising higher and higher. No doubt part of this increase in wages is merely a consequence of the increase of the supply of money (gold production and an increase in fiduciary media), which has brought about a fall in the objective exchange value of money. Yet another part is to be attributed to the increase in profits resulting from improvements in productivity; a part of the reward for this productivity goes to the workers in line with their direct contribution to the production process. This gain would have gone to the workers even without labor unions and wage conflicts. But is that all that labor unions have achieved?

Very many are of the opinion that the workers have achieved far more by uniting their forces than what would have fallen into their laps anyway. One can read today in all sociopolitical writings that the labor unions have raised the level of wages; people want to believe that this provides an inductive proof against the conclusions of those theories that declared the impossibility of increasing wages through this method. This is taken to be so obvious that no one has taken the trouble of designing a theory of wages to justify it.

One has difficulty figuring out what is the theory of wages in the approach of the German Historical School. One of its leading representatives tells us that, in the face of the limitless difficulties involved in finding a universally applicable explanation, the School has given up on developing a theory of wages.20 But these writers must have had something in mind if they spoke about wages and a wage policy. We do not think that we are far wrong if we assume that they vaguely had in mind a naïve “exploitation” theory of wages. Today it is the folk theory of wages. It can look back upon a famous literary past in the form of Marx’s theory of surplus value, an honorable but fruitless attempt by an ingenious spirit.

But Marx did not create the exploitation theory. He merely picked it up off the street and tried to formulate and establish it scientifically, an undertaking that by no means seemed pointless given the state of political economy at that time. It had already become widely known, however, long before Marx. The fact that Marx adopted it and the activities of the Social Democrats carried it out into the world may have multiplied its inherent attractiveness by a hundredfold. However, its strength and popularity are not rooted in the Marxian theory of value; thus it was able to survive the collapse of Marxism without being harmed.21

Many have read Das Kapital, but only a few have understood it. Even among the leaders of the Social Democratic Party one can find only a small group who are connoisseurs of the Marxian theory of value. Today, the basic conception of the theory of value in the Social Democratic movement is a naïve idea of exploitation, which is more closely related to that of Chartism22 than to the objective theory of value in the dialectical system of Karl Marx. This traditional exploitation theory, which, to vary a Marxist expression, one could also call people’s socialism,23 is, of course, never offered in a scientifically precise, mature, and conclusive manner. Nevertheless, at least in Germany today, one must designate it as the communis opinio. For outside the narrow circle of the friends of economic theory, it almost reigns unchallenged. It is the basis of what is taught everywhere nowadays about the nature of wages, whether in the textbooks, from the podium, in parliaments and in the press, in the churches, or in the National Assembly.

It influences legislation, and it serves as a guiding principle for the policies of the labor unions. Even the entrepreneurs have not been able to completely avoid its influence.24 The folk theory of exploitation seems to divide society into two mutually hostile classes: on the one side are the workers, whose industry creates all value and to whom by right the full product of labor ought to go. On the other side stand all those who live off unearned income; they live exactly on what they withhold from the workers. Wage determination is the outcome of a battle between entrepreneurs and workers; the more successful the workers are in this battle, the higher their wages rise and the greater their share of the national product. Labor unions strengthen the power of the workers and thus help them to achieve results.

If one disregards this naïve theory of exploitation, whose indefensibility probably does not need to be more carefully explained, there is not much to be found in the sociopolitical literature that can be used to support the supposed correctness of the doctrine that labor unions can succeed in raising wages. Nevertheless, it is striking that all those writers who start off with no comprehensive economic theory of value and price have no hesitation in asserting that it has been the unions who have had the power to raise the real wages of the workers.

So, on the one hand, it is said that the scientific theory of wages provides us with no basis upon which to decide whether the unionized organization of the workers can raise wages; on the other hand, we have the undisputed assertion that the organization of the workers increases the labor force’s share of the social product at the expense of the other classes in society. Or can we assume that all those millions of workers who see their salvation in union organization, and that all those thousands of entrepreneurs who oppose them, deceive themselves in their judgments about the effects of labor organization?

This seemingly insoluble contradiction with which we are confronted is easy to explain with the help of the theory that we developed earlier. It is true that no effort by labor unions can permanently succeed in pushing wages above their natural level. In the best of cases, all that they can achieve is to raise wages, but they cannot prevent the necessary adjustment of wages back to their natural level. The adjustment, however, does not come about by nominal wages coming down again to their old level. The money wage remains unchanged. The rise in the prices of goods has the effect of bringing real wages back to the “natural” wage that corresponds to the given conditions of the market.

Employers can raise wages above the natural level only in the expectation that they will be able to retain their entrepreneurs’ normal profit by passing the wage increase along in the form of higher prices for their products. What the consumers can do, however, to pay or not pay the higher prices can be seen from what has been said above. Hence the success of the organization of labor lies in the advantages that come to the workers during the transition period, before the higher money wages have been adjusted back to the natural level of wages through the rise in the prices of finished goods. If this adjustment is completed, then any success that the working class has achieved by raising the money wage is completely gone. The labor unions can make permanent this advantage offered to the workers only by attempting over and over again to raise the money wage above its natural level. They repeatedly create, however, a new tendency for a change in the objective exchange value of money.

In a static economy there would be no place for such an influence by the labor unions. In such a static economy, the law of wages would have to rule with its full force. Only in a dynamic economy does there come into effect that which has just been explained. Under dynamic conditions the labor unions can also do something more; for example, they can reduce the number of unemployed during the transition periods.25

A Shortage of Raw Materials as a Cause of Rising Prices

People are used to often asserting that a rise in the costs of production is a particular reason behind a general inflation. This view cannot be reconciled with the theory of subjective value. The modern school of economics points out that the prices of the goods of higher order are dependent upon the prices of goods of the first order. Thus, the popular explanation must be rejected in advance. Moreover, it does not solve the problem; it only postpones it. Instead of the question of what causes a rise in the prices of consumer goods, it shifts the question to what causes a rise in the prices of the means of production.

Behind this concept stands the idea that the supply of goods becomes smaller and that as a consequence there is a tendency for the prices of these goods to rise. The economic interest in the availability of consumer goods always eventually leads back to the availability of higher goods that are provided by nature. All of man’s production activities amount to nothing more than combining the original forces of nature in such a way that a particular desired result will be forthcoming. The materials and forces existing in nature constitute the only fund that we have at our disposal. The progress in developing the methods of production certainly makes it possible for us to enlarge the quantities of goods available by employing higher and higher orders of goods and following longer and technically more fruitful roundabout paths of production.

Yet the assumption is still taken for granted that technological progress lags behind the consumption of the existing supply of resources. From time to time we hear geologists and engineers express the fear that we are more and more rapidly approaching a point in time when the exhaustion of the mineral wealth of the Earth will bring about a severe crisis for us or our posterity. How far these assertions are justified, economic theory cannot say. But we shall assume that they fully agree with the facts. Thus, a general rise of the money prices of goods would result from this if money, alone among all economic goods, were not subject to this same tendency. While in the case of all other economic goods the relationship between supply and demand would change unfavorably for supply, it would have to be otherwise for money.

However, if the same change were to happen with money, too, then the supply of money available to individuals would decrease and the change in the exchange value between money and other economic goods would not occur. If a change occurred in the exchange relationship existing between money and other goods, then its explanation would have to lie among those provided by the quantity theory. Either the supply of and the demand for money had changed in a different direction than that between the supply of or demand for goods, or the latter has remained unchanged while the former has changed. We obtain no new knowledge either for economic theory or for a new approach to economic policy.26 It is completely reasonable, on the other hand, to bring up the progressive depletion of the natural resources available for mankind to explain the rise in prices for specific groups of goods. The rise in the prices of furs or of caviar is, of course, not that significant, but they are the most obvious examples.

The Recognition of the Reasons for Inflation and Inflationary Policy

Public opinion sees in inflation one of the most disturbing aspects of economic life. The struggle against inflation is proclaimed by governments and by political parties today with the same determination as was the battle against the decline in the prices of goods during the time between 1873 and about 1895.

He who wants to fight against an evil must first recognize what it is. One cannot get rid of inflation as long as one does not understand its causes and its nature. What the mass of consumers are most directly critical of, in the first place, is the rise in the prices of particular individual goods, and most especially the price of food. The protective tariff policy that all countries, with the exception of England, have been following for years has raised the prices of specific groups of goods in every country. In this instance, the fight against inflation coincides with that against high protective tariffs. General inflation is only an incidental consideration. Generally only those producers who are disadvantaged by the protective tariff refer to it in order to direct the attention of consumers to the obvious and easily correctible reasons for the rise in particular prices.

One speaks of the “international character” of rising prices in order to disguise the national policies behind the inflation; and one refers to the “generality” of rising prices in order to obscure the fact that, in addition to the rise in prices in general, a rise in the prices of a number of particular goods has been observed. In all of this there is no honest desire to debate the problem of inflation in general, so as to gain a clear sense about the significance and role that economic policy should take with regard to it.

The general hand-wringing about inflation, with which the general public is more or less in agreement, leaves little doubt that the general depreciation of money is widely unpopular. But the views of those who oppose inflation are by no means clear, and even less so in the case of the millions who agree with their opinions. It is known that in Europe and in America during the last quarter of the nineteenth century inflationism has had more advocates than opponents. The inflationist projects, especially the plan for an international bimetallic currency, have not been realized; but that is only because in the leading countries of the world there have been small but strong supporters of sound money, led by gifted leaders who have triumphed over the fiat-money people. Who knows whether the outcome would not have finally gone against the gold standard if the struggle had lasted a few years longer?

The “friends” of rising prices turned their attention in other directions; they became advocates of tariff protection because they saw in protective tariffs an appropriate tool for achieving their ends. In addition, the general decline in the objective exchange value of money that began in the second half of the 1890s, and which is still continuing, made the case for bimetallism irrelevant. The economic policy goal of most countries between 1873 and 1895 was attained.27 If today a violent reaction is taking place [in response to the general decline in the value of money], this can be explained by the great social changes that have taken place in the meantime.

The interests of producers, which until recently were still a determining factor in politics, are being partly superseded by the interests of consumers. If previously the slogan “good prices” was popular, today the slogan is “cheap prices.” It seems quite certain that the attractiveness of this slogan will continue to grow in the coming years. Nevertheless, it remains doubtful whether this will last, and whether it will succeed in destroying the old deeply rooted notion that high prices mean national economic prosperity.

If we look at the social consequences of the changes—it is the consequences from the devaluation that alone concern us here—from the objective exchange value of money, we find that their meaning is different depending on the underlying cause. A general decline of the purchasing power of money always brings with it changes in the distribution of wealth and income, from whatever cause it springs. But in every case, some groups of society benefit from it and other groups are harmed by it. If the objective exchange value of money decreases because the relationship between the supply of and the demand for money has undergone a change due to a disproportionate increase of the quantity of money in circulation, then those parts of the population to whom the additional money flows first achieve the greatest benefit, while those to whom it goes last are most severely harmed. Generally, no matter whether the increase in the quantity of money (in the broader sense) is caused by the production of money [an increase in the mining and minting of gold] or by expanding the quantity of fiduciary media, on the whole the entrepreneurs will have an advantage relative to the workers and clerical employees. It is certainly conceivable that in such circumstances clerical employees and workers, in general, easily could be won over to the side of those who oppose monetary devaluation.

But at the present, changes in the relationship between supply of and demand for money are not the sole and probably also not the most important cause behind the general rise in prices. We have succeeded in showing that, as a result of certain technical features of how markets are organized, forces are set in motion where money is the intermediary in exchanges that necessarily lead to a constant decrease in the objective exchange value of money. Those people are at an advantage who better understand than others how to anticipate the rise in the prices of the goods and services they sell. These are not always the entrepreneurs. Alongside the best-organized cartels are the best-organized labor unions. The big cartels of so-called heavy industry and the unions of the most easily organized clerical employees and working class members are the beneficiaries of the rise in prices so far as it is rooted in these causes.

At a disadvantage, however, are the groups that are difficult or impossible to organize. They can raise the prices of the goods and services they sell on the market only if the goods and services they buy have already risen in price; because of this lag between the rise in the prices of the goods they buy and the prices of the goods they sell, the harm which they always suffer in the meantime cannot be made up for. Only creditors who have monetary claims to specific amounts of money under contract obligations are in both cases harmed relative to their debtors.

Aside from this, however, since the social effects from a rise in prices are different depending upon their cause, there can be no single policy prescription.

In the first case is a relatively narrow circle of groups who are the beneficiaries of such changes in the objective exchange value of money; it does not include the broad stratum of wage earners whose burdens and demands are nowadays the decisive factor in politics. These groups, therefore, would prefer a monetary system in which the relationship between the supply of and the demand for money remains constant: that is, a situation in which there are no factors tending to bring about a change in the objective exchange value of money. Since this ideal is unachievable, then from the perspective of the wage earner (and also from the viewpoint of the many entrepreneurs who on this issue have the same interest as the workers, as well as from the standpoint of all creditors), those measures are condemned that aim at a reduction in interest rates brought about by an artificial increase in the quantity of fiduciary media. As was already explained, a permanent reduction in the rate of interest can never be brought about by an increase in unbacked banknotes and by an extension of the use of checks; the end result of such measures can only be an increase in the price of goods.

Judged quite differently are those changes in the objective exchange value of money that arise from those previously described particular properties of prices formed on the market through the intermediation of money. They benefit not only the most easily organized groups of businessmen, but also the best-organized strata of labor, which is to say, all those who better anticipate the rise in the prices of the goods they buy on the market relative to increases in prices of the goods and services they sell on the market. Insofar as the rise in prices has its root cause in this process, there is nothing that can be done to stop it. The only conceivable method would be government price controls; however, that would be in insoluble contradiction with the individualistic principles of organizing the economy.

It may appear to many that the struggle against the progressive rise in the prices of goods and services has only a small chance of success. There seem to exist few effective methods to slow down this process even a little bit, unless there again comes a time in which—as in between 1873 and 1895—there is a decline in gold production and a strong tendency for a progressive change in the economy that brings about a decline in money prices. It would be a gross exaggeration to think, however, that people would want to see this happen again.

As I have explained elsewhere,28 there is a serious danger for the future of the individualistic organization of the economy in the development of fiduciary media; if the legislature does not put some obstacle in the way of its expansion, an unrestrained inflation could easily come about, the destructive effects of which cannot really be imagined. Even if we ignore this, as yet, not immediate threat, there is sufficient risk from the very nature of the system of fiduciary media. We have already mentioned that it would be desirable to put an end to the artificial expansion of fiduciary media. It would not only slow down the rate of devaluation, but it would also be the best way of preventing economic crises.

If one pays no attention to this, then there is no reason why a progressive rise in prices should be seen as a disruptive influence. Only the completely uninformed can, perhaps, imagine that a rise in prices is a symptom of a deteriorating provision of goods that is leading to a progressive impoverishment of the population.

In reality, the disadvantages that it brings to some and the advantages that it brings to others are only transitory in nature. The fact that price increases keep going on results in its being appealed to over and over again, but then it arises again and again with its impact being reinforced by the fact that inflation and effects of inflation have occurred before.

As far as price increases have their cause in an increase in gold production, one must accept it as an unavoidable ill. It still can be hoped that the growth in gold production will once again experience an interruption. Insofar as inflation is a result of the method by which market prices are formed through indirect exchange, one must see it as a sign of the lively activity in the economic process coming from constant changes in the relationship between production and consumption. Only one who prefers the peace of the cemetery to the bustling whirl of life can be sorry that the purely static condition of an economy is only a conceptual device of theory; reality always means dynamism, change, and development.

[1. ][This article originally appeared in German in Archiv für Sozialwissenschaft und Sozialpolitik, vol. 37 (1913).—Ed.]

[2. ][This refers to the development of the theory of marginal utility, or subjective value, especially as formulated by the “Austrian economists.” See Carl Menger, Principles of Economics (New York: New York University Press, [1871] 1981); Eugen von Böhm-Bawerk, Capital and Interest, vol. 2, The Positive Theory of Capital (South Holland, Ill.: Libertarian Press, [1914] 1959), pp. 121-256. On the resistance of the German Historical School to the ideas and methods of the Austrian School, see Eugen von Böhm-Bawerk, “The Historical versus the Deductive Method in Political Economy,” (1891) reprinted in Israel M. Kirzner, ed., Classics in Austrian Economics: A Sampling in the History of a Tradition (London: William Pickering, 1994), pp. 109-29; and Ludwig von Mises, “The Historical Setting of the Austrian School of Economics,” [1969] reprinted in Bettina Bien Greaves, ed., Austrian Economics: An Anthology (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996), pp. 53-76.

[3. ][On Mises’s recollections of his own confrontations with members of the German Historical School during the years before the First World War, see “Remarks Concerning the Ideological Roots of the Monetary Catastrophe of 1923,” Chapter 29 in the present volume.—Ed.]

[4. ]Cf. my Theory of Money and Credit (Indianapolis: Liberty Fund, 3rd rev. ed., [1924; 1951] 1981), pp. 146-77.

[5. ]Ibid., p. 154. [In The Theory of Money and Credit, pp. 63-67, 155-56, 393-404, and in Human Action: A Treatise on Economics (Indianapolis: Liberty Fund, [1949; 4th rev. ed. 1996] 2007), pp. 432-44, and his other writings on monetary theory and policy, Mises defined “money substitutes” as claims to a commodity money such as gold in the form of banknotes or checks that are readily and generally accepted in transactions and that are believed to be fully redeemable on demand at the banking institution that has issued them. Mises distinguished between money substitutes that are backed 100 percent by commodity money reserves at the issuing institution (“money certificates”) and those money substitutes issued by a bank that are less than fully backed (“fiduciary media”). Loans extended on the basis of 100 percent reserve backing were referred to as “commodity credit” and those loans extended on the basis of less than 100 percent reserve backing were called “circulation credit.” Mises argued that it was the extension of fiduciary media not covered by 100 percent reserves that was the source of business cycles, in that it created the illusion of more savings available in society (in the form of money loans extended through the banking system) to support and sustain investment and capital formation than really existed.—Ed.]

[6. ][See Ludwig von Mises, “The Position of Money Among Economic Goods,” (1932) in Richard M. Ebeling, ed., Money, Method, and the Market Process: Essays by Ludwig von Mises (Norwell, Mass.: Kluwer Academic Press, 1990), pp. 55-69, especially 59-62.—Ed.]

[7. ][See Mises, The Theory of Money and Credit, pp. 215-23; also, Ludwig von Mises, “Monetary Stabilization and Cyclical Policy,” (1928) in Mises, The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression (Auburn, Ala.: Ludwig von Mises Institute, 2006), pp. 73-79; Mises, “The Suitability of Methods of Ascertaining Changes in Purchasing Power for the Guidance of International Currency and Banking Policy,” (1930) in Ebeling, ed., Money, Method, and the Market Proces s, pp. 78-95, and especially 86-90, and Human Action, pp. 219-23.—Ed.]

[8. ][Mises, The Theory of Money and Credit, pp. 377-404.—Ed.]

[9. ][Othmar Spann (1878-1950) was a prominent and highly popular professor at the University of Vienna during the period between the two world wars. He was an opponent of individualism, political and economic liberalism, Marxism, and materialism. He referred to individualism in all its forms as “the dragon-seed of evil.” Instead, he advocated what he called “universalism,” a conception of society as an organic whole or totality greater than the individuals of which it was composed. He proposed a corporativist structure to society, in which each sector of the economy would be organized in a hierarchy of guilds. He was greatly admired by many Austrian fascists, but was prevented from teaching by the new Nazi regime after the German annexation of Austria in 1938.—Ed.]

[10. ][The Physiocrats were a group of eighteenth-century French Enlightenment thinkers who often referred to themselves as “the Economists.” Opponents of mercantilism, they developed a theory of society’s “natural order” that emphasized the self-regulating patterns of the market.—Ed.]

[11. ]Cf. Spann, Theorie der Preisverschiebung als Grundlage zur Erklärung der Teuerungen [Theory of Price Change as Foundation for the Explanation of Inflations] (Vienna, 1913), pp. 3-5.

[12. ][See Mises, Human Action, pp. 201-03.—Ed.]

[13. ][See Mises, The Theory of Money and Credit, pp. 185-89.—Ed.]

[14. ][The idea of the “unevenness” or “nonneutral” effects on prices following an increase (or decrease) in the quantity of money has been a central theme in the Austrian School theory of money, especially in the writings of Ludwig von Mises. See Mises, The Theory of Money and Credit, pp. 160-68, 225-46; “Monetary Stabilization and Cyclical Policy,” pp. 80-88; Mises, “The Non-Neutrality of Money,” (1938) in Ebeling, ed., Money, Method, and the Market Process, pp. 68-77; and Human Action, pp. 398-432; also, Friedrich A. Hayek, Prices and Production (New York: Augustus M. Kelley, [1935] 1967), pp. 1-31, 129-31.—Ed.]

[15. ][Eugen von Böhm-Bawerk (1851-1914) was one of the leading members of the Austrian School of economics in the years before the First World War. His major contributions were to the theory of capital and interest, as well as the general theory of value and price. He was a professor of political economy at the University of Innsbruck from 1880 to 1889. He worked in the Austrian Ministry of Finance throughout the 1890s and served three times as minister of finance, the longest and last time from 1900 to 1904. Böhm-Bawerk returned to teaching as a full-time professor of political economy at the University of Vienna in 1905, a position that he held until his death.—Ed.]

[16. ][John Bates Clark (1847-1938) was a leading proponent of the marginalist approach in the United States. His 1899 volume, The Distribution of Wealth, developed the theory of marginal productivity to explain the allocation of income among the factors of production. He was professor of economics at Columbia University from 1895 to 1923.—Ed.]

[17. ]See Chapter 5, “The Fourth Issuing Right of the Austro-Hungarian Bank,” footnote 9.

[18. ][See Eugen von Böhm-Bawerk, “Control or Economic Law,” (1914) in Shorter Classics of Böhm-Bawerk (South Holland, Ill.: Libertarian Press, 1962), pp. 139-99, for a detailed analysis of this argument by a leading member of the early Austrian School.—Ed.]

[19. ][A ca’ canny policy is a deliberate reduction in the working speed and production by workers to demonstrate their discontent with working conditions.—Ed.]

[20. ]Thus Bernhard, “Lohn und Löhnungsmethoden” [Wage and Payment Methods], in Handwörterbuch der Staatswissenschaften, vol. VI, p. 513.

[21. ][Here Mises is alluding to Böhm-Bawerk’s famous critique of Marx’s theory of surplus value and exploitation of workers under capitalism; see Böhm-Bawerk, Capital and Interest, vol. 1, History and Critique of Interest Theories (South Holland, Ill.: Libertarian Press, [1884] 1959), pp. 281-321; and Böhm-Bawerk, “The Unresolved Contradiction in the Marxian Economic System,” (1896) in Shorter Classics of Böhm-Bawerk, pp. 201-302.—Ed.]

[22. ][“Chartism” was a social and political reform movement in Great Britain in the middle of the nineteenth century dedicated to extending voting rights to the working class as a means of acquiring the power to influence social and economic policy in a more socialist direction. Chartists were willing to use physical violence in the form of strikes and political demonstrations to advance their goals.—Ed.]

[23. ]I find this expression in Vogelstein, “Das Ertragsgesetz der Industrie” [The Law of Profit of Industry], Archiv für Sozialwissenschaft und Sozialpolitik, vol. 34, p. 775.

[24. ]Cf. Eugen von Böhm-Bawerk, Einige strittige Fragen der Kapitalstheorie (Vienna, 1900), pp. 110ff.

[25. ]In the static state there are no unemployed.

[26. ]Cf. John A. Hobson, Gold, Prices, and Wages: With an Examination of the Quantity Theory (London: Meuthen & Co., 1913), pp. 94ff.

[27. ][An end to the general decline in prices and the rise in the general purchasing power of money.—Ed.]

[28. ]Cf. The Theory of Money and Credit, pp. 368-90.