Tag: capitalism, economics, freedom, money

The core of the doctrine consists in the proposition that the supply of money and the demand for it both affect its value. This proposition is probably a sufficiently good hypothesis to explain big changes in prices; but it is far from containing a complete theory of the value of money. It describes one cause of changes in prices; it is nevertheless inadequate for dealing with the problem exhaustively. By itself it does not comprise a theory of the value of money; it needs the basis of a general value theory. One after another, the doctrine of supply and demand, the cost-of-production theory, and the subjective theory of value have had to provide the foundations for the Quantity Theory.

The older theories, which started from an erroneous conception of the social demand for money, could never arrive at a solution of this problem. Their sole contribution is limited to paraphrases of the proposition that an increase in the stock of money at the disposal of the community while the demand for it rClnains the same decreases the objective exchange-value of money, and that an increase of the demand with a constant available stock has the contrary effect, and so on. By a flash of genius, the formulators of the Quantity Theory had already recognized this. We cannot by any means call it an advance when the formula giving the amount of the demand for money (Volume of Transactions + Velocity of Circulation) was reduced to its elements.

a variation in the objective exchange-value of money can arise only when a force is exerted in one direction that is not cancelled by a counteracting force in the opposite direction. If the causes that alter the ratio between the stock of money and the demand for it from the point of view of an individual consist merely in accidental and personal factors that concern that particular individual only, then, according to the law of large numbers, it is likely that the forces arising from this cause, and acting in both directions in the market, will counterbalance each other.

It will be the obvious result of this that the prices of the goods concerned will rise, and that the objective exchange-value of money will fall in comparison. But this rise of prices will by no means be restricted to the market for those goods that are desired by those who originally have the new money at their disposal. In addition, those who have brought these goods to market will have their incomes and their proportionate stocks of money increased and, in their tum, will be in a position to demand more intensively the goods they want, so that these goods will also rise in price. Thus the increase of prices continues, having a diminishing effect, until all commodities, some to a greater and some to a lesser extent, are reached by it.

If the possessor of a units of money receives h additional units, then it is not at all true to say that he will value the total stock a + h exactly as highly as he had previously valued the stock a alone. Because he now has disposal over a larger stock, he will now value each unit less than he did before; but how much less will depend upon a whole series of individual circumstances, upon subjective valuations that will be different for each individual.

It must be pointed out that the level of the total stock of money and of the value of the money unit are matters of complete indifference as far as the utility obtained from the use of the money is concerned. Society is always in enjoyment of the maximum utility obtainable from the use of money. Half of the money at the disposal of the community would yield the same utility as the whole stock, even if the variation in the value of the monetary unit was not proportioned to the variation in the stock of money.

The mistake in the argument of those who suppose that a variation in the quantity of money results in an inversely proportionate variation in its purchasing power lies in its starting-point. If we wish to arrive at a correct conclusion, we must start with the valuations of separate individuals; we must examine the way in which an increase or decrease in the quantity of money affects the value-scales of individuals, for it is from these alone that variations in the exchange-ratios of goods proceed.

Let us assume that a man gets half his income in the form of interest-bearing securities and half in the form of money; and that he is in the habit of saving three-quarters of his income, and does this by retaining the securities and using that half of his income which he receives in cash in equal parts for paying for current consumption and for the purchase of further securities. Now let us assume that a variation in the composition of his income occurs, so that he receives three-quarters of it in cash and only one-quarter in securities. From now on this man will use two-thirds of his cash receipts for the purchase of interest-bearing securities. If the price of the securities rises or, which is the same thing, if their rate of interest falls, then in either case he will be less willing to buy and will reduce the sum of money that he would otherwise have employed for their purchase; he is likely to find that the advantage of a slightly increased reserve exceeds that which could be obtained from the acquisition of the securities. In the second case he will doubtless be inclined to pay a higher price, or more correctly, to purchase a greater quantity at the higher price, than in the first case. But he will certainly not be prepared to pay double as much for a unit of securities in the second case as in the first case.

If we compare two static economic systems, which differ in no way from one another except that in one there is twice as much money as in the other, it appears that the purchasing power of the monetary unit in the one system must be equal to half that of the monetary unit in the other. Nevertheless, we may not conclude from this that a doubling of the quantity of money must lead to a halving of the purchasing power of the monetary unit; for every variation in the quantity of money introduces a dynamic factor into the static economic system. The new position of static equilibrium that is established when the effects of the fluctuations thus set in motion are completed cannot be the same as that which existed before the introduction of the additional quantity of money. Consequently, in the new state of equilibrium the conditions of demand for money, given a certain exchange-value of the monetary unit, will also be different. If the purchasing power of each unit of the doubled quantity of money were halved, the unit would not have the same significance for each individual under the new conditions as it had in the static system before the increase in the quantity of money.

Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility. It was not until it became customary to acquire certain goods merely in order to use them as media of exchange that people began to esteem them more highly than before, on account of this possibility of using them in indirect exchange. The individual valued them in the first place because they were useful in the ordinary sense, and then additionally because they could be used as media of exchange. Both sorts of valuation are subject to the law of marginal utility.

The error in this conclusion may be most simply demonstrated by means of an actual example. Let us select for this purpose the monetary history of Austria, which Laughlin also uses as an illustration. From 1859 onwards the Austrian National Bank was released from the obligation to convert its notes on demand into silver, and nobody could tell when the State paper-money issued in 1866 would be redeemed, or even if it would be redeemed at all. It was not until the later ‘nineties that the transition to metallic money was completed by the actual resumption of cash payments on the part of the Austro-Hungarian Bank.

To a naive observer, money made out of precious metal was ‘sound money’ because the piece of precious metal was an ‘intrinsically’ valuable object, while paper money was ‘bad money’ because its value was only ‘artificial’. But even the layman who holds this opinion accepts the money in the course of business transactions, not for the sake of its industrial use-value, but for the sake of its objective exchange-value, which depends largely upon its monetary employment. He values a gold coin not merely for the sake of its industrial use-value, say because of the possibility of using it as jewellery, but chiefly on account of its monetary utility. But, of course, to do something, and to render an account to oneself of what one does and why one does it, are quite different things.