WEBVTT NOTE 11.14. The Fallacy of Measuring and Stabilizing the PPM 1 00:00:00.000 --> 00:00:07.000 14. The Fallacy of Measuring and Stabilizing the PPM 2 00:00:07.000 --> 00:00:10.720 a. Measurement 3 00:00:10.720 --> 00:00:17.120 In olden times before the development of economic science, people naively assumed that the value 4 00:00:17.120 --> 00:00:24.280 of money remained always unchanged. Value was assumed to be an objective quantity in 5 00:00:24.280 --> 00:00:34.520 and money was the measure, the fixed yardstick of the values of goods and their changes. 6 00:00:34.520 --> 00:00:41.540 The value of the monetary unit, its purchasing power with respect to other goods, was assumed 7 00:00:41.540 --> 00:00:43.480 to be fixed. 8 00:00:43.480 --> 00:00:49.560 Conventional accounting practice is based on a fixed value of the monetary unit. 9 00:00:49.560 --> 00:00:56.240 The analogy of a fixed standard of measurement which had become familiar to the natural sciences 10 00:00:56.240 --> 00:01:04.320 – weight, length, etc. – was unthinkingly applied to human action. 11 00:01:04.320 --> 00:01:10.420 Economists then discovered and made clear that money does not remain stable in value, 12 00:01:10.420 --> 00:01:13.880 that the PPM does not remain fixed. 13 00:01:13.880 --> 00:01:22.400 The PPM can and does vary in response to changes in the supply of or the demand for money. 14 00:01:22.400 --> 00:01:29.440 These in turn can be resolved into the stock of goods and the total demand for money. 15 00:01:29.440 --> 00:01:35.200 Individual money prices, as we have seen in section 8, are determined by the stock of 16 00:01:35.200 --> 00:01:42.660 and demand for money, as well as by the stock of and demand for each good. 17 00:01:42.660 --> 00:01:47.920 It is clear, then, that the money relation, and the demand for, and the stock of, each 18 00:01:47.920 --> 00:01:53.780 individual good, are intertwined in each particular price transaction. 19 00:01:53.780 --> 00:02:00.900 Thus, when Smith decides whether or not to purchase a hat for two gold ounces, he weighs 20 00:02:00.900 --> 00:02:06.060 the utility of the hat against the utility of the two ounces. 21 00:02:06.060 --> 00:02:12.420 Entering into every price, then, is the stock of the good, the stock of money, and the 22 00:02:12.420 --> 00:02:19.460 The demand for money and the good, both ultimately based on individual's utilities. 23 00:02:19.460 --> 00:02:27.160 The money relation is contained in particular price demands and supplies, and cannot in 24 00:02:27.160 --> 00:02:30.180 practice be separated from them. 25 00:02:30.180 --> 00:02:37.540 If then there is a change in the supply of or demand for money, the change will not be 26 00:02:37.540 --> 00:02:46.540 are neutral, but will affect different specific demands for goods and different prices in varying proportions. 27 00:02:46.540 --> 00:02:55.540 There is no way of separately measuring changes in the PPM and changes in the specific prices of goods. 28 00:02:55.540 --> 00:03:03.540 The fact that the use of money as a medium of exchange enables us to calculate relative exchange ratios 29 00:03:03.540 --> 00:03:15.540 has misled some economists into believing that separate measurement of changes in the PPM is possible. 30 00:03:15.540 --> 00:03:28.540 Thus, we could say that one hat is worth, or can exchange for, 100 pounds of sugar, or that one TV set can exchange for 50 hats. 31 00:03:28.540 --> 00:03:35.980 Hats. It is a temptation then to forget that these exchange ratios are purely hypothetical 32 00:03:35.980 --> 00:03:43.260 and can be realized in practice only through monetary exchanges, and to consider them as 33 00:03:43.260 --> 00:03:50.940 constituting some barter world of their own. In this mythical world the exchange ratios between 34 00:03:50.940 --> 00:03:57.180 the various goods are somehow determined separately from the monetary transactions, 35 00:03:57.180 --> 00:04:03.180 And it then becomes more plausible to say that some sort of method can be found 36 00:04:03.180 --> 00:04:09.820 of isolating the value of money from these relative values and establishing the former 37 00:04:09.820 --> 00:04:17.500 as a constant yardstick. Actually, this barter world is a pure figment. These relative ratios 38 00:04:17.500 --> 00:04:26.300 are only historical expressions of past transactions that can be affected only by and with money. 39 00:04:27.180 --> 00:04:34.180 Let us now assume that the following is the array of prices in the PPM on day one. 40 00:04:34.180 --> 00:04:47.180 10 cents per pound of sugar, $10 per hat, $500 per TV set, $5 per hour legal service of Mr. Jones, lawyer. 41 00:04:47.180 --> 00:04:54.180 Now, suppose the following array of prices of the same goods on day two. 42 00:04:54.180 --> 00:05:06.180 15 cents per pound of sugar, $20 per hat, $300 per TV set, $8 per hour of Mr. Jones' legal service. 43 00:05:06.180 --> 00:05:13.180 Now, what can economics say has happened to the PPM over these two periods? 44 00:05:13.180 --> 00:05:22.180 All that we can legitimately say is that now $1 can buy 1 20th of a hat instead of 1 10th of a hat, 45 00:05:22.180 --> 00:05:29.180 1 300th of a TV set instead of 1 500th of a set, etc. 46 00:05:29.180 --> 00:05:37.180 Thus we can describe, if we know the figures, what happened to each individual price in the market array. 47 00:05:37.180 --> 00:05:44.180 But how much of the price rise of the hat was due to a rise in the demand for hats, 48 00:05:44.180 --> 00:05:48.180 and how much to a fall in the demand for money? 49 00:05:48.180 --> 00:05:55.140 There is no way of answering such a question. We do not even know for certain whether the PPM 50 00:05:55.140 --> 00:06:03.220 has risen or declined. All we do know is that the purchasing power of money has fallen in terms of 51 00:06:03.220 --> 00:06:12.100 sugar, hats and legal services, and risen in terms of TV sets. Even if all the prices in the array 52 00:06:12.100 --> 00:06:39.100 If the supply of money changed during this interval, we would not know how much of the change was due to the increased supply and how much to the other determinants. 53 00:06:39.100 --> 00:06:45.980 Changes are taking place all the time in each of these determinants. 54 00:06:45.980 --> 00:06:52.900 In the real world of human action, there is no one determinant that can be used as a fixed 55 00:06:52.900 --> 00:06:54.020 benchmark. 56 00:06:54.020 --> 00:07:01.900 The whole situation is changing in response to changes in stocks of resources and products, 57 00:07:01.900 --> 00:07:07.420 and to the changes in the valuations of all the individuals on the market. 58 00:07:07.420 --> 00:07:13.860 In fact, one lesson above all should be kept in mind when considering the claims of the 59 00:07:13.860 --> 00:07:17.780 various groups of mathematical economists. 60 00:07:17.780 --> 00:07:23.660 In human action, there are no quantitative constants. 61 00:07:23.660 --> 00:07:29.200 Professor Mises has pointed out that the assertion of the mathematical economists that their 62 00:07:29.200 --> 00:07:36.920 Where task is made difficult by the existence of many variables in human action, Grossly 63 00:07:36.920 --> 00:07:44.400 understates the problem, for the point is that all the determinants are variables, and 64 00:07:44.400 --> 00:07:51.560 that in contrast to the natural sciences, there are no constants. 65 00:07:51.560 --> 00:08:01.760 As a necessary corollary, all praxeological economic laws are qualitative, not quantitative. 66 00:08:01.760 --> 00:08:08.900 The index number method of measuring changes in the PPM attempts to conjure up some sort 67 00:08:08.900 --> 00:08:16.580 of totality of goods whose exchange ratios remain constant among themselves so that a 68 00:08:16.580 --> 00:08:24.580 and a kind of general averaging will enable a separate measurement of changes in the PPM itself. 69 00:08:24.580 --> 00:08:30.580 We have seen, however, that such separation or measurement is impossible. 70 00:08:30.580 --> 00:08:41.580 The only attempt to use index numbers that has any plausibility is the construction of fixed-quantity weights for a base period. 71 00:08:41.580 --> 00:08:47.660 Each price is weighted by the quantity of the goods sold in the base period. 72 00:08:47.660 --> 00:08:54.420 These weighted quantities representing a typical market basket proportion of goods bought in 73 00:08:54.420 --> 00:08:56.140 that period. 74 00:08:56.140 --> 00:09:01.620 The difficulties in such a market basket concept are insuperable, however. 75 00:09:01.620 --> 00:09:08.660 Aside from the considerations mentioned earlier, there is in the first place no average buyer 76 00:09:08.660 --> 00:09:10.220 or housewife. 77 00:09:10.220 --> 00:09:16.700 There are only individual buyers, and each buyer has bought a different proportion and 78 00:09:16.700 --> 00:09:18.780 type of goods. 79 00:09:18.780 --> 00:09:26.020 If one person purchases a TV set and another goes to the movies, each activity is the result 80 00:09:26.020 --> 00:09:32.960 of differing value scales, and each has different effects on the various commodities. 81 00:09:32.960 --> 00:09:40.280 There is no average person who goes partly to the movies and buys part of a TV set. 82 00:09:40.280 --> 00:09:48.720 There is therefore no average housewife buying some given proportion of a totality of goods. 83 00:09:48.720 --> 00:09:56.320 Goods are not bought in their totality against money, but only by individuals in individual 84 00:09:56.320 --> 00:10:03.440 Transactions, and therefore there can be no scientific method of combining them. 85 00:10:03.440 --> 00:10:10.080 Secondly, even if there were meaning to the market basket concept, the utilities of the 86 00:10:10.080 --> 00:10:17.240 goods in the basket, as well as the basket proportions themselves, are always changing, 87 00:10:17.240 --> 00:10:23.560 and this completely eliminates any possibility of a meaningful constant with which to measure 88 00:10:23.560 --> 00:10:25.420 price changes. 89 00:10:25.420 --> 00:10:33.760 The non-existent typical housewife would have to have constant valuations as well, an impossibility 90 00:10:33.760 --> 00:10:37.260 in the real world of change. 91 00:10:37.260 --> 00:10:44.420 All sorts of index numbers have been spawned in a vain attempt to surmount these difficulties. 92 00:10:44.420 --> 00:10:48.860 Quantity weights have been chosen that vary for each year covered. 93 00:10:48.860 --> 00:10:56.020 Arithmetical, geometrical and harmonic averages have been taken at variable and fixed weights, 94 00:10:56.020 --> 00:11:04.420 ideal formulas have been explored, all with no realization of the futility of these endeavors. 95 00:11:04.420 --> 00:11:14.660 No such index number, no attempt to separate and measure prices and quantities can be valid. 96 00:11:14.660 --> 00:11:18.100 B. Stabilization. 97 00:11:18.100 --> 00:11:23.940 The knowledge that the purchasing power of money could vary led some economists to try 98 00:11:23.940 --> 00:11:31.920 to improve on the free market by creating, in some way, a monetary unit which would remain 99 00:11:31.920 --> 00:11:36.020 stable and constant in its purchasing power. 100 00:11:36.020 --> 00:11:42.340 All these stabilization plans, of course, involve in one way or another an attack on 101 00:11:42.340 --> 00:11:49.240 from the gold or other commodity standard, since the value of gold fluctuates as a result 102 00:11:49.240 --> 00:11:55.420 of the continual changes in the supply of and the demand for gold. 103 00:11:55.420 --> 00:12:02.580 The stabilizers want the government to keep an arbitrary index of prices constant by pumping 104 00:12:02.580 --> 00:12:10.100 money into the economy when the index falls and taking money out when it rises. 105 00:12:10.100 --> 00:12:16.340 The outstanding proponent of stable money, Irving Fisher, revealed the reason for his 106 00:12:16.340 --> 00:12:21.380 urge toward stabilization in the following autobiographical passage. 107 00:12:21.380 --> 00:12:28.860 I became increasingly aware of the imperative need of a stable yardstick of value. 108 00:12:28.860 --> 00:12:35.740 I had come into economics from mathematical physics, in which fixed units of measure contribute 109 00:12:35.740 --> 00:12:38.500 the essential starting point. 110 00:12:38.500 --> 00:12:44.300 Apparently, Fisher did not realize that there could be fundamental differences in the nature 111 00:12:44.300 --> 00:12:50.340 of the sciences of physics and of purposeful human action. 112 00:12:50.340 --> 00:12:56.100 It is difficult indeed to understand what the advantages of a stable value of money 113 00:12:56.100 --> 00:12:58.200 are supposed to be. 114 00:12:58.200 --> 00:13:03.620 One of the most frequently cited advantages, for example, is that debtors will no longer 115 00:13:03.620 --> 00:13:09.540 will no longer be harmed by unforeseen rises in the value of money, while creditors will 116 00:13:09.540 --> 00:13:14.700 no longer be harmed by unforeseen declines in its value. 117 00:13:14.700 --> 00:13:20.960 Yet if creditors and debtors want such a hedge against future changes, they have an easy 118 00:13:20.960 --> 00:13:23.340 way out on the free market. 119 00:13:23.340 --> 00:13:29.780 When they make their contracts, they can agree that repayment be made in a sum of money corrected 120 00:13:29.780 --> 00:13:36.660 by some agreed-upon index number of changes in the value of money. 121 00:13:36.660 --> 00:13:44.540 Such a voluntary tabular standard for business contracts has long been advocated by stabilizationists, 122 00:13:44.540 --> 00:13:50.380 who have been rather puzzled to find that a course which appears to them so beneficial 123 00:13:50.380 --> 00:13:54.300 is almost never adopted in business practice. 124 00:13:54.300 --> 00:14:00.300 Despite the multitude of index numbers and other schemes that have been proposed to businessmen 125 00:14:00.300 --> 00:14:07.020 by these economists, creditors and debtors have somehow failed to take advantage of them. 126 00:14:07.020 --> 00:14:13.780 Yet, while stabilization plans have made no headway among the groups that they would supposedly 127 00:14:13.780 --> 00:14:20.360 benefit the most, the stabilizationists have remained undaunted in their zeal to force 128 00:14:20.360 --> 00:14:33.160 There seem to be two basic reasons for this failure of business to adopt a tabular standard. 129 00:14:33.160 --> 00:14:40.600 A. As we have seen, there is no scientific objective means of measuring changes in the 130 00:14:40.600 --> 00:14:42.520 value of money. 131 00:14:42.520 --> 00:14:49.320 Scientifically, one index number is just as arbitrary and bad as any other. 132 00:14:49.320 --> 00:14:56.160 Federal creditors and debtors have not been able to agree on any one index number, therefore, 133 00:14:56.160 --> 00:15:01.280 that they can abide by as a measure of change in purchasing power. 134 00:15:01.280 --> 00:15:07.480 Each, according to his own interests, would insist on including different commodities 135 00:15:07.480 --> 00:15:11.040 at different weights in his index number. 136 00:15:11.040 --> 00:15:16.920 Thus, a debtor who is a wheat farmer would want to weigh the price of wheat heavily in 137 00:15:16.920 --> 00:15:23.680 in his Index of the Purchasing Power of Money, a creditor who goes often to nightclubs would 138 00:15:23.680 --> 00:15:28.920 want to hedge against the price of nightclub entertainment, etc. 139 00:15:28.920 --> 00:15:29.920 b. 140 00:15:29.920 --> 00:15:35.760 A second reason is that businessmen apparently prefer to take their chances in a speculative 141 00:15:35.760 --> 00:15:42.000 world rather than agree on some sort of arbitrary hedging device. 142 00:15:42.000 --> 00:15:58.000 Stock exchange speculators and commodity speculators are continually attempting to forecast future prices, and indeed, all entrepreneurs are engaged in anticipating the uncertain conditions of the market. 143 00:15:58.000 --> 00:16:09.000 Apparently, businessmen are willing to be entrepreneurs in anticipating future changes in purchasing power as well as any other changes. 144 00:16:09.000 --> 00:16:21.000 The failure of business to adopt voluntarily any sort of tabular standard seems to demonstrate the complete lack of merit in compulsory stabilization schemes. 145 00:16:21.000 --> 00:16:33.000 Setting this argument aside, however, let us examine the contention of the stabilizers that somehow they can create certainty in the purchasing power of money, 146 00:16:33.000 --> 00:16:40.680 while at the same time leaving freedom and uncertainty in the prices of particular goods. 147 00:16:40.680 --> 00:16:43.480 This is sometimes expressed in the statement, 148 00:16:43.480 --> 00:16:51.560 individual prices should be left free to change, the price level should be fixed and constant. 149 00:16:51.560 --> 00:16:58.200 This contention rests on the myth that some sort of general purchasing power of money 150 00:16:58.200 --> 00:17:08.120 or some sort of price level exists on a plane apart from specific prices in specific transactions. 151 00:17:08.120 --> 00:17:16.040 As we have seen, this is purely fallacious. There is no price level and there is no way that the 152 00:17:16.040 --> 00:17:24.440 exchange value of money is manifested except in specific purchases of goods, that is, specific 153 00:17:24.440 --> 00:17:31.880 Prices. There is no way of separating the two concepts. Any array of prices establishes, 154 00:17:31.880 --> 00:17:40.200 at one and the same time, an exchange relation, or objective exchange value, between one good 155 00:17:40.200 --> 00:17:47.480 and another, and between money and a good. And there is no way of separating these elements 156 00:17:47.480 --> 00:17:59.480 It is thus clear that the exchange value of money cannot be quantitatively separated from the exchange value of goods. 157 00:17:59.480 --> 00:18:10.480 Since the general exchange value, or PPM, of money cannot be quantitatively defined and isolated in any historical situation, 158 00:18:10.480 --> 00:18:18.480 and its changes cannot be defined or measured, it is obvious that it cannot be kept stable. 159 00:18:18.480 --> 00:18:25.480 If we do not know what something is, we cannot very well act to keep it constant. 160 00:18:25.480 --> 00:18:31.480 The fact that the purchasing power of the monetary unit is not quantitatively definable 161 00:18:31.480 --> 00:18:39.480 does not negate the fact of its existence, which is established by prior praxeological knowledge. 162 00:18:39.480 --> 00:18:54.480 It thereby differs, for example, from the competitive price-monopoly-price dichotomy, which cannot be independently established by praxeological deduction for free market conditions. 163 00:18:55.480 --> 00:19:03.480 We have seen that the ideal of a stabilized value of money is impossible to attain or even define. 164 00:19:03.480 --> 00:19:07.480 If it were attainable, however, what would be the result? 165 00:19:07.480 --> 00:19:14.080 Supposed, for example, that the purchasing power of money rises and that we disregard 166 00:19:14.080 --> 00:19:21.040 the problem of measuring the rise, why, if this is the result of action on an unhampered 167 00:19:21.040 --> 00:19:25.440 market, should we consider it a bad result? 168 00:19:25.440 --> 00:19:31.660 If the total supply of money in the community has remained constant, falling prices will 169 00:19:31.660 --> 00:19:38.140 will be caused by a general increase in the demand for money, or by an increase in the 170 00:19:38.140 --> 00:19:43.040 supply of goods as a result of increased productivity. 171 00:19:43.040 --> 00:19:50.020 An increased demand for money stems from the free choice of individuals, say, in the expectation 172 00:19:50.020 --> 00:19:55.780 of a more troubled future, or of future price declines. 173 00:19:55.780 --> 00:20:01.680 Human Action would deprive people of the chance to increase their real cash holdings and the 174 00:20:01.680 --> 00:20:08.280 real value of the dollar by free, mutually agreed-upon actions. 175 00:20:08.280 --> 00:20:14.920 As in any other aspect of the free market, those entrepreneurs who successfully anticipate 176 00:20:14.920 --> 00:20:22.060 the increased demand will benefit, and those who err will lose in their speculations. 177 00:20:22.060 --> 00:20:30.060 and even the losses of the latter are purely the consequence of their own voluntarily assumed risks. 178 00:20:30.060 --> 00:20:37.060 Furthermore, falling prices resulting from increased productivity are beneficial to all 179 00:20:37.060 --> 00:20:44.060 and are precisely the means by which the fruits of industrial progress spread on the free market. 180 00:20:44.060 --> 00:20:51.060 Any interference with falling prices blocks the spread of the fruits of an advancing economy 181 00:20:51.060 --> 00:21:02.060 and then real wages could increase only in particular industries and not, as on the free market, over the economy as a whole. 182 00:21:02.060 --> 00:21:15.060 Similarly, stabilization would deprive people of the chance to decrease their real cash holdings and the real value of the dollar should their demand for money fall. 183 00:21:15.060 --> 00:21:42.200 The Intertwining of General Purchasing Power and Specific Prices raises another consideration. 184 00:21:42.200 --> 00:21:48.500 For money could not be pumped into the system to combat a supposed increase in the value 185 00:21:48.500 --> 00:21:55.460 of money without distorting the previous exchange values between the various goods. 186 00:21:55.460 --> 00:22:01.780 We have seen that money cannot be neutral with respect to goods and that therefore the 187 00:22:01.780 --> 00:22:08.360 whole price structure will change with any change in the supply of money. 188 00:22:08.360 --> 00:22:15.600 Hence, the stabilizationist program of fixing the value of money, or price level, without 189 00:22:15.600 --> 00:22:21.160 distorting relative prices, is necessarily doomed to failure. 190 00:22:21.160 --> 00:22:24.000 It is an impossible program. 191 00:22:24.000 --> 00:22:31.160 Thus, even were it possible to define and measure changes in the purchasing power of 192 00:22:31.160 --> 00:22:37.280 money, stabilization of this value would have effects that many advocates consider 193 00:22:37.280 --> 00:22:45.260 are undesirable, but the magnitudes cannot even be defined, and stabilization would depend 194 00:22:45.260 --> 00:22:48.800 on some sort of arbitrary index number. 195 00:22:48.800 --> 00:22:55.340 Whichever commodities and weights are included in the index, pricing and production will 196 00:22:55.340 --> 00:22:57.760 be distorted. 197 00:22:57.760 --> 00:23:04.280 At the heart of the stabilizationist ideal is a misunderstanding of the nature of money. 198 00:23:04.280 --> 00:23:11.880 Money is considered either a mere numeraire or a grandiose measure of values. 199 00:23:11.880 --> 00:23:19.300 Forgotten is the truth that money is desired and demanded as a useful commodity, even when 200 00:23:19.300 --> 00:23:23.640 this use is only as a medium of exchange. 201 00:23:23.640 --> 00:23:30.260 When a man holds money in his cash balance, he is deriving utility from it. 202 00:23:30.260 --> 00:23:36.780 Those who neglect this fact scoff at the gold standard as a primitive anachronism and fail 203 00:23:36.780 --> 00:23:41.740 to realize that hoarding performs a useful social function.