Where the free exchange of goods and services is unknown, money is not wanted. In a state of society in which the division of labor was a purely domestic matter and production and consumption were consummated within the single household it would be just as useless as it would be for an isolated man. But even in an economic order based on division of labor, money would still be unnecessary if the means of production were socialized, the control of production and the distribution of the finished product were in the hands of a central body, and individuals were not allowed to exchange the consumption goods allotted to them for the consumption goods allotted to others.

The phenomenon of money presupposes an economic order in which production is based on division of labor and in which private property consists not only in goods of the first order (consumption goods), but also in goods of higher orders (production goods). In such a society, there is no systematic centralized control of production, for this is inconceivable without centralized disposal over the means of production. Production is “anarchistic.” What is to be produced, and how it is to be produced, is decided in the first place by the owners of the means of production, who produce, however, not only for their own needs, but also for the needs of others, and in their valuations take into account, not only the use-value that they themselves attach to their products, but also the use-value that these possess in the estimation of the other members of the community. The balancing of production and consumption takes place in the market, where the different producers meet to exchange goods and services by bargaining together. The function of money is to facilitate the business of the market by acting as a common medium of exchange.

Indirect exchange is distinguished from direct exchange according as a medium is involved or not.

Suppose that A and B exchange with each other a number of units of the commodities m and n. A acquires the commodity n because of the use-value that it has for him. He intends to consume it. The same is true of B, who acquires the commodity m for his immediate use. This is a case of direct exchange.

If there are more than two individuals and more than two kinds of commodity in the market, indirect exchange also is possible. A may then acquire a commodity p, not because he desires to consume it, but in order to exchange it for a second commodity q which he does desire to consume. Let us suppose that A brings to the market two units of the commodity m, B two units of the commodity n, and C two units of the commodity o, and that A wishes to acquire one unit of each of the commodities n and o, B one unit of each of the commodities o and m, and C one unit of each of the commodities m and n. Even in this case a direct exchange is possible if the subjective valuations of the three commodities permit the exchange of each unit of m, n, and o for a unit of one of the others. But if this or a similar hypothesis does not hold good, and in by far the greater number of all exchange transactions it does not hold good, then indirect exchange becomes necessary, and the demand for goods for immediate wants is supplemented by a demand for goods to be exchanged for others.1

Let us take, for example, the simple case in which the commodity p is desired only by the holders of the commodity q, while the comodity q is not desired by the holders of the commodity p but by those, say, of a third commodity r, which in its turn is desired only by the possessors of p. No direct exchange between these persons can possibly take place. If exchanges occur at all, they must be indirect; as, for instance, if the possessors of the commodity p exchange it for the commodity q and then exchange this for the commodity r which is the one they desire for their own consumption. The case is not essentially different when supply and demand do not coincide quantitatively; for example, when one indivisible good has to be exchanged for various goods in the possession of several persons.

Indirect exchange becomes more necessary as division of labor increases and wants become more refined. In the present stage of economic development, the occasions when direct exchange is both possible and actually effected have already become very exceptional. Nevertheless, even nowadays, they sometimes arise. Take, for instance, the payment of wages in kind, which is a case of direct exchange so long on the one hand as the employer uses the labor for the immediate satisfaction of his own needs and does not have to procure through exchange the goods in which the wages are paid, and so long on the other hand as the employee consumes the goods he receives and does not sell them. Such payment of wages in kind is still widely prevalent in agriculture, although even in this sphere its importance is being continually diminished by the extension of capitalistic methods of management and the development of division of labor.2

Thus along with the demand in a market for goods for direct consumption there is a demand for goods that the purchaser does not wish to consume but to dispose of by further exchange. It is clear that not all goods are subject to this sort of demand. An individual obviously has no motive for an indirect exchange if he does not expect that it will bring him nearer to his ultimate objective, the acquisition of goods for his own use. The mere fact that there would be no exchanging unless it was indirect could not induce individuals to engage in indirect exchange if they secured no immediate personal advantage from it. Direct exchange being impossible, and indirect exchange being purposeless from the individual point of view, no exchange would take place at all. Individuals have recourse to indirect exchange only when they profit by it; that is, only when the goods they acquire are more marketable than those which they surrender.

Now all goods are not equally marketable. While there is only a limited and occasional demand for certain goods, that for others is more general and constant. Consequently, those who bring goods of the first kind to market in order to exchange them for goods that they need themselves have as a rule a smaller prospect of success than those who offer goods of the second kind. If, however, they exchange their relatively unmarketable goods for such as are more marketable, they will get a step nearer to their goal and may hope to reach it more surely and economically than if they had restricted themselves to direct exchange.

It was in this way that those goods that were originally the most marketable became common media of exchange; that is, goods into which all sellers of other goods first converted their wares and which it paid every would-be buyer of any other commodity to acquire first. And as soon as those commodities that were relatively most marketable had become common media of exchange, there was an increase in the difference between their marketability and that of all other commodities, and this in its turn further strengthened and broadened their position as media of exchange.3

Thus the requirements of the market have gradually led to the selection of certain commodities as common media of exchange. The group of commodities from which these were drawn was originally large, and differed from country to country; but it has more and more contracted. Whenever a direct exchange seemed out of the question, each of the parties to a transaction would naturally endeavor to exchange his superfluous commodities, not merely for more marketable commodities in general, but for the most marketable commodities; and among these again he would naturally prefer whichever particular commodity was the most marketable of all. The greater the marketability of the goods first acquired in indirect exchange, the greater would be the prospect of being able to reach the ultimate objective without further maneuvering. Thus there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.

This stage of development in the use of media of exchange, the exclusive employment of a single economic good, is not yet completely attained. In quite early times, sooner in some places than in others, the extension of indirect exchange led to the employment of the two precious metals gold and silver as common media of exchange. But then there was a long interruption in the steady contraction of the group of goods employed for that purpose. For hundreds, even thousands, of years the choice of mankind has wavered undecided between gold and silver The chief cause of this remarkable phenomenon is to be found in the natural qualities of the two metals. Being physically and chemically very similar, they are almost equally serviceable for the satisfaction of human wants. For the manufacture of ornaments and jewelry of all kinds the one has proved as good as the other. (It is only in recent times that technological discoveries have been made which have considerably extended the range of uses of the precious metals and may have differentiated their utility more sharply.) In isolated communities, the employment of one or the other metal as sole common medium of exchange has occasionally been achieved, but this short-lived unity has always been lost again as soon as the isolation of the community has succumbed to participation in international trade.

Economic history is the story of the gradual extension of the economic community beyond its original limits of the single household to embrace the nation and then the world. But every increase in its size has led to a fresh duality of the medium of exchange whenever the two amalgamating communities have not had the same sort of money. It would not be possible for the final verdict to be pronounced until all the chief parts of the inhabited earth formed a single commercial area, for not until then would it be impossible for other nations with different monetary systems to join in and modify the international organization.

Of course, if two or more economic goods had exactly the same marketability, so that none of them was superior to the others as a medium of exchange, this would limit the development toward a unified monetary system. We shall not attempt to decide whether this assumption holds good of the two precious metals gold and silver. The question, about which a bitter controversy has raged for decades, has no very important bearings upon the theory of the nature of money. For it is quite certain that even if a motive had not been provided by the unequal marketability of the goods used as media of exchange, unification would still have seemed a desirable aim for monetary policy. The simultaneous use of several kinds of money involves so many disadvantages and so complicates the technique of exchange that the endeavor to unify the monetary system would certainly have been made in any case.

The theory of money must take into consideration all that is implied in the functioning of several kinds of money side by side. Only where its conclusions are unlikely to be affected one way or the other, may it proceed from the assumption that a single good is employed as common medium of exchange. Elsewhere, it must take account of the simultaneous use of several media of exchange. To neglect this would be to shirk one of its most difficult tasks.

• 1See Wicksell, Über Wert, Kapital und Rente (Jena, 1893; London, 1933), pp. 50 f.
• 2The conclusion that indirect exchange is necessary in the majority of cases is extremely obvious. As we should expect, it is among the earliest discoveries of economics. We find it clearly expressed in the famous fragment of the Pandects of Paulus: “Quia non semper nec facile concurrebat, ut, cum tu haberas, quod ego desiderarem, invicem haberem, quod tu accipere velles” (Paulus, lib. 33 ad edictum 1.I pr. D. de contr. empt. 18, I).
  
  Schumpeter is surely mistaken in thinking that the necessity for money can be proved solely from the assumption of indirect exchange (see his Wesen und Hauptinhalt der theoretischen Nationalökonomie [Leipzig, 1908], pp. 273 ff.). On this point, cf. Weiss, Die moderne Tendenz in der Lehre vom Geldwert, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 19, pp. 518 ff.
• 3See Menger, Untersuchungen über die Methode der Sozialwissenschaften und der politischen Okonomie insbesondere (Leipzig, 1883), pp. 172 ff.; Grundsätze der Volkswirtschaftslehre, 2d ed. (Vienna, 1923), pp. 247 ff.

The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further “functions”—as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.

After Menger’s review of the question, further discussion of the connection between the secondary functions of money and its basic function should be unnecessary.4  Nevertheless, certain tendencies in recent literature on money make it appear advisable to examine briefly these secondary functions—some of them are coordinated with the basic function by many writers—and to show once more that all of them can be deduced from the function of money as a common medium of exchange.

This applies in the first place to the function fulfilled by money in facilitating credit transactions. It is simplest to regard this as part of its function as medium of exchange. Credit transactions are in fact nothing but the exchange of present goods against future goods. Frequent reference is made in English and American writings to a function of money as a standard of deferred payments.5  But the original purpose of this expression was not to contrast a particular function of money with its ordinary economic function, but merely to simplify discussions about the influence of changes in the value of money upon the real amount of money debts. It serves this purpose admirably. But it should be pointed out that its use has led many writers to deal with the problems connected with the general economic consequences of changes in the value of money merely from the point of view of modifications in existing debt relations and to overlook their significance in all other connections.

The functions of money as a transmitter of value through time and space may also be directly traced back to its function as medium of exchange. Menger has pointed out that the special suitability of goods for hoarding, and their consequent widespread employment for this purpose, has been one of the most important causes of their increased marketability and therefore of their qualification as media of exchange.6  As soon as the practice of employing a certain economic good as a medium of exchange becomes general, people begin to store up this good in preference to others. In fact, hoarding as a form of investment plays no great part in our present stage of economic development, its place having been taken by the purchase of interest-bearing property.7  On the other hand, money still functions today as a means for transporting value through space.8  This function again is nothing but a matter of facilitating the exchange of goods. The European farmer who emigrates to America and wishes to exchange his property in Europe for a property in America, sells the former, goes to America with the money (or a bill payable in money), and there purchases his new homestead. Here we have an absolute textbook example of an exchange facilitated by money.

Particular attention has been devoted, especially in recent times, to the function of money as a general medium of payment. Indirect exchange divides a single transaction into two separate parts which are connected merely by the ultimate intention of the exchangers to acquire consumption goods. Sale and purchase thus apparently become independent of each other Furthermore, if the two parties to a sale-and-purchase transaction perform their respective parts of the bargain at different times, that of the seller preceding that of the buyer (purchase on credit), then the settlement of the bargain, or the fulfillment of the seller’s part of it (which need not be the same thing), has no obvious connection with the fulfillment of the buyer’s part. The same is true of all other credit transactions, especially of the most important sort of credit transaction—lending. The apparent lack of a connection between the two parts of the single transaction has been taken as a reason for regarding them as independent proceedings, for speaking of the payment as an independent legal act, and consequently for attributing to money the function of being a common medium of payment. This is obviously incorrect. “If the function of money as an object which facilitates dealings in commodities and capital is kept in mind, a function that includes the payment of money prices and repayment of loans...there remains neither necessity nor justification for further discussion of a special employment, or even function of money, as a medium of payment.”9

The root of this error (as of many other errors in economics) must be sought in the uncritical acceptance of juristical conceptions and habits of thought. From the point of view of the law, outstanding debt is a subject which can and must be considered in isolation and entirely (or at least to some extent) without reference to the origin of the obligation to pay. Of course, in law as well as in economics, money is only the common medium of exchange. But the principal, although not exclusive, motive of the law for concerning itself with money is the problem of payment. When it seeks to answer the question, What is money? it is in order to determine how monetary liabilities can be discharged. For the jurist, money is a medium of payment. The economist, to whom the problem of money presents a different aspect, may not adopt this point of view if he does not wish at the very outset to prejudice his prospects of contributing to the advancement of economic theory.

• 4See Menger, Grundsätze, pp. 278 ff.
• 5See Nicholson, A Treatise on Money and Essays on Present Monetary Problems (Edinburgh, 1888), pp. 22 ff.; Laughlin, The Principles of Money (London, 1903), pp. 22 f.
• 6Cf. Menger, Grundsätze, pp. 284 ff.
• 7That is, apart from the exceptional propensity to hoard gold, silver, and foreign bills, encouraged by inflation and the laws enacted to further it.
• 8Knies in particular (Geld und Kredit, 2d ed. [Berlin, 1885], vol. 1, pp. 233 ff.) has laid stress upon the function of money as interlocal transmitter of value.
• 9Cf. Menger, Grundsätze, pp. 282 f.

Although it is usual to speak of money as a measure of value and prices, the notion is entirely fallacious. So long as the subjective theory of value is accepted, this question of measurement cannot arise. In the older political economy, the search for a principle governing the measurement of value was to a certain extent justifiable. If, in accordance with an objective theory of value, the possibility of an objective concept of commodity values is accepted, and exchange is regarded as the reciprocal surrender of equivalent goods, then the conclusion necessarily follows that exchange transactions must be preceded by measurement of the quantity of value contained in each of the objects that are to be exchanged. And it is then an obvious step to regard money as the measure of value.

But modern value theory has a different starting point. It conceives of value as the significance attributed to individual commodity units by a human being who wishes to consume or otherwise dispose of various commodities to the best advantage. Every economic transaction presupposes a comparison of values. But the necessity for such a comparison, as well as the possibility of it, is due only to the circumstance that the person concerned has to choose between several commodities. It is quite irrelevant whether this choice is between a commodity in his own possession and one in somebody else’s possession for which he might exchange it, or between the different uses to which he himself might put a given quantity of productive resources. In an isolated household, in which (as on Robinson Crusoe’s desert island) there is neither buying nor selling, changes in the stocks of goods of higher and lower orders do nevertheless occur whenever anything is produced or consumed; and these changes must be based upon valuations if their returns are to exceed the outlay they involve. The process of valuation remains fundamentally the same whether the question is one of transforming labor and flour into bread in the domestic bakehouse, or of obtaining bread in exchange for clothes in the market. From the point of view of the person making the valuation, the calculation whether a certain act of production would justify a certain outlay of goods and labor is exactly the same as the comparison between the values of the commodities to be surrendered and the values of the commodities to be acquired that must precede an exchange transaction. For this reason it has been said that every economic act may be regarded as a kind of exchange.1

Acts of valuation are not susceptible of any kind of measurement. It is true that everybody is able to say whether a certain piece of bread seems more valuable to him than a certain piece of iron or less valuable than a certain piece of meat. And it is therefore true that everybody is in a position to draw up an immense list of comparative values; a list which will hold good only for a given point of time, since it must assume a given combination of wants and commodities. If the individual’s circumstances change, then his scale of values changes also.

But subjective valuation, which is the pivot of all economic activity, only arranges commodities in order of their significance; it does not measure this significance. And economic activity has no other basis than the value scales thus constructed by individuals. An exchange will take place when two commodity units are placed in a different order on the value scales of two different persons. In a market, exchanges will continue until it is no longer possible for reciprocal surrender of commodities by any two individuals to result in their each acquiring commodities that stand higher on their value scales than those surrendered. If an individual wishes to make an exchange on an economic basis, he has merely to consider the comparative significance in his own judgment of the quantities of commodities in question. Such an estimate of relative values in no way involves the idea of measurement. An estimate is a direct psychological judgment that is not dependent on any kind of intermediate or auxiliary process.

(Such considerations also provide the answer to a series of objections to the subjective theory of value. It would be rash to conclude, because psychology has not succeeded and is not likely to succeed in measuring desires, that it is therefore impossible ultimately to attribute the quantitatively exact exchange ratios of the market to subjective factors. The exchange ratios of commodities are based upon the value scales of the individuals dealing in the market. Suppose that A possesses three pears and B two apples; and that A values the possession of two apples more than that of three pears, while B values the possession of three pears more than that of two apples. On the basis of these estimations an exchange may take place in which three pears are given for two apples. Yet it is clear that the determination of the numerically precise exchange ratio 2 : 3, taking a single fruit as a unit, in no way presupposes that A and B know exactly by how much the satisfaction promised by possession of the quantities to be acquired by exchange exceeds the satisfaction promised by possession of the quantities to be given up.)

General recognition of this fact, for which we are indebted to the authors of modern value theory, was hindered for a long time by a peculiar sort of obstacle. It is not altogether a rare thing that those very pioneers who have not hesitated to clear new paths for themselves and their followers by boldly rejecting outworn traditions and ways of thinking should yet shrink sometimes from all that is involved in the rigid application of their own principles. When this is so, it remains for those who come after to endeavor to put the matter right. The present is a case in point. On the subject of the measurement of value, as on a series of further subjects that are very closely bound up with it, the founders of the subjective theory of value refrained from the consistent development of their own doctrines. This is especially true of Böhm-Bawerk. At least it is especially striking in him; for the arguments of his which we are about to consider are embodied in a system that would have provided an alternative and, in the present writer’s opinion, a better, solution of the problem, if their author had only drawn the decisive conclusion from them.

Böhm-Bawerk points out that when we have to choose in actual life between several satisfactions which cannot be had simultaneously because our means are limited, the situation is often such that the alternatives are on the one hand one big satisfaction and on the other hand a large number of homogeneous smaller satisfactions. Nobody will deny that it lies in our power to come to a rational decision in such cases. But it is equally clear that a judgment merely to the effect that a satisfaction of the one sort is greater than a satisfaction of the other sort is inadequate for such a decision; as would even be a judgment that a satisfaction of the first sort is considerably greater than one of the other sort. Böhm-Bawerk therefore concludes that the judgment must definitely affirm how many of the smaller satisfactions outweigh one of the first sort, or in other words how many times the one satisfaction exceeds one of the others in magnitude.2

The credit of having exposed the error contained in the identification of these two last propositions belongs to Cuhel. The judgment that so many small satisfactions are outweighed by a satisfaction of another kind is in fact not identical with the judgment that the one satisfaction is so many times greater than one of the others. The two would be identical only if the satisfaction afforded by a number of commodity units taken together were equal to the satisfaction afforded by a single unit on its own multiplied by the number of units. That this assumption cannot hold good follows from Gossen’s law of the satisfaction of wants. The two judgments, “I would rather have eight plums than one apple” and “I would rather have one apple than seven plums,” do not in the least justify the conclusion that Böhm-Bawerk draws from them when he states that therefore the satisfaction afforded by the consumption of an apple is more than seven times but less than eight times as great as the satisfaction afforded by the consumption of a plum. The only legitimate conclusion is that the satisfaction from one apple is greater than the total satisfaction from seven plums but less than the total satisfaction from eight plums.3

This is the only interpretation that can be harmonized with the fundamental conception expounded by the marginal-utility theorists, and especially by Böhm-Bawerk himself, that the utility (and consequently the subjective use-value also) of units of a commodity decreases as the supply of them increases. But to accept this is to reject the whole idea of measuring the subjective use-value of commodities. Subjective use-value is not susceptible of any kind of measurement.

The American economist Irving Fisher has attempted to approach the problem of value measurement by way of mathematics.4  His success with this method has been no greater than that of his predecessors with other methods. Like them, he has not been able to surmount the difficulties arising from the fact that marginal utility diminishes as supply increases, and the only use of the mathematics in which he clothes his arguments, and which is widely regarded as a particularly becoming dress for investigations in economics, is to conceal a little the defects of their clever but artificial construction.

Fisher begins by assuming that the utility of a particular good or service, though dependent on the supply of that good or service, is independent of the supply of all others. He realizes that it will not be possible to achieve his aim of discovering a unit for the measurement of utility unless he can first show how to determine the proportion between two given marginal utilities. If, for example, an individual has a hundred loaves of bread at his disposal during one year, the marginal utility of a loaf to him will be greater than if he had one hundred and fifty loaves. The problem is, to determine the arithmetical proportion between the two marginal utilities. Fisher attempts to do this by comparing them with a third utility. He therefore supposes the individual to have B gallons of oil annually as well, and calls β that increment of B whose utility is equal to that of the 100th loaf of bread. In the second case, when not a hundred but a hundred and fifty loaves are available, it is assumed that the supply of B remains unchanged. Then the utility of the 150th loaf may be equal, say, to the utility of β/2. Up to this point it is unnecessary to quarrel with Fisher’s argument; but now follows a jump that neatly avoids all the difficulties of the problem. That is to say, Fisher simply continues, as if he were stating something quite self-evident: “Then the utility of the 150th loaf is said to be half the utility of the 100th.” Without any further explanation he then calmly proceeds with his problem, the solution of which (if the above proposition is accepted as correct) involves no further difficulties, and so succeeds eventually in deducing a unit which he calls a “util.” It does not seem to have occurred to him that in the particular sentence just quoted he has argued in defiance of the whole of marginal-utility theory and set himself in opposition to all the fundamental doctrines of modern economics. For obviously this conclusion of his is legitimate only if the utility of β is equal to twice the utility of β/2. But if this were really so, the problem of determining the proportion between two marginal utilities could have been solved in a quicker way, and his long process of deduction would not have been necessary. Just as justifiably as he assumes that the utility of β is equal to twice the utility of β/2, he might have assumed straightaway that the utility of the 150th loaf is two-thirds of that of the 100th.

Fisher imagines a supply of B gallons that is divisible into n small quantities β, or 2n small quantities β/2. He assumes that an individual who has this supply B at his disposal regards the value of commodity unit x as equal to that of β and the value of commodity unit y as equal to that of β/2. And he makes the further assumption that in both valuations, that is, both in equating the value of x with that of β and in equating the value of y with that of β/2, the individual has the same supply of B gallons at his disposal.

He evidently thinks it possible to conclude from this that the utility of β is twice as great as that of β/2. The error here is obvious. The individual is in the one case faced with the choice between x (the value of the 100th loaf) and β = 2β/2. He finds it impossible to decide between the two, i.e., he values both equally. In the second case he has to choose between y (the value of the 150th loaf) and β/2. Here again he finds that both alternatives are of equal value. Now the question arises, what is the proportion between the marginal utility of β and that of β/2? We can determine this only by asking ourselves what the proportion is between the marginal utility of the nth part of a given supply and that of the 2nth part of the same supply, between that of β/n and that of β/2n. For this purpose let us imagine the supply B split up into 2n portions of β/2n. Then the marginal utility of the (2n-1)th portion is greater than that of the 2nth portion. If we now imagine the same supply B divided into n portions, then it clearly follows that the marginal utility of the nth portion is equal to that of the (2n-1)th portion plus that of the 2nth portion in the previous case. It is not twice as great as that of the 2nth portion, but more than twice as great. In fact, even with an unchanged supply, the marginal utility of several units taken together is not equal to the marginal utility of one unit multiplied by the number of units, but necessarily greater than this product. The value of two units is greater than, but not twice as great as, the value of one unit.5

Perhaps Fisher thinks that this consideration may be disposed of by supposing β and β/2 to be such small quantities that their utility may be reckoned infinitesimal. If this is really his opinion, then it must first of all be objected that the peculiarly mathematical conception of infinitesimal quantities is inapplicable to economic problems. The utility afforded by a given amount of commodities, is either great enough for valuation, or so small that it remains imperceptible to the valuer and cannot therefore affect his judgment. But even if the applicability of the conception of infinitesimal quantities were granted, the argument would still be invalid, for it is obviously impossible to find the proportion between two finite marginal utilities by equating them with two infinitesimal marginal utilities.

Finally, a few words must be devoted to Schumpeter’s attempt to set up as a unit the satisfaction resulting from the consumption of a given quantity of commodities and to express other satisfactions as multiples of this unit. Value judgments on this principle would have to be expressed as follows: “The satisfaction that I could get from the consumption of a certain quantity of commodities is a thousand times as great as that which I get from the consumption of an apple a day,” or “For this quantity of goods I would give at the most a thousand times this apple.”6  Is there really anybody on earth who is capable of adumbrating such mental images or pronouncing such judgments? Is there any sort of economic activity that is actually dependent on the making of such decisions? Obviously not.7  Schumpeter makes the same mistake of starting with the assumption that we need a measure of value in order to be able to compare one “quantity of value” with another. But valuation in no way consists in a comparison of two “quantities of value.” It consists solely in a comparison of the importance of different wants. The judgment “Commodity a is worth more to me than commodity b“ no more presupposes a measure of economic value than the judgment “A is dearer to me—more highly esteemed—than B“ presupposes a measure of friendship.

• 1See Simmel, Philosophie des Geldes, 2d ed. (Leipzig, 1907), p. 35; Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie (Leipzig, 1908), p. 50.
• 2Cf. Böhm-Bawerk, “Grundzüge der Theorie des wirtschaftlichen Güterwertes,” Jahrbücher für Nationalökonomie und Statistik (1886), New Series, vol. 13, p. 48.
• 3See Cuhel, Zur Lehre von den Bedürfnissen (Innsbruck, 1906), pp. 186 ff.; Weiss, Die moderne Tendenz in der Lehre vom Geldwert, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 19, pp. 532 ff. In the last edition of his masterpiece Capital and Interest, revised by himself, Böhm-Bawerk endeavored to refute Cuhel’s criticism, but did not succeed in putting forward any new considerations that could help toward a solution of the problem (see Kapital und Kapitalzins, 3d ed. [Innsbruck, 1909-12], pp. 331 ff. Exkurse, pp. 280 ff.).
• 4See Fisher, Mathematical Investigations in the Theory of Value and Prices, Transactions of the Connecticut Academy (New Haven, 1892), vol. 9, pp. 14 ff.
• 5See also Weiss, op. cit., p. 538.
• 6Cf. Schumpeter, op. cit., p. 290.
• 7Cf. further Weiss, op. cit., pp. 534 ff.

If it is impossible to measure subjective use-value, it follows directly that it is impracticable to ascribe “quantity” to it. We may say, the value of this commodity is greater than the value of that; but it is not permissible for us to assert, this commodity is worth so much. Such a way of speaking necessarily implies a definite unit. It really amounts to stating how many times a given unit is contained in the quantity to be defined. But this kind of calculation is quite inapplicable to processes of valuation.

The consistent application of these principles implies a criticism also of Schumpeter’s views on the total value of a stock of goods. According to Wieser, the total value of a stock of goods is given by multiplying the number of items or portions constituting the stock by their marginal utility at any given moment. The untenability of this argument is shown by the fact that it would prove that the total stock of a free good must always be worth nothing. Schumpeter therefore suggests a different formula in which each portion is multiplied by an index corresponding to its position on the value scale (which, by the way, is quite arbitrary) and these products are then added together or integrated. This attempt at a solution, like the preceding, has the defect of assuming that it is possible to measure marginal utility and “intensity” of value. The fact that such measurement is impossible renders both suggestions equally useless. Mastery of the problem must be sought in some other way.

Value is always the result of a process of valuation. The process of valuation compares the significance of two complexes of commodities from the point of view of the individual making the valuation. The individual making the valuation and the complexes of goods valued, that is, the subject and the objects of the valuation, must enter as indivisible elements into any given process of valuation. This does not mean that they are necessarily indivisible in other respects as well, whether physically or economically. The subject of an act of valuation may quite well be a group of persons, a state or society or family, so long as it acts in this particular case as a unit, through a representative. And the objects thus valued may be collections of distinct units of commodities so long as they have to be dealt with in this particular case as a whole. There is nothing to prevent either subject or object from being a single unit for the purposes of one valuation even though in another their component parts may be entirely independent of each other The same people who, acting together through a representative as a single agent, such as a state, make a judgment as to the relative values of a battleship and a hospital, are the independent subjects of valuations of other commodities, such as cigars and newspapers. It is just the same with commodities. Modern value theory is based on the fact that it is not the abstract importance of different kinds of need that determines the scales of values, but the intensity of specific desires. Starting from this, the law of marginal utility was developed in a form that referred primarily to the usual sort of case in which the collections of commodities are divisible. But there are also cases in which the total supply must be valued as it stands.

Suppose that an economically isolated individual possesses two cows and three horses and that the relevant part of his scale of values (that item valued highest being placed first) is as follows: 1, a cow; 2, a horse; 3, a horse; 4, a horse; 5, a cow. If this individual has to choose between one cow and one horse he will rather be inclined to sacrifice the cow than the horse. If wild animals attack one of his cows and one of his horses, and it is impossible for him to save both, then he will try to save the horse. But if the whole of his stock of either animal is in danger, his decision will be different. Supposing that his stable and cowshed catch fire and that he can only rescue the occupants of one and must leave the others to their fate, then if he values three horses less than two cows he will attempt to save not the three horses but the two cows. The result of that process of valuation which involves a choice between one cow and one horse is a higher estimation of the horse. The result of the process of valuation which involves a choice between the whole available stock of cows and the whole available stock of horses is a higher estimation of the stock of cows.

Value can rightly be spoken of only with regard to specific acts of appraisal. It exists in such connections only; there is no value outside the process of valuation. There is no such thing as abstract value. Total value can be spoken of only with reference to a particular instance of an individual or other valuing “subject” having to choose between the total available quantities of certain economic goods. Like every other act of valuation, this is complete in itself. The person making the choice does not have to make use of notions about the value of units of the commodity. His process of valuation, like every other, is an immediate inference from considerations of the utilities at stake. When a stock is valued as a whole, its marginal utility, that is to say, the utility of the last available unit of it, coincides with its total utility, since the total supply is one indivisible quantity. This is also true of the total value of free goods, whose separate units are always valueless, that is, are always relegated to a sort of limbo at the very end of the value scale, promiscuously intermingled with the units of all the other free goods.8

• 8See also Clark, Essentials of Economic Theory (New York, 1907), p. 41. In the first German edition of the present work, the above argument contained two further sentences that summarized in an inadequate fashion the results of investigation into the problem of total value. In deference to certain criticisms of C. A. Verrijn Stuart (Die Grundlagen der Volkswirtschaft [Jena, 1923], p. 115), they were omitted from the second edition.

What has been said should have made sufficiently plain the unscientific nature of the practice of attributing to money the function of acting as a measure of price or even of value. Subjective value is not measured, but graded. The problem of the measurement of objective use-value is not an economic problem at all. (It may incidentally be remarked that a measurement of efficiency is not possible for every species of commodity and is at the best only available within separate species, while every possibility, not only of measurement, but even of mere scaled comparison, vanishes as soon as we seek to establish a relation between two or more kinds of efficiency. It may be possible to measure and compare the calorific value of coal and of wood, but it is in no way possible to reduce to a common objective denominator the objective efficiency of a table and that of a book.)

Neither is objective exchange value measurable, for it too is the result of the comparisons derived from the valuations of individuals. The objective exchange value of a given commodity unit may be expressed in units of every other kind of commodity. Nowadays exchange is usually carried on by means of money, and since every commodity has therefore a price expressible in money, the exchange value of every commodity can be expressed in terms of money. This possibility enabled money to become a medium for expressing values when the growing elaboration of the scale of values which resulted from the development of exchange necessitated a revision of the technique of valuation.

That is to say, opportunities for exchanging induce the individual to rearrange his scales of values. A person in whose scale of values the commodity “a cask of wine” comes after the commodity “a sack of oats” will reverse their order if he can exchange a cask of wine in the market for a commodity that he values more highly than a sack of oats. The position of commodities in the value scales of individuals is no longer determined solely by their own subjective use-value, but also by the subjective use-value of the commodities that can be obtained in exchange for them, whenever the latter stand higher than the former in the estimation of the individual. Therefore, if he is to obtain the maximum utility from his resources, the individual must familiarize himself with all the prices in the market.

For this, however, he needs some help in finding his way among the confusing multiplicity of the exchange ratios. Money, the common medium of exchange, which can be exchanged for every commodity and with which every commodity can be procured, is preeminently suitable for this. It would be absolutely impossible for the individual, even if he were a complete expert in commercial matters, to follow every change of market conditions and make the corresponding alterations in his scale of use-values and exchange values, unless he chose some common denominator to which he could reduce each exchange ratio. Because the market enables any commodity to be turned into money and money into any commodity, objective exchange value is expressed in terms of money. Thus money becomes a price index, in Menger’s phrase. The whole structure of the calculations of the entrepreneur and the consumer rests on the process of valuing commodities in money. Money has thus become an aid that the human mind is no longer able to dispense with in making economic calculations.9  If in this sense we wish to attribute to money the function of being a measure of prices, there is no reason why we should not do so. Nevertheless, it is better to avoid the use of a term which might so easily be misunderstood as this. In any case the usage certainly cannot be called correct—we do not usually describe the determination of latitude and longitude as a “function” of the stars.10

• 9On the indispensability of money for economic calculation, see my book Die Gemeinwirtschaft: Untersuchungen über den Sozialismus(Jena, 1922), pp. 100 ff.
• 10[This chapter deals with technical matters which may present difficulty to readers unacquainted with general economic theory. It may be omitted on a first reading, but it is essential to complete understanding of certain issues, such as the index-number problem, which are dealt with later.—Editor.]

When an indirect exchange is transacted with the aid of money, it is not necessary for the money to change hands physically; a perfectly secure claim to an equivalent sum, payable on demand, may be transferred instead of the actual coins. In this by itself there is nothing remarkable or peculiar to money. What is peculiar, and only to be explained by reference to the special characteristics of money; is the extraordinary frequency of this way of completing monetary transactions.

In the first place, money is especially well adapted to constitute the substance of a generic obligation. Whereas the fungibility of nearly all other economic goods is more or less circumscribed and is often only a fiction based on an artificial commercial terminology, that of money is almost unlimited. Only that of shares and bonds can be compared with it. The sole factor that could possibly prevent any of these from being completely fungible is the difficulty of sub-dividing their separate units; and various expedients have been adopted, which, at least as far as money is concerned, have entirely robbed this difficulty of all practical significance.

A still more important circumstance is involved in the nature of the function that money performs. A claim to money may be transferred over and over again in an indefinite number of indirect exchanges without the person by whom it is payable ever being called upon to settle it. This is obviously not true as far as other economic goods are concerned, for these are always destined for ultimate consumption.

The special suitability for facilitating indirect exchanges possessed by absolutely secure and immediately payable claims to money, which we may briefly refer to as money substitutes, is further increased by their standing in law and commerce.

Technically, and in some countries legally as well, the transfer of a banknote scarcely differs from that of a coin. The similarity of outward appearance is such that those who are engaged in commercial dealings are usually unable to distinguish between those objects that actually perform the function of money and those that are merely employed as substitutes for them. The businessman does not worry about the economic problems involved in this; he is only concerned with the commercial and legal characteristics of coins, notes, checks, and the like. To him, the facts that banknotes are transferable without documentary evidence, that they circulate like coins in round denominations, that no fight of recovery lies against their previous holders, that the law recognizes no difference between them and money as an instrument of debt settlement, seem good enough reason for including them within the definition of the term money, and for drawing a fundamental distinction between them and cash deposits, which can be transferred only by a procedure that is much more complex technically and is also regarded in law as of a different kind. This is the origin of the popular conception of money by which everyday life is governed. No doubt it serves the purposes of the bank official, and it may even be quite useful in the business world at large, but its introduction into the scientific terminology of economics is most undesirable.

The controversy about the concept of money is not exactly one of the most satisfactory chapters in the history of our science. It is chiefly remarkable for the smother of juristic and commercial technicalities in which it is enveloped and for the quite undeserved significance that has been attached to what is after all merely a question of terminology. The solution of the question has been re garded as an end in itself and it seems to have been completely forgotten that the real aim should have been simply to facilitate further investigation. Such a discussion could not fail to be fruitless.

In attempting to draw a line of division between money and those objects that outwardly resemble it, we only need to bear in mind the goal of our investigation. The present discussion aims at tracing the laws that determine the exchange ratio between money and other economic goods. This and nothing else is the task of the economic theory of money. Now our terminology must be suited to our problem. If a particular group of objects is to be singled out from among all those that fulfill a monetary function in commerce and, under the special name of money (which is to be reserved to this group alone), sharply contrasted with the rest (to which this name is denied), then this distinction must be made in a way that will facilitate the further progress of the investigation.

It is considerations such as these that have led the present writer to give the name of money substitutes and not that of money to those objects that are employed like money in commerce but consist in perfectly secure and immediately convertible claims to money.

Claims are not goods;1  they are means of obtaining disposal over goods. This determines their whole nature and economic significance. They themselves are not valued directly, but indirectly; their value is derived from that of the economic goods to which they refer. Two elements are involved in the valuation of a claim: first, the value of the goods to whose possession it gives a right; and, second, the greater or less probability that possession of the goods in question will actually be obtained. Furthermore, if the claim is to come into force only after a period of time, then consideration of this circumstance will constitute a third factor in its valuation. The value on January 1 of a right to receive ten sacks of coal on December 31 of the same year will be based not directly on the value of ten sacks of coal, but on the value of ten sacks of coal to be delivered in a year’s time. This sort of calculation is a matter of common experience, as also is the fact that in reckoning the value of claims their soundness or security is taken into account.

Claims to money are, of course, no exception. Those which are payable on demand, if there is no doubt about their soundness and no expense connected with their settlement, are valued just as highly as cash and tendered and accepted in the same way as money.2  Only claims of this sort—that is, claims that are payable on demand, absolutely safe as far as human foresight goes, and perfectly liquid in the legal sense—are for business purposes exact substitutes for the money to which they refer. Other claims, of course, such as notes issued by banks of doubtful credit or bills that are not yet mature, also enter into financial transactions and may just as well be employed as general media of exchange. This, according to our terminology, means that they are money. But then they are valued independently; they are reckoned equivalent neither to the sums of money to which they refer nor even to the worth of the rights that they embody. What the further special factors are that help to determine their exchange value, we shall discover in the course of our argument.

Of course it would be in no way incorrect if we attempted to include in our concept of money those absolutely secure and immediately convertible claims to money that we have preferred to call money substitutes. But what must be entirely condemned is the widespread practice of giving the name of money to certain classes of money substitutes, usually banknotes, token money, and the like, and contrasting them sharply with the remaining kinds, such as cash deposits.3  This is to make a distinction without any adequate difference; for banknotes, say, and cash deposits differ only in mere externals, important perhaps from the business and legal points of view, but quite insignificant from the point of view of economics.

On the other hand, arguments of considerable weight may be urged in favor of including all money substitutes without exception in the single concept of money. It may be pointed out, for instance, that the significance of perfectly secure and liquid claims to money is quite different from that of claims to other economic goods; that whereas a claim on a commodity must sooner or later be liquidated, this is not necessarily true of claims to money. Such claims may pass from hand to hand for indefinite periods and so take the place of money without any attempt being made to liquidate them. It may be pointed out that those who require money will be quite satisfied with such claims as these, and that those who wish to spend money will find that these claims answer their purpose just as well; and that consequently the supply of money substitutes must be reckoned in with that of money, and the demand for them with the demand for money. It may further be pointed out that whereas it is impossible to satisfy an increase in the demand, say, for bread by issuing more breadtickets without adding to the actual supply of bread itself, it is perfectly possible to satisfy an increased demand for money by just such a process as this. It may be argued, in brief, that money substitutes have certain peculiarities of which account is best taken by including them in the concept of money.

Without wishing to question the weight of such arguments as these, we shall on grounds of convenience prefer to adopt the narrower formulation of the concept of money, supplementing it with a separate concept of money substitutes. Whether this is the most advisable course to pursue, whether perhaps some other procedure might not lead to a better understanding of our subject matter, must be left to the judgment of the reader To the author it appears that the way chosen is the only way in which the difficult problems of the theory of money can be solved.

• 1See Böhm-Bawerk, Rechte und Verhältnisse (Innsbruck, 1881), pp. 120 ff.
• 2Wagner, Beiträge zur Lehre von den Banken (Leipzig, 1857), pp. 34 ff.
• 3For instance, Helfferich, Das Geld, 6th ed. (Leipzig, 1923), pp. 267 ff.; English trans., Money (London, 1927), pp. 284 ff.

Economic discussion about money must be based solely on economic considerations and may take legal distinctions into account only insofar as they are significant from the economic point of view also. Such discussion consequently must proceed from a concept of money based, not on legal definitions and discriminations, but on the economic nature of things. It follows that our decision not to regard drafts and other claims to money as constituting money itself must not be interpreted merely in accordance with the narrow juristic concept of a claim to money. Besides strictly legal claims to money, we must also take into account such relationships as are not claims in the juristic sense, but are nevertheless treated as such in commercial practice because some concern or other deals with them as if they actually did constitute claims against itself.3

There can be no doubt that the German token coins minted in accordance with the Coinage Act of July 9, 1873, did not in law constitute claims to money. Perhaps there are some superficial critics who would be inclined to classify these coins actually as money because they consisted of stamped silver or nickel or copper discs that had every appearance of being money. But despite this, from the point of view of economics these token coins merely constituted drafts on the national Treasury. The second paragraph of section nine of the Coinage Act (in its form of June 1, 1909) obliged the Bundesrat to specify those centers that would pay out gold coins on demand in return for not less than 200 marks’ worth of silver coins or fifty marks’ worth of nickel and copper coins. Certain branches of the Reichsbank were entrusted with this function. Another section of the Coinage Act (sec. 8) provided that the Reich would always be in a position actually to maintain this convertibility. According to this section, the total value of the silver coins minted was never to exceed twenty marks per head of the population, nor that of the nickel and copper coins two and one-half marks per head. In the opinion of the legislature, these sums represented the demand for small coins, and there was consequently no danger that the total issue of token coinage would exceed the public demand for it. Admittedly, there was no statutory recognition of any right to conversion on the part of holders of token coins, and the limitation of legal tender (sec. 9, par 1) was only an inadequate substitute for this. Nevertheless, it is a matter of general knowledge that the token coins were in fact cashed without any demur at the branches of the Reichsbank specified by the Chancellor.

Exactly the same sort of significance was enjoyed by the Reich Treasury notes, of which not more than 120 million marks’ worth were allowed to be in circulation. These also (sec. 5 of the act of April 30, 1874) were always cashed for gold by the Reichsbank on behalf of the Treasury. It is beside the point that the Treasury notes were not legal tender in private transactions while everybody was obliged to accept silver coins in amounts up to twenty marks and nickel and copper coins in amounts up to one mark; for, although they were not legally bound to accept them in settlement of debts, people in fact accepted them readily.

Another example is afforded by the German thaler of the period from the introduction of the gold standard until the withdrawal of the thaler from circulation on October 1, 1907. During the whole of this period the thaler was undoubtedly legal tender. But if we seek to go behind this expression, whose juristic derivation makes it useless for our present purpose, and ask if the thaler was money during this period, the answer must be that it was not. It is true that it was employed in commerce as a medium of exchange; but it could be used in this way solely because it was a claim to something that really was money, that is, to the common medium of exchange. For although neither the Reichsbank nor the Reich nor its separate constituent kingdoms and duchies nor anybody else was obliged to cash them, the Reichsbank, acting on behalf of the government, always took pains to ensure that no more thalers were in circulation than were demanded by the public. It achieved this result by refusing to press thalers on its customers when paying out. This, together with the circumstance that thalers were legal tender both to the bank and to the Reich, was sufficient to turn them in effect into drafts that could always be converted into money, with the result that they circulated at home as perfectly satisfactory substitutes for money. It was repeatedly suggested to the directors of the Reichsbank that they should cash their own notes not in gold but in thalers (which would have been well within the letter of the law) and pay out gold only at a premium, with the object of hindering the export of it. But the bank steadily refused to adopt this or any proposal of a similar nature.

The exact nature of the token coinage in other countries has not always been so easy to understand as that of Germany, whose banking and currency system was fashioned under the influence of such men as Bamberger, Michaelis, and Soetbeer. In some legislation, the theoretical basis of modern token-coinage policy may not be so easy to discover or to demonstrate as in the examples already dealt with. Nevertheless, all such policy has ultimately the same intent. The universal legal peculiarity of token coinage is the limitation of its power of payment to a specified maximum sum; and as a rule this provision is supplemented by legislative restriction of the amount that may be minted.

There is no such thing as an economic concept of token coinage. All that economics can distinguish is a particular subgroup within the group of claims to money that are employed as substitutes for money, the members of this subgroup being intended for use in transactions where the amounts involved are small. The fact that the issue and circulation of token coins are subjected to special legal rules and regulations is to be explained by the special nature of the purpose that they serve. The general recognition of the right of the holder of a banknote to receive money in exchange for it while the conversion of token coins is in many countries left to administrative discretion is a result of the different lines of development that notes and token coinage have followed respectively. Token coins have arisen from the need for facilitating the exchange of small quantities of goods of little value. The historical details of their development have not yet been brought to light and, almost without exception, all that has been written on the subject is of purely numismatical or metrological importance.5  Nevertheless, one thing can safely be asserted: token coinage is always the result of attempts to remedy deficiencies in the existing monetary system. It is those technical difficulties, that hinder the subdivision of the monetary unit into small coins, that have led, after all sorts of unsuccessful attempts, to the solution of the problem that we adopt nowadays. In many countries, while this development has been going on, a kind of fiat money6  has sometimes been used in small transactions, with the very inconvenient consequence of having two independent kinds of money performing side by side the function of a common medium of exchange. To avoid the inconveniences of such a situation the small coins were brought into a fixed legal ratio with those used in larger transactions and the necessary precautions were taken to prevent the quantity of small coins from exceeding the requirements of commerce. The most important means to this end has always been the restriction of the quantity minted to that which seems likely to be needed for making small payments, whether this is fixed by law or strictly adhered to without such compulsion. Along with this has gone the limitation of legal tender in private dealings to a certain relatively small amount. The danger that these regulations would prove inadequate has never seemed very great, and consequently legislative provision for conversion of the token coins has been either entirely neglected or left incomplete by omission of a clear statement of the holder’s right to change them for money. But everywhere nowadays those token coins that are rejected from circulation are accepted without demur by the state, or some other body such as the central bank, and thus their nature as claims to money is established. Where this policy has been discontinued for a time and the attempt made by suspending effectual conversion of the token coins to force more of them into circulation than was required, they have become credit money, or even commodity money. Then they have no longer been regarded as claims to money, payable on demand, and therefore equivalent to money, but have been valued independently.

The banknote has followed quite a different line of development. It has always been regarded as a claim, even from the juristic point of view. The fact has never been lost sight of that if its value was to be kept equal to that of money, steps would have to be taken to ensure its permanent convertibility into money. That a cessation of cash payments would alter the economic character of banknotes could hardly escape notice; in the case of the quantitatively less important coins used in small transactions it could more easily be forgotten. Furthermore, the smaller quantitative importance of token coins means that it is possible to maintain their permanent convertibility without establishing special funds for the purpose. The absence of such special funds may also have helped to disguise the real nature of token coinage.7

Consideration of the monetary system of Austria-Hungary is particularly instructive. The currency reform that was inaugurated in 1892 was never formally completed, and until the disruption of the Hapsburg monarchy the standard remained legally what is usually called a paper standard, since the Austro-Hungarian Bank was not obliged to redeem its own notes, which were legal tender to any amount. Nevertheless, from 1900 to 1914 Austria-Hungary really possessed a gold standard or gold-exchange standard, for the bank did in fact readily provide gold for commercial requirements. Although according to the letter of the law it was not obliged to cash its notes, it offered bills of exchange and other claims payable abroad in gold (checks, notes, and the like), at a price below the upper theoretical gold point. Under such conditions, those who wanted gold for export naturally preferred to buy claims of this sort, which enabled them to achieve their purpose more cheaply than by the actual export of gold.

For internal commerce as well, in which the use of gold was exceptional since the population had many years before gone over to banknotes and token coins,8  the bank cashed its notes for gold without being legally bound to do so. And this policy was pursued, not accidentally or occasionally or without full recognition of its significance, but deliberately and systematically, with the object of permitting Austria and Hungary to enjoy the economic advantages of the gold standard. Both the Austrian and the Hungarian governments, to whose initiative this policy of the bank was due, cooperated as far as they were able. But in the first place it was the bank itself which had to ensure, by following an appropriate discount policy, that it would always be in a position to carry out with promptitude its voluntary undertaking to redeem its notes. The measures that it took with this purpose in view did not differ fundamentally in any way from those adopted by the banks-of-issue in other gold-standard countries.9  Thus the notes of the Austro-Hungarian Bank were in fact nothing but money substitutes. The money of the country, as of other European countries, was gold.

• 3See Laughlin, The Principles of Money (London, 1903), pp. 516 ff.
• 5See Kalkmann, Englands Übergang zur Goldwährung im 18. Jahrhundert (Strassburg, 1895), pp. 64 ff.; Schmoller, “Über die Ausbildung einer richtigen Scheidemünzpolitik vom 14. bis zum 19. Jahrhundert,” Jahrbuch fur Gesetzgebung, Verwaltung und Volkswirtschaft im Deutschen Reich 24 (1900): 1247-74; Helfferich, Studien über Geld und Bankwessen (Berlin, 1900), pp. 1-37.
• 6On the concepts of commodity money, credit money, and fiat money, see sec. 3 of this chap.
• 7On the nature of token coinage, see Say, Cours complet d’économie politique pratique, 3d ed. (Paris, 1852), vol, 1, p. 408; and Wagner, Theoretische Sozialökonomik (Leipzig, 1909), Part II pp. 504 ff. Very instructive discussions are to be found in the memoranda and debates that preceded the Belgian Token Coinage Act of 1860. In the memorandum of Pirmez, the nature of modern convertible token coins is characterized as follows: “With this property (of convertibility) the coins are no longer merely coins; they become claims, promises to pay. The holder no longer has a mere property right to the coin itself [jus in re]; he has a claim against the state to the amount of the nominal value of the coin [jus ad rem], a right which he can exercise at any moment by demanding its conversion. Token coins cease to be money and become a credit instrument [une institution de crédit], banknotes inscribed on pieces of metal ...” (see Loi décretant la fabrication d’une monnaie d’appoint ... précédee des notes sur la monnaie de billon en Belgique ainsi que la discussion de la loi à la Chambre des Représentants [Brussels, 1860], p. 50).
• 8The silver gulden in Austria-Hungary held the same position as the silver thaler in Germany from 1873 to 1907. It was legal tender, but economically a claim to money, since the bank-of-issue in fact always cashed it on demand.
• 9See my articles “Das Problem gesetzlicher Aufnahme der Barzahlungen in Österreich-Ungarn,” Jahrbuch für Gesetzgebung, Verwaltung und Volkswirtschaft im Deutschen Reich 33 (1909): 985-1037; “Zum Problem gesetzlicher Aufnahme der Barzahlungen in Österreich-Ungarn,” ibid. 34 (1910): 1877-84; “The Foreign Exchange Policy of the Austro-Hungarian Bank,” Economic Journal 19 (1909): 202-11; “Das vierte Privilegium der Österreichisch-Ungarischen Bank,” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung 21 (1922): 611-24.

The economic theory of money is generally expressed in a terminology that is not economic but juristic. This terminology has been built up by writers, statesmen, merchants, judges, and others whose chief interests have been in the legal characteristics of the different kinds of money and their substitutes. It is useful for dealing with those aspects of the monetary system that are of importance from the legal point of view; but for purposes of economic investigation it is practically valueless. Sufficient attention has scarcely been devoted to this shortcoming, despite the fact that confusion of the respective provinces of the sciences of law and economics has nowhere been so frequent and so fraught with mischievous consequences as in this very sphere of monetary theory. It is a mistake to deal with economic problems according to legal criteria. The juristic phraseology, like the results of juristic research into monetary problems, must be regarded by economics as one of the objects of its investigations. It is not the task of economics to criticize it, although it is entitled to exploit it for its own purposes. There is nothing to be said against using juristic technical terms in economic argument where this leads to no undesirable consequences. But for its own special purposes, economics must construct its own special terminology.

There are two sorts of thing that may be used as money: on the one hand, physical commodities as such, like the metal gold or the metal silver; and, on the other hand, objects that do not differ technologically from other objects that are not money, the factor that decides whether they are money being not a physical but a legal characteristic. A piece of paper that is specially characterized as money by the imprint of some authority is in no way different, technologically considered, from another piece of paper that has received a similar imprint from an unauthorized person, just as a genuine five-franc piece does not differ technologically from a “genuine replica.” The only difference lies in the law that regulates the manufacture of such coins and makes it impossible without authority. (In order to avoid every possible misunderstanding, let it be expressly stated that all that the law can do is to regulate the issue of the coins and that it is beyond the power of the state to ensure in addition that they actually shall become money; that is, that they actually shall be employed as a common medium of exchange. All that the state can do by means of its official stamp is to single out certain pieces of metal or paper from all the other things of the same kind so that they can be subjected to a process of valuation independent of that of the rest. Thus it permits those objects possessing the special legal qualification to be used as a common medium of exchange while the other commodities of the same sort remain mere commodities. It can also take various steps with the object of encouraging the actual employment of the qualified commodities as common media of exchange. But these commodities can never become money just because the state commands it; money can be created only by the usage of those who take part in commercial transactions.)

We may give the name commodity money to that sort of money that is at the same time a commercial commodity; and the name fiat money to money that comprises things with a special legal qualification. A third category may be called credit money, this being that sort of money which constitutes a claim against any physical or legal person. But these claims must not be both payable on demand and absolutely secure; if they were, there could be no difference between their value and that of the sum of money to which they referred, and they could not be subjected to an independent process of val uation on the part of those who dealt with them. In some way or other the maturity of these claims must be postponed to some future time. It can hardly be contested that fiat money in the strict sense of the word is theoretically conceivable. The theory of value proves the possibility of its existence. Whether fiat money has ever actually existed is, of course, another question, and one that cannot offhand be answered affirmatively. It can hardly be doubted that most of those kinds of money that are not commodity money must be classified as credit money. But only detailed historical investigation could clear this matter up.

Our terminology should prove more useful than that which is generally employed. It should express more clearly the peculiarities of the processes by which the different types of money are valued. It is certainly more correct than the usual distinction between metallic money and paper money. Metallic money comprises not only standard money but also token coins and such coins as the German thaler of the period 1873-1907; and paper money, as a rule, comprises not merely such fiat money and credit money as happen to be made of paper, but also convertible notes issued by banks or the state. This terminology is derived from popular usage. Previously, when more often than nowadays “metallic” money really was money and not a money substitute, perhaps the nomenclature was a little less inappropriate than it is now. Furthermore, it corresponded—perhaps still corresponds—to the naive and confused popular conception of value that sees in the precious metals something “intrinsically” valuable and in paper credit money something necessarily anomalous. Scientifically, this terminology is perfectly useless and a source of endless misunderstanding and misrepresentation. The greatest mistake that can be made in economic investigation is to fix attention on mere appearances, and so to fail to perceive the fundamental difference between things whose externals alone are similar, or to discriminate between fundamentally similar things whose externals alone are different.

Admittedly, for the numismatist and the technologist and the historian of art there is very little difference between the five-franc piece before and after the cessation of free coinage of silver, while the Austrian silver gulden even of the period 1879 to 1892 appears to be fundamentally different from the paper gulden. But it is regrettable that such superficial distinctions as this should still play a part in economic discussion.

Our threefold classification is not a matter of mere terminological gymnastics; the theoretical discussion of the rest of this book should demonstrate the utility of the concepts that it involves.

The decisive characteristic of commodity money is the employment for monetary purposes of a commodity in the technological sense. For the present investigation, it is a matter of complete indifference what particular commodity this is; the important thing is that it is the commodity in question that constitutes the money, and that the money is merely this commodity. The case of fiat money is quite different. Here the deciding factor is the stamp, and it is not the material bearing the stamp that constitutes the money, but the stamp itself. The nature of the material that bears the stamp is a matter of quite minor importance. Credit money, finally, is a claim falling due in the future that is used as a general medium of exchange.

Even when the differentiation of commodity money, credit money, and fiat money is accepted as correct in principle and only its utility disputed, the statement that the freely mintable currency of the present day and the metallic money of previous centuries are examples of commodity money is totally rejected by many authorities and by still more of the public at large. It is true that as a rule nobody denies that the older forms of money were commodity money. It is further generally admitted that in earlier times coins circulated by weight and not by tale. Nevertheless, it is asserted, money changed its nature long ago. The money of Germany and England in 1914, it is said, was not gold, but the mark and the pound. Money nowadays consists of “specified units with a definite significance in terms of value, that is assigned to them by law” (Knapp). “By ‘the standard’ we mean the units of value (florins, francs, marks, etc.) that have been adopted as measures of value, and by ‘money’ we mean the tokens (coins and notes) that represent the units that function as a measure of value. The controversy as to whether silver or gold or both together should function as a standard and as currency is an idle one, because neither silver nor gold ever has performed these functions or ever could have done so” (Hammer).10

Before we proceed to test the truth of these remarkable assertions, let us make one brief observation on their genesis—although it would really be more correct to say renascence than to say genesis, since the doctrines involved exhibit a very close relationship with the oldest and most primitive theories of money. Just as these were, so the nominalistic monetary theories of the present day are, characterized by their inability to contribute a single word toward the solution of the chief problem of monetary theory—one might in fact simply call it the problem of monetary theory—namely that of explaining the exchange ratios between money and other economic goods. For their authors, the economic problem of value and prices simply does not exist. They have never thought it necessary to consider how market ratios are established or what they signify. Their attention is accidentally drawn to the fact that a German thaler (since 1873), or an Austrian silver florin (since 1879), is essentially different from a quantity of silver of the same weight and fineness that has not been stamped at the government mint. They notice a similar state of affairs with regard to “paper money.” They do not understand this, and endeavor to find an answer to the riddle. But at this point, just because of their lack of acquaintance with the theory of value and prices, their inquiry takes a peculiarly unlucky turn. They do not inquire how the exchange ratios between money and other economic goods are established. This obviously seems to them quite a self-evident matter. They formulate their problem in another way: How does it come about that three twenty-mark pieces are equivalent to twenty thalers despite the fact that the silver contained in the thalers has a lower market value than the gold contained in the marks? And their answer runs: Because the value of money is determined by the state, by statute, by the legal system. Thus, ignoring the most important facts of monetary history, they weave an artificial network of fallacies; a theoretical construction that collapses immediately the question is put: What exactly are we to understand by a unit of value? But such impertinent questions can only occur to those who are acquainted with at least the elements of the theory of prices. Others are able to content themselves with references to the “nominality” of the unit of value. No wonder, then, that these theories should have achieved such popularity with the man in the street, especially since their kinship with inflationism was bound to commend them strongly to all “cheap-money” enthusiasts.

It may be stated as an assured result of investigation into monetary history that at all times and among all peoples the principal coins have been tendered and accepted, not by tale without consideration of their quantity and quality, but only as pieces of metal of specific degrees of weight and fineness. Where coins have been accepted by tale, this has always been in the definite belief that the stamp showed them to be of the usual fineness of their kind and of the correct weight. Where there were no grounds for this assumption, weighing and testing were resorted to again.

Fiscal considerations have led to the promulgation of a theory that attributes to the minting authority the right to regulate the purchasing power of the coinage as it thinks fit. For just as long as the minting of coins has been a government function, governments have tried to fix the weight and content of the coins as they wished. Philip VI of France expressly claimed the right “to mint such money and give it such currency and at such rate as we desire and seems good to us”11  and all medieval rulers thought and did as he in this matter. Obliging jurists supported them by attempts to discover a philosophical basis for the divine right of kings to debase the coinage and to prove that the true value of the coins was that assigned to them by the ruler of the country.

Nevertheless, in defiance of all official regulations and prohibitions and fixing of prices and threats of punishment, commercial practice has always insisted that what has to be considered in valuing coins is not their face value but their value as metal. The value of a coin has always been determined, not by the image and superscription it bears nor by the proclamation of the mint and market authorities, but by its metal content. Not every kind of money has been accepted at sight, but only those kinds with a good reputation for weight and fineness. In loan contracts, repayment in specific kinds of money has been stipulated for, and in the case of a change in the coinage, fulfillment in terms of metal required.12  In spite of all fiscal influences, the opinion gradually gained general acceptance, even among the jurists, that it was the metal value—the bonitas intrinseca as they called it—that was to be considered when repaying money debts.13

Debasement of the coinage was unable to force commercial practice to attribute to the new and lighter coins the same purchasing power as the old and heavier coins.14  The value of the coinage fell in proportion to the diminution of its weight and quality. Even price regulations took into account the diminished purchasing power of money due to its debasement. Thus the Schöffen or assessors of Schweidnitz in Silesia used to have the newly minted pfennigs submitted to them, assess their value, and then in consultation with the city council and elders fix the prices of commodities accordingly. There has been handed down to us from thirteenth-century Vienna a forma institutionis que fit per civium arbitrium annuatim tempore quo denarii renovantur pro rerum venalium qualibet emptione in which the prices of commodities and services are regulated in connection with the introduction of a new coinage in the years 1460 to 1474. Similar measures were taken on similar occasions in other cities.15

Wherever disorganization of the coinage had advanced so far that the presence of a stamp on a piece of metal was no longer any help in determining its actual content, commerce ceased entirely to rely on the official monetary system and created its own system of measuring the precious metals. In large transactions, ingots and trade tokens were used. Thus, the German merchants visiting the fair at Geneva took ingots of refined gold with them and made their purchases with these, employing the weights used at the Paris market, instead of using money. This was the origin of the Markenskudo or scutus marcharum, which was nothing but the merchants’ usual term for 3.765 grams of refined gold. At the beginning of the fifteenth century, when the Geneva trade was gradually being transferred to Lyons, the gold mark had become such a customary unit of account among the merchants that bills of exchange expressed in terms of it were carried to and from the market. The old Venetian lire di grossi had a similar origin.16  In the giro banks that sprang up in all big commercial centers at the beginning of the modern era we see a further attempt to free the monetary system from the authorities’ abuse of the privilege of minting. The clearinghouse business of these banks was based either on coins of a specific fineness or on ingots. This bank money was commodity money in its most perfect form.

The nominalists assert that the monetary unit, in modern countries at any rate, is not a concrete commodity unit that can be defined in suitable technical terms, but a nominal quantity of value about which nothing can be said except that it is created by law. Without touching upon the vague and nebulous nature of this phraseology, which will not sustain a moment’s criticism from the point of view of the theory of value, let us simply ask: What, then, were the mark, the franc, and the pound before 1914? Obviously, they were nothing but certain weights of gold. Is it not mere quibbling to assert that Germany had not a gold standard but a mark standard? According to the letter of the law, Germany was on a gold standard, and the mark was simply the unit of account, the designation of 1/2790 kg. of refined gold. This is in no way affected by the fact that nobody was bound in private dealings to accept gold ingots or foreign gold coins, for the whole aim and intent of state intervention in the monetary sphere is simply to release individuals from the necessity of testing the weight and fineness of the gold they receive, a task which can only be undertaken by experts and which involves very elaborate precautionary measures. The narrowness of the limits within which the weight and fineness of the coins are legally allowed to vary at the time of minting, and the establishment of a further limit to the permissible loss by wear of those in circulation, are much better means of securing the integrity of the coinage than the use of scales and nitric acid on the part of all who have commercial dealings. Again, the right of free coinage, one of the basic principles of modern monetary law, is a protection in the opposite direction against the emergence of a difference in value between the coined and uncoined metal. In large-scale international trade, where differences that are negligible as far as single coins are concerned have a cumulative importance, coins are valued, not according to their number, but according to their weight; that is, they are treated not as coins but as pieces of metal. It is easy to see why this does not occur in domestic trade. Large payments within a country never involve the actual transfer of the amounts of money concerned, but merely the assignment of claims, which ultimately refer to the stock of precious metal of the central bank.

The role played by ingots in the gold reserves of the banks is a proof that the monetary standard consists in the precious metal, and not in the proclamation of the authorities.

Even for present-day coins, so far as they are not money substitutes, credit money, or fiat money, the statement is true that they are nothing but ingots whose weight and fineness are officially guaranteed.17  The money of those modern countries where metal coins with no mint restrictions are used is commodity money just as much as that of ancient and medieval nations.

• 10See esp. Hammer, Die Hauptprinzipien des Geld-und Währungswesens und die Lösung der Valutafrage (Vienna, 1891), pp. 7 ff.; Gesell, Die Anpassung des Geldes und seiner Verwaltung an die Bedürfnisse des modernen Verkehres (Buenos Aires, 1897), pp. 21 ff.; Knapp, Staatliche Theorie des Geldes, 3d ed. (Munich, 1921), pp. 20 ff.
• 11See Luschin, Allgemeine Münzkunde und Geldgeschichte des Mittelalters und der neureren Zeit (Munich, 1904), P. 215; Babelon, La théorie féodale de la monnaie (Extrait des mémoires de l’Académie des Inscriptions et Belles-Lettres, vol. 38, Part I [Paris, 1908], p. 35).
• 12For important references, see Babelon, op. cit., p. 35.
• 13See Seidler, “Die Schwankungen des Geldwertes und die juristische Lehre von dem Inhalt der Geldschulden,” Jahrbücher für Nationalökonomie und Statistik (1894), 3d. Series, vol. 7, p. 688.
• 14For earlier conditions in Russia, see Gelesnoff, Grundzüge der Volkswirtschaftslehre, trans. into German by Altschul (Leipzig, 1918), p. 357.
• 15See Luschin, op. cit., pp. 221 f.
• 16Ibid., p. 155; Endemann, Studien in der romanisch-kanonistischen Wirtschafts-und Rechtslehre bis gegen Ende des 17. Jahrhunderts (Berlin, 1874), vol. 1, pp. 180 ff.
• 17Chevalier, Cours d’économie politique, III., La monnaie (Paris, 1850), pp. 21 ff; Goldschmidt, Handbuch des Handelsrechts (Erlangen, 1868), vol. 1, Part II, pp. 1073 ff.

The position of the state in the market differs in no way from that of any other parties to commercial transactions. Like these others, the state exchanges commodities and money on terms which are governed by the laws of price. It exercises its sovereign rights over its subjects to levy compulsory contributions from them; but in all other respects it adapts itself like everybody else to the commercial organization of society. As a buyer or seller the state has to conform to the conditions of the market. If it wishes to alter any of the exchange ratios established in the market, it can only do this through the market’s own mechanism. As a rule it will be able to act more effectively than anyone else, thanks to the resources at its command outside the market. It is responsible for the most pronounced disturbances of the market because it is able to exercise the strongest influence on demand and supply. But it is nonetheless subject to the rules of the market and cannot set aside the laws of the pricing process. In an economic system based on private ownership of the means of production, no government regulation can alter the terms of exchange except by altering the factors that determine them.

Kings and republics have repeatedly refused to recognize this. Diocletian’s edict de pretiis rerum venalium, the price regulations of the Middle Ages, and the maximum prices of the French Revolution are the most well-known examples of the failure of authoritative interference with the market. These attempts at intervention were not frustrated by the fact that they were valid only within the state boundaries and ignored elsewhere. It is a mistake to imagine that similar regulations would have led to the desired result even in an isolated state. It was the functional, not the geographical, limitations of the government that rendered them abortive. They could have achieved their aim only in a socialistic state with a centralized organization of production and distribution. In a state that leaves production and distribution to individual enterprise, such measures must necessarily fail of their effect.

The concept of money as a creature of law and the state is clearly untenable. It is not justified by a single phenomenon of the market. To ascribe to the state the power of dictating the laws of exchange, is to ignore the fundamental principles of money-using society.

When both parties to an exchange fulfill their obligations immediately and surrender a commodity for ready cash, there is usually no motive for the judicial intervention of the state. But when the exchange is one of present goods against future goods it may happen that one party fails to fulfill his obligations although the other has carried out his share of the contract. Then the judiciary may be invoked. If the case is one of lending or purchase on credit, to name only the most important examples, the court has to decide how a debt contracted in terms of money can be liquidated. Its task thus becomes that of determining, in accordance with the intent of the contracting parties, what is to be understood by money in commercial transactions. From the legal point of view, money is not the common medium of exchange, but the common medium of payment or debt settlement. But money only becomes a medium of payment by virtue of being a medium of exchange. And it is only because it is a medium of exchange that the law also makes it the medium for fulfilling obligations not contracted in terms of money, but whose literal fulfillment is for some reason or other impossible.

The fact that the law regards money only as a means of canceling outstanding obligations has important consequences for the legal definition of money. What the law understands by money is in fact not the common medium of exchange but the legal medium of payment. It does not come within the scope of the legislator or jurist to define the economic concept of money.

In determining how monetary debts may be effectively paid off there is no reason for being too exclusive. It is customary in business to tender and accept in payment certain money substitutes instead of money itself. If the law refused to recognize the validity of money substitutes that are sanctioned by commercial usage, it would only open the door to all sorts of fraud and deceit. This would offend against the principle malitiis non est indulgendum. Besides this, the payment of small sums would, for technical reasons, hardly be possible without the use of token money. Even ascribing the power of debt settlement to banknotes does not injure creditors or other recipients in any way, so long as the notes are regarded by the businessman as equivalent to money.

But the state may ascribe the power of debt settlement to other objects as well. The law may declare anything it likes to be a medium of payment, and this ruling will be binding on all courts and on all those who enforce the decisions of the courts. But bestowing the property of legal tender on a thing does not suffice to make it money in the economic sense. Goods can become common media of exchange only through the practice of those who take part in commercial transactions; and it is the valuations of these persons alone that determine the exchange ratios of the market. Quite possibly, commerce may take into use those things to which the state has ascribed the power of payment; but it need not do so. It may, if it likes, reject them.

Three situations are possible when the state has declared an object to be a legal means of fulfilling an outstanding obligation. First, the legal means of payment may be identical with the medium of exchange that the contracting parties had in mind when entering into their agreement; or, if not identical, it may yet be of equal value with this medium at the time of payment. For example, the state may proclaim gold as a legal medium for settling obligations contracted in terms of gold, or, at a time when the relative values of gold and silver are as 1 to 15½, it may declare that liabilities in terms of gold may be settled by payment of 15½ times the quantity of silver. Such an arrangement is merely the legal formulation of the presumable intent of the agreement. It damages the interests of neither party. It is economically neutral.

The case is otherwise when the state proclaims as medium of payment something that has a higher or lower value than the contractual medium. The first possibility may be disregarded; but the second, of which numerous historical examples could be cited, is important. From the legal point of view, in which the fundamental principle is the protection of vested rights, such a procedure on the part of the state can never be justified, although it might sometimes be vindicated on social or fiscal grounds. But it always means, not the fulfillment of obligations, but their complete or partial cancellation. When notes that are appraised commercially at only half their face value are proclaimed legal tender, this amounts fundamentally to the same thing as granting debtors legal relief from half of their liabilities.

State declarations of legal tender affect only those monetary obligations that have already been contracted. But commerce is free to choose between retaining its old medium of exchange or creating a new one for itself, and when it adopts a new medium, so far as the legal power of the contracting parties reaches, it will attempt to make it into a standard of deferred payments also, in order to deprive of its validity, at least for the future, the standard to which the state has ascribed complete powers of debt settlement. When, during the last decade of the nineteenth century, the bimetallist party in Germany gained so much power that the possibility of experiment with its inflationist proposals had to be reckoned with, gold clauses began to make their appearance in long-term contracts. The recent period of currency depreciation has had a similar effect. If the state does not wish to render all credit transactions impossible, it must recognize such devices as these and instruct the courts to acknowledge them. And, similarly, when the state itself enters into ordinary business dealings, when it buys or sells, guarantees loans or borrows, makes payments or receives them, it must recognize the common business medium of exchange as money. The legal standard, the particular group of things that are endued with the property of unlimited legal tender, is in fact valid only for the settlement of existing debts, unless business usage itself adopts it as a general medium of exchange.

State activity in the monetary sphere was originally restricted to the manufacture of coins. To supply ingots of the greatest possible degree of similarity in appearance, weight, and fineness, and provide them with a stamp that was not too easy to imitate and that could be recognized by everybody as the sign of the state coinage, was and still is the premier task of state monetary activity. Beginning with this, the influence of the state in the monetary sphere has gradually extended.

Progress in monetary technique has been slow. At first, the impression on a coin was merely a proof of the genuineness of its material, including its degree of fineness, while the weight had to be separately checked at each payment. (In the present state of knowledge this cannot be stated dogmatically; and in any case the development is not likely to have followed the same lines everywhere.) Later, different kinds of coins were distinguished, all the separate coins of any particular kind being regarded as interchangeable. The next step after the innovation of classified money. was the development of the parallel standard. This consisted in the juxtaposition of two monetary systems, one based on gold commodity money, and one on silver. The coins belonging to each separate system constituted a self-contained group. Their weights bore a definite relation to each other, and the state gave them a legal relation also, in the same proportion, by sanctioning the commercial practice which had gradually been established of regarding different coins of the same metal as interchangeable. This stage was reached without further state influence. All that the state had done till then in the monetary sphere was to provide the coins for commercial use. As controller of the mint, it supplied in handy form pieces of metal of specific weight and fineness, stamped in such a way that everybody could recognize without difficulty what their metallic content was and whence they originated. As legislator, the state attributed legal tender to these coins—the significance of this has just been expounded—and as judge it applied this legal provision. But the matter did not end at this stage. For about the last two hundred years the influence of the state on the monetary system has been greater than this. One thing, however, must be made clear; even now the state has not the power of directly making anything into money, that is to say into a common medium of exchange. Even nowadays, it is only the practice of the individuals who take part in business that can make a commodity into a medium of exchange. But the state’s influence on commercial usage, both potential and actual, has increased. It has increased, first, because the state’s own importance as an economic agent has increased; because it occupies a greater place as buyer and seller as payer of wages and levier of taxes, than in past centuries. In this there is nothing that is remarkable or that needs special emphasis. It is obvious that the influence of an economic agent on the choice of a monetary commodity will be the greater in proportion to its share in the dealings of the market; and there is no reason to suppose that there should be any difference in the case of the one particular economic agent, the state.

But, besides this, the state exercises a special influence on the choice of the monetary commodity, which is due not to its commercial position nor to its authority as legislator and judge, but to its official standing as controller of the mint and to its power to change the character of the money substitutes in circulation.

The influence of the state on the monetary system is usually that ascribed to its legislative and judicial authority. It is assumed that the law, which can authoritatively alter the tenor of existing debt relations and force new contracts of indebtedness in a particular direction, enables the state to exercise a deciding influence in the choice of the commercial medium of exchange.

Nowadays the most extreme form of this argument is to be found in Knapp’s State Theory of Money;1  but very few German writers are completely free from it. Helfferich may be mentioned as an example. It is true that this writer declares, with regard to the origin of money, that it is perhaps doubtful whether it was not the function of common medium of exchange alone that sufficed to make a thing money and to make money the standard of deferred payments of every kind. Nevertheless, he constantly regards it as quite beyond any sort of doubt that for our present economic organization certain kinds of money in some countries, and the whole monetary system in other countries, are money, and function as a medium of exchange, only because compulsory payments and obligations contracted in terms of money must or may be fulfilled in terms of these particular objects.2

It would be difficult to agree with views of this nature. They fail to recognize the meaning of state intervention in the monetary sphere. By declaring an object to be fitted in the juristic sense for the liquidation of liabilities expressed in terms of money, the state cannot influence the choice of a medium of exchange, which belongs to those engaged in business. History shows that those states that have wanted their subjects to accept a new monetary system have regularly chosen other means than this of achieving their ends.

The establishment of a legal ratio for the discharge of obligations incurred under the regime of the superseded kind of money constitutes a merely secondary measure which is significant only in connection with the change of standard which is achieved by other means. The provision that taxes are in future to be paid in the new kind of money, and that other liabilities imposed in terms of money will be fulfilled only in the new money, is a consequence of the transition to the new standard. It proves effective only when the new kind of money has become a common medium of exchange in commerce generally. A monetary policy can never be carried out merely by legislative means, by an alteration in the legal definitions of the content of contracts of indebtedness and of the system of public expenditure; it must be based on the executive authority of the state as controller of the mint and as issuer of claims to money, payable on demand, that can take the place of money in commerce. The necessary measures must not merely be passively recorded in the protocols of legislative assemblies and official gazettes, but—often at great financial sacrifice—must be actually put into operation.

A country that wishes to persuade its subjects to go over from one precious-metal standard to another cannot rest content with expressing this aspiration in appropriate provisions of the civil and fiscal law. It must make the new money take the commercial place of the old. Exactly the same is true of the transition from a credit-money or fiat-money standard to commodity money. No statesman faced with the task of such a change has ever had even a momentary doubt about the matter. It is not the enactment of a legal ratio and the order that taxes are to be paid in the new money that are the decisive steps, but the provision of the necessary quantity of the new money and the withdrawal of the old.

This may be confirmed by a few historical examples. First, the impossibility of modifying the monetary system merely by the exercise of authority may be illustrated by the ill success of bimetallistic legislation. This was once thought to offer a simple solution of a big problem. For thousands of years, gold and silver had been employed side by side as commodity money; but the continuance of this practice had constantly grown more burdensome, for the parallel standard, or simultaneous employment as currency of two kinds of commodity, has many disadvantages. Since no spontaneous assistance was to be expected from the individuals engaged in business, the state decided to intervene in the hope of cutting the Gordian knot. Just as it had previously removed certain obvious difficulties by declaring that debts contracted in terms of thalers might be discharged by payment of twice as many half-thalers or four times as many quarter-thalers, so it now proceeded to establish a fixed ratio between the two different precious metals. Debts payable in silver, for instance, could be discharged by payment of 1 : 15½ times the same weight of gold. It was thought that this had solved the problem, while in fact the difficulties that it involved had not even been suspected; as events were to prove. All the results followed that are attributed by Gresham’s law to the legislative equating of coins of unequal value. In all debt settlements and similar payments, only that money was used which the law rated more highly than the market. When the law had happened to hit upon the existing market ratio as its par, then this effect was delayed a little until the next movement in the prices of the precious metals. But it was bound to occur as soon as a difference arose between the legislative and the market ratios of the two kinds of money. The parallel standard was thus turned, not into a double standard, as the legislators had intended, but into an alternative standard.

The primary result of this was a decision, for a little while at least, between the two precious metals. Not that this was what the state had intended. On the contrary, the state had no thought whatever of deciding in favor of the use of one or the other metal; it had hoped to secure the circulation of both. But the official regulation, which in declaring the reciprocal substitutability of gold and silver money overestimated the market ratio of the one in terms of the other, merely succeeded in differentiating the utility of the two for monetary purposes. The consequence was the increased employment of one of the metals and the disappearance of the other. The legislative and judicial intervention of the state had completely failed. It had been demonstrated, in striking fashion, that the state alone could not make a commodity into a common medium of exchange, that is, into money, but that this could be done only by the common action of all the individuals engaged in business.

But what the state fails to achieve through legislative means may be to a certain degree within its power as controller of the mint. It was in the latter capacity that the state intervened when the alternative standard was replaced by permanent monometallism. This happened in various ways. The transition was quite simple and easy when the action of the state consisted in preventing a return to the temporarily undervalued metal in one of the alternating monometallic periods by rescinding the fight of free coinage. The matter was even simpler in those countries where one or the other metal had gained the upper hand before the state had reached the stage necessary for the modern type of regulation, so that all that remained for the law to do was to sanction a situation that was already established.

The problem was much more difficult when the state attempted to persuade businessmen to abandon the metal that was being used and adopt the other. In this case, the state had to manufacture the necessary quantity of the new metal, exchange it for the old currency, and either turn the metal thus withdrawn from circulation into token coinage or sell it for nonmonetary use or for recoinage abroad. The reform of the German monetary system after the foundation of the Reich in 1871 may be regarded as a perfect example of the transition from one metallic commodity standard to another. The difficulties that this involved, and that were overcome by the help of the French war indemnity, are well known. They were involved in the performance of two tasks—the provision of the gold and the disposal of the silver. This and nothing else was the essence of the problem that had to be solved when the decision was taken to change the standard. The Reich completed the transition to gold by giving gold and claims to gold in exchange for the silver money and claims to silver money held by its citizens. The corresponding alterations in the law were mere accompaniments of the change.3

The change of standard occurred in just the same way in Austria-Hungary, Russia, and the other countries that reformed their monetary systems in the succeeding years. Here also the problem was merely that of providing the requisite quantities of gold and setting them in circulation among those engaged in business in place of the media previously employed. This process was extraordinarily facilitated and, what was even more to the point, the amount of gold necessary for the changeover was considerably decreased, by the device of permitting the coins constituting the old fiat money or credit money to remain wholly or partly in circulation, while fundamentally changing their economic character by transforming them into claims that were always convertible into the new kind of money. This gave a different outward appearance to the transaction, but it remained in essence the same. It is scarcely open to question that the steps taken by those countries that adopted this kind of monetary policy consisted essentially in the provision of quantities of metal.

The exaggeration of the importance in monetary policy of the power at the disposal of the state in its legislative capacity can only be attributed to superficial observation of the processes involved in the transition from commodity money to credit money. This transition has normally been achieved by means of a state declaration that inconvertible claims to money were as good means of payment as money itself. As a rule, it has not been the object of such a declaration to carry out a change of standard and substitute credit money for commodity money. In the great majority of cases, the state has taken such measures merely with certain fiscal ends in view. It has aimed to increase its own resources by the creation of credit money. In the pursuit of such a plan as this, the diminution of the money’s purchasing power could hardly seem desirable. And yet it has always been this depreciation in value which, through the coming into play of Gresham’s law, has caused the change of monetary standard. It would be quite out of harmony with the facts to assert that cash payments had ever been stopped; that is, that the permanent convertibility of the notes had been suspended, with the intention of effecting a transition to a credit standard. This result has always come to pass against the will of the state, not in accordance with it.

Business usage alone can transform a commodity into a common medium of exchange. It is not the state, but the common practice of all those who have dealings in the market, that creates money. It follows that state regulation attributing general power of debt liquidation to a commodity is unable of itself to make that commodity into money. If the state creates credit money—and this is naturally true in a still greater degree of fiat money—it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility. Commerce would always protect itself against any other method of introducing a government credit currency. The attempt to put credit money into circulation has never been successful, except when the coins or notes in question have already been in circulation as money substitutes.4

This is the limit of the constantly overestimated influence of the state on the monetary system. What the state can do in certain circumstances, by means of its position as controller of the mint, by means of its power of altering the character of money substitutes and depriving them of their standing as claims to money that are payable on demand, and above all by means of those financial resources which permit it to bear the cost of a change of currency, is to persuade commerce to abandon one sort of money and adopt another. That is all.

• 1Knapp, Staatliche Theorie des Geldes (3d. ed., 1921); trans. into English by H. M. Lucas and J. Bonar as The State Theory of Money (London, 1924).
• 2See Helfferich, Das Geld, 6th ed. (Leipzig, 1923), p. 294; English trans., Money (London, 1927), p. 312.
• 3See Helfferich, Die Reform des deutschen Geldwesens nach der Gründung des Reiches (Leipzig, 1898), vol. 1, pp. 307 ff; Lotz, Geschichte und Kritik des deutschen Bankgesetzes vom 14. März 1875 (Leipzig, 1888), pp. 137 ff.
• 4See Subercaseaux, Essai sur la nature du papier monnaie (Paris, 1909), pp. 5 ff.

It is usual to divide economic goods into the two classes of those which satisfy human needs directly and those which only satisfy them indirectly: that is, consumption goods, or goods of the first order; and production goods, or goods of higher orders.1  The attempt to include money in either of these groups meets with insuperable difficulties. It is unnecessary to demonstrate that money is not a consumption good. It seems equally incorrect to call it a production good.

Of course, if we regard the twofold division of economic goods as exhaustive we shall have to rest content with putting money in one group or the other. This has been the position of most economists; and since it has seemed altogether impossible to call money a consumption good, there has been no alternative but to call it a production good.

This apparently arbitrary procedure has usually been given only a very cursory vindication. Roscher, for example, thought it sufficient to mention that money is “the chief instrument of every transfer” (vornehmstes Werkzeug jeden Verkehrs).2

In opposition to Roscher, Knies made room for money in the classification of goods by replacing the twofold division into production goods and consumption goods by a threefold division into means of production, objects of consumption, and media of exchange.3  His arguments on this point, which are unfortunately scanty, have hardly attracted any serious attention and have been often misunderstood. Thus Helfferich attempts to confute Knies’s proposition, that a sale-and-purchase transaction is not in itself an act of production but an act of (interpersonal) transfer, by asserting that the same sort of objection might be made to the inclusion of means of transport among instruments of production on the grounds that transport is not in itself an act of production but an act of (interlocal) transfer and that the nature of goods is no more altered by transport than by a change of ownership.4

Obviously, it is the ambiguity of the German word Verkehr that has obscured the deeper issues here involved. On the one hand, Verkehr bears a meaning that may be roughly translated by the word commerce; that is, the exchange of goods and services on the part of individuals. But it also means the transfer through space of persons, goods, and information. These two groups of things denoted by the German word Verkehr have nothing in common but their name. It is therefore impossible to countenance the suggestion of a relationship between the two meanings of the word that is involved in the practice of speaking of “Verkehr in the broader sense,” by which is meant the transfer of goods from one person’s possession to that of another, and “Verkehr in the narrower sense,” by which is meant the transfer of goods from one point in space to another.5  Even popular usage recognizes two distinct meanings here, not a narrower and a broader version of the same meaning.

The common nomenclature of the two meanings, as also their incidental confusion, may well be attributable to the fact that exchange transactions often, but by no means always, go hand in hand with acts of transport, through space and vice versa.6  But obviously this is no reason why science should impute an intrinsic similarity to these essentially different processes.

It should never have been called in question that the transportation of persons, goods, and information is to be reckoned part of production, so far as it does not constitute an act of consumption, as do pleasure trips for example. All the same, two things have hindered recognition of this fact. The first is the widespread misconception of the nature of production. There is a naive view of production that regards it as the bringing into being of matter that did not previously exist, as creation in the true sense of the word. From this it is easy to derive a contrast between the creative work of production and the mere transportation of goods. This way of regarding the matter is entirely inadequate. In fact, the role played by man in production always consists solely in combining his personal forces with the forces of Nature in such a way that the cooperation leads to some particular desired arrangement of material. No human act of production amounts to more than altering the position of things in space and leaving the rest to Nature.7  This disposes of one of the objections to regarding transportation as a productive process.

The second objection arises from insufficient insight into the nature of goods. It is often overlooked that, among other natural qualities, the position of a thing in space has important bearings on its capacity for satisfying human wants. Things that are of perfectly identical technological composition must yet be regarded as specimens of different kinds of goods if they are not in the same place and in the same state of readiness for consumption or further production. Till now the position of a good in space has been recognized only as a factor determining its economic or noneconomic nature. It is hardly possible to ignore the fact that drinking water in the desert and drinking water in a well-watered mountain district, despite their chemical and physical similarity and their equal thirst-quenching properties, have nevertheless a totally different significance for the satisfaction of human wants. The only water that can quench the thirst of the traveler in the desert is the water that is on the spot, ready for consumption.

Within the group of economic goods itself, however, the factor of situation has been taken into consideration only for goods of certain kinds—those whose position has been fixed, whether by man or nature; and even among these, attention has seldom been given to any but the most outstanding example, land. As far as movable goods are concerned, the factor of situation has been treated as negligible.

This attitude is in consonance with commercial technology. The microscope fails to reveal any difference between two lots of beet sugar, of which one is warehoused in Prague and the other in London. But for the purposes of economics it is better to regard the two lots of sugar as goods of different kinds. Strictly speaking, only those goods should be called goods of the first order which are already where they can immediately be consumed. All other economic goods, even if they are ready for consumption in the technological sense, must be regarded as goods of higher orders which can be transmuted into goods of the first order only by combination with the complementary good, “means of transport.” Regarded in this light, means of transport are obviously production goods. “Production,” says Wieser, “is the utilization of the more advantageous among remote conditions of welfare.”8  There is nothing to prevent us from interpreting the word remote in its literal sense for once, and not just figuratively.

We have seen that transfer through space is one sort of production; and means of transport, therefore, so far as they are not consumption goods such as pleasure yachts and the like, must be included among production goods. Is this true of money as well? Are the economic services that money renders comparable with those rendered by means of transport? Not in the least. Production is quite possible without money. There is no need for money either in the isolated household or in the socialized community. Nowhere can we discover a good of the first order of which we could say that the use of money was a necessary condition of its production.

It is true that the majority of economists reckon money among production goods. Nevertheless, arguments from authority are invalid; the proof of a theory is in its reasoning, not in its sponsorship; and with all due respect for the masters, it must be said that they have not justified their position very thoroughly in this matter. This is most remarkable in Böhm-Bawerk. As has been said, Knies recommends the substitution of a threefold classification of economic goods into objects of consumption, means of production, and media of exchange, for the customary twofold division into consumption goods and production goods. In general, Böhm-Bawerk treats Knies with the greatest respect and, whenever he feels obliged to differ from him, criticizes his arguments most carefully. But in the present case he simply disregards them. He unhesitatingly includes money in his concept of social capital, and incidentally specifies it as a product destined to assist further production. He refers briefly to the objection that money is an instrument, not of production, but of exchange; but instead of answering this objection, he embarks on an extended criticism of those doctrines that treat stocks of good in the hands of producers and middlemen as goods ready for consumption instead of as intermediate products.

Böhm-Bawerk’s argument proves conclusively that production is not completed until the goods have been brought to the place where they are wanted, and that it is illegitimate to speak of goods being ready for consumption until the final process of transport is completed. But it contributes nothing to our present discussion; for the chain of reasoning gives way just at the critical link. After having proved that the horse and wagon with which the farmer brings home his corn and wood must be reckoned as means of production and as capital, Böhm-Bawerk adds that “logically all the objects and apparatus of ‘bringing home’ in the broader economic sense, the things that have to be transported, the roads, railways, and ships, and the commercial tool money, must be included in the concept of capital.”9

This is the same jump that Roscher makes. It leaves out of consideration the difference between transport, which consists in an alteration of the utility of things, and exchange, which constitutes a separate economic category altogether. It is illegitimate to compare the part played by money in production with that played by ships and railways. Money is obviously not a “commercial tool” in the same sense as account books, exchange lists, the stock exchange, or the credit system.

Böhm-Bawerk’s argument in its turn has not remained uncontradicted. Jacoby objects that while it treats money and the stocks of commodities in the hands of producers and middlemen as social capital, it nevertheless maintains the view that social capital is a pure economic category and independent of all legal definitions, although money and the “commodity” aspect of consumption goods are peculiar to a “commercial” type of economic organization.10

The invalidity of this criticism, so far as it is an objection to regarding commodities as production goods, is implied by what has been said above. There is no doubt that Böhm-Bawerk is in the right here, and not his critic. It is otherwise with the second point, the question of the inclusion of money. Admittedly, Jacoby’s own discussion of the capital concept is not beyond criticism, and Böhm-Bawerk’s refusal to accept it is probably justified.11  But that does not concern us at present. We are only concerned with the problem of the concept of goods. On this point as well Böhm-Bawerk disagrees with Jacoby. In the third edition of volume two of his masterpiece, Capital and Interest, he argues that even a complex socialistic organization could hardly do without undifferentiated orders or certificates of some sort, “like money,” which refer to the product awaiting distribution.12  This particular argument of his was not directly aimed at our present problem. Nevertheless, it is desirable to inquire whether the opinion expressed in it does not contain something that may be useful for our purpose as well.

Every sort of economic organization needs not only a mechanism for production but also a mechanism for distributing what is produced. It will scarcely be questioned that the distribution of goods among individual consumers constitutes a part of production, and that in consequence we should include among the means of production not only the physical instruments of commerce such as stock exchanges, account books, documents, and the like, but also everything that serves to maintain the legal system which is the foundation of commerce, as, for example, fences, railings, walls, locks, safes, the paraphernalia of the law courts, and the equipment of the organs of government entrusted with the protection of property. In a socialist state, this category might include among other things Böhm-Bawerk’s “undifferentiated certificates” (to which, however, we cannot allow the description “like money”; for since money is not a certificate, it will not do to say of a certificate that it is like money. Money is always an economic good, and to say of a claim, which is what a certificate is, that it is like money, is only to drop back into the old practice of regarding rights and business connections as goods. Here we can invoke Böhm-Bawerk’s own authority against himself).13

What prevents us nevertheless from reckoning money among these “distribution goods” and so among production goods (and incidentally the same objection applies to its inclusion among consumption goods) is the following consideration. The loss of a consumption good or production good results in a loss of human satisfaction; it makes mankind poorer The gain of such a good results in an improvement of the human economic position; it makes mankind richer The same cannot be said of the loss or gain of money. Both changes in the available quantity of production goods or consumption goods and changes in the available quantity of money involve changes in values; but whereas the changes in the value of the production goods and consumption goods do not mitigate the loss or reduce the gain of satisfaction resulting from the changes in their quantity, the changes in the value of money are accommodated in such a way to the demand for it that, despite increases or decreases in its quantity, the economic position of mankind remains the same. An increase in the quantity of money can no more increase the welfare of the members of a community, than a diminution of it can decrease their welfare. Regarded from this point of view, those goods that are employed as money are indeed what Adam Smith called them, “dead stock, which ... produces nothing.”14

We have shown that, under certain conditions, indirect exchange is a necessary phenomenon of the market. The circumstance that goods are desired and acquired in exchange not for their own sakes but only in order to be disposed of in further exchange can never disappear from our type of market dealing, because the conditions that make it inevitable are present in the overwhelming majority of all exchange transactions. Now the economic development of indirect exchange leads to the employment of a common medium of exchange, to the establishment and elaboration of the institution of money. Money, in fact, is indispensable in our economic order But as an economic good it is not a physical component of the social distributive apparatus in the way that account books, prisons, or firearms are. No part of the total result of production is dependent on the collaboration of money, even though the use of money may be one of the fundamental principles on which the economic order is based.

Production goods derive their value from that of their products. Not so money; for no increase in the welfare of the members of a society can result from the availability of an additional quantity of money. The laws which govern the value of money are different from those which govern the value of production goods and from those which govern the value of consumption goods. All that these have in common is their general underlying principle, the fundamental economic law of value. This is a complete justification of the suggestion put forward by Knies that economic goods should be divided into means of production, objects of consumption, and media of exchange; for, after all, the primary object of economic terminology is to facilitate investigation into the theory of value.

• 1See Menger, Grundsätze der Volkswirtschaftslehre, 2d ed. (Vienna, 1923), pp. 20 ff.; Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Wertes (Vienna, 1884), pp. 42 ff.
• 2Roscher, System der Volkswirtschaft, ed. Pöhlmann, 24th ed. (Stuttgart, 1906), vol. 1, p. 123.
• 3See Knies, Geld und Kredit, 2d ed. (Berlin, 1885), vol. 1, pp. 20 ff.
• 4See Helfferich, Das Geld, 6th ed. (Leipzig, 1923), pp. 264 f.; Money (London, 1924), p. 280.
• 5E.g. Philippovich, Grundriss der politischen Ökonomie 1st-3d eds. (Tübingen, 1907), vol. 2; Wagner, Theoretische Sozialökonomik (Leipzig, 1909), vol. 2, Part 2 p. 1.
• 6The older meaning, at least the only earlier meaning in literature, appears to have been that relating to the sale of goods. It is remarkable that even Grimm’s Dictionary, vol. 12, published in 1891, contains no mention of the meaning relating to transportation.
• 7See J. S. Mill, Principles of Political Economy (London, 1867), p. 16; Böhm-Bawerk, Kapital und Kapitalzins, pp. 10 ff.
• 8Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Wertes, p. 47. See also Böhm-Bawerk, op. cit., pp. 131 f.; Clark, The Distribution of Wealth (New York, 1908), p. 11.
• 9Böhm-Bawerk, op. cit., Part II pp. 131 ff. See also, on the historical aspect, Jacoby, Der Streit um den Kapitalsbegriff (Jena, 1908), pp. 90 ff; Spiethoff, “Die Lehre vom Kapital,” Schmoller-Festschrift Die Entwicklung der deutschen Volkswirtschaftslehre im 19. Jahrhundert (Leipzig, 1908), vol. 4, p. 26.
• 10See Jacoby, op. cit., pp. 59 f.
• 11See Böhm-Bawerk, op. cit., p. 125 n.
• 12Ibid., p. 132 n.
• 13Böhm-Bawerk, Rechte und Verhältnisse, pp. 36 ff.
• 14 Smith, The Wealth of Nations, Cannan’s ed. (London, 1930).

We have not undertaken this investigation into the relationship between money and production goods merely for its terminological interest. What is of importance for its own sake is not our ultimate conclusion, but the incidental light shed by our argument upon those peculiarities of money that distinguish it from other economic goods. These special characteristics of the common medium of exchange will receive closer attention when we turn to consider the laws that regulate the value of money and its variations.

But the result of our reasoning, too, the conclusion that money is not a production good, is not entirely without significance. It will help us to answer the question whether money is capital or not. This question in its turn is not an end in itself, but it provides a check upon the answer to a further problem concerning the relations between the equilibrium rate of interest and the money rate of interest, which will be dealt with in the third part of this book. If each conclusion confirms the other, then we may assume with a considerable degree of assurance that our arguments have not led us into error.

The first grave difficulty in the way of any investigation into the relation between money and capital arises from the difference of opinion that exists about the definition of the concept of capital. The views of scholars on the definition of capital are more divergent than their views on any other point of economics. None of the many definitions that have been suggested has secured general recognition; nowadays, in fact, the controversy about the theory of capital rages more fiercely than ever. If from among the large number of conflicting concepts we select that of Böhm-Bawerk to guide us in our investigation into the relation of money to capital, we could justify our procedure merely by reference to the fact that Böhm-Bawerk is the best guide for any serious attempt to study the problem of interest, even if such a study leads eventually (and by no means entirely without indebtedness to the labor that Böhm-Bawerk bestowed on this problem) to conclusions that differ widely from those which he himself arrived at. Furthermore, all those weighty arguments with which Böhm-Bawerk established his concept and defended it against his critics support such a choice. But quite apart from these, a reason that appears to be quite decisive is provided by the fact that no other concept of capital has been developed with equal clarity.15  This last point is particularly important. It is not the object of the present discussion to arrive at any kind of conclusion respecting terminology or to provide any criticism of concepts, but merely to shed some light on one or two points that are of importance for the problem of the relations between the equilibrium and the money rates of interest. Hence it is less important for us to classify things correctly than to avoid vague ideas about their nature. Various opinions may be held as to whether money should be included in the concept of capital or not. The delimitation of concepts of this nature is merely a question of expediency, in connection with which it is quite easy for differences of opinion to arise. But the economic function of money is a matter about which it should be possible to arrive at perfect agreement.

Of the two concepts of capital that Böhm-Bawerk distinguishes, following the traditional economic terminology, that of what is called private or acquisitive capital is both the older and the wider. This was the original root idea from which the narrower concept of social or productive capital was afterward separated. It is therefore logical to begin our investigation by inquiring into the connection between private capital and money.

Böhm-Bawerk defines private capital as the aggregate of the products that serve as a means to the acquisition of goods.16  It has never been questioned that money must be included in this category. In fact, the development of the scientific concept of capital starts from the notion of an interest-bearing sum of money. This concept of capital has been broadened little by little until at last it has taken the form which it bears in modern scientific discussion, on the whole in approximate coincidence with popular usage.

The gradual evolution of the concept of capital has meant at the same time an increasing understanding of the function of money as capital. Early in history the lay mind discovered an explanation of the fact that money on loan bears interest—that money, in fact, “works.” But such an explanation as this could not long satisfy scientific requirements. Science therefore countered it with the fact that money itself is barren. Even in ancient times general recognition must have been accorded to the view which later in the shape of the maxim pecunia pecuniam parere non potest was to be the basis of all discussion of the problem of interest for hundreds and even thousands of years, and Aristotle undoubtedly did not state it in the famous passage in his Politics as a new doctrine but as a generally accepted commonplace.17  Despite its obviousness, this perception of the physical unfruitfulness of money was a necessary step on the way to full realization of the problem of capital and interest. If sums of money on loan do bear “fruit,” and it is not possible to explain this phenomenon by the physical productivity of the money, then other explanations must be sought.

The next step toward an explanation was provided by the observation that after a loan is made the borrower as a rule exchanges the money for other economic goods, and that those owners of money who wish to obtain a profit from their money without lending it do the same. This was the starting point for the extension of the concept of capital referred to above, and for the development of the problem of the money rate of interest into the problem of the “natural” rate of interest.

It is true that centuries passed before these further steps were accomplished. At first there was a complete halt in the development of the theory of capital. Further progress was in fact not desired; what was already attained sufficed perfectly; for the aim of science then was not to explain reality but to vindicate ideals. And public opinion disapproved of the taking of interest. Even later, when the taking of interest was recognized in Greek and Roman law, it was still not considered respectable, and all the writers of classical times strove to outdo one another in condemning it. When the church adopted this proscription of interest, and attempted to support its attitude by quotations from the Bible, it cut the ground away from beneath all unauthorized attempts to deal with the matter. Every theorist who turned his attention to the problem was already convinced that the taking of interest was harmful, unnatural, and uncharitable, and found his principal task in the search for new objections to it. It was not for him to explain how interest came to exist, but to sustain the thesis that it was reprehensible. In such circumstances it was easy for the doctrine of the sterility of money to be taken over uncritically by one writer from another as an extraordinarily powerful argument against the payment of interest, and thus, not for the sake of its content but for the sake of the conclusion it supported, to become an obstacle in the way of the development of interest theory. It became a help and no longer a hindrance to this development, when a move was made toward the construction of a new theory of capital after the downfall of the old canonist theory of interest. Its first effect, then, was to necessitate an extension of the concept of capital, and consequently of the problem of interest. In popular usage and in the terminology of scholars, capital was no longer “sums of money on loan” but “accumulated stocks of goods.”18

The doctrine of the unfruitfulness of money has another significance for our problem. It sheds light on the position of money within the class of things constituting private capital. Why do we include money in capital? Why is interest paid for sums of money on loan? How is it possible to use sums of money, even without lending them, so that they yield an income? There can be no doubt about the answers to these questions. Money is an acquisitive instrument only when it is exchanged for some other economic good. In this respect money may be compared with those consumption goods that form part of private capital only because they are not consumed by their owners themselves but are used for the acquisition of other goods or services by means of exchange. Money is no more acquisitive capital than these consumption goods are; the real acquisitive capital consists in the goods for which the money or the consumption goods are exchanged. Money that is lying “idle,” that is, money that is not exchanged for other goods, is not a part of capital; it produces no fruit. Money is part of the private capital of an individual only if and so far as it constitutes a means by which the individual in question can obtain other capital goods.

• 15This is true even bearing in mind the discussions of Menger and Clark. But in any case, an investigation, both of this matter and of the problems dealt with in part 3, chap. 19, which started from Menger’s or Clark’s capital concept would lead eventually to the same result as one based on Böhm-Bawerk’s definition.
• 16See Böhm-Bawerk, Kapital und Kapitalzins, pp. 54 f.
• 17I, 3, 23.
• 18See Böhm-Bawerk, Kapital und Kapitalzins, Part I, pp. 16 ff., Part II, pp. 23 ff.

By social or productive capital Böhm-Bawerk means the aggregate of the products intended for employment in further production.19  If we accept the views expounded above, according to which money cannot be included among productive goods, then neither can it be included in social capital. It is true that Böhm-Bawerk includes it in social capital, as the majority of the economists that preceded him had done. This attitude follows logically from regarding money as a productive good; this is its only justification, and in endeavoring to show that money is not a productive good we have implied how baseless a justification it is.

In any case, perhaps we may suggest that those writers who include money among productive goods and consequently among capital goods are not very consistent. They usually reckon money as a part of social capital in that division of their systems where they deal with the concepts of money and capital, but certain obvious further conclusions are not drawn from this. On the contrary, where the doctrine of the nature of money as capital should logically be applied it appears to have been suddenly forgotten. In reviewing the determinants of the rate of interest, writers emphasize over and over again that it is not the greater or smaller quantity of money that is of importance, but the greater or smaller quantity of other economic goods. To reconcile this assertion, which is indubitably a correct summary of the matter, with the other assertion that money is a productive good, is simply impossible.

• 19Ibid., Part II pp. 54 f., 130 ff.

It has been shown that under certain conditions, which occur the more frequently as division of labor and the differentiation of wants are extended, indirect exchange becomes inevitable; and that the evolution of indirect exchange gradually leads to the employment of a few particular commodities, or even one commodity only, as a common medium of exchange. When there is no exchange of any sort, and hence no indirect exchange, the use of media of exchange naturally remains unknown. This was the situation when the isolated household was the typical economic unit, and this, according to socialist aspirations, is what it will be again one day in that purely socialistic order where production and distribution are to be systematically regulated by a central body. This vision of the future socialistic system has not been described in detail by its prophets; and, in fact, it is not the same vision which they all see. There are some among them who allow a certain scope for exchange of economic goods and services, and so far as this is the case the continued use of money remains possible.

On the other hand, the certificates or orders that the organized society would distribute to its members cannot be regarded as money. Supposing that a receipt was given, say, to each laborer for each hour’s labor, and that the social income, so far as it was not employed for the satisfaction of collective needs or the support of those not able to work, was distributed in proportion to the number of receipts in the possession of each individual, so that each receipt represented a claim to an aliquot part of the total amount of goods to be distributed. Then the significance of any particular receipt as a means of satisfying the wants of an individual, in other words its value, would vary in proportion to the size of the total dividend. If, with the same number of hours of labor, the income of the society in a given year was only half as big as in the previous year, then the value of each receipt would likewise be halved.

The case of money is different. A decrease of fifty percent in the real social income would certainly involve a reduction in the purchasing power of money. But this reduction in the value of money need not bear any direct relation to the decrease in the size of the income. It might accidentally happen that the purchasing power of money was exactly halved also; but it need not happen so. This difference is of fundamental importance.

In fact, the exchange value of money is determined in a totally different way from that of a certificate or warrant. Titles like these are not susceptible of an independent process of valuation at all. If it is certain that a warrant or order will always be honored on demand, then its value will be equal to that of the goods to which it refers. If this certainty is not absolute, the value of the warrant will be correspondingly less.

If we suppose that a system of exchange might be developed even in a socialist society—not merely the exchange of labor certificates but, say, the exchange of consumption goods between individuals—then we may conceive of a place for the function of money even within the framework of such a society. This money would not be so frequently and variously employed as in an economic order based on private ownership of the means of production, but its use would be governed by the same fundamental principles.

These considerations dictate the attitude toward money that must be assumed by any attempt to construct an imaginary social order, if self-contradiction is to be avoided. So long as such a scheme completely excludes the free exchange of goods and services, then it follows logically that it has no need for money; but so far as any sort of exchange at all is allowed, it seems that indirect exchange achieved by means of a common medium of exchange must be permitted also.

Superficial critics of the capitalistic economic system are in the habit of directing their attacks principally against money. They are willing to permit the continuance of private ownership of the means of production and consequently, given the present stage of division of labor, of free exchange of goods also; and yet they want this exchange to be achieved without any medium, or at least without a common medium, or money. They obviously regard the use of money as harmful and hope to overcome all social evils by eliminating it. Their doctrine is derived from notions that have always been extraordinarily popular in lay circles during periods in which the use of money has been increasing.

All the processes of our economic life appear in a monetary guise; and those who do not see beneath the surface of things are only aware of monetary phenomena and remain unconscious of deeper relationships. Money is regarded as the cause of theft and murder, of deception and betrayal. Money is blamed when the prostitute sells her body and when the bribed judge perverts the law. It is money against which the moralist declaims when he wishes to oppose excessive materialism. Significantly enough avarice is called the love of money; and all evil is attributed to it.1

The confused and vague nature of such notions as these is obvious. It is not so clear whether it is thought that a return to direct exchange by itself will be able to overcome all the disadvantages of the use of money, or whether it is thought that other reforms will be necessary as well. The world makers and world improvers responsible for these notions feel no obligation to follow up their ideas inexorably to their final consequences. They prefer to call a halt at the point where the difficulties of the problem are just beginning. And this, incidentally, accounts for the longevity of their doctrines; so long as they remain nebulous, they offer nothing for criticism to seize upon.

Even less worthy of serious attention are those schemes of social reform which, while not condemning the use of money in general, object to the use of gold and silver In fact, such hostility to the precious metals has something very childish in it. When Thomas More, for example, endows the criminals in his utopia with golden chains and the ordinary citizens with gold and silver chamber pots,2  it is in something of the spirit that leads primitive mankind to wreak vengeance on lifeless images and symbols.

It is hardly worthwhile to devote even a moment to such fantastic suggestions, which have never been taken seriously. All the criticism of them that was necessary has been completed long ago.3  But one point, which usually escapes notice, must be emphasized.

Among the many confused enemies of money there is one group that fights with other theoretical weapons than those used by its usual associates. These enemies of money take their arguments from the prevailing theory of banking and propose to cure all human ills by means of an “elastic credit system, automatically adapted to the need for currency.” It will surprise no one acquainted with the unsatisfactory state of banking theory to find that scientific criticism has not dealt with such proposals as it should have done, and that it has in fact been incapable of doing so. The rejection of schemes such as Ernest Solvay’s “social comptabilism”4  is to be attributed solely to the practical man’s timidity and not to any strict proof of the weaknesses of the schemes, which has indeed not been forthcoming. All the banking theorists whose views are derived from the system of Tooke and Fullarton (and this includes nearly all present-day writers) are helpless with regard to Solvay’s theory and others of the same kind. They would like to condemn them, since their own feelings as well as the trustworthy judgments of practical men warn them against the airy speculations of reformers of this type; but they have no arguments against a system which, in the last analysis, involves nothing but the consistent application of their own theories.

The third part of this book is devoted exclusively to problems of the banking system. There the theory of the elasticity of credit is subjected to a detailed investigation, the results of which perhaps render any further discussion of this kind of doctrine unnecessary.

• 1On the history of such ideas, see Hildebrand, Die Nationalökonomie der Gegenwart und Zunkunft (Frankfurt, 1848), pp. 118 ff.; Roscher, System der Volkswirtschaft, ed. Pöhlmann, 24th ed. (Stuttgart, 1906), vol. 1, pp. 345 f.; Marx, Das Kapital, 7th ed. (Hamburg, 1914), vol. 1, pp. 95 f. n.
• 2More, Utopia.
• 3See Marx, Zur Kritik der politischen Ökonomie, ed. Kautsky (Stuttgart, 1897), pp. 70 if.; Knies, Geld und Kredit, 2d ed. (Berlin, 1885), vol. 1, pp. 239 ff.; Aucuy, Les systèmes socialistes d’Éxchange (Paris, 1908), pp. 114 ff.
• 4See the three memoranda published in 1889 in Brussels by Solvay under the title La monnaie et le Compte, and also his Gesellschaftlicher Comptabilismus (Brussels, 1897). Solvay’s theories also contain various other fundamental errors.