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CHAPTER 8: On Rising Prices and Purchasing Power Policies 1 - Ludwig von Mises, Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War 
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).
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This 2012 Liberty Fund edition is published by arrangement with Hillsdale College. Introduction, editorial additions, and translation © 2012 by Hillsdale College. Original materials used for the translations that appear in the present edition are © by the estate of Ludwig von Mises and are used by permission.
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On Rising Prices and Purchasing Power Policies1
In the middle of the nineteenth century, prices increased dramatically all over Europe and reached their peak in 1874. At that point, prices began to decline and continued their downward movement until the mid-nineties. Since about 1896 a new upward movement in prices has set in, and its end point is nowhere in sight. This decline in the purchasing power of money has given new impetus to the old demand for a type of money that would not be susceptible to fluctuations in its objective exchange value. Ideally, with this type of money, the exchange relationship between money and all other economic goods would be stable from the money side. Similarly, there could be no general increase or decline in prices. The only disturbance in these stable market relationships would be a decline or rise in individual commodity prices with respect to each other, something that would be acceptable from the standpoint of both economic theory and political reality.
Money with an invariant objective exchange value, however, is an unattainable ideal.
It was commonly believed that the quantity theory of money provided the means to attain this goal. According to this theory, a change in the relationship between the supply of and the demand for money implied a change in the objective exchange value of money. All other things equal, an increase in the supply of money had to lead to a decline in the purchasing power of the monetary unit. This is one of the oldest and most firmly established doctrines of monetary theory.
Two factors, however, impede the practical application of this insight for stabilizing the value of money. The first is the inability to precisely predict how great will be the effect from a given change in the quantity of money in circulation. For even though it is certain that a decline or a rise in money’s purchasing power will result from an increase or reduction in the quantity of money, the extent of the changes in the objective exchange value of money brought about by specific changes in the quantity of money can never be predicted in advance. Changes in the quantity of money do not directly affect prices. Contrary to the notions of the older mechanistic price theory of supply and demand, changes in the quantity of money affect prices not directly but indirectly, by influencing the subjective valuations made by individuals.
Given this insurmountable problem, some proposals were made that accepted the intrinsic impossibility of creating money with a stable exchange value and settled for a more limited goal. For the bulk of transactions, money as we know it today would continue to be used despite all its imperfections. For credit transactions, however—whether by legislation or by voluntary agreement between the parties concerned—the means of exchange would not be money but a uniform composite of the majority of commodities. The debtor would agree to fulfill his obligations by repaying not a nominal sum of money but a sum of money representing the same purchasing power for a fixed number of commodities. The idea was to supplement a currency based on precious metals with a currency based on commodities.
These more modest reform proposals limit themselves to keeping the value of money stable only for long-term credit transactions and possibly for salaries of persons with a guaranteed position. But even the implementation of these proposals would not preclude a general rise in prices and the adverse consequences that would result from this in transactions between individuals.
Even within this self-imposed limitation, the compensatory commodity currency project has another deficiency. While it has managed to circumvent one of the problems faced by all proposals for stabilizing the value of money, it founders on the second flaw, which makes all these proposals unrealizable. Its mistake lies in its assumption that the fluctuations in the objective exchange value of money can be accurately measured. The various index number systems seem to be precise, but in reality they are not.2
To obtain useful results, index numbers must differentiate the effects between individual commodity prices. Changes in the price of wheat will not have the same impact as changes in the price of poppy seeds. Commodities must be treated according to the role they play in consumption. To take this into account, a weighted average is used, that is, changes in one commodity are counted more heavily than those in another according to a predetermined relationship. Changes in the price of wheat, for example, are given a hundred times greater weight in the determination of the index numbers than changes in the price of poppy seeds.
Obviously, the most important thing is the assignment of the proper weights to each commodity. The relatively best method of weighting is provided by the American budget method. Individual commodities are weighted according to the frequency with which they appear in individual households budgets. This method would be unobjectionable if consumption patterns did not tend to change over time; it is flawed because in the real world the relative amounts of these commodities keep shifting, reflecting the way human beings change their subjective valuations concerning those commodities. Just think how different is the pattern of consumption in a household in 1913 from a household in 1863, let alone 1813.
Even if we make the dubious assumption that we are merely comparing a contemporary social group with a social group in the past of comparable standing and income, many problems are left unsolved. Even a city dweller of modest means has different needs from those of his forebears fifty or a hundred years ago. And even with the same needs, we now have different ways and means of satisfying them than in days of old.
This lack of an objectively valid method for establishing a weighted average fully explains why all proposals that have been made in the course of the last three generations for stabilizing the objective value of money have fallen by the wayside.3
More recently, the American economist Irving Fisher proposed ending the free coinage of gold as a way to create money with a stable objective exchange value.4
Fisher takes the currency situation in India, the Philippines, and Austria-Hungary as his model. He maintains that these countries maintain currency parity with countries using a gold-backed currency by increasing or decreasing the quantity of money in circulation according to the state of the foreign exchange rate. Fisher has no support for this—erroneous—view of the gold exchange standard. The parity value of the Austro-Hungarian currency is not maintained by increasing or decreasing the amount of currency in circulation. Parity is not exceeded because the notes of the Austro-Hungarian Bank are in fact convertible into foreign exchange at a fixed exchange rate. It is the legal right to freely coin gold that preserves the currency’s parity.
The same can be said of all other countries with a similar arrangement, except for their having legally established the convertibility of notes into gold. People have sometimes claimed that the Austro-Hungarian Bank occasionally refuses to issue foreign currency and that the exchange rate might then exceed the gold point.5 Whether or not this claim is correct, all it would prove is that in the eyes of its advocates prompt convertibility of notes into foreign currencies is a prerequisite for parity of the coinage.
Starting from this erroneous assumption, Fisher proposes that bank-notes should be convertible not into a given amount of gold agreed to in advance, but to an amount of money that corresponds to a given purchasing power. He suggests that the quantity of gold against which notes are converted should increase when the purchasing power of the gold unit goes down and it should decrease when it rises. It is apparent that Fisher’s proposal is merely an expansion of the idea of a complementary commodity currency. It contains nothing that would help overcome the above-mentioned difficulty, that is, the impossibility of accurately measuring the fluctuations in the objective exchange value of the monetary unit. Neither does it offer anything to overcome the difficulties inherent in using monetary policy to manage changes in the quantity of money in circulation. Fisher’s proposals thus can be easily rebutted by the very same persuasive arguments that Karl Helfferich6 recently presented against similar projects.
Given that a monetary system with a fixed domestic exchange value is not attainable, Helfferich concludes that no government policy seeking to regulate the value of money can serve a useful purpose. Much as he may regret the subservience of our modern monetary system to the vicissitudes of gold production, he nevertheless considers it preferable to a dependence on human failings and errors and to policies catering to unbridled special interests. Even if one concurs with Helfferich’s views on this point, one might still favor government intervention against a decline in the purchasing power of money in some cases.
Notwithstanding complaints about increasing prices and despite all efforts to increase the purchasing power of money, the quantity of money in circulation, that is, notes and bank credit not covered by commodity money, is steadily expanding. In Austria-Hungary and especially in Germany there is a steady pressure to enlarge the circulation of uncovered notes. Both in the German Reich and in Austria-Hungary the quantity of tax-exempt notes has risen markedly in the last few years; Austria has seen a 50 percent increase, from 400 to 600 million crowns.7
Attempts are being made in Germany to extend the use of checks for smaller and medium-sized payments; the German Reichspost [post office] has added increasingly popular checking transactions to its services. The Austrian and Hungarian postal savings banks offer postal money orders that are exemplary. Yet these measures go counter to all the teachings of economic theory.
Since the time of Adam Smith, economic studies have confirmed that when businessmen complain about lack of money, they are really referring to a lack of capital; yet this lack of capital cannot be remedied by an expansion of the money supply. There is no dispute today about the basic correctness of this insight. Nevertheless, the attempt persists to relieve the lack of capital and to lower the interest rate by increasing the money in circulation. In truth, all these efforts in trying to lower the interest rate are of no avail. The only effect is to increase prices.
What should be done, therefore, is to give up all attempts to artificially expand the quantity of money in circulation. Presumably the flaws in the current policy will soon be recognized. It is already generally admitted that the sharp increase in the quantity of money and fiduciary media is one of the most important causes of the currently high level of prices. There is no need to decrease the quantity of fiduciary media, nor must their future expansion even be impeded. To moderate price rises, one must merely avoid artificially expanding them.
All this assumes, of course, that a policy to prevent increases in prices is inherently reasonable, as one might well imagine from the general clamor in support of this idea. In theoretically examining this problem, one must first clarify why a decline in the purchasing power of money is considered to be deleterious. One must also investigate whether all groups in society suffer from it equally, and whether certain groups might not actually benefit from a rise in prices. Only then can a purchasing power policy be integrated harmoniously into the whole system of social policies.
If changes in the purchasing power of money occurred simultaneously and affected all goods and services proportionally, their only effect would be to favor debtors over creditors. All those engaged in credit transactions who have claims on money would feel the effect of a reduced purchasing power, unless they had foreseen the impending change in the value of money at the time that they extended credit, and accordingly included this expectation when they drew up the loan contract. If it were possible to predict exactly the direction and extent of future changes in the objective value of money, appropriate provisions by one side or the other concerning monetary repayments could be included in long-term contracts. As no perfect prediction of this kind is possible, creditors are the ones who suffer from a decline in the value of money. The clamor against higher prices has such unanimous support, however, that it cannot be out of concern for those persons who derive their income from interest on their capital. The true reason for the unpopularity of rising prices lies elsewhere.
The fact is that rising prices will never affect all goods simultaneously and to the same extent, as was assumed above. Changes in the quantity of money in circulation spread out from a specific point, showing themselves wherever additional amounts of money flow into the economy. If the change is triggered by increased gold production, gold producers will be the first to experience the increase. The first possessors of the additional quantities of money will first express their changed evaluation of the value of money to those persons with whom they exchange. The decline in the value of money is then spread progressively from one class to another, from one economic group to the next, until it finally affects all commodities.
It should be noted, incidentally—though we will not go into any details—that not all commodities are equally affected by the change in the purchasing power of money even at the end of the process. Certain differences may well persist because changes in the value of money have a differential impact on various individuals and will therefore cause a shift in the underlying supply and demand relationships.
Furthermore, the fact that changes in the value of money do not affect all commodities simultaneously has a decisive influence on the way they are interpreted in society. The hardest hit are those persons who offer goods and services on the market whose prices have not yet been increased by the decline in the purchasing power of money, but who must already pay higher prices for commodities and services that they buy. They must pay more for what they buy, although they still sell only at the older prices.
Public servants with fixed incomes are especially victimized by rising prices because, generally speaking, their income lags behind changes in the price of goods. Public servants already must pay higher prices, although their salary has not yet gone up. When, finally, their remuneration commensurately goes up, the increase fails to compensate them for the loss they have incurred in the meantime. In Austria, for example, the salaries of senior public servants have not been raised in the last forty years. The same applies for certain incomes that tradition and customs have set at a fixed level, and where changes are exceedingly slow. Typical examples are physicians’ fees, fees for certain services, examination fees, and so on.
The situation is different with most wage earners, particularly workers and employees in private enterprises. We shall examine, next, how wages are formed and therefore identify a second cause for the changes in the purchasing power of money.
Wage earnings have been steadily rising for several decades. This undoubtedly depends in part on the unionization of workers and lower-level employees. One of the most controversial issues with respect to the problem of increasing prices, and in the theory of wages as well, is whether and to what extent this rise in real or “nominal” wages has any bearing on rising commodity prices. One side maintains there is no cause and effect between these two events. According to the other side, wage increases are the most important cause behind the rise in commodity prices, while a third group attributes the increase in wages to higher commodity prices.
There is no doubt that the working class has improved its economic position in the last several decades. All observers agree on that point, and even the most fanatical adherents to Marx’s theory of pauperization cannot fail to acknowledge this fact in the long run. The upward social mobility of the working class has generally been ascribed to the activities of the trade unions, for instance in Lujo Brentano’s8 and Sidney Webb’s writings.9
When it is asserted that trade union organizations are enabling workers to obtain a higher wage level, a serious difficulty arises from the fact that all scientifically developed wage theories deny the possibility that workers can permanently secure higher wages through trade union contracts. All wage theories share the view that the determination of wage rates is connected with the theory of value. The various solutions to this problem have led to numerous attempts to solve the problem of the theory of wages. The labor theory of value naturally pursued a different path from modern subjective value theory, the latter being the first approach to adequately deal with this problem.
Imputation theory provides a way to determine the value of the individual complementary factors of production. It thus supplies the indispensable logical link for any theory about the formation of the prices of factors of production, and thus to any theory of the distribution of the final product.10
The level of wages is a market phenomenon and can never be influenced by interventions outside the marketplace. A wage policy, that is, a policy that shifts the level of wages away from the level it tends to reach in an unhampered market (the “natural wage level,” in Clark’s terminology), can operate in only one way. It must act by influencing those factors whose joint action on the market determines the specific level of wages. One can lower wages, for instance, by facilitating the immigration of foreign workers and raise wages by impeding this immigration. These methods exert an indirect influence on the market determination of wages. Whenever wages are formed in the marketplace under the influence of such changed conditions, the “natural” level of wage will reflect this new state of affairs.
It is just as impossible to directly influence wages as it is to directly influence other market prices, because a reaction will inevitably set in to restore the natural level. Officially set wage rates are no more effective than any wage policy imposed by trade unions.
Since trade unions are generally incapable of changing market conditions, they can have only a limited impact on wages. Clark11 gives a detailed discussion of the cases where trade unions can bring about a real improvement in workers’ income. These are exceptional cases in which the actual wage level would have stayed below the natural wage level if not for trade union intervention.
Clark is convinced, however, that trade unions cannot permanently push wages above their natural level, and in this respect Clark actually agrees with Marx, or at least Marx in his early writings. It is a well-known fact that Marx took the iron law of wages as his starting point and proclaimed this openly in The Communist Manifesto. The iron law of wages essentially contests the possibility that the wages of workers can be permanently raised above their natural level.
It is usually asserted that Marx subsequently abandoned the iron law of wages. What is overlooked is that the theory of surplus value rests on this law. For surplus value is defined as the difference between the value of the product produced by labor and the amount of that value received as wages. The product of the labor force is the amount of work required to produce and maintain the labor force. That is another way of saying that it is the wage corresponding to the iron law of wages. In the recently published text of a lecture given by Marx in 1865, we read that Marx, like Clark, believed that trade unions could make only a marginal contribution to the betterment of workers’ wages.12
The actual wages in the last few decades are difficult to reconcile with these scientific wage theories. This fact has encouraged the Historical School of economics to give up on wage theories altogether. But there is one scientific theory of wages developed by the modern school that can actually be brought to bear on the facts of the case.
While it is true that trade unions are incapable of raising wages permanently above their natural level, they nevertheless can affect the point in time when wages change in response to changes in the purchasing power of money. It is of course of vital importance whether increases in wages, which are bound to occur sooner or later in conjunction with changes in the purchasing power of money, occur sooner rather than later; any negative effect resulting from the delay, discussed earlier, will thereby be avoided.
There is a further point: the working class may overshoot the mark in its struggle, and may at this time force wages up to a level that will prove to be unsustainably too high. Let us assume that wages increased 10 percent above the natural wage level. Though a reaction is unavoidable, this reaction may not take the form of a reduction in money wages but of a corresponding increase in the prices of all products. The increased money wage is sustained, but the real wage is eventually forced back to the natural level of wages.
Price theory teaches us that potential buyers resist any excessive price demands by potential sellers. This indisputable proposition applies in this manner only to direct exchanges; in indirect exchanges mediated by money, which is the only significant form of exchange at the present stage of economic development, a modification in the theory must be introduced. The potential buyer may decide to pay a money price that exceeds his evaluation of the commodity’s worth in the hope that when he himself acts as a seller, he will in turn receive a higher money price when he sells the product. The employer may give in to wage demands of unionized workers that he considers to be excessive on the assumption that he will be able to sell his product at a higher price. The consumer pays the higher price asked by the producers because he is not only a consumer and buyer but also a producer and seller; and he, in turn, expects to obtain higher prices in his capacity as a producer and seller. This is what is likely to happen under conditions of indirect exchange.
In fact, the more that improvements in communication permit a globalized expansion of markets, the more predominant will be these processes of indirect exchange. Only where all parties are fully represented in the marketplace, that is, only at daily, weekly, or annual markets in isolated areas or when certain branches of business assemble at the bourse, can face-to-face bargaining be effective.
In all other situations where two traders meet face-to-face, they represent only very small cross-sections of the global market for a particular commodity. Under these circumstances, bargaining is pointless, since what matters is not the respective strength of the two particular traders confronting each other on the market but the relative strength of all buyers and sellers of that particular good. We can thus see why a seemingly “fixed” price is being substituted in more and more places for a price set by bargaining. When prices are “fixed,” there are only two options: forgoing the purchase, something that may not always be feasible when an essential want is involved, or paying the higher price in anticipation of obtaining an equally higher price oneself on another segment of the market. This is a correct way to visualize how business and labor unions influence price formation under current conditions.
As long as increases in the prices of goods stem from these features of indirect exchange, they do not warrant the concern they often arouse. On the contrary, they should be viewed as symptoms of buoyant activity, burgeoning development, and unceasing transformation in the nature of production and consumption. The mutual exchange relations for economic goods are constantly in flux because every day sees the emergence of new consumption demands and of new ways to satisfy them. And from a sociopolitical point of view, price increases have even fewer adverse consequences—to the extent that they are attributable to this cause.
We have already referred to the fact that rising prices benefit organized labor and improve its position at a slight expense to those who live off their capital, a consequence that can hardly be given much weight.
In light of this, a comprehensive policy to deal with rising prices that pays no attention to the basic cause for the decline in the purchasing power of money is not worth implementing. Once we have broken down into their various component parts the forces that drive up commodity prices, we can restrict our countermeasures to those components that warrant an intervention.
[1. ][This essay was originally delivered in German as Ludwig von Mises’s inaugural lecture at the University of Vienna in February 1913, on the basis of which he received the status of Privatdozent [unsalaried lecturer]. It has not been previously published. From 1913 until the spring of 1934, Mises regularly taught a seminar almost every semester (except during the war years of 1914-1918, when he served in the Austrian Army) at the University of Vienna on a wide variety of topics in general economic theory, monetary and business cycle theory, economic policy and comparative economic systems, and methodology of the social sciences.—Ed.]
[2. ][See Chapter 7, “The General Rise in Prices in the Light of Economic Theory,” footnote 7.—Ed.]
[3. ][Also see Basset Jones, Horses and Apples: A Study in Index Numbers (New York: John Day, 1934), and Michael A. Heilperin, International Monetary Economics (London: Longmans, Green, 1939), the appendix “Note on the Use of Statistical Constructions,” pp. 259-70; also, Gottfried Haberler, The Different Meanings Attached to the Term “Fluctuations in the Purchasing Power of Gold” and the Best Instrument or Instruments for Measuring Such Fluctuations, Official No. F/Gold.74 (Geneva: League of Nations, 1931).—Ed.]
[4. ][Irving Fisher (1867-1947) was one of the most prominent American economists in the first half of the twentieth century. He formulated a widely used version of the quantity theory of money, utilizing the equation of exchange in The Purchasing Power of Money (1911). He advocated using a system of index numbers to vary the gold content of the dollar to maintain a stable purchasing power of the monetary unit.—Ed.]
[5. ][See “On the Problem of Legal Resumption of Specie Payments in Austria-Hungary,” Chapter 4 in the present volume.—Ed.]
[6. ][Karl Helfferich (1872-1924) was a German economist, politician, and financier. His most important book on monetary themes was Money (New York: Augustus M. Kelley,  1969).—Ed.]
[7. ][See J. van Walre de Bordies, The Austrian Crown: Its Depreciation and Stabilization (London: P.S. King & Son, 1924), p. 37, for the amounts by which Austrian banknotes in circulation increased between 1909 and 1914.—Ed.]
[8. ][Lujo Brentano (1844-1931) was a German economist and social reformer. He was a founding member of the Verein für Sozialpolitik (Society for Social Policy) and a supporter of the social market economy, which rejected both socialism and laissez-faire capitalism, combining private enterprise with heavy government regulation and social welfare. In 1914, he signed the “Manifesto of the Ninety-Three,” which galvanized support for the war throughout German schools and universities. After the revolution of November 1918, he for a very short period served as people’s commissar (minister) of trade.—Ed.]
[9. ][Sidney Webb (1859-1947) was an early member of the British Fabian Society, which called for the achievement of socialism through incremental legislation. He was also a prominent intellectual force in the British Labor Party, having written in 1918 the famous “Clause Four” in the Labor Party program that called for the nationalization of the means of production. In 1935, he coauthored with his wife, Beatrice, Soviet Communism: A New Civilization ? in which he predicted that the Soviet system of central economic planning would eventually spread around the rest of the world. In 1929, he was granted the title Lord Passfield.—Ed.]
[10. ][The theory of imputation attempts to demonstrate the process by which the value of the finished product on the market is reflected back into the relative values of the factors of production utilized in its manufacture, thus determining the distribution of income among those factors. The theory was most systematically developed among the early Austrian economists by Friedrich von Wieser, Natural Value (New York: Augustus M. Kelley,  1971). See also F. A. Hayek, “Some Remarks on the Problem of Imputation,” (1926) in Money, Capital and Fluctuations: Early Essays (Chicago: University of Chicago Press, 1984), pp. 33-54; and Hans Mayer, “Imputation,” (1928) in Israel M. Kirzner, ed., Classics in Austrian Economics: A Sampling in the History of a Tradition (London: William Pickering, 1994), pp. 19-53. The more generally accepted answer to this problem is derived from the theory of marginal productivity developed by John Bates Clark, The Distribution of Wealth (New York: Augustus M. Kelley,  1965).—Ed.]
[11. ]See Chapter 7, “The General Rise in Prices in the Light of Economic Theory,” footnote 16.
[12. ][See Karl Marx, Value, Price and Profit (Chicago: Charles H. Kerr & Co.,  1910).—Ed.]