Human Action: A Treatise on Economics

by Ludwig Von Mises

  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 amatter 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 categorially 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 be acknowledged as “the unintentional outcome, the resultant not deliberately designed and aimed at by specifically individual endeavors of the members of a society.” 6

  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 or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. 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.7 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 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 passed. 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.8

  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 nonmonetary—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 as a medium of exchange by its employment for industrial purposes. The very problem, the explanation of the specific monetary component of its exchange value, remains unsolved. Here too the critics are mistaken. That component of money's value which is an outcome of the services it renders as a medium of exchange is entirely explained by reference to these specific monetary services 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 a demand on the part of people eager to use it for industrial purposes, i.e., 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 nonmonetary 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 catallactic 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 enounced apodictically as implied in the apriorism 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 vendible 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 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 vendible 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. Knowledge 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 vendible 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 (nonmonetary) 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.

  Changes in the supply of money must necessarily alter the disposition position of vendible 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 of 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 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 cither 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 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—viz., 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 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 under way, 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 of the goods they must buy for their daily consumption. 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 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 vendible 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 economists' 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 fo
r the most part demanded 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 “dishoarding” 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 (e.g., through a withdrawal of paper money) or the demand for money increases (e.g., through a tendency toward “hoarding,” the keeping of greater cash balances). The process is always uneven and by steps, disproportionate and asymmetrical.