Chapter 17 Indirect Exchange 1. Media of Exchange and Money
Interpersonal exchange is called indirect exchange if, between the commodities and services, the reciprocal exchange of which is the ultimate end of exchanging, one or several media of exchange are interposed.
The subject matter of the theory of indirect exchange is the study of the ratios of exchange between the media of exchange on the one hand and the goods and services of all orders on the other hand.
The statements of the theory of indirect exchange refer to all instances of indirect exchange and to all things which are employed as media of exchange.
A medium of exchange which is commonly used as such is called money.
The notion of money is vague as its definition refers to the vague term commonly used.
There are borderline cases in which it cannot be decided whether a medium of exchange is
or is not commonly used and should be called money.
But this vagueness in the denotation of money in no way affects the exactitude and precision
required by praxeological theory.
For all that is to be predicated of money is valid for every medium of exchange.
It is therefore immaterial whether one preserves the traditional term theory of money or substitutes
for it another term.
The theory of money was and is always the theory of indirect exchange and of the media
of exchange.
The theory of monetary calculation does not belong to the theory of indirect exchange.
It is a part of the general theory of praxeology.
2.
Observations on some widespread errors.
The fateful errors of popular monetary doctrines, which have led astray the monetary policies
of almost all governments, would hardly have come into existence if many economists had
not themselves committed blunders in dealing with monetary issues, and did not stubbornly
cling to them.
There is, first of all, the spurious idea of the supposed neutrality of money.
An outgrowth of this doctrine was the notion of the level of prices that rises or falls
proportionately with the increase or decrease in the quantity of money in circulation.
It was not realized that changes in the quantity of money can never affect the prices of all
goods and services at the same time and to the same extent.
Nor was it realized that changes in the purchasing power of the monetary unit are necessarily
linked with changes in the mutual relations between those buying and selling.
In order to prove the doctrine that the quantity of money and prices rise and fall proportionately,
recourse was had in dealing with the theory of money to a procedure entirely different
from that modern economics applies in dealing with all its other problems.
Instead of starting from the actions of individuals, as catallactics must do without exception,
formulas were constructed designed to comprehend the whole of the market economy.
Elements of these formulas were the total supply of money available in the Volkswirtschaft,
The volume of trade, that is, the money equivalent of all transfers of commodities and services
as effected in the Volkswirtschaft.
The average velocity of circulation of the monetary units.
The level of prices.
These formulas seemingly provided evidence of the correctness of the price-level doctrine.
In fact, however, this whole mode of reasoning is a typical case of arguing in a circle.
For the equation of exchange already involves the level doctrines which it tries to prove.
It is essentially nothing but a mathematical expression of the untenable doctrine that
there is proportionality in the movements of the quantity of money and of prices.
In analyzing the equation of exchange, one assumes that one of its elements, total supply
Supply of Money, Volume of Trade, Velocity of Circulation, Changes, without asking how
such changes occur.
It is not recognized that changes in these magnitudes do not emerge in the Volkswirtschaft
as such, but in the individual actor's conditions, and that it is the interplay of the reactions
of these actors that results in alterations of the price structure.
The mathematical economists refuse to start from the various individuals' demand for
and supply of money.
They introduce instead the spurious notion of velocity of circulation, fashioned according
to the patterns of mechanics.
There is at this point of our reasoning no need to deal with the question of whether
or not the mathematical economists are right in assuming that the services rendered by
by Money consist wholly or essentially in its turnover, in its circulation.
Even if this were true, it would still be faulty to explain the purchasing power, the
price, of the monetary unit on the basis of its services.
The services rendered by water, whiskey and coffee do not explain the prices paid for
these things.
What they explain is only why people, as far as they recognize these services, under certain
further conditions, demand definite quantities of these things.
It is always demand that influences the price structure, not the objective value in use.
It is true that with regard to money the task of catallactics is broader than with regard
to vendable goods.
It is not the task of catallactics but of psychology and physiology to explain why people
are intent on securing the services which the various vendable commodities can render.
It is a task of catallactics, however, to deal with this question with regard to money.
Catallactics alone can tell us what advantages a man expects from holding money.
But it is not these expected advantages which determine the purchasing power of money.
The eagerness to secure these advantages is only one of the factors in bringing about
the demand for money.
It is demand, a subjective element whose intensity is entirely determined by value judgments,
and not any objective fact, any power to bring about a certain effect, that plays a role
in the formation of the market's exchange ratios.
The deficiency of the equation of exchange and its basic elements is that they look at
market phenomena from a holistic point of view.
They are deluded by their prepossession with the Volkswirtschaft notion.
But where there is, in the strict sense of the term, a Volkswirtschaft, there is neither
a market nor prices and money.
On a market, there are only individuals or groups of individuals acting in concert.
What motivates these actors is their own concerns, not those of the whole market economy.
If there is any sense in such notions as volume of trade and velocity of circulation, then
they refer to the resultant of the individual's actions.
It is not permissible to resort to these notions in order to explain the actions of the individual.
of Individuals.
The first question that catallactics must raise with regard to changes in the total
quantity of money available in the market system is how such changes affect the various
individual's conduct.
Modern economics does not ask what iron or bread is worth, but what a definite piece
of Iron or of Bread is worth to an acting individual at a definite date and a definite
place.
It cannot help proceeding in the same way with regard to money.
The equation of exchange is incompatible with the fundamental principles of economic thought.
It is a relapse to the thinking of ages in which people failed to comprehend praxeological
phenomena because they were committed to holistic notions.
It is sterile, as were the speculations of earlier ages concerning the value of iron
and bread in general.
The theory of money is an essential part of the catallactic theory.
It must be dealt with in the same manner which is applied to all other catallactic problems.
3.
Demand for Money and Supply of Money
In the marketability of the various commodities and services there prevail considerable differences.
There are goods for which it is not difficult to find applicants ready to disperse the highest
recompense which, under the given state of affairs, can possibly be obtained, or a recompense
only slightly smaller.
There are other goods for which it is very hard to find a customer quickly, even if the
The vendor is ready to be content with a compensation much smaller than he could reap if he could
find another aspirant whose demand is more intense.
It is these differences in the marketability of the various commodities and services which
created indirect exchange.
A man who, at the instant, cannot acquire what he wants to get for the conduct of his
in his own household or business, or who does not yet know what kind of goods he will need
in the uncertain future, comes nearer to his ultimate goal if he exchanges a less marketable
good he wants to trade against a more marketable one.
It may also happen that the physical properties of the merchandise he wants to give away, as
As for instance its perishability or the costs incurred by its storage or similar circumstances
impel him not to wait longer.
Sometimes he may be prompted to hurry in giving away the good, concerned because he is afraid
of a deterioration of its market value.
In all such cases he improves his own situation in acquiring a more marketable good, even
Question if this good is not suitable to satisfy directly any of his own needs.
A medium of exchange is a good which people acquire neither for their own consumption
nor for employment in their own production activities, but with the intention of exchanging
it at a later date against those goods which they want to use, either for consumption or
for production.
Money is a medium of exchange.
It is the most marketable good which people acquire because they want to offer it in later
acts of interpersonal exchange.
Money is the thing which serves as the generally accepted and commonly used medium of exchange.
This is its only function.
All the other functions which people ascribe to money are merely particular aspects of
of its primary and sole function, that of a medium of exchange.
Media of exchange are economic goods.
They are scarce.
There is a demand for them.
There are on the market people who desire to acquire them and are ready to exchange goods
and services against them.
Media of exchange have value in exchange.
People make sacrifices for their acquisition.
They pay prices for them.
The peculiarity of these prices lies merely in the fact that they cannot be expressed
in terms of money.
In reference to the vendable goods and services, we speak of prices or of money prices.
In reference to money, we speak of its purchasing power with regard to various vendable goods.
There exists a demand for media of exchange because people want to keep a store of them.
Every member of a market society wants to have a definite amount of money in his pocket
or box, a cash holding or cash balance of a definite height.
Sometimes he wants to keep a larger cash holding, sometimes a smaller.
In exceptional cases, he may even renounce any cash holding.
At any rate, the immense majority of people aim not only to own various vendable goods,
they want no less to hold money. Their cash holding is not merely a residuum, an unspent
margin of their wealth. It is not an unintentional remainder left over after all intentional
acts of buying and selling have been consummated. Its amount is determined by a deliberate demand
for Cash, and as with all other goods it is the changes in the relation between demand
for and supply of money that bring about changes in the exchange ratio between money and the
vendable goods.
Every piece of money is owned by one of the members of the market economy.
The transfer of money from the control of one actor into that of another is temporally
Money can be immediate and continuous. There is no fraction of time in between in which
the money is not a part of an individual's or a firm's cash holding, but just in circulation.
Money can be in the process of transportation, it can travel in trains, ships or planes from
one place to another, but it is, in this case too, always subject to somebody's control.
It is unsound to distinguish between circulating and idle money.
It is no less faulty to distinguish between circulating money and hoarded money.
What is called hoarding is a height of cash-holding which, according to the personal opinion of
an observer, exceeds what is deemed normal and adequate.
However, hoarding is cash-holding.
Money is still money, and it serves in the hoards the same purposes which it serves in
cash holdings called normal.
He who hoards money believes that some special conditions make it expedient to accumulate
a cash holding which exceeds the amount he himself would keep under different conditions,
or other people keep, or an economist censuring his action considers appropriate.
And he acts in this way influences the configuration of the demand for money in the same way in
which every normal demand influences it.
Many economists avoid applying the terms demand and supply in the sense of demand for and
supply of money for cash holding because they fear a confusion with the current terminology
as used by the bankers.
It is, in fact, customary to call demand for money the demand for short-term loans, and
supply of money the supply of such loans.
Accordingly, one calls the market for short-term loans the money market.
One says money is scarce if there prevails a tendency toward a rise in the rate of interest
for short-term loans, and one says money is plentiful if the rate of interest for such
which loans is decreasing.
These modes of speech are so firmly entrenched that it is out of the question to venture
to discard them.
But they have favored the spread of fateful errors.
They made people confound the notions of money and of capital and believe that increasing
the quantity of money could lower the rate of interest lastingly.
But it is precisely the crassness of these errors which makes it unlikely that the terminology
suggested could create any misunderstanding.
It is hard to assume that economists could err with regard to such fundamental issues.
Others maintain that one should not speak of the demand for and supply of money because
Because the aims of those demanding money differ from the aims of those demanding vendable
commodities.
Commodities, they say, are demanded ultimately for consumption, while money is demanded in
order to be given away in further acts of exchange.
This objection is no less invalid.
The use which people make of a medium of exchange consists eventually in its being given away.
But first of all they are eager to accumulate a certain amount of it in order to be ready
for the moment in which a purchase may be accomplished.
Precisely because people do not want to provide for their own needs right at the instant at
which they give away the goods and services they themselves bring to the market.
Precisely because they want to wait, or are forced to wait until propitious conditions
for buying appear.
They barter not directly but indirectly through the interposition of a medium of exchange.
The fact that money is not worn out by the use one makes of it, and that it can render
its services practically for an unlimited length of time, is an important factor in
the configuration of its supply.
But it does not alter the fact that the appraisement of money is to be explained in the same way
as the appraisement of all other goods, by the demand on the part of those who are eager
to acquire a definite quantity of it.
Economists have tried to enumerate the factors which, within the whole economic system, may
increase or decrease the demand for money.
Such factors are the population figure, the extent to which the individual households
Institutions provide for their own needs by autarkic production and the extent to which
they produce for other people's needs, selling their products and buying for their own consumption
on the market, the distribution of business activity and the settlement of payments over
the various seasons of the year, institutions for the settlement of claims and counterclaims
by mutual cancellation such as clearing houses.
All these factors indeed influence the demand for money and the height of the various individuals
and firms cash holding.
But they influence them only indirectly by the role they play in the considerations of
people concerning the determination of the amount of cash balances they deem appropriate.
What decides the matter is always the value judgments of the men concerned.
The various actors make up their minds about what they believe the adequate height of their
cash-holding should be.
They carry out their resolution by renouncing the purchase of commodities, securities and
interest-bearing claims, and by selling such assets or conversely by increasing their purchases.
With money, things are not different from what they are with regard to all other goods
and services. The demand for money is determined by the conduct of people intent upon acquiring
it for their cash holding.
Another objection raised against the notion of the demand for money was this. The marginal
utility of the money unit decreases much more slowly than that of the other commodities.
In fact, its decrease is so slow that it can be practically ignored.
With regard to money, nobody ever says that his demand is satisfied, and nobody ever forsakes
an opportunity to acquire more money, provided the sacrifice required is not too great.
It is therefore impermissible to consider the demand for money as limited.
The very notion of an unlimited demand is, however, contradictory.
This popular reasoning is entirely fallacious.
It confounds the demand for money for cash holding with the desire for more wealth as
expressed in terms of money.
He who says that his thirst for more money can never be quenched does not mean to say
that his cash holding can never be too large.
What he really means is that he can never be rich enough.
If additional money flows into his hands, he will not use it for an increase of his
cash balance, or he will use only a part of it for this purpose.
He will expend the surplus either for instantaneous consumption or for investment.
Nobody ever keeps more money than he wants to have as cash holding.
The insight that the exchange ratio between money on the one hand and the vendable commodities
and services on the other hand is determined in the same way as the mutual exchange ratios
between the various vendable goods by demand and supply was the essence of the quantity
theory of money.
This theory is essentially an application of the general theory of supply and demand
to the Special Instance of Money.
Its merit was the endeavor to explain the determination of money's purchasing power
by resorting to the same reasoning which is employed for the explanation of all other
exchange ratios.
Its shortcoming was that it resorted to a holistic interpretation.
It looked at the total supply of money in the Volkswirtschaft and not at the actions
An outgrowth of this erroneous point of view was the idea that there prevails a proportionality
in the changes of the total quantity of money and of money prices.
But the older critics failed in their attempts to explode the errors inherent in the quantity
theory, and to substitute a more satisfactory theory for it.
They did not fight what was wrong in the quantity theory.
They attacked, on the contrary, its nucleus of truth.
They were intent upon denying that there is a causal relation between the movements of
prices and those of the quantity of money.
This denial led them into a labyrinth of errors, contradictions and nonsense.
Modern monetary theory takes up the thread of the traditional quantity theory as far
As far as it starts from the cognition that changes in the purchasing power of money must
be dealt with according to the principles applied to all other market phenomena, and
that there exists a connection between the changes in the demand for and supply of money
on the one hand, and those of purchasing power on the other.
In this sense, one may call the modern theory of money an improved variety of the quantity
Theory.
The Epistemological Import of Carl Menger's Theory of the Origin of Money
Carl Menger has not only provided an irrefutable praxeological theory of the origin of money.
He has also recognized the import of his theory for the elucidation of fundamental principles
of praxeology and its methods of research.
There were authors who tried to explain the origin of money by decree or covenant.
The authority, the state, or a compact between citizens has purposively and consciously established
indirect exchange and money.
The main deficiency of this doctrine is not to be seen in the assumption that people of
an age unfamiliar with indirect exchange and money could design a plan of a new economic
Order entirely different from the real conditions of their own age, and could comprehend the
importance of such a plan.
Neither is it to be seen in the fact that history does not afford a clue for the support
of such statements.
There are more substantial reasons for rejecting it.
If it is assumed that the conditions of the parties concerned are improved by every step
that leads from direct exchange to indirect exchange, and subsequently to giving preference
for use as a medium of exchange to certain goods distinguished by their especially high
marketability.
It is difficult to conceive why one should, in dealing with the origin of indirect exchange,
resort in addition to authoritarian decree or an explicit compact between citizens.
A man who finds it hard to obtain in direct barter what he wants to acquire renders better
his chances to acquire what he is asking for in later acts of exchange by the procurement
of a more marketable good.
Under these circumstances there was no need of government interference or of a compact
between the citizens.
The happy idea of proceeding in this way could strike the shrewdest individuals and the less
This resourceful could imitate the former's method.
It is certainly more plausible to take for granted that the immediate advantages conferred
by indirect exchange were recognized by the acting parties than to assume that the whole
image of a society trading by means of money was conceived by a genius, and if we adopt
the covenant doctrine made obvious to the rest of the people by persuasion.
If, however, we do not assume that individuals discovered the fact that they fare better
through indirect exchange than through waiting for an opportunity for direct exchange, and,
for the sake of argument, admit that the authorities or a compact introduced money, further questions
are raised.
We must ask what kind of measures were applied in order to induce people to adopt a procedure,
The utility of which they did not comprehend, and which was technically more complicated
than direct exchange.
We may assume that compulsion was practiced, but then we must ask, further, at what time
and by what occurrences indirect exchange and the use of money later ceased to be procedures
troublesome or at least indifferent to the individuals concerned and became advantageous
to them.
The praxeological method traces all phenomena back to the actions of individuals.
If conditions of interpersonal exchange are such that indirect exchange facilitates the
transactions, and if and as far as people realize these advantages, indirect exchange
and money come into being.
Historical experience shows that these conditions were and are present.
How, in the absence of these conditions, people could have adopted indirect exchange and money
and clung to these modes of exchanging is inconceivable.
The historical question concerning the origin of indirect exchange and money is, after all,
of no concern to praxeology.
The only relevant thing is that indirect exchange and money exist because the conditions for
for their existence were and are present. If this is so, praxeology does not need to resort
to the hypothesis that authoritarian decree or a covenant invented these modes of exchanging.
The atatists may, if they like, continue to ascribe the invention of money to the state,
however unlikely this may be. What matters is that a man acquires a good not in order
All theorems of the catalactic theory of media of exchange and of money refer to the services which a good renders in its capacity as a medium of exchange.
Exchange.
Even if it were true that the impulse for the introduction of indirect exchange and
money was provided by the authorities or by an agreement between the members of society,
the statement remains unshaken that only the conduct of exchanging people can create indirect
exchange and money.
History may tell us where and when for the first time media of exchange came into use
and how, subsequently, the range of goods employed for this purpose was more and more
restricted.
As the differentiation between the broader notion of a medium of exchange and the narrower
notion of money is not sharp, but gradual, no agreement can be reached about the historical
transition from simple media of exchange to money.
This is a matter of historical understanding.
But as has been mentioned, the distinction between direct exchange and indirect exchange
is sharp, and everything that catallactics establishes with regard to media of exchange
refers categorically to all goods which are demanded and acquired as such media.
As far as the statement that indirect exchange and money were established by decree or by
Covenant is meant to be an account of historical events, it is the task of historians to expose
its falsity.
As far as it is advanced merely as a historical statement, it can in no way affect the catallactic
theory of money and its explanation of the evolution of indirect exchange.
But if it is designed as a statement about human action and social events, it is useless,
because it states nothing about action.
It is not a statement about human action to declare that one day rulers or citizens assembled
in convention were suddenly struck by the inspiration that it would be a good idea to
exchange indirectly and through the intermediary of a commonly used medium of exchange.
It is merely pushing back the problem involved.
It is necessary to comprehend that one does not contribute anything to the scientific
conception of human actions and social phenomena if one declares that the state, or a charismatic
leader, or an inspiration which descended upon all the people, have created them.
Neither do such statements refute the teachings of a theory showing how such phenomena can
can be acknowledged as the unintentional outcome, the resultant, not deliberately designed and
aimed at by specifically individual endeavors of the members of a society.
4.
The Determination of the Purchasing Power of Money
As soon as an economic good is demanded not only by those who want to use it for consumption
The amount of other goods which can be obtained in giving away a medium of exchange, its price, as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange.
If people stop using the good in question as a medium of exchange, this additional specific demand disappears, and the price drops concomitantly.
Thus, the demand for a medium of exchange is the composite of two partial demands, the demand displayed by the intention to use it in consumption and production, and that displayed by the intention to use it as a medium of exchange.
With regard to modern metallic money, one speaks of the industrial demand and of the monetary demand.
The value in exchange, purchasing power, of a medium of exchange is the resultant of the cumulative effect of both partial demands.
Now the extent of that part of the demand for a medium of exchange,
which is displayed on account of its service as a medium of exchange, depends on its value
in exchange.
This fact raises difficulties which many economists considered insoluble, so that they
abstained from following farther along this line of reasoning.
It is illogical, they said, to explain the purchasing power of money by reference to
to the demand for money, and the demand for money by reference to its purchasing power.
The difficulty is, however, merely apparent. The purchasing power, which we explain by
referring to the extent of specific demand, is not the same purchasing power, the height
of which determines this specific demand. The problem is to conceive the determination
of the Purchasing Power of the Immediate Future of the Impending Moment.
For the solution of this problem, we refer to the purchasing power of the immediate past,
of the moment just past.
These are two distinct magnitudes.
It is erroneous to object to our theorem, which may be called the regression theorem,
that it moves in a vicious circle.
But, say the critics, this is tantamount to merely pushing back the problem.
For now, one must still explain the determination of yesterday's purchasing power.
If one explains this in the same way by referring to the purchasing power of the day before
yesterday, and so on, one slips into a regressus in infinitum.
This reasoning, they assert, is certainly not a complete and logically satisfactory
Solution of the Problem Involved.
What these critics fail to see is that the regression does not go back endlessly.
It reaches a point at which the explanation is completed, and no further question remains
unanswered.
If we trace the purchasing power of money back step by step, we finally arrive at the
point at which the service of the good concerned as a medium of exchange begins.
At this point, yesterday's exchange value is exclusively determined by the non-monetary,
industrial demand, which is displayed only by those who want to use this good for other
employments than that of a medium of exchange.
But the critics continue.
This means explaining that part of money's purchasing power, which is due to its service
is entirely explained by reference to these specific monetary services, and by reference
and the demand they create.
Two facts are not to be denied, and are not denied by anybody.
First, that the demand for a medium of exchange is determined by considerations of its exchange
value, which is an outcome both of the monetary and the industrial services it renders.
Second, that the exchange value of a good which has not yet been demanded for service
as a medium of exchange is determined solely by a demand on the part of people eager to
use it for industrial purposes, that is, either for consumption or for production.
Now the regression theorem aims at interpreting the first emergence of a monetary demand for
a good which previously had been demanded exclusively for industrial purposes as influenced
by the exchange value that was ascribed to it at this moment, on account of its non-monetary
services only.
This certainly does not involve explaining the specific monetary exchange value of a
medium of exchange on the ground of its industrial exchange value.
Finally, it was objected to the regression theorem that its approach is historical, not
theoretical.
This objection is no less mistaken.
To explain an event historically means to show how it was produced by forces and factors
operating at a definite date and a definite place.
These individual forces and factors are the ultimate elements of the interpretation.
They are ultimate data, and as such not open to any further analysis and reduction.
To explain a phenomenon theoretically means to trace back its appearance to the operation
of general rules which are already comprised in the theoretical system.
The regression theorem complies with this requirement.
It traces the specific exchange value of a medium of exchange back to its function as
such a medium, and to the theorems concerning the process of valuing and pricing as developed
by the General Catalactic Theory.
It deduces a more special case from the rules of a more universal theory.
It shows how the special phenomenon necessarily emerges out of the operation of the rules
generally valid for all phenomena.
It does not say, This happened at that time and at that place.
It says, This always happens when the conditions appear.
Whenever a good which has not been demanded previously for the employment as a medium
of exchange begins to be demanded for this employment, the same effects must appear again.
No good can be employed for the function of a medium of exchange which at the very beginning
of its use for this purpose did not have exchange value on account of other employments.
And all these statements implied in the regression theorem are announced apodictically, as implied
in the a priorism of praxeology.
It must happen this way.
Nobody can ever succeed in constructing a hypothetical case in which things were to
occur in a different way.
The purchasing power of money is determined by demand and supply, as is the case with
the Prices of All Vendable Goods and Services.
As action always aims at a more satisfactory arrangement of future conditions, he who considers
acquiring or giving away money is, of course, first of all interested in its future purchasing
power and the future structure of prices.
But he cannot form a judgment about the future purchasing power of money otherwise than by
by looking at its configuration in the immediate past.
It is this fact that radically distinguishes the determination of the purchasing power
of money from the determination of the mutual exchange ratios between the various vendable
goods and services.
With regard to these latter, the actors have nothing else to consider than their importance
for future want satisfaction.
If a new commodity unheard of before is offered for sale, as was, for instance, the case with
radio sets a few decades ago, the only question that matters for the individual is whether
or not the satisfaction that the new gadget will provide is greater than that expected
from those goods he would have to renounce in order to buy the new thing.
Judge about past prices is, for the buyer, merely a means to reap a consumer's surplus.
If he were not intent upon this goal, he could, if need be, arrange his purchases without
any familiarity with the market prices of the immediate past, which are popularly called
present prices.
He could make value judgments without appraisement.
As has been mentioned already, the obliteration of the memory of all prices of the past would
not prevent the formation of new exchange ratios between the various vendable things.
But if knowledge about money's purchasing power were to fade away, the process of developing
indirect exchange and media of exchange would have to start anew.
It would become necessary to begin again with employing some goods more marketable than
the rest as media of exchange.
The demand for these goods would increase and would add to the amount of exchange value
derived from their industrial, non-monetary employment, a specific component due to their
new use as a medium of exchange.
A value judgment is, with reference to money, only possible if it can be based on appraisement.
The acceptance of a new kind of money presupposes that the thing in question already has previous
exchange value on account of the services it can render directly to consumption or production.
Neither a buyer nor a seller could judge the value of a monetary unit if he had no information
about its exchange value, its purchasing power, in the immediate past.
The relation between the demand for money and the supply of money, which may be called
the money relation, determines the height of purchasing power.
Today's money relation, as it is shaped on the ground of yesterday's purchasing power,
determines today's purchasing power.
He who wants to increase his cash holding restricts his purchases and increases his sales, and
thus brings about a tendency toward falling prices.
He who wants to reduce his cash holding increases his purchases, either for consumption or for
production and investment, and restricts his sales, thus he brings about a tendency toward
rising prices.
Individuals in the supply of money must necessarily alter the disposition of vendable goods as
owned by various individuals and firms.
The quantity of money available in the whole market system cannot increase or decrease
otherwise than by first increasing or decreasing the cash holdings of certain individual members.
We may, if we like, assume that every member gets a share of the additional money right
at the moment of its inflow into the system, or shares in the reduction in the quantity
of money.
But whether we assume this or not, the final result of our demonstration will remain the
same.
This result will be that changes in the structure of prices brought about by changes in the
The supply of money available in the economic system never affect the prices of the various commodities and services to the same extent and at the same date.
Let us assume that the government issues an additional quantity of paper money.
The government plans either to buy commodities and services, or to repay debts incurred, or to pay interest on such debts.
However this may be, the Treasury enters the market with an additional demand for goods
and services.
It is now in a position to buy more goods than it could buy before.
The prices of the commodities it buys rise.
If the government had expended in its purchases money collected by taxation, the taxpayers
would have restricted their purchases, and while the prices of the goods bought by the
If the government would have risen, those of other goods would have dropped.
But this fall in the prices of the goods the taxpayers used to buy does not occur if the
government increases the quantity of money at its disposal without reducing the quantity
of money in the hands of the public.
The prices of some commodities, namely of those the government buys, rise immediately,
while those of the other commodities remain unaltered for the time being.
But the process goes on.
Those selling the commodities asked for by the government are now themselves in a position
to buy more than they used previously.
The prices of the things these people are buying in larger quantities therefore rise
too.
Thus the boom spreads from one group of commodities and services to other groups until all prices
Prices and Wage Rates have risen. The rise in prices is thus not synchronous with the
various commodities and services. When eventually, in the further course of the increase in the
quantity of money, all prices have risen, the rise does not affect the various commodities
and services to the same extent, for the process has affected the material position of various
Individuals, to different degrees.
While the process is underway, some people enjoy the benefit of higher prices for the
goods or services they sell, while the prices of the things they buy have not yet risen
or have not risen to the same extent.
On the other hand, there are people who are in the unhappy situation of selling commodities
and services whose prices have not yet risen or not in the same degree as the prices
for the former, the progressive rise in prices is a boon, for the latter, a calamity. Besides,
the debtors are favored at the expense of the creditors. When the process once comes
to an end, the wealth of various individuals has been affected in different ways and to
to different degrees. Some are enriched, some impoverished. Conditions are no longer what
they were before. The new order of things results in changes in the intensity of demand
for various goods. The mutual ratio of the money prices of the vendable goods and services
is no longer the same as before. The price structure has changed apart from the fact
that all prices in terms of money have risen. The final prices to the establishment of
which the market tends after the effects of the increase in the quantity of money have
been fully consummated are not equal to the previous final prices multiplied by the same
multiplier. The main fault of the old quantity theory, as well as the mathematical economist's
The market's equation of exchange is that they have ignored this fundamental issue.
Changes in the supply of money must bring about changes in other data, too.
The market system before and after the inflow or outflow of a quantity of money is not merely
changed in that the cash holdings of the individuals and prices have increased or decreased.
There have been effected also changes in the reciprocal exchange ratios between the various
commodities and services, which, if one wants to resort to metaphors, are more adequately
described by the image of price revolution than by the misleading figure of an elevation
or a sinking of the price level.
We may at this point disregard the effects brought about by the influence on the content
of All Deferred Payments as Stipulated by Contracts.
We will deal later with them, and with the operation of monetary events on consumption
and production, investment in capital goods, and accumulation and consumption of capital.
But even in setting aside all these things, we must never forget that changes in the quantity
of money affect prices in an uneven way.
It depends on the data of each particular case at what moment and to what extent the
prices of the various commodities and services are affected.
In the course of a monetary expansion, inflation, the first reaction is not only that the prices
of some of them rise more quickly and more steeply than others.
It may also occur that some fall at first, as they are for the most part demanded by
by those groups whose interests are hurt.
Changes in the money relation are not only caused by governments issuing additional paper money.
An increase in the production of the precious metals employed as money has the same effects,
although, of course, other classes of the population may be favored or hurt by it.
Prices also rise in the same way if, without a corresponding reduction in the quantity of money available, the demand for money falls because of a general tendency toward a diminution of cash holdings.
The money expended additionally by such a dis-hoarding brings about a tendency toward higher prices in the same way as that flowing from the gold mines or from the printing press.
Conversely, prices drop when the supply of money falls, for example, through a withdrawal of paper money, or the demand for money increases, for example, through a tendency toward hoarding, the keeping of greater cash balances.
The process is always uneven, and by steps, disproportionate and asymmetrical.
It could be and has been objected that the normal production of the gold mines brought to the market may well entail an increase in the quantity of money, but does not increase the income, still less the wealth of the owners of the mines.
These people earn only their normal income, and thus their spending of it cannot disarrange market conditions and the prevailing tendencies toward the establishment of final prices and the equilibrium of the evenly rotating economy.
For them, the annual output of the mines does not mean an increase in riches and does not impel them to offer higher prices.
They will continue to live at the standard at which they used to live before.
Their spending within these limits will not revolutionize the market.
Thus the normal amount of gold production, although certainly increasing the quantity of money available,
cannot put into motion the process of depreciation.
It is neutral with regard to prices.
As against this reasoning, one must first of all observe that within a progressing economy in which population figures are increasing and the division of labor and its corollary, industrial specialization, are perfected, there prevails a tendency toward an increase in the demand for money.
Additional people appear on the scene and want to establish cash holdings.
The extent of economic self-sufficiency, that is, of production for the household's own needs, shrinks, and people become more dependent upon the market.
This will, by and large, impel them to increase their holding of cash.
Thus, the price-raising tendency emanating from what is called the normal gold production
encounters a price-cutting tendency emanating from the increased demand for cash holding.
However, these two opposite tendencies do not neutralize each other.
Both processes take their own course.
Both result in a disarrangement of existing social conditions, making some people richer,
and People Poorer.
Both affect the prices of various goods at different dates and to a different degree.
It is true that the rise in the prices of some commodities caused by one of these processes
can finally be compensated by the fall caused by the other process.
It may happen that at the end, some or many prices come back to their previous height.
But this final result is not the outcome of an absence of movements provoked by changes
in the money relation.
It is rather the outcome of the joint effect of the coincidence of two processes independent
of each other, each of which brings about alterations in the market data as well as
in the material conditions of various individuals and groups of individuals.
The new structure of prices may not differ very much from the previous one, but it is
the resultant of two series of changes which have accomplished all inherent social transformations.
The fact that the owners of gold mines rely upon steady yearly proceeds from their gold
production does not cancel the newly mined gold's impression upon prices.
The owners of the mines take from the market, in exchange for the gold produced, the goods
and services required for their mining, and the goods needed for their consumption and
their investments in other lines of production.
If they had not produced this amount of gold, prices would not have been affected by it.
It is beside the point that they have anticipated the future yield of the mines and capitalized
it, and that they have adjusted their standard of living to the expectation of steady proceeds
from the mining operations.
The effects which the newly mined gold exercises on their expenditure, and on that of those
people whose cash holdings step by step it enters later, begin only at the instant this
gold is available in the hands of the mine owners.
If in the expectation of future yields they had expended money at an earlier date, and
the expected yield failed to appear, conditions would not differ from other cases in which
consumption was financed by credit based on expectations not realized by later events.
Changes in the extent of the desired cash-holding of various people neutralize one another only
to the extent that they are regularly recurring and mutually connected by a causal reciprocity.
Salaried people and wage earners are not paid daily, but at certain paydays for a period
of one or several weeks.
They do not plan to keep their cash holding within the period between paydays at the same
level.
The amount of cash in their pockets declines with the approach of the next payday.
On the other hand, the merchants who supply them with the necessities of life increase
their cash holdings concomitantly.
The two movements condition each other.
There is a causal interdependence between them, which harmonizes them both with regard
to time and to quantitative amount.
Neither the dealer nor his customer lets himself be influenced by these recurrent fluctuations.
It was this phenomenon that led economists to the image of a regular circulation of money, and to the neglect of the changes in the individual's cash holdings.
However, we are faced with a concatenation which is limited to a narrow, neatly circumscribed field.
Only as far as the increase in the cash holding of one group of people is temporally and quantitatively related to the decrease in the cash holding of another group,
and as far as these changes are self-liquidating within the course of a period which the members
of both groups consider as a whole in planning their cash holding, can the neutralization
take place? Beyond this field, there is no question of such a neutralization.
5. The Problem of Hume and Mill and the Driving Force of Money
Is it possible to think of a state of affairs in which changes in the purchasing power of
money occur at the same time and to the same extent, with regard to all commodities and
services, and in proportion to the changes effected in either the demand for or the supply
of money?
In other words, is it possible to think of neutral money within the frame of an economic
System which does not correspond to the imaginary construction of an evenly rotating economy.
We may call this pertinent question the problem of Hume and Mill.
It is uncontested that neither Hume nor Mill succeeded in finding a positive answer to
this question.
Is it possible to answer it categorically in the negative?
We imagine two systems of an evenly rotating economy, A and B. The two systems are independent
and in no way connected with one another. The two systems differ from one another only
in the fact that to each amount of money M in A there corresponds an amount N M in B,
N being greater or smaller than one. We assume that there are no deferred payments and that
The money used in both systems serves only monetary purposes and does not allow of any
non-monetary use. Consequently, the prices in the two systems are in the ratio 1 to N.
Is it thinkable that conditions in A can be altered at one stroke in such a way as to
make them entirely equivalent to conditions in B?
The answer to this question must obviously be in the negative.
He who wants to answer it in the positive must assume that a deus ex machina approaches
every individual at the same instant, increases or decreases his cash holding by multiplying
it by n, and tells him that henceforth he must multiply by n all price data which he
employs in his appraisements and calculations.
This cannot happen without a miracle.
It has been pointed out already that in the imaginary construction of an evenly rotating
economy, the very notion of money vanishes into an unsubstantial calculation process,
self-contradictory and devoid of any meaning.
It is impossible to assign any function to indirect exchange, media of exchange and money
within an imaginary construction, the characteristic mark of which is unchangeability and rigidity
of conditions.
Where there is no uncertainty concerning the future, there is no need for any cash holding.
As money must necessarily be kept by people in their cash holdings, there cannot be any
money.
The use of media of exchange and the keeping of cash holdings are conditioned by the changeability
of Economic Data.
Money in itself is an element of change.
Its existence is incompatible with the idea of a regular flow of events in an evenly rotating
economy.
Every change in the money relation alters, apart from its effects upon deferred payments,
the conditions of the individual members of society.
Some become richer, some poorer.
It may happen that the effects of a change in the demand for and supply of money encounter
the effects of opposite changes occurring by and large at the same time and to the same
extent.
It may happen that the resultant of the two opposite movements is such that no conspicuous
changes in the price structure emerge.
But even then, the effects on the conditions of the various individuals are not absent.
Each change in the money relation takes its own course and produces its own particular
effects.
If an inflationary movement and a deflationary one occur at the same time, or if an inflation
is temporally followed by a deflation in such a way that prices finally are not very much
Much Changed, the social consequences of each of the two movements do not cancel each other.
To the social consequences of an inflation, those of a deflation are added.
There is no reason to assume that all or even most of those favored by one movement will
be hurt by the second one, or vice versa.
Money is neither an abstract numérère nor a standard of value or prices.
It is necessarily an economic good, and as such it is valued and appraised on its own
merits, that is, the services which a man expects from holding cash.
On the market there is always change and movement.
Only because there are fluctuations is there money.
Money is an element of change not because it circulates, but because it is kept in cash
holdings.
Only because people expect changes about the kind and extent of which they have no certain
knowledge whatsoever, do they keep money.
While money can be thought of only in a changing economy, it is in itself an element of further
changes.
Every change in the economic data sets it in motion and makes it the driving force of
new changes.
Every shift in the mutual relation of the exchange ratios between the various non-monetary
goods not only brings about changes in production and in what is popularly called distribution,
but also provokes changes in the money relation and thus further changes.
Nothing can happen in the orbit of vendible goods without affecting the orbit of money,
And all that happens in the orbit of money affects the orbit of commodities.
The notion of a neutral money is no less contradictory than that of a money of stable purchasing
power.
Money without a driving force of its own would not, as people assume, be a perfect money.
It would not be money at all.
It is a popular fallacy to believe that perfect money should be neutral and endowed with unchanging
and Purchasing Power, and that the goal of monetary policy should be to realize this
perfect money.
It is easy to understand this idea as a reaction against the still more popular postulates
of the inflationists, but it is an excessive reaction.
It is in itself confused and contradictory, and it has worked havoc because it was strengthened
and by an inveterate error inherent in the thought of many philosophers and economists.
These thinkers are misled by the widespread belief that a state of rest is more perfect
than one of movement.
Their idea of perfection implies that no more perfect state can be thought of, and consequently
that every change would impair it.
The best that can be said of a motion is that it is directed toward the attainment of a
The State of Perfection in which there is rest, because every further movement would
lead into a less perfect state.
Motion is seen as the absence of equilibrium and full satisfaction, as a manifestation
of trouble and want.
As far as such thoughts merely establish the fact that action aims at the removal of uneasiness,
and ultimately at the attainment of full satisfaction, they are well founded.
But one must not forget that rest and equilibrium are not only present in a state in which perfect
contentment has made people perfectly happy, but no less in a state in which, although
wanting in many regards, they do not see any means of improving their condition.
The absence of action is not only the result of full satisfaction.
It can no less be the corollary of the inability to render things more satisfactory.
It can mean hopelessness as well as contentment.
With the real universe of action and unceasing change, with the economic system which cannot
be rigid, neither neutrality of money nor stability of its purchasing power are compatible.
A world of the kind which the necessary requirements of neutral and stable money presuppose would
be a world without action.
It is therefore neither strange nor vicious that in the frame of such a changing world,
money is neither neutral nor stable in purchasing power.
All plans to render money neutral and stable are contradictory.
Money is an element of action and, consequently, of change.
Changes in the money relation, that is, in the relation of the demand for and the supply
of Money affect the exchange ratio between money on the one hand and the vendable commodities
on the other hand.
These changes do not affect at the same time and to the same extent the prices of the various
commodities and services.
may consequently affect the wealth of the various members of society in a different way.