The central element in the economic problem of money is the objective exchange value of money, popularly called its purchasing power. This is the necessary starting point of all discussion; for it is only in connection with its objective exchange value that those peculiar properties of money that have differentiated it from commodities are conspicuous.

This must not be understood to imply that subjective value is of less importance in the theory of money than elsewhere. The subjective estimates of individuals are the basis of the economic valuation of money just as of that of other goods. And these subjective estimates are ultimately derived, in the case of money as in the case of other economic goods, from the significance attaching to a good or complex of goods as the recognized necessary condition for the existence of a utility, given certain ultimate aims on the part of some individual.1  Nevertheless, while the utility of other goods depends on certain external facts (the objective use-value of the commodity) and certain internal facts (the hierarchy of human needs), that is, on conditions that do not belong to the category of the economic at all but are partly of a technological and partly of a psychological nature, the subjective value of money is conditioned by its objective exchange value, that is, by a characteristic that falls within the scope of economics.

In the case of money, subjective use-value and subjective exchange value coincide.2  Both are derived from objective exchange value, for money has no utility other than that arising from the possibility of obtaining other economic goods in exchange for it. It is impossible to conceive of any function of money, qua money, that can be separated from the fact of its objective exchange value. As far as the use-value of a commodity is concerned, it is immaterial whether the commodity also has exchange value or not; but for money to have use-value, the existence of exchange value is essential.

This peculiarity of the value of money can also be expressed by saying that, as far as the individual is concerned, money has no use-value at all, but only subjective exchange value. This, for example, is the practice of Rau3  and Böhm-Bawerk.4  Whether the one or the other phraseology is employed, scientific investigation of the characteristic will lead to the same conclusions. There is no reason to enter upon a discussion of this point, especially since the distinction between value in use and value in exchange no longer holds the important place in the theory of value that it used to have.5  All that we are concerned with is to show that the task of economics in dealing with the value of money is a bigger one than its task in dealing with the value of commodities. When explaining the value of commodities, the economist can and must be content to take subjective use-value for granted and leave investigation of its origins to the psychologist; but the real problem of the value of money only begins where it leaves off in the case of commodity values, viz., at the point of tracing the objective determinants of its subjective value, for there is no subjective value of money without objective exchange value. It is not the task of the economist, but of the natural scientist, to explain why corn is useful to man and valued by him; but it is the task of the economist alone to explain the utility of money. Consideration of the subjective value of money without discussion of its objective exchange value is impossible. In contrast to commodities, money would never be used unless it had an objective exchange value or purchasing power. The subjective value of money always depends on the subjective value of the other economic goods that can be obtained in exchange for it. Its subjective value is in fact a derived concept. If we wish to estimate the significance that a given sum of money has, in view of the known dependence upon it of a certain satisfaction, we can do this only on the assumption that the money possesses a given objective exchange value. ”The exchange value of money is the anticipated use-value of the things that can be obtained with it.”6  Whenever money is valued by anybody it is because he supposes it to have a certain purchasing power.

It might possibly be objected that the mere possession by money of an undefined amount of objective exchange value is not alone sufficient to guarantee the possibility of using it as a medium of exchange; that it is also necessary that this purchasing power should be present in a certain degree, neither too great nor too small, but such that the proportion between the value of the units of money and that of the units of commodity is a convenient one for carrying through the ordinary exchange transactions of daily life; that even if it were true that half of the money in a country could perform the same service as the whole stock if the value of the monetary unit were doubled, yet it is doubtful if a similar proposition could be asserted of the case in which its value was increased a millionfold, or diminished to one-millionth, in inverse correspondence with changes in the quantity of it, since such a currency would hardly be capable of fulfilling the functions of a common medium of exchange so well as the currencies in actual use; that we should try to imagine a commodity money of which a whole ton, or one of which only a thousandth of a milligram was equivalent to a dollar, and think of the inconveniences, the insuperable obstacles in fact, which the employment of such a medium would inevitably place in the way of commerce.

However true this may be, the question of the actual dimensions of the exchange ratio between money and commodities and of the size of the monetary unit is not an economic problem. It is a question that belongs to discussion of the technical conditions that make any particular good suitable for use as money. The relative scarcity of the precious metals, great enough to give them a high objective exchange value but not so great as that of the precious stones or radium and therefore not great enough to make their exchange value too high, must indeed be reckoned, along with such of their other characteristics as their practically unlimited divisibility, their malleability, and their powers of resistance to destructive external influences, as among the factors that were once decisive in causing them to be recognized as the most marketable goods and consequently to be employed as money. But nowadays, as monetary systems have developed, the particular level of value of the precious metals no longer has any important bearing on their use as money. The modern organization of the clearing system and the institution of fiduciary media have made commerce independent of the volume and weight of the monetary material.

• 1See Böhm-Bawerk, Kapital und Kapitalzins, pp. 211 ff.
• 2See Walsh, The Fundamental Problem in Monetary Science (New York, 1903), p. 11; and in like manner, Spiethoff, “Die Quantitätstheorie insbesondere in ihrer Verwertbarkeit als Haussetheorie,” Festgaben für Adolf Wagner (Leipzig, 1905), p. 256.
• 3See Rau, Grundsätze der Volkswirtschaftslehre, 6th ed. (Leipzig, 1855), p. 80.
• 4See Böhm-Bawerk, op. cit., Part II, p. 275. And similarly in Wieser, Der natürliche Wert, p. 45; “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132: 507.
• 5See Böhm-Bawerk, op. cit., Part II, pp. 273 ff.; Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie (Leipzig, 1908), p. 108.
• 6Wieser, Der natürliche Wert, p. 46.

It follows from what has been said that there can be no discussion of the problem of the value of money without consideration of its objective exchange value. Under modern conditions, objective exchange value, which Wieser also calls Verkehrswert (or value in business transactions), is the most important kind of value, because it governs the social and not merely the individual aspect of economic life. Except in its explanation of the fundamentals of value theory, economics deals almost exclusively with objective exchange value.7  And while this is true to some extent of all goods, including those which are useful apart from any exchange value which they possess, it is still truer of money.

“The objective exchange value of goods is their objective significance in exchange, or, in other words, their capacity in given circumstances to procure a specific quantity of other goods as an equivalent in exchange.”8  It should be observed that even objective exchange value is not really a property of the goods themselves, bestowed on them by nature, for in the last resort it also is derived from the human process of valuing individual goods. But the exchange ratios that are established between different goods in commercial transactions, and are determined by the collective influence of the subjective valuations of all the persons doing business in the market, present themselves to separate individuals, who usually have an infinitesimal influence on the determination of the ratios, as accomplished facts, which in most cases have to be accepted unconditionally. It has thus been easy for false abstraction from this state of affairs to give rise to the opinion that each good comes to the market endowed with a definite quantity of value independent of the valuations of individuals.9  From this point of view, goods are not exchanged for one another, by human beings; they simply exchange.

Objective exchange value, as it appears in the subjective theory of value, has nothing except its name in common with the old idea developed by the Classical School of a value in exchange inherent in things themselves. In the value theory of Smith and Ricardo, and in that of their successors, value in exchange plays the leading part. These theories attempt to explain all the phenomena of value by starting from value in exchange, which they interpret as labor value or cost-of-production value. For modern value theory their terminology can claim only a historical importance, and a confusion of the two concepts of exchange value need no longer be feared. This removes the objections that have recently been made to the continued use of the expression “objective exchange value.”10

If the objective exchange value of a good is its power to command a certain quantity of other goods in exchange, its price is this actual quantity of other goods. It follows that the concepts of price and objective exchange value are by no means identical. “But it is, nevertheless, true that both obey the same laws. For when the law of price declares that a good actually commands a particular price, and explains why it does so, it of course implies that the good is able to command this price, and explains why it is able to do so. The law of price comprehends the law of exchange value.”11

By “the objective exchange value of money” we are accordingly to understand the possibility of obtaining a certain quantity of other economic goods in exchange for a given quantity of money; and by “the price of money” this actual quantity of other goods. It is possible to express the exchange value of a unit of money in units of any other commodity and speak of the commodity price of money; but in actual life this phraseology and the concept it expresses are unknown. For nowadays money is the sole indicator of prices.

• 7Ibid., p. 52.
• 8Böhm-Bawerk, op cit., Part II, pp. 214 f.
• 9See Helfferich, Das Geld, 6th ed. (Leipzig, 1923), pp. 301 f.
• 10Thus Schumpeter, op. cit., p. 109.
• 11See Böhm-Bawerk, op. cit., Part II, p. 217.

The theory of money must take account of the fundamental difference between the principles which govern the value of money and those which govern the value of commodities. In the theory of the value of commodities it is not necessary at first to pay any attention to objective exchange value. In this theory, all phenomena of value and price determination can be explained with subjective use-value as the starting point. It is otherwise in the theory of the value of money; for since money, in contrast to other goods, can fulfill its economic function only if it possesses objective exchange value, an investigation into its subjective value demands an investigation first into this objective exchange value. In other words, the theory of the value of money leads us back through subjective exchange value to objective exchange value.

Under the present economic system, which is founded on the division of labor and the free exchange of products, producers as a rule do not work directly on their own behalf but with a view to supplying the market. Consequently their economic calculations are determined not by the subjective use-values of their products, but by their subjective exchange values. Valuations which ignore the subjective exchange value, and consequently the objective exchange value, of a product and take account only of its subjective use-value, are nowadays most exceptional. They are on the whole limited to those cases in which the object has a sentimental value. But if we disregard those things to which certain individuals attach a symbolical significance because they remind them of experiences or persons that they wish to remember, while in the eyes of others for which they have not this personal interest the things possess a very much lower value or even no value at all, it cannot be denied that human valuations of goods are based upon their exchange value. It is not use-value, but exchange value, that appears to govern the modern economic order. Nevertheless, if we trace to its deepest springs, first the subjective and then the objective exchange value of commodities, we find that in the last resort it is still the subjective use-value of things that determines the esteem in which they are held. For, quite apart from the fact that the commodities acquired in exchange for the products are always valued according to their subjective use-value, the only valuations that are of final importance in the determination of prices and objective exchange value are those based on the subjective use-value that the products have for those persons who are the last to acquire them through the channels of commerce and who acquire them for their own consumption.

The case of money is different. Its objective exchange value cannot be referred back to any sort of use-value independent of the existence of this objective exchange value. In the origins of monetary systems, money is still a commodity which eventually ceases to circulate on reaching the hands of a final buyer or consumer.12  In the early stages of the history of money there were even monetary commodities whose natural qualities definitely precluded their employment as money for more than a short time. An ox or a sack of corn cannot remain in circulation for ever; it has sooner or later to be withdrawn for consumption if that part of its value which does not depend on its employment as money is not to be diminished by a deterioration of its substance. In a developed monetary system, on the other hand, we find commodity money, of which large quantifies remain constantly in circulation and are never consumed or used in industry; credit money, whose foundation, the claim to payment, is never made use of; and possibly even fiat money, which has no use at all except as money.

Many of the most eminent economists have taken it for granted that the value of money and of the material of which it is made depends solely on its industrial employment and that the purchasing power of our present-day metallic money, for instance, and consequently the possibility of its continued employment as money, would immediately disappear if the properties of the monetary material as a useful metal were done away with by some accident or other.13  Nowadays this opinion is no longer tenable, not merely because there is a whole series of phenomena which it leaves unaccounted for, but chiefly because it is in any case opposed to the fundamental laws of the theory of economic value. To assert that the value of money is based on the nonmonetary employment of its material is to eliminate the real problem altogether.14  Not only have we to explain the possibility of fiat money, the material of which has a far lower value without the official stamp than with it; we must also answer the question, whether the possibility of a monetary employment of the commodity money material affects its utility and consequently its value, and if so to what extent. The same problem arises in the case of credit money.

Part of the stock of gold at the command of mankind is used for monetary purposes, part for industrial. A change from one kind of use to the other is always possible. Ingots pass from the vaults of the banks to the workshops of the goldsmiths and gilders, who also directly withdraw current coins from circulation and melt them down. On the other hand, things made of gold, even with a high value as works of art, find their way to the mint when unfavorable market conditions render a sale at anything higher than the bullion price impossible. One and the same piece of metal can even fulfill both purposes simultaneously, as will be seen if we think of ornaments that are used as money or of a coin that is worn by its owner as jewelry until he parts with it again.15

Investigations into the foundations of the value of money must eliminate those determinants that arise from the properties of the monetary material as a commodity, since these present no peculiarity that could distinguish the value of money from that of other commodities. The value of commodity money is of importance for monetary theory only insofar as it depends on the peculiar economic position of the money, on its function as a common medium of exchange. Changes in the value of the monetary material that arise from its characteristics as a commodity are consequently to be considered only so far as they seem likely to make it more or less suitable for performing the function of money. Apart from this, monetary theory must take the value of the monetary material that arises from its industrial usefulness as given.

The material of which commodity money is made must have the same value whether it is used as money or otherwise. Whether a change in the value of gold originates in its employment as money or in its employment as a commodity, in either case the value of the whole stock changes uniformly.16

It is otherwise with credit money and fiat money. With these, the substance that bears the impression is essentially insignificant in the determination of the value of the money. In some circumstances it may have a relatively high exchange value comprising a considerable fraction of the total exchange value of the individual coin or note. But this value, which is not based on the monetary properties of the coin or note, only becomes of practical importance at the moment when the value based on the monetary property vanishes, that is, at the moment when the individuals participating in commerce cease to use the coin or note in question as a common medium of exchange. When this is not the case, the coins or notes bearing the monetary impression must have a higher exchange value than other pieces of the same material so long as these are not marked out by any special characteristics.

Again, in the case of credit money the claims used as money have similarly a different exchange value from other claims of the same kind that are not used as money. The hundred-gulden notes which circulated as money in Austria-Hungary before the reform of the currency had a higher exchange value than, say, a government security with a nominal value of a hundred gulden, notwithstanding the fact that the latter bore interest and the former did not.

Until gold was used as money it was valued merely on account of the possibility of using it for ornamental purposes. If it had never been used as money, or if it had ceased to be so used, its present-day value would be determined solely by the extent to which it was known to be useful in industry. But additional opportunities of using it provided an addition to the original reasons for esteeming it; gold began to be valued partly because it could be used as a common medium of exchange. It is not surprising that its value consequently rose, or that at least a decrease in its value which possibly would have occurred for other reasons was counterbalanced. Nowadays the value of gold, our principal modern monetary material, is based on both possibilities of employment, on that for monetary purposes and on that for industrial purposes.17

It is impossible to say how far the present value of money depends on its monetary employment and how far on its industrial employment. When the institution of money was first established, the industrial basis of the value of the precious metals may have preponderated; but with progress in the monetary organization of economic life the monetary employment has become more and more important. It is certain that nowadays the value of gold is largely supported by its monetary employment, and that its demonetization would affect its price in an overwhelming fashion.18  The sharp decline in the price of silver since 1873 is recognized as largely due to the demonetization of this metal in most countries. And when, between 1914 and 1918, many countries replaced gold by banknotes and Treasury notes so that gold flowed to those countries that had remained on a gold standard, the value of gold fell very considerably.

The value of the materials that are used for the manufacture of fat money and credit money is also influenced by their use as money as well as by all their other uses. The production of token coins is nowadays one of the most important uses of silver, for example. Again, when the minting of coins from nickel was begun over fifty years ago, the price of nickel rose so sharply that the director of the English mint stated in 1873 that if minting from nickel were continued the cost of the metal alone would exceed the face value of the coins.19  If we prefer to regard this sort of use as industrial and not monetary, however, it is because token coins are not money but money substitutes, and consequently the peculiar interactions between changes in the value of money and changes in the value of the monetary material are absent in these cases.

The task of the theory of the value of money is to expound the laws which regulate the determination of the objective exchange value of money. It is not its business to concern itself with the determination of the value of the material from which commodity money is made so far as this value does not depend on the monetary, but on the other, employment of this material. Neither is it its task to concern itself with the determination of the value of those materials that are used for making the concrete embodiments of fiat money. It discusses the objective exchange value of money only insofar as this depends on its monetary function.

The other forms of value present no special problems for the theory of the value of money. There is nothing to be said about the subjective value of money that differs in any way from what economics teaches of the subjective value of other economic goods. And all that it is important to know about the objective use-value of money may be summed up in the one statement—it depends on the objective exchange value of money.

• 12See Wieser, “Der Geldwert und seine geschichtlichen Veränderungen,” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung 13 (1904): 45.
• 13Thus even as late as Menger, Grundsätze der Volkswirtschaftslehre (Vienna, 1871), p. 259 n; and also Knies, Geld und Kredit (Berlin, 1885), vol. 1, p. 323.
• 14See Simmel, Philosophie des Geldes, 2d ed. (Leipzig, 1907), p. 130.
• 15But, as a general rule, objects of art, jewelry and other things made of precious metal should not be regarded as constituting part of the stock of metal which performs the function of commodity money. They are goods of the first order, in relation to which the bullion or coined metal must be regarded as goods of superior orders.
• 16See Wieser, “Der Geldwert und seine geschichtlichen Veränderungen,” p. 46.
• 17More than two hundred years ago, John Law, far ahead of his time and with an insight amounting to genius, had seized upon this truth: “Il est raisonnable de penser que l’argent s’échangeait sur le pied de ce qu’il était évalué pour les usages, comme métal, et q’on le donnait comme monnaie dans les échanges à raison de sa valeur. Le nouvel usage de la monnaie, auquel l’argent fut appliqué, dut ajouter à sa valeur, parce que, comme monnaie, obviait aux désavantages et aux inconvénients de l’échange; et conséquemment les demandes d’argent venant à s’augmenter, il reçut une valeur additionnelle, égale à l’accroissement de la demande occasionnée par son usage comme monnaie. Et cette valeur additionnelle n’est pas plus imaginaire que la valeur que l’argent avait dans les échanges comme métal, parce que telle ou telle valeur dérivait de son application à tels ou tels usages, et quelle était plus grande ou moindre, suivant les demandes d’argent comme métal, en proportion de sa quantité. Le valeur additionnelle que l’argent reçut de son usage comme monnaie provient de ses qualités, qui le rendaient propre a cet usage; et cette valeur fut en raison de la demande additionnelle occasionnée par son usage comme monnaie. Si l’une et l’autre de ces valeurs sont imaginaires, alors toutes les valeurs le sont; car aucune chose n’a de valeur que par l’usage auquel on l’applique, et à raison des demandes qu’on en fait, proportionellement à sa quantité” (Considerations sur le numéraire et le commerce, ed. Daire, Économistes financiers du XVIIIe siécle, 2nd. ed. [Paris, 1851]), pp. 447 f. See further Walras, Théorie de la monnaie (Lausanne, 1886), p. 40; Knies, op. cit., vol. 1, p. 324. Objective theories of value are unable to comprehend this fundamental principle of the theory of the value of money. This is best shown by the lack of comprehension with which Marx confronts the arguments of Law cited above (see Marx, Das Kapital, 7th ed. (Hamburg, 1914) vol. 1, p. 56, n. 46; trans. E. and C. Paul into English).
• 18See Heyn, Irrtümer auf dem Gebiete des Geldwesens (Berlin, 1900), p. 3; Simmel, op. cit., pp. 116 ff.
• 19Jevons, Money and the Mechanism of Exchange, 13th ed. (London, 1902), pp. 49 f.

Let us at first ignore the possibility of various kinds of money being employed side by side, and assume that in a given district one kind of money serves exclusively as the common medium of exchange. The problem of the reciprocal exchange ratios of different kinds of money will then form the subject matter of the next chapter In this chapter, however, let us imagine an isolated geographical area of any size whose inhabitants engage in mutual trade and use a single good as common medium of exchange. It makes no immediate difference whether we think of this region as composed of several states, or as part of one large state, or as a particular individual state. It will not be necessary until a later stage in our argument to mention certain incidental modifications of the general formula which result from differences in the legal concepts of money in different states.

It has already been mentioned that two economic goods, which are of similar constitution in all other respects, are not to be regarded as members of the same species if they are not both ready for consumption at the same place. For many purposes it seems more convenient to regard them as goods of different species related to one another as goods of higher and lower orders.1  Only in the case of money is it permissible in certain circumstances to ignore the factor of position in space. For the utility of money, in contrast to that of other economic goods, is to a certain extent free from the limitations of geographical distance. Checks and clearing systems, and similar institutions, have a tendency to make the use of money more or less independent of the difficulties and costs of transport. They have had the effect of permitting gold stored in the cellars of the Bank of England, for instance, to be used as a common medium of exchange anywhere in the world. We can easily imagine a monetary organization which, by the exclusive use of notes or clearinghouse methods, allows all transfers to be made with the instrumentality of sums of money that never change their position in space. If we assume, further, that the costs associated with every transaction are not influenced by the distance between the two parties to the contract and between each of them and the place where the money is (it is well known that this condition is already realized in some cases; for example, in the charges made for postal and money-order services), then there is sufficient justification for ignoring differences in the geographical situation of money. But a corresponding abstraction with regard to other economic goods would be inadmissible. No institution can make it possible for coffee in Brazil to be consumed in Europe. Before the consumption good “coffee in Europe” can be made out of the production good “coffee in Brazil,” this production good must first be combined with the complementary good “means of transport.”

If differences due to the geographical position of money are disregarded in this way, we get the following law for the exchange ratio between money and other economic goods: every economic good, that is ready for consumption (in the sense in which that phrase is usually understood in commerce and technology), has a subjective use-value qua consumption good at the place where it is and qua production good at those places to which it may be brought for consumption. These valuations originate independently of each other; but, for the determination of the exchange ratio between money and commodities, both are equally important. The money price of any commodity in any place, under the assumption of completely unrestricted exchange and disregarding the differences arising from the time taken in transit, must be the same as the price at any other place, augmented or diminished by the money cost of transport.

Now there is no further difficulty in including in this formula the cost of transport of money, or a further factor, on which the banker and exchange dealer lay great weight, namely, the costs arising from the recoinage which may be necessary. All these factors, which it is not necessary to enumerate in further detail, have a combined effect on the foreign exchange rate (cable rate, etc.) the resultant of which must be included in our calculation as a positive or negative quantity. To prevent any possible misunderstanding, it should once more be explicitly remarked that we are concerned here only with the rate of exchange between places in which the same kind of money is in use, although it is a matter of indifference whether the same coins are legal tender in both places. The essentially different problems of the rate of exchange between different kinds of money will not occupy us until the following chapter.

• 1See p. 81 f.

In contrast to the law of interlocal price relations that has just been explained is the popular belief in local variations in the purchasing power of money. The assertion is made again and again that the purchasing power of money may be different in different markets at the same time, and statistical data are continually being brought forward to support this assertion. Few economic opinions are so firmly rooted in the lay mind as this. Travelers are in the habit of bringing it home with them, usually as a piece of knowledge gained by personal observation. Few visitors to Austria from Germany at the beginning of the twentieth century had any doubts that the value of money was higher in Germany than in Austria. That the objective exchange value of gold, our commodity money κατ’ εξοχην (kat esechun), stood at different levels in different parts of the world, passed for established truth in even economic literature.2

We have seen where the fallacy lies in this, and may spare ourselves unnecessary repetition. It is the leaving out of account of the positional factor in the nature of economic goods, a relic of the crudely materialist conception of the economic problem, that is to blame for this confusion of ideas. All the alleged local differences in the purchasing power of money can easily be explained in this way. It is not permissible to deduce a difference in the purchasing power of money in Germany and in Russia from the fact that the price of wheat is different in these countries, for wheat in Russia and wheat in Germany represent two different species of goods. To what absurd conclusions should we not come if we regarded goods lying in bond in a customs or excise warehouse and goods of the same technological species on which the duty or tax had already been paid as belonging to the same species of goods in the economic sense? We should then apparently have to suppose that the purchasing power of money could vary from building to building or from district to district within a single town. Of course, if there are those who prefer to retain commercial terminology, and think it better to distinguish species of goods merely by their external characteristics, we cannot say that they shall not do this. To contend over terminological questions would be an idle enterprise. We are not concerned with words, but with facts. But if this form of expression, in our opinion the less appropriate, is employed, care must be taken in some way to make full allowance for distinctions based on differences in the places at which the commodities are situated ready for consumption. It is not sufficient merely to take account of costs of transport and of customs duties and indirect taxes. The effect of direct taxes, for example, the burden of which is to a large extent transferable also, must be included in the calculation.

It seems better to us to use the terminology suggested above, which stresses with greater clearness that the purchasing power of money shows a tendency to come to the same level throughout the world, and that the alleged differences in it are almost entirely explicable by differences in the quality of the commodities offered and demanded, so that there is only a small and almost negligible remainder left over, that is due to differences in the quality of the offered and demanded money.

The existence of the tendency itself is hardly questioned. But the force which it exerts, and hence its importance also, are estimated variously, and the old classical proposition, that money like every other commodity always seeks out the market in which it has the highest value, is said to be mistaken. Wieser has said in this connection that the monetary transactions involved in exchange are induced by the commodity transactions; that they constitute an auxiliary movement, which proceeds only so far as is necessary to permit the completion of the principal movement. But the international movement of commodities, Wieser declares, is even nowadays noticeably small in comparison with domestic trade. The transmitted national equilibrium of prices is broken through for relatively few commodities whose prices are world prices. Consequently, the transmitted value of money is still for the most part as significant as ever. It will not be otherwise until, in place of the national organization of production and labor which still prevails today, a complete world organization has been established; but it will be a long while before this happens. At present the chief factor of production, labor, is still subject to national limitations everywhere; a nation adopts foreign advances in technique and organization only to the degree permitted by its national characteristics, and, in general, does not very easily avail itself of opportunities of work abroad, whereas within the nation entrepreneurs and wage laborers move about to a considerable extent. Consequently, wages everywhere retain the national level at which they have been historically determined, and thus the most important element in costs remains nationally determined at this historical level; and the same is true of most other cost elements. On the whole, the transmitted value of money forms the basis of further social calculations of costs and values. Meanwhile, the international contacts are not yet strong enough to raise national methods of production on to a single world level and to efface the differences in the transmitted national exchange values of money.3

It is hardly possible to agree with these arguments, which smack a little too much of the cost-of-production theory of value and are certainly not to be reconciled with the principles of the subjective theory. Nobody would wish to dispute the fact that costs of production differ greatly from one another in different localities. But it must be denied that this exercises an influence on the price of commodities and on the purchasing power of money. The contrary follows too clearly from the principles of the theory of prices, and is too clearly demonstrated day by day in the market, to need any special proof in addition. The consumer who seeks the cheapest supply and the producer who seeks the most paying sale concur in the endeavor to liberate prices from the limitations of the local market. Intending buyers do not bother much about the national costs of production when those abroad are lower (And because this is so, the producer working with higher costs of production calls for protective duties.) That differences in the wages of labor in different countries are unable to influence the price levels of commodities is best shown by the circumstance that even the countries with high levels of wages are able to supply the markets of the countries with low levels of wages. Local differences in the prices of commodities whose natures are technologically identical are to be explained on the one hand by differences in the cost of preparing them for consumption (expenses of transport, cost of retailing, etc.) and on the other hand by the physical and legal obstacles that restrict the mobility of commodities and human beings.

• 2See Senior, Three Lectures on the Cost of Obtaining Money, pp. 1 ff.
• 3See Wieser, “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132: 531 f.

There is a certain connection between the assertion of local differences in the purchasing power of money and the widespread belief in local differences in the cost of living. It is supposed to be possible “to live” more cheaply in some places than in others. It might be supposed that both statements come to the same thing, and that it makes no difference whether we say that the Austrian crown was “worth” less in 1913 than the eighty-five pfennigs which corresponded to its gold value, or that “living” was dearer in Austria than in Germany. But this is not correct. The two propositions are by no means identical. The opinion that living is more expensive in one place than in another in no way implies the proposition that the purchasing power of money is different. Even with complete equality of the exchange ratio between money and other economic goods it may happen that an individual is involved in unequal costs in securing the same level of satisfaction in different places. This is especially likely to be the case when residence in a certain place awakens wants which the same individual would not have been conscious of elsewhere. Such wants may be social or physical in nature. Thus, the Englishman of the richer classes is able to live more cheaply on the Continent, because he is obliged to fulfill a series of social duties at home that do not exist for him abroad. Again, living in a large town is dearer than in the country if only because the immediate propinquity in town of so many possibilities of enjoyment stimulates desires and calls forth wants that are unknown to the provincial. Those who often visit theaters, concerts, art exhibitions, and similar places of entertainment, naturally spend more money than those who live in otherwise similar circumstances, but have to go without these pleasures. The same is true of the physical wants of human beings. In tropical areas, Europeans have to take a series of precautions for the protection of health which would be unnecessary in the temperate zones. All those wants whose origin is dependent on local circumstances demand for their satisfaction a certain stock of goods which would otherwise be used for the satisfaction of other wants, and consequently they diminish the degree of satisfaction that a given stock of goods can afford.

Hence, the statement that the cost of living is different in different localities only means that the same individual cannot secure the same degree of satisfaction from the same stock of goods in different places. We have just given one reason for this phenomenon. But, besides this, the belief in local differences in the cost of living is also supported by reference to local differences in the purchasing power of money. It would be possible to prove the incorrectness of this view. It is no more appropriate to speak of a difference between the purchasing power of money in Germany and in Austria than it would be justifiable to conclude from differences between the prices charged by hotels on the peaks and in the valleys of the Alps that the objective exchange value of money is different in the two situations and to formulate some such proposition as that the purchasing power of money varies inversely with the height above sea level. The purchasing power of money is the same everywhere; only the commodities offered are not the same. They differ in a quality that is economically significant—the position in space of the place at which they are ready for consumption.

But although the exchange ratios between money and economic goods of completely similar constitution in all parts of a unitary market area in which the same sort of money is employed are at any time equal to one another, and all apparent exceptions can be traced back to differences in the spatial quality of the commodities, it is nevertheless true that price differentials evoked by the difference in position (and hence in economic quality) of the commodities may under certain circumstances constitute a subjective justification of the assertion that there are differences in the cost of living. He who voluntarily visits Karlsbad on account of his health would be wrong in deducing from the higher price of houses and food there that it is impossible to get as much enjoyment from a given sum of money in Karlsbad as elsewhere and that consequently living is dearer there. This conclusion does not allow for the difference in quality of the commodities whose prices are being compared. It is just because of this difference in quality, just because it has a certain value for him, that the visitor comes to Karlsbad. If he has to pay more in Karlsbad for the same quantity of satisfactions, this is due to the fact that in paying for them he is also paying the price of being able to enjoy them in the immediate neighborhood of the medicinal springs. The case is different for the businessman and laborer and official who are merely tied to Karlsbad by their occupations. The propinquity of the waters has no significance for the satisfaction of their wants, and so their having to pay extra on account of it for every good and service that they buy will, since they obtain no additional satisfaction from it, appear to them as a reduction of the possibilities of the enjoyment that they might otherwise have. If they compare their standard of living with that which they could achieve with the same expenditure in a neighboring town, they will arrive at the conclusion that living is really dearer at the spa than elsewhere. They will then only transfer their activity to the dearer spa if they believe that they will be able to secure there a sufficiently higher money income to enable them to achieve the same standard of living as elsewhere. But in comparing the standards of satisfaction attainable they will leave out of account the advantage of being able to satisfy their wants in the spa itself because this circumstance has no value in their eyes. Every kind of wage will therefore, under the assumption of complete mobility, be higher in the spa than in other, cheaper, places. This is generally known as far as it applies to contract wages; but it is also true of official salaries. The government pays a special bonus to those of its employees who have to take up their duties in “dear” places, in order to put them on a level with those functionaries who are able to live in cheaper places. The laborers too have to be compensated by higher wages for the higher cost of living.

This also is the clue to the meaning of the sentence, “Living is dearer in Austria than in Germany,” a sentence which has a certain meaning even though there is no difference between the purchasing power of money in the two countries. The differences in prices in the two areas do not refer to commodities of the same nature; what are supposed to be identical commodities really differ in an essential point; they are available for consumption in different places. Physical causes on the one hand, social causes on the other, give to this distinction a decisive importance in the determination of prices. He who values the opportunity of working in Austria as an Austrian among Austrians, who has been brought up to work and earn money in Austria, and cannot get a living anywhere else on account of language difficulties, national customs, economic conditions, and the like, would nevertheless be wrong in concluding from a comparison of domestic and foreign commodity prices that living was dearer at home. He must not forget that part of every price he pays is for the privilege of being able to satisfy his wants in Austria. An independent rentier with a free choice of domicile is in a position to decide whether he prefers a life of apparently limited satisfactions in his native country among his own kindred to one of apparently more abundant satisfaction among strangers in a foreign land. But most people are spared the trouble of such a choice; for most, staying at home is a matter of necessity, emigration an impossibility.

To recapitulate: the exchange ratio subsisting between commodities and money is everywhere the same. But men and their wants are not everywhere the same, and neither are commodities. Only if these distinctions are ignored is it possible to speak of local differences in the purchasing power of money or to say that living is dearer in one place than in another.

The existence of an exchange ratio between two sorts of money is dependent upon both being used side by side, at the same time, by the same economic agents, as common media of exchange. We could perhaps conceive of two economic areas, not connected in any other way, being linked together only by the fact that each exchanged the commodity it used for money against that used for money by the other, in order then to use the acquired monetary commodity otherwise than as money. But this would not be a case of an exchange ratio between different kinds of money simply arising from their monetary employment. If we wish successfully to conduct our investigation as an investigation into the theory of money, then even in the present chapter we must disregard the nonmonetary uses of the material of which commodity money is made; or, at least, take account of them only where this is necessary for the complete clarification of all the processes connected with our problem. Now the assertion that, apart from the effects of the industrial use of the monetary material, an exchange ratio can be established between two sorts of money only when both are used as money simultaneously and side by side, is not the usual view. That is to say, prevailing opinion distinguishes two cases: that in which two or more domestic kinds of money exist side by side in the parallel standard, and that in which the money in exclusive use at home is of a kind different from the money used abroad. Both cases are dealt with separately, although there is no theoretical difference between them as far as the determination of the exchange ratio between the two sorts of money is concerned.

If a gold-standard country and a silver-standard country have business relations with each other and constitute a unitary market for certain economic goods, then it is obviously incorrect to say that the common medium of exchange consists of gold only for the inhabitants of the gold-standard country, and of silver only for those of the silver-standard country. On the contrary, from the economic point of view both metals must be regarded as money for each area. Until 1873, gold was just as much a medium of exchange for the German buyer of English commodities as silver was for the English buyer of German commodities. The German farmer who wished to exchange corn for English steel goods could not do so without the instrumentality of both gold and silver. Exceptional cases might arise, where a German sold in England for gold and bought again with gold, or where an Englishman sold in Germany for silver and bought with silver; but this merely demonstrates more clearly still the monetary characteristic of both metals for the inhabitants of both areas. Whether the case is one of an exchange through the instrumentality of money used once or used more than once, the only important point is that the existence of international trade relations results in the consequence that the money of each of the single areas concerned is money also for all the other areas.

It is true that there are important differences between that money which plays the chief part in domestic trade, is the instrument of most exchanges, predominates in the dealings between consumers and sellers of consumption goods, and in loan transactions, and is recognized by the law as legal tender, and that money which is employed in relatively few transactions, is hardly ever used by consumers in their purchases, does not function as an instrument of loan operations, and is not legal tender. In popular opinion, the former money only is domestic money, the latter foreign money. Although we cannot accept this if we do not want to close the way to an understanding of the problem that occupies us, we must nevertheless emphasize that it has great significance in other connections. We shall have to come back to it in the chapter which deals with the social effects of fluctuations in the objective exchange value of money.

For the exchange ratio between two or more kinds of money, whether they are employed side by side in the same country (the parallel standard) or constitute what is popularly called foreign money and domestic money, it is the exchange ratio between individual economic goods and the individual kinds of money that is decisive. The different kinds of money are exchanged in a ratio corresponding to the exchange ratios existing between each of them and the other economic goods. If 1 kg. of gold is exchanged for m kg. of a particular sort of commodity, and 1 kg. of silver for m/15 1/2 kg. of the same sort of commodity, then the exchange ratio between gold and silver will be established at 15 1/2. If some disturbance tends to alter this ratio between the two sorts of money, which we shall call the static or natural ratio, then automatic forces will be set in motion that will tend to reestablish it.1

Let us consider the case of two countries each of which carries on its domestic trade with the aid of one sort of money only, which is different from that used in the other country. If the inhabitants of two areas with different currencies who have previously exchanged their commodities directly without the intervention of money begin to make use of money in the transaction of their business, they will base the exchange ratio between the two kinds of money on the exchange ratio between each kind of money and the commodities. Let us assume that a gold-standard country and a silver-standard country had exchanged cloth directly for wheat on such terms that one meter of cloth was given for one bushel of wheat. Let the price of cloth in the country of its origin be one gram of gold per meter; that of wheat, 15 grams of silver per bushel. If international trade is now put on a monetary basis, then the price of gold in terms of silver must be established at 15. If it were established higher, say at 16, then indirect exchange through the instrumentality of money would be disadvantageous from the point of view of the owners of the wheat as compared with direct exchange; in indirect exchange for a bushel of wheat they would obtain only fifteen-sixteenths of a meter of cloth as against a whole meter in direct exchange. The same disadvantage would arise for the owners of the cloth if the price of gold was established at anything lower, say at 14 grams of silver. This, of course, does not imply that the exchange ratios between the different kinds of money have actually developed in this manner. It is to be understood as a logical, not a historical, explanation. Of the two precious metals gold and silver it must especially be remarked that their reciprocal exchange ratios have slowly developed with the development of their monetary position.

If no other relations than those of barter exist between the inhabitants of two areas, then balances in favor of one party or the other cannot arise. The objective exchange values of the quantities of commodities and services surrendered by each of the contracting parties must be equal, whether present goods or future goods are involved. Each constitutes the price of the other. This fact is not altered in any way if the exchange no longer proceeds directly but indirectly through the intermediaryship of one or more common media of exchange. The surplus of the balance of payments that is not settled by the consignment of goods and services but by the transmission of money was long regarded merely as a consequence of the state of international trade. It is one of the great achievements of Classical political economy to have exposed the fundamental error involved in this view. It demonstrated that international movements of money are not consequences of the state of trade; that they constitute not the effect, but the cause, of a favorable or unfavorable trade balance. The precious metals are distributed among individuals and hence among nations according to the extent and intensity of their demands for money. No individual and no nation need fear at any time to have less money than it needs. Government measures designed to regulate the international government of money in order to ensure that the community shall have the amount it needs, are just as unnecessary and inappropriate as, say intervention to ensure a sufficiency or corn or iron or the like. This argument dealt the Mercantilist theory its death blow.2

Nevertheless statesmen are still greatly exercised by the problem of the international distribution of money. For hundreds of years, the Midas theory, systematized by Mercantilism, has been the rule followed by governments in taking measures of commercial policy. In spite of Hume, Smith, and Ricardo, it still dominates men’s minds more than would be expected. Phoenixlike, it rises again and again from its own ashes. And indeed it would hardly be possible to overcome it with objective argument; for it numbers its disciples among that great host of the half-educated who are proof against any argument, however simple, if it threatens to rob them of longcherished illusions that have become too dear to part with. It is only regrettable that these lay opinions not only predominate in discussions of economic policy on the part of legislators, the press—even the technical journals—and businessmen, but still occupy much space even in scientific literature. The blame for this must again be laid to the account of obscure notions concerning the nature of fiduciary media and their significance as regards the determination of prices. The reasons which, first in England and then in all other countries, were urged in favor of the limitation of the fiduciary note issue have never been understood by modern writers, who know them only at secondhand or thirdhand. That they in general plead for their retention, or only demand such modifications as leave the principle untouched, merely expresses their reluctance to replace an institution which on the whole has indubitably justified itself by a system whose effects they, to whom the phenomena of the market constitute an insoluble riddle, are naturally least of all able to foresee. When these writers seek for a motive in present-day banking policy, they can find none but that characterized by the slogan, “Protection of the national stock of the precious metals.” We can pass the more lightly over these views in the present place since we shall have further opportunity in part three to discuss the true meaning of the bank laws that limit the note issue.

Money does not flow to the place where the rate of interest is highest; neither is it true that it is the richest nations that attract money to themselves. The proposition is as true of money as of every other economic good, that its distribution among individual economic agents depends on its marginal utility. Let us first completely abstract from all geographical and political concepts, such as country and state, and imagine a state of affairs in which money and commodities are completely mobile within a unitary market area. Let us further assume that all payments, other than those cancelled out by offsetting or mutual balancing of claims, are made by transferring money, and not by the cession of fiduciary media; that is to say, that uncovered notes and deposits are unknown. This supposition, again, is similar to that of the “purely metallic currency” of the English Currency School, although with the help of our precise concept of fiduciary media we are able to avoid the obscurities and shortcomings of their point of view. In a state of affairs corresponding to these suppositions of ours, all economic goods, including of course money, tend to be distributed in such a way that a position of equilibrium between individuals is reached, when no further act of exchange that any individual could undertake would bring him any gain, any increase of subjective value. In such a position of equilibrium, the total stock of money, just like the total stocks of commodities, is distributed among individuals according to the intensity with which they are able to express their demand for it in the market. Every displacement of the forces affecting the exchange ratio between money and other economic goods brings about a corresponding change in this distribution, until a new position of equilibrium is reached. This is true of individuals, but it is also true of all the individuals in a given area taken together. For the goods possessed and the goods demanded by a nation are only the sums of the goods possessed and the goods demanded by all the economic agents, private as well as public, which make up the nation, among which the state as such admittedly occupies an important position, but a very far from dominant one.

Trade balances are not causes but merely concomitants of movements of money. For if we look beneath the veil with which the forms of monetary transactions conceal the nature of exchanges of goods, then it is clear that, even in international trade, commodities are exchanged for commodities, through the instrumentality of money. Just as the single individual does, so also all the individuals in an economic community taken together, wish in the last analysis to acquire not money, but other economic goods. If the state of the balance of payments is such that movements of money would have to occur from one country to the other, independently of any altered estimation of money on the part of their respective inhabitants, then operations are induced which reestablish equilibrium. Those persons who receive more money than they need will hasten to spend the surplus again as soon as possible, whether they buy production goods or consumption goods. On the other hand, those persons whose stock of money falls below the amount they need will be obliged to increase their stock of money, either by restricting their purchases or by disposing of commodities in their possession. The price variations, in the markets of the countries in question, that occur for these reasons, give rise to transactions which must always reestablish the equilibrium of the balance of payments. A credit or debit balance of payments that is not dependent upon an alteration in the conditions of demand for money can only be transient.3

Thus international movements of money, so far as they are not of a transient nature and consequently soon rendered ineffective by movements in the contrary direction, are always called forth by variations in the demand for money. Now it follows from this that a country in which fiduciary media are not employed is never in danger of losing its stock of money to other countries. Shortage of money and superabundance of money can no more be a permanent experience for a nation than for an individual. Ultimately they are spread out uniformly among all economic agents using the same economic good as common medium of exchange, and naturally their effects on the objective exchange value of money which bring about the adjustment between the stock of money and the demand for it are finally uniform for all economic agents. Measures of economic policy which aim at increasing the quantity of money circulating in a country could be successful so far as the money circulates in other countries also, only if they brought about a displacement in relative demands for money. Nothing is fundamentally altered in all this by the employment of fiduciary media. So far as there remains a demand for money in the narrower sense despite the use of fiduciary media, it will express itself in the same way.

There are many gaps in the Classical doctrine of international trade. It was built up at a time when international exchange relations were largely limited to dealings in present goods. No wonder, then, that its chief reference was to such goods or that it left out of account the possibility of an international exchange of services, and of present goods for future goods. It remained for a later generation to undertake the expansion and correction here necessary, a task that was all the easier since all that was wanted was a consistent expansion of the same doctrine to cover these phenomena as well. The classical doctrine had further restricted itself to that part of the problem presented by international metallic money. The treatment with which credit money had to be content was not satisfactory, and this shortcoming has not been entirely remedied yet. The problem has been regarded too much from the point of view of the technique of the monetary system and too little from that of the theory of exchange of goods. If the latter point of view had been adopted, it would have been impossible to avoid commencing the investigation with the proposition that the balance of trade between two areas with different currencies must always be in equilibrium, without the emergence of a balance needing to be corrected by the transport of money.4  If we take a gold-standard and a silver-standard country as an example, then there still remains the possibility that the money of the one country will be put to a nonmonetary use in the other. Such a possibility must naturally be ruled out of account. The relations between two countries with fiat money would be the best example to take; if we merely make our example more general by supposing that metallic money may be in use, then only the monetary use of the metallic money must be considered. It is then immediately clear that goods and services can only be paid for with other goods and services; that in the last analysis there can be no question of payment in money.

• 1The theory put forward above, which comes from Ricardo, is advocated with particular forcefulness nowadays by Cassel, who uses the name purchasing-power parity for the static exchange ratio. See Cassel, Money and Foreign Exchange After 1914 (London, 1922), p. 181 f.
• 2See Senior, Three Lectures on the Transmission of the Precious Metals from Country to Country and the Mercantile Theory of Wealth (London, 1828), pp. 5 ff.
• 3See Ricardo, “Principles of Political Economy and Taxation,” in Works, ed. McCulloch, 2d ed. (London, 1852), pp. 213 ff.; Hertzka, Das Wesen des Geldes (Leipzig, 1887), pp. 42 ff.; Kinley, Money (New York, 1909), pp. 78 ff.; Wieser, “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132: 530 ff.
• 4Transitory displacements are possible, if foreign money is acquired in the speculative anticipation of its appreciating.

The problem of measuring the objective exchange value of money and its variations has attracted much more attention than its significance warrants. If all the columns of figures and tables and curves that have been prepared in this connection could perform what has been promised of them, then we should certainly have to agree that the tremendous expenditure of labor upon their construction would not have been in vain. In fact, nothing less has been hoped from them than the solution of the difficult questions connected with the problem of the objective exchange value of money. But it is very well known, and has been almost ever since the methods were discovered, that such aids cannot avail here.

The fact that, in spite of all this, the improvement of methods of calculating index numbers is still worked at most zealously, and that they have even been able to achieve a certain popularity that is otherwise denied to economic investigation, may well appear puzzling. It becomes explicable if we take into account certain peculiarities of the human mind. Like the king in Rückert’s Weisheit des Brahmanen, the layman always tends to seek for formulae that sum up the results of scientific investigation in a few words. But the briefest and most pregnant expression for such summaries is in figures. Simple numerical statement is sought for even where the nature of the case excludes it. The most important results of research in the social sciences leave the multitude apathetic, but any set of figures awakens its interest. Its history becomes a series of dates, its economics a collection of statistical data. No other objection is more often brought against economics by laymen than that there are no economic laws; and if an attempt is made to meet this objection, then almost invariably the request is made that an example of such a law should be named and expounded—as if fragments of systems, whose study demands years of thought on the part of the expert, could be made intelligible to the novice in a few minutes. Only by letting fall morsels of statistics is it possible for the economic theorist to maintain his prestige in the face of questions of this sort.

Great names in the history of economics are associated with various systems of index numbers. Indeed, it was but natural that the best brains should have been the most attracted by this extraordinarily difficult problem. But in vain. Closer investigation shows us how little the inventors of the various index-number methods themselves thought of their attempts, how justly, as a rule, they were able to estimate their importance. He who cares to go to the trouble of demonstrating the uselessness of index numbers for monetary theory and the concrete tasks of monetary policy will be able to select a good proportion of his weapons from the writings of the very men who invented them.

The objective exchange value of the monetary unit can be expressed in units of any individual commodity. Just as we are in the habit of speaking of a money price of the other exchangeable goods, so we may conversely speak of the commodity price of money, and have then so many expressions for the objective exchange value of money as there are commercial commodities that are exchanged for money. But these expressions tell us little; they leave unanswered the questions that we want to solve. There are two parts to the problem of measuring the objective exchange value of money. First we have to obtain numerical demonstration of the fact of variations in the objective exchange value of money; then the question must be decided whether it is possible to make a quantitative examination of the causes of particular price movements, with special reference to the question whether it would be possible to produce evidence of such variations in the purchasing power of money as lie on the monetary side of the ratio1

So far as the first-named problem is concerned, it is self-evident that its solution must assume the existence of a good, or complex of goods, of unchanging objective exchange value. The fact that such goods are inconceivable needs no further elucidation. For a good of this sort could exist only if all the exchange ratios between all goods were entirely free from variations. With the continually varying foundations on which the exchange ratios of the market ultimately rest, this presumption can never be true of a social order based upon the free exchange of goods.2

To measure is to determine the ratio of one quantity to another which is invariable or assumed to be invariable. Invariability in respect of the property to be measured, or at least the legitimacy of assuming such invariability, is a sine qua non of all measurement. Only when this assumption is admissible is it possible to determine the variations that are to be measured. Then, if the ratio between the measure and the object to be measured alter, this can only be referred to causes directly affecting the latter. Thus the problems of measuring the two kinds of variation in the objective exchange value of money go together. If the one is proved to be soluble, then so also is the other; and proof of the insolubility of the one is also proof of the insolubility of the other.

• 1[Following Menger, we should call the first of these two problems the problem of the measurability of the äussere objective exchange value of money, the second that of the measurability of its innere objective exchange value. See also p. 146 n. H.E.B.]
• 2See Menger, Grundsätze der Volkswirtschaftslehre, 2d ed. (Vienna, 1923), pp. 298 ff.

Nearly all the attempts that have hitherto been made to solve the problem of measuring the objective exchange value of money have started from the idea that if the price movements of a large number of commodities were combined by a particular method of calculation, the effects of those determinants of the price movements which lie on the side of the commodities would largely cancel one another out, and consequently, that such calculations would make it possible to discover the direction and extent of the effects of those determinants of price movements that lie on the monetary side. This assumption would prove correct, and the inquiries instituted with its help could led to the desired results, if the exchange ratios between the other economic goods were constant among themselves. Since this assumption does not hold good, refuge must be taken in all sorts of artificial hypotheses in order to obtain at least some sort of an idea of the significance of the results gained. But to do this is to abandon the safe ground of statistics and enter into a territory in which, in the absence of any reliable guidance (such as could be provided only by a complete understanding of all the laws governing the value of money), we must necessarily go astray. So long as the determinants of the objective exchange value of money are not satisfactorily elucidated in some other way, the sole possible reliable guide through the tangle of statistical material is lacking. But even if investigation into the determinants of prices and their fluctuations, and the separation Of these determinants into single factors, could be achieved with complete precision, statistical investigation of prices would still be thrown on its own resources at the very point where it most needs support. That is to say, in monetary theory, as in every other branch of economic investigation, it will never be possible to determine the quantitative importance of the separate factors. Examination of the influence exerted by the separate determinants of prices will never reach the stage of being able to undertake numerical imputation among the different factors. All determinants of prices have their effect only through the medium of the subjective estimates of individuals; and the extent to which any given factor influences these subjective estimates can never be predicted. Consequently, the evaluation of the results of statistical investigations into prices, even if they could be supported by established theoretical conclusions, would still remain largely dependent on the rough estimates of the investigator, a circumstance that is apt to reduce their value considerably. Under certain conditions, index numbers may do very useful service as an aid to investigation into the history and statistics of prices; for the extension of the theory of the nature and value of money they are unfortunately not very important.

Very recently Wieser has made a new suggestion which constitutes an improvement of the budgetary method of calculating index numbers, notably employed by Falkner.3  This is based on the view that when nominal wages change but continue to represent the same real wages, then the value of money has changed, because it expresses the same real quantity of value differently from before, or because the ratio of the monetary unit to the unit of real value has changed. On the other hand, the value of money is regarded as unchanged when nominal wages go up or down, but real wages move exactly parallel with them. If the contrast between money income and real income is substituted for that between nominal and real wages and the whole sum of the individuals in the community substituted for the single individual, then it is said to follow that such variations of the total money income as are accompanied by corresponding variations of the total real income do not indicate variations in the value of money at all, even if at the same time the prices of goods have changed in accordance with the altered conditions of supply. Only when the same real income is expressed by a different money income has the specific value of money changed. Thus to measure the value of money, a number of typical kinds of income should be chosen and the real expenditure corresponding to each determined, that is, the quantity of each kind of thing on which the incomes are spent. The money expenditure corresponding to this real expenditure is also to be shown, all for a particular base year; and then for each year the sums of money are to be evaluated in which the same quantities of real value were represented, given the prices ruling at the time. The result, it is claimed, would be the possibility of working out an average which would give for the whole country the monetary expression, as determined year by year in the market, of the real income taken as base. Thus it would be discovered whether a constant real value had a constant, a higher, or a lower, money expression year by year, and so a measure would be obtained of variations in the value of money.4

The technical difficulties in the way of employing this method, which is the most nearly perfect and the most deeply thought out of all methods of calculating index numbers, are apparently insurmountable. But even if it were possible to master them, this method could never fulfill the purpose that it is intended to serve. It could attain its end only under the same supposition that would justify all other methods; namely, the supposition that the exchange ratios between the individual economic goods excluding money are constant, and that only the exchange ratio between money and each of the other economic goods is liable to fluctuation. This would naturally involve an inertia of all social institutions, of population, of the distribution of wealth and income, and of the subjective valuations of individuals. Where everything is in a state of flux the supposition breaks down completely.

It was impossible for this to escape Wieser, who insists on allowance for the fact that the types of income and the classes into which the community is divided gradually alter, and that in the course of time certain kinds of consumption are discontinued and new kinds begun. For short periods, Wieser is of the opinion that this involves no particular difficulty; that it would be easy to retain the comparability of the totals by eliminating expenditures that did not enter into both sets of budgets. For long periods, he recommends Marshall’s chain method of always including a sufficient number of transitional types and restricting comparisons to any given type and that immediately preceding or following it. This hardly does away with the difficulty. The farther we went back in history, the more we should have to eliminate; ultimately it seems that only those portions of real income would remain that serve to satisfy the most fundamental needs of existence. Even within this limited scope, comparisons would be impossible, as, say, between the clothing of the twentieth century and that of the tenth century. It is still less possible to trace back historically the typical incomes, which would necessarily involve consideration of the existing division of society into classes. The progress of social differentiation constantly increases the number of types of income. And this is by no means simply due to the splitting up of single types; the process is much more complicated. Members of one group break off and intermingle with other groups or portions of other groups in a most complicated manner. With what type of income of the past can we compare that, say, of the modern factory worker?

But even if we were to ignore all these considerations, other difficulties would arise. It is quite possible, even most probable, that subjective valuations of equal portions of real income have altered in the course of time. Changes in ways of living, in tastes, in opinions concerning the objective use value of individual economic goods, evoke quite extraordinarily large fluctuations here, even in short periods. If we do not take account of this in estimating the variations of the money value of these portions of income, then new sources of error arise that may fundamentally affect our results. On the other hand, there is no basis at all for taking account of them.

All index-number systems, so far as they are intended to have a greater significance for monetary theory than that of mere playing with figures, are based upon the idea of measuring the utility of a certain quantity of money.5  The object is to determine whether a gram of gold is more or less useful today than it was at a certain time in the past. As far as objective use value is concerned, such an investigation may perhaps yield results. We may assume the fiction, if we like, that, say, a loaf of bread is always of the same utility in the objective sense, always comprises the same food value. It is not necessary for us to enter at all into the question of whether this is permissible or not. For certainly this is not the purpose of index numbers; their purpose is the determination of the subjective significance of the quantity of money in question. For this, recourse must be had to the quite nebulous and illegitimate fiction of an eternal human with invariable valuations. In Wieser’s typical incomes that have to be traced back through the centuries may be seen an attempt to refine this fiction and to free it from its limitations. But even this attempt cannot make the impossible possible, and was necessarily bound to fail. It represents the most perfect conceivable development of the index-number system, and the fact that this also leads to no practical result condemns the whole business. Of course, this could not escape Wieser. If he neglected to lay particular stress upon it, this is probably due solely to the circumstance that his concern was not so much to indicate a way of solving this insoluble problem, as to extract from a usual method all that could be got from it.

• 3On Falkner’s method, see Laughlin, The Principles of Money (London, 1903), pp. 213—21; Kinley, Money (New York, 1909), pp. 253 ff.
• 4See Wieser, “Uber die Messung der Veränderungen des Geldwerts,” Schriften des Vereins für Sozialpolitik 132 (Leipzig, 1910): 544 ff. Joseph Lowe seems to have made a similar proposal as early as 1822; on this, see Walsh, The Measurement of General Exchange Value (New York, 1901), p. 84.
• 5See Weiss, Die moderne Tendenz in der Lehre vom Geldwert, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 19, p. 546.

The inadmissibility of the methods proposed for measuring variations in the value of money does not obtrude itself too much if we only want to use them for solving practical problems of economic policy. Even if index numbers cannot fulfill the demands that theory has to make, they can still, in spite of their fundamental shortcomings and the inexactness of the methods by which they are actually determined, perform useful workaday services for the politician.

If we have no other aim in view than the comparison of points of time that lie close to one another, then the errors that are involved in every method of calculating numbers may be so far ignored as to allow us to draw certain rough conclusions from them. Thus, for example, it becomes possible to a certain extent to span the temporal gap that lies, in a period of variation in the value of money, between movements of stock exchange rates and movements of the purchasing power that is expressed in the prices of commodities.6

In the same way we can follow statistically the progress of variations in purchasing power from month to month. The practical utility of all these calculations for certain purposes is beyond doubt; they have proved their worth in quite recent events. But we should beware of demanding more from them than they are able to perform.

• 6See also pp. 213 ff. below.

Variations in the objective exchange value of money evoke displacements in the distribution of income and property, on the one hand because individuals are apt to overlook the variability of the value of money, and on the other hand because variations in the value of money do not affect all economic goods and services uniformly and simultaneously.

For hundreds, even thousands, of years, people completely failed to see that variations in the objective exchange value of money could be induced by monetary factors. They tried to explain all variations of prices exclusively from the commodity side. It was Bodin’s great achievement to make the first attack upon this assumption, which then quickly disappeared from scientific literature. It long continued to dominate lay opinion, but nowadays it appears to be badly shaken even here. Nevertheless, when individuals are exchanging present goods against future goods they do not take account in their valuations of variations in the objective exchange value of money. Lenders and borrowers are not in the habit of allowing for possible future fluctuations in the objective exchange value of money.

Transactions in which present goods are exchanged for future goods also occur when a future obligation has to be fulfilled, not in money, but in other goods. Still more frequent are transactions in which the contracts do not have to be fulfilled by either party until a later point of time. All such transactions involve a risk, and this fact is well known to all contractors. When anybody buys (or sells) corn, cotton, or sugar futures, or when anybody enters into a long-term contract for the supply of coal, iron, or timber, he is well aware of the risks that are involved in the transaction. He will carefully weigh the chances of future variations in prices, and often take steps, by means of insurance or hedging transactions such as the technique of the modern exchange has developed, to reduce the aleatory factor in his dealings.

In making long-term contracts involving money, the contracting parties are generally unconscious that they are taking part in a speculative transaction. Individuals are guided in their dealings by the belief that money is stable in value, that its objective exchange value is not liable to fluctuations, at least so far as its monetary determinants are concerned. This is shown most clearly in the attitude assumed by legal systems with regard to the problem of the objective exchange value of money.

In law, the objective exchange value of money is stable. It is sometimes asserted that legal systems adopt the fiction of the stability of the exchange value of money; but this is not true. In setting up a fiction, the law requires us to take an actual situation and imagine it to be different from what it really is, either by thinking of nonexistent elements as added to it or by thinking of existing elements as removed from it, so as to permit the application of legal maxims which refer only to the situation as thus transformed. Its purpose in doing this is to make it possible to decide cases according to analogy when a direct ruling does not apply. The whole nature of legal fictions is determined by this purpose, and they are sustained only so far as it requires. The legislator and the judge always remain aware that the fictitious situation does not correspond to reality. So it is also with the so-called dogmatic fiction that is employed in jurisprudence to permit legal facts to be systematically classified and related to each other. Here again, the situation is thought of as existing, but it is not assumed to exist.1

The attitude of the law to money is quite a different matter. The jurist is totally unacquainted with the problem of the value of money; he knows nothing of fluctuations in its exchange value. The naive popular belief in the stability of the value of money has been admitted, with all its obscurity, into the law, and no great historical cause of large and sudden variations in the value of money has ever provided a motive for critical examination of the legal attitude toward the subject. The system of civil law had already been completed when Bodin set the example of attempting to trace back variations in the purchasing power of money to causes exerting their influence from the monetary side. In this matter, the discoveries of more modern economists have left no trace on the law. For the law, the invariability of the value of money is not a fiction, but a fact.

All the same, the law does devote its attention to certain incidental questions of the value of money. It deals thoroughly with the question of how existing legal obligations and indebtednesses should be reckoned as affected by a transition from one currency to another. In earlier times, jurisprudence devoted the same attention to the royal debasement of the coinage as it was later to devote to the problems raised by the changing policies of states in choosing first between credit money and metallic money and then between gold and silver. Nevertheless, the treatment that these questions have received at the hands of the jurists has not resulted in recognition of the fact that the value of money is subject to continual fluctuation. In fact, the nature of the problem, and the way in which it was dealt with, made this impossible from the very beginning. It was treated, not as a question of the attitude of the law toward variations in the value of money, but as a question of the power of the prince or state arbitrarily to modify existing obligations and thus to destroy existing rights. At one time, this gave rise to the question whether the legal validity of the money was determined by the stamp of the ruler of the country or by the metal content of the coin; later, to the question whether the command of the law or the free usage of business was to settle if the money was legal tender or not. The answer of public opinion, grounded on the principles of private property and the protection of acquired rights, ran the same in both cases: “Prout quidque contractum est, ita et solvi debet; ut cum re contraximus, re solvi debet, veluti cum mutuum dedimus, ut retro pecuniae tantundem solvi debeat.”2  The proviso in this connection, that nothing was to be regarded as money except what passed for such at the time when the transaction was entered into and that the debt must be repaid not merely in the metal but in the currency that was specified in the contract, followed from the popular view, regarded as the only correct one by all classes of the community but especially by the tradesmen, that what was essential about a coin was its metallic content, and that the stamp had no other significance than as an authoritative certificate of weight and fineness. It occurred to nobody to treat coins in business transactions any differently from other pieces of metal of the same weight and fineness. In fact, it is now removed beyond doubt that the standard was a metallic one.

The view that in the fulfillment of obligations contracted in terms of money the metallic content alone of the money was to be taken into account prevailed against the nominalistic doctrine expounded by the minting authorities. It is manifested in the legal measures taken for stabilizing the metal content of the coinage, and since the end of the seventeenth century when currencies developed into systematic monetary standards it has provided the criterion for determining the ratio between different coins of the same metal (when current simultaneously or successively), and for the attempts, admittedly unsuccessful, to combine the two precious metals in a uniform monetary system.

Even the coming of credit money, and the problems that it raised, could not direct the attention of jurisprudence to the question of the value of money. A system of paper money was thought of as according with the spirit of the law only if the paper money remained constantly equivalent to the metallic money to which it was originally equivalent and which it had replaced or if the metal content or metal value of the claims remained decisive in contracts of indebtedness. But the fact that the exchange value of even metallic money is liable to variation has continued to escape explicit legal recognition and public opinion, at least as far as gold is concerned (and no other metal need nowadays be taken into consideration); there is not a single legal maxim that takes account of it, although it has been well known to economists for more than three centuries.

In its naive belief in the stability of the value of money the law is in complete harmony with public opinion. When any sort of difference arises between law and opinion, a reaction must necessarily follow; a movement sets in against that part of the law that is felt to be unjust. Such conflicts always tend to end in a victory of opinion over the law; ultimately the views of the ruling class become embodied in the law. The fact that it is nowhere possible to discover a trace of opposition to the attitude of the law on this question of the value of money shows clearly that its provisions relating to this matter cannot possibly be opposed to general opinion. That is to say, not only the law but public opinion also has never been troubled with the slightest doubt whatever concerning the stability of the value of money; in fact, so free has it been from doubts on this score that for an extremely long period money was regarded as the measure of value. And so when anybody enters into a credit transaction that s to be fulfilled in money it never occurs to him to take account of future fluctuations in the purchasing power of money.

Every variation in the exchange ratio between money and other economic goods shifts the position initially assumed by the parties to credit transactions in terms of money. An increase in the purchasing power of money is disadvantageous to the debtor and advantageous to the creditor; a decrease in its purchasing power has the contrary significance. If the parties to the contract took account of expected variations in the value of money when they exchanged present goods against future goods, these consequences would not occur. (But it is true that neither the extent nor the direction of these variations can be foreseen.)

The variability of the purchasing power of money is only taken into account when attention is drawn to the problem by the co-existence of two or more sorts of money whose exchange ratio is liable to big fluctuations. It is generally known that possible future variations in foreign-exchange rates are fully allowed for in the terms of credit transactions of all kinds. The part played by considerations of this sort, both in trade within countries where more than one sort of money is in use and in trade between countries with different currencies, is well known. But the allowance for the variability of the value of money in such cases is made in a fashion that is still not incompatible with the supposition that the value of money is stable. The fluctuations in value of one kind of money are measured by the equivalent of one of its units in terms of units of another kind of money, but the value of this other kind of money is for its part assumed to be stable. The fluctuations of the currency whose stability is in question are measured in terms of gold; but the fact that gold currencies are also liable to fluctuation is not taken into account. In their dealings individuals allow for the variability of the objective exchange value of money, so far as they are conscious of it; but they are conscious of it only with regard to certain kinds of money, not with regard to all. Gold, the principal common medium of exchange nowadays, is thought of as stable in value.3

So far as variations in the objective exchange value of money are foreseen, they influence the terms of credit transactions. If a future fall in the purchasing power of the monetary unit has to be reckoned with, lenders must be prepared for the fact that the sum of money which a debtor repays at the conclusion of the transaction will have a smaller purchasing power than the sum originally lent. Lenders, in fact, would do better not to lend at all, but to buy other goods with their money. The contrary is true for debtors. If they buy commodities with the money they have borrowed and sell them again after a time, they will retain a surplus over and above the sum that they have to pay back. The credit transaction results in a gain for them. Consequently it is not difficult to understand that, so long as continued depreciation is to be reckoned with, those who lend money demand higher rates of interest and those who borrow money are willing to pay the higher rates. If, on the other hand, it is expected that the value of money will increase, then the rate of interest will be lower than it would otherwise have been.4

Thus if the direction and extent of variations in the exchange value of money could be foreseen, they would not be able to affect the relations between debtor and creditor; the coming alterations in purchasing power could be sufficiently allowed for in the original terms of the credit transaction.5  But since this assumption, even so far as fluctuations in credit money or fiat money relatively to gold money are concerned, never holds good except in a most imperfect manner, the allowance made in debt contracts for future variations in the value of money is necessarily inadequate; while even nowadays, after the big and rapid fluctuations in the value of gold that have occurred since the outbreak of the world war, the great majority of those concerned in economic life (one might, in fact, say all of them, apart from the few who are acquainted with theoretical economics) are completely ignorant of the fact that the value of gold is variable. The value of gold currencies is still regarded as stable.

Those economists who have recognized that the value of even the best money is variable have recommended that in settling the terms of credit transactions, that is to say, the terms on which present goods are exchanged for future goods, the medium of exchange should not be one good alone, as is usual nowadays, but a “bundle” of goods; it is possible in theory if not in practice to include all economic goods in such a “bundle”. If this proposal were adopted, money would still be used as a medium for the exchange of present goods; but in credit transactions the outstanding obligation would be discharged, not by payment of the nominal sum of money specified in the contract, but by payment of a sum of money with the purchasing power that the original sum had at the time when the contract was made. Thus, if the objective exchange value of money rises during the period of the contract, a correspondingly smaller sum of money will be payable; if it falls, a correspondingly larger sum.

The arguments devoted above to the problem of measuring variations in the value of money show the fundamental inadequacy of these recommendations. If the prices of the various economic goods are given equal weight in the determination of the parity coefficients without consideration of their relative quantities, then the evils for which a remedy is sought may merely be aggravated. If variations in the prices of such commodities as wheat, rye, cotton, coal, and iron are given the same significance as variations in the prices of such commodities as pepper, opium, diamonds, or nickel, then the establishment of the tabular standard would have the effect of making the content of long-term contracts even more uncertain than at present. If what is called a weighted average is used, in which individual commodities have an effect proportioned to their significance,6  then the same consequences will still follow as soon as the conditions of production and consumption alter. For the subjective values attached by human beings to different economic goods are just as liable to constant fluctuation as are the conditions of production; but it is impossible to take account of this fact in determining the parity coefficients, because these must be invariable in order to permit connection with the past.

It is probable that the immediate associations of any mention nowadays of the effects of variations in the value of money on existing debt relations will be in terms of the results of the monstrous experiments in inflation that have characterized the recent history of Europe. In all countries, during the latter part of this period, the jurists have thoroughly discussed the question of whether it would have been possible or even whether it was still possible, by means of the existing law, or by creating new laws, to offset the injury done to creditors. In these discussions it was usually overlooked that the variations in the content of debt contracts that were consequent upon the depreciation of money were due to the attitude toward the problem taken by the law itself. It is not as if the legal system were being invoked to remedy an inconvenience for which it was not responsible. It was just its own attitude that was felt to be an inconvenience—the circumstance that the government had brought about depreciation. For the legal maxim by which an inconvertible banknote is legal tender equally with the gold money that was in circulation before the outbreak of the war, with which it has nothing in common but the name mark, is a part of the whole system of legal rules which allow the state to exploit its power to create new money as a source of income. It can no more be dissociated from this system than can the laws canceling the obligation of the banks to convert their notes and obliging them to make loans to the government by the issue of new notes.

When jurists and businessmen assert that the depredation of money has a very great influence on all kinds of debt relations, that it makes all kinds of business more difficult, or even impossible, that it invariably leads to consequences that nobody desires and that everybody feels to be unjust, we naturally agree with them. In a social order that is entirely founded on the use of money and in which all accounting is done in terms of money, the destruction of the monetary system means nothing less than the destruction of the basis of all exchange. Nevertheless, this evil cannot be counteracted by ad hoc laws designed to remove the burden of the depreciation from single persons, or groups of persons, or classes of the community, and consequently to impose it all the more heavily on others. If we do not desire the pernicious consequences of depreciation, then we must make up our minds to oppose the inflationary policy by which the depreciation is created.

It has been proposed that monetary liabilities should be settled in terms of gold and not according to their nominal amount. If this proposal were adopted, for each mark that had been borrowed that sum would have to be repaid that could at the time of repayment buy the same weight of gold as one mark could at the time when the debt contract was entered into.7  The fact that such proposals are now put forward and meet with approval shows that etatism has already lost its hold on the monetary system and that inflationary policies are inevitably approaching their end.8  Even only a few years ago, such a proposal would either have been ridiculed or else branded as high treason. (It is, by the way, characteristic that the first step toward enforcing the idea that the legal tender of paper money should be restricted to its market value was taken without exception in directions that were favorable to the national exchequer.)

To do away with the consequences of unlimited inflationary policy one thing only is necessary—the renunciation of all inflationary measures. The problem which the proponents of the tabular standard seek to solve by means of a “commodity currency” supplementing the metallic currency, and which Irving Fisher seeks to solve by his proposals for stabilizing the purchasing power of money, is a different one—that of dealing with variations in the value of gold.

• 1See Dernburg, Pandekten, 6th ed. (Berlin, 1900), vol. 1, p. 84. On the fact that one of the chief characteristics of a fiction is the explicit consciousness of its fictitiousness, see also Vaihinger, Die Philosophie des Als ob, 6th ed. (Leipzig, 1920), p. 173; English trans., The Philosophy of “As If” (London: Kegan Paul, 1924).
• 2L. 80, Dig. de solutionibus et liberationibus 46, 3. Pomponius libro quarto ad Quintum Mucium. See further Seidler, “Die Schwankungen des Geldwertes und die juristische Lehre von dem Inhalt der Geldschulden,” Jahrbücher für Nationalökonomie und Statistik (1894), 3d series, vol. 7, pp. 685 ff.; Endemann, Studien in der romanische-kanonistischen Wirtschafts-und Rechtslehre bis gegen Ende des 17 Jahrhunderts (Berlin, 1874), vol. 2, p. 173.
• 3In a review of the first edition (Die Neue Zeit, 30th year, vol. 2, p. 1024-1027), Hilferding criticized the above arguments as “merely funny.” Perhaps it is demanding too much to expect this detached sense of humor to be shared by those classes of the German nation who have suffered in consequence of the depreciation of the mark. Yet only a year or two ago even these do not appear to have understood the problem any better. Fisher (Hearings Before the Committee on Banking and Currency of the House of Representatives, 67th Cong., 4th sess., on H.R. 1788 [Washington, D.C., 1923], pp. 5 ff., 25 ff.) gives typical illustrations. It was certainly an evil fate for Germany that its monetary and economic policy in recent years should have been in the hands of men like Hilferding and Havenstein, who were not qualified even for dealing with the depreciation of the mark in relation to gold.
• 4See Knies, Geld und Kredit, (Berlin, 1876), vol. 2, Part I, pp. 105 ff.; Fisher, The Rate of Interest (New York, 1907), pp. 77 ff., 257 ff., 327 ff., 356 ff.
• 5See Clark, Essentials of Economic Theory (New York, 1907), pp. 541 ff.
• 6See Walsh, The Measurement of General Exchange Value (New York, 1901), pp. 80 ff.; Zizek, Die statistischen Mittelwerte (Leipzig, 1908), pp. 183 ff.
• 7See Mügel, Geldentwertung und Gesetzgebung (Berlin, 1923), p. 24.
• 8[It should be remembered that all this was written in 1924. H.E.B.]

The naive conception of money as stable in value or as a measure of value is also responsible for economic calculation being carried out in terms of money.

Even in other respects, accountancy is not perfect. The precision of its statements is only illusory. The valuations of goods and rights with which it deals are always based on estimates depending on more or less uncertain and unknown factors. So far as this uncertainty arises from the commodity side of the valuations, commercial practice, sanctioned by the law, attempts to get over the difficulty by the exercise of the greatest possible caution. With this purpose it demands conservative estimates of assets and liberal estimates of liabilities, so that the merchant may be preserved from self-deceit about the success of his enterprises and his creditors protected.

But there are also shortcomings in accountancy that are due to the uncertainty in its valuations that results from the liability to variation of the value of money itself. Of this, the merchant, the accountant, and the commercial court are alike unsuspicious. They hold money to be a measure of price and value, and they reckon as freely in monetary units as in units of length, area, capacity, and weight. And if an economist happens to draw their attention to the dubious nature of this procedure, they do not even understand the point of his remarks.9

This disregard of variations in the value of money in economic calculation falsities accounts of profit and loss. If the value of money falls, ordinary bookkeeping, which does not take account of monetary depreciation, shows apparent profits, because it balances against the sums of money received for sales a cost of production calculated in money of a higher value, and because it writes off from book values originally estimated in money of a higher value items of money of a smaller value. What is thus improperly regarded as profit, instead of as part of capital, is consumed by the entrepreneur or passed on either to the consumer in the form of price reductions that would not otherwise have been made or to the laborer in the form of higher wages, and the government proceeds to tax it as income or profits. In any case, consumption of capital results from the fact that monetary depreciation falsities capital accounting. Under certain conditions the consequent destruction of capital and increase of consumption may be partly counteracted by the fact that the depreciation also gives rise to genuine profits, those of debtors, for example, which are not consumed but put into reserves. But this can never more than partly balance the destruction of capital induced by the depreciation.10

The consumers of the commodities that are sold too cheaply as a result of the false reckoning induced by the depreciation need not be inhabitants of the territory in which the depreciating money is used as the national currency. The price reductions brought about by currency depreciation encourage export to countries the value of whose money is either not falling at all or at least falling less rapidly. The entrepreneur who is reckoning in terms of a currency with a stable value is unable to compete with the entrepreneur who is prepared to make a quasi-gift of part of his capital to his customers. In 1920 and 1921, Dutch traders who had sold commodities to Austria could buy them back again after a while much more cheaply than they had originally sold them, because the Austrian traders completely failed to see that they were selling them for less than they had cost.

So long as the true state of the case is not recognized, it is customary to rejoice in a naive Mercantilistic fashion over the increase of exports and to see in the depreciation of money a welcome “export premium.” But once it is discovered that the source whence this premium flows is the capital of the community, then the “selling off” procedure is usually regarded less favorably. Again, in importing countries the public attitude wavers between indignation against “dumping” and satisfaction with the favorable conditions of purchase.

Where the currency depreciation is a result of government inflation carried out by the issue of notes, it is possible to avert its disastrous effect on economic calculation by conducting all bookkeeping in a stable money instead. But so far as the depreciation is a depreciation of gold, the world money, there is no such easy way out.11

• 9At Vienna in March 1892 at the sessions of the Currency Inquiry Commission, which was appointed in preparation for the regulation of the Austrian currency, Carl Menger remarked: “I should like to add that not only legislators, but all of us in our everyday life, are in the habit of disregarding the fluctuations in the purchasing power of money. Even such distinguished bankers as yourselves, gentlemen, draw up your balance sheet at the end of the year without inquiring whether by any chance the sum of money representing the share capital has gained or lost in purchasing power.” These remarks of Menger’s were not understood by the director of the Bodenkreditanstalt, Theodor von Taussig, the most outstanding of all Austrian bankers. He replied: “A balance sheet is a balancing of the property or assets of a company or individual against its liabilities, both expressed in terms of the accepted measure of value or monetary standard, that is, for Austria in gulden. Now I cannot see how, when we are thus expressing property and indebtedness in terms of the standard (which we have assumed to be homogeneous), we are to take account of variations in the standard of measurement instead of taking account of variations in the object to be measured, as is customary.” Taussig completely failed to see that the point at issue concerned the estimation of the value of goods and the amount of depreciation to be written off, and not the balancing of monetary claims and monetary obligations, or that a profit and loss account, if it is not to be hopelessly inexact, must take account of variations in the value of money. Menger had no occasion to raise this point in his reply, since he was rather concerned to show that his remarks were not to be interpreted, as Taussig was inclined to interpret them, as an accusation of dishonest practice on the part of the bank directors. Menger added: “What I said was merely that all of us, not only the directors of the banks (I said even such men as are at the head of the banks), make the mistake of not taking account in everyday life of changes in the value of money” (Stenographische Protokolle über die vom 8. bis 17. März 1892 abgehaltenen Sitzungen der nach Wien einberufenen Währungs-Enquete- Kommission [Vienna, 2892], pp. 221, 257, 270).
• 10See my book, Nation, Staat und Wirtschaft (Vienna, 1919), pp. 129 ff. A whole series of writings dealing with these questions has since appeared in Germany and Austria.
• 11Cf. further pp. 401 ff. below.

If we disregard the exchange of present goods for future goods, and restrict our considerations for the time being to those cases in which the only exchanges are those between present goods and present money, we shall at once observe a fundamental difference between the effects of an isolated variation in a single commodity price, emanating solely from the commodity side, and the effects of a variation in the exchange ratio between money and other economic goods in general, emanating from the monetary side. Variations in the price of a single commodity influence the distribution of goods among individuals primarily because the commodity in question, if it plays a part in exchange transactions at all, is ex definitione not distributed among individuals in proportion to their demands for it. There are economic agents who produce it (in the broadest sense of the word, so as to include dealers) and sell it, and there are economic agents who merely buy it and consume it. And it is obvious what effects would result from a displacement of the exchange ratio between this particular good and the other economic goods (including money); it is clear who would be likely to benefit by them and who to be injured.

The effects in the case of money are different. As far as money is concerned, all economic agents are to a certain extent dealers.12  Every separate economic agent maintains a stock of money that corresponds to the extent and intensity with which he is able to express his demand for it in the market. If the objective exchange value of all the stocks of money in the world could be instantaneously and in equal proportion increased or decreased, if all at once the money prices of all goods and services could rise or fall uniformly, the relative wealth of individual economic agents would not be affected. Subsequent monetary calculation would be in larger or smaller figures; that is all. The variation in the value of money would have no other significance than that of a variation of the calendar or of weights and measures.

The social displacements that occur as consequences of variations in the value of money result solely from the circumstance that this assumption never holds good. In the chapter dealing with the determinants of the objective exchange value of money it was shown that variations in the value of money always start from a given point and gradually spread out from this point through the whole community. And this alone is why such variations have an effect on the social distribution of income.

It is true that the variations in market exchange ratios that emanate from the commodity side are also not as a rule completed all at once; they also start at some particular point and then spread with greater or less rapidity. And because of this, price variations of this sort too are followed by consequences that are due to the fact that the variations in prices do not occur all at once but only gradually. But these are consequences that are encountered in a marked degree by a limited number of economic agents only namely, those who, as dealers or producers, are sellers of the commodity in question. And further, this is not the sum of the consequences of variations in the objective exchange value of a commodity. When the price of coal falls because production has increased while demand has remained unaltered, then, for example, those retailers are involved who have taken supplies from the wholesale dealers at the old higher price but are now able to dispose of them only at the new and lower price. But this alone will not account for all the social changes brought about by the increase of production of coal. The increase in the supply of coal will have improved the economic position of the community. The fall in the price of coal does not merely amount to a rearrangement of income and property between producer and consumer; it also expresses an increase in the national dividend and national wealth. Many have gained what none have lost. The case of money is different.

The most important of the causes of a diminution in the value of money of which we have to take account is an increase in the stock of money while the demand for it remains the same, or tails off, or, if it increases, at least increases less than the stock. This increase in the stock of money, as we have seen, starts with the original owners of the additional quantity of money and then transfers itself to those that deal with these persons, and so forth. A lower subjective valuation of money is then passed on from person to person because those who come into possession of an additional quantity of money are inclined to consent to pay higher prices than before. High prices lead to increased production and rising wages, and, because all of this is generally regarded as a sign of economic prosperity, a fall in the value of money is, and always has been, considered an extraordinarily effective means of increasing economic welfare.13  This is a mistaken view, for an increase in the quantity of money results in no increase of the stock of consumption goods at people’s disposal. Its effect may well consist in an alteration of the distribution of economic goods among human beings but in no case, apart from the incidental circumstance referred to on page 138 above, can it directly increase the total amount of goods possessed by human beings, or their welfare. It is true that this result may be brought about indirectly, in the way in which any change in distribution may affect production as well; that is, by those classes in whose favor the redistribution occurs using their additional command of money to accumulate more capital than would have been accumulated by those people from whom the money was withdrawn. But this does not concern us here. What we are concerned with is whether the variation in the value of money has any other economic significance than its effect on distribution. If it. has no other economic significance, then the increase of prosperity can only be apparent; for it can only benefit a part of the community at the cost of a corresponding loss by the other part. And thus in fact the matter is. The cost must be borne by those classes or countries that are the last to be reached by the fall in the value of money.

Let us, for instance, suppose that a new gold mine is opened in an isolated state. The supplementary quantity of gold that streams from it into commerce goes at first to the owners of the mine and then by turns to those who have dealings with them. If we schematically divide the whole community into four groups, the mine owners, the producers of luxury goods, the remaining producers, and the agriculturalists, the first two groups will be able to enjoy the benefits resulting from the reduction in the value of money the former of them to a greater extent than the latter. But even as soon as we reach the third group, the situation is altered. The profit obtained by this group as a result of the increased demands of the first two will already be offset to some extent by the rise in the prices of luxury goods which will have experienced the full effect of the depreciation by the time it begins to affect other goods. Finally for the fourth group, the whole process will result in nothing but loss. The farmers will have to pay dearer for all industrial products before they are compensated by the increased prices of agricultural products. It is true that when at last the prices of agricultural products do rise, the period of economic hardship for the farmers is over; but it will no longer be possible for them to secure profits that will compensate them for the losses they have suffered. That is to say, they will not be able to use their increased receipts to purchase commodities at prices corresponding to the old level of the value of money; for the increase of prices will already have gone through the whole community. Thus the losses suffered by the farmers at the time when they still sold their products at the old low prices but had to pay for the products of others at the new and higher prices remain uncompensated. It is these losses of the groups that are the last to be reached by the variation in the value of money which ultimately constitute the source of the profits made by the mine owners and the groups most closely connected with them.

There is no difference between the effects on the distribution of income and wealth that are evoked by the fact that variations in the objective exchange value of money do not affect different goods and services at the same time and in the same degree, whether the case is that of metallic money or that of fiat or credit money. When the increase of money proceeds by way of issue of currency notes or inconvertible banknotes, at first only certain economic agents benefit and the additional quantity of money only spreads gradually through the whole community. If, for example, there is an issue of paper money in time of war, the new notes will first go into the pockets of the war contractors. “As a result, these persons’ demands for certain articles will increase and so also the price and the sale of these articles, but especially in so far as they are luxury articles. Thus the position of the producers of these articles will be improved, their demand for other commodities will also increase, and thus the increase of prices and sales will go on, distributing itself over a constantly augmented number of articles, until at last it has reached them all.”14  In this case, as before, there are those who gain by inflation and those who lose by it. The sooner anybody is in a position to adjust his money income to its new value, the more favorable will the process be for him. Which persons, groups, and classes fare better in this, and which worse, depends upon the actual data of each individual case, without knowledge of which we are not in a position to form a judgment.

Let us now leave the example of the isolated state and turn our attention to the international movements that arise from a fall in the value of money due to an increase in its amount. Here, again, the process is the same. There is no increase in the available stock of goods; only its distribution is altered. The country in which the new mines are situated and the countries that deal directly with it have their position bettered by the fact that they are still able to buy commodities from other countries at the old lower prices at a time when depreciation at home has already occurred. Those countries that are the last to be reached by the new stream of money are those which must ultimately bear the cost of the increased welfare of the other countries. Thus Europe made a bad bargain when the newly discovered gold fields of America, Australia, and South Africa evoked a tremendous boom in these countries. Palaces rose over night where there was nothing a few years before but virgin forest and wilderness; the prairies were intersected with railways; and anything and everything in the way of luxury goods that could be produced by the Old World found markets in territories which a little earlier had been populated by naked nomads and among people who in many cases had previously been without even the barest necessaries of existence. All of this wealth was imported from the old industrial countries by the new colonists, the fortunate diggers, and paid for in gold that was spent as freely as it had been received. It is true that the prices paid for these commodities were higher than would have corresponded to the earlier purchasing power of money; nevertheless, they were not so high as to make full allowance for the changed circumstances. Europe had exported ships and rails, metal goods and textiles, furniture and machines, for gold which it little needed or did not need at all, for what it had already was enough for all its monetary transactions.

A diminution of the value of money brought about by any other kind of cause has an entirely similar effect. For the economic consequences of variations in the value of money are determined, not by their causes, but by the nature of their slow progress, from person to person, from class to class, and from country to country. If we consider in particular those variations in the value of money which arise from the action of sellers in increasing prices, as described in the second chapter of this part, we shall find that the resultant gradual diminution of the value of money constitutes one of the motives of the groups which apparently dictate the rise of prices. The groups which begin the rise have it turned to their own disadvantage when the other groups eventually raise their prices too; but the former groups receive their higher prices at a time when the prices of the things they buy are still at the lower level. This constitutes a permanent gain for them. It is balanced by the losses of those groups who are the last to raise the prices of their goods or services; for these already have to pay the higher prices at a time when they are still receiving only the lower prices for what they sell. And when they eventually raise their prices also, being the last to do this they can no longer offset their earlier losses at the expense of other classes of the community. Wage laborers used to be in this situation, because as a rule the price of labor did not share in the earlier stages of upward price movements. Here the entrepreneurs gained what the laborers lost. For a long time, civil servants were in the same situation. Their multitudinous complaints were partly based on the fact that, since their money incomes could not easily be increased, they had largely to bear the cost of the continual rise in prices. But recently this state of affairs has been changed through the organization of the civil servants on trade-union lines, which has enabled them to secure a quicker response to demands for increases of salaries.

The converse of what is true of a depreciation in the value of money holds for an increase in its value. Monetary appreciation, like monetary depreciation, does not occur suddenly and uniformly throughout a whole community, but as a rule starts from single classes and spreads gradually. If this were not the case, and if the increase in the value of money took place almost simultaneously in the whole community, then it would not be accompanied by the special kind of economic consequences that interest us here. Let us assume, for instance, that bankruptcy of the credit-issuing institutions of a country leads to a panic and that everybody is ready to sell commodities at any price whatever in order to put himself in possession of cash, while on the other hand buyers cannot be found except at greatly reduced prices. It is conceivable that the increase in the value of money that would arise in consequence of such a panic would reach all persons and commodities uniformly and simultaneously. As a rule, however, an increase in the value of money spreads only gradually. The first of those who have to con tent themselves with lower prices than before for the commodities they sell, while they still have to pay the old higher prices for the commodities they buy, are those who are injured by the increase in the value of money. Those, however, who are the last to have to reduce the prices of the commodities they sell, and have meanwhile been able to take advantage of the fall in the prices of other things, are those who profit by the change.

• 12See Ricardo, Letters to Malthus, ed. Bonar (Oxford, 1887), p. 10.
• 13See Hume, Essays, ed. Frowde (London), p. 294 ff.
• 14Auspitz and Lieben, Untersuchungen über die Theorie des Preises (Leipzig, 1889), p. 65.

Among the consequences of variations in the value of money it is those of variations in the exchange ratio between two different kinds of money in which economic science has been chiefly interested. This interest has been aroused by the events of monetary history. In the course of the nineteenth century international trade developed in a hitherto undreamed-of manner, and the economic connections between countries became extraordinarily close. Now just at this time when commercial relations were beginning to grow more active, the monetary standards of the individual states were becoming more diverse. A number of countries went over for a shorter or longer period to credit money and the others, which were partly on gold and partly on silver, were soon in difficulties, because the ratio between the values of these two precious metals, which had changed but slowly during centuries, suddenly began to exhibit sharp variations. And in recent years this problem has been given a much greater practical significance still by monetary happenings in the war and postwar periods.

Let us suppose that one kilogram of silver had been exchangeable for ten quintals of wheat, and that upon the objective exchange value of silver being halved, owing, say, to the discovery of new and prolific mines, one kilogram of it was no longer able to purchase more than five bushels of wheat. From what has been said on the natural exchange ratio of different kinds of money, it follows that the objective exchange value of silver in terms of other kinds of money would now also be halved. If it had previously been possible to purchase one kilogram of gold with fifteen kilograms of silver, thirty kilograms would now be needed to make the same purchase; for the objective exchange value of gold in relation to commodities would have remained unchanged, while that of silver had been halved. Now this change in the purchasing power of silver over commodities will not occur all at once, but gradually. A full account has been given of the way in which it will start from a certain point and gradually spread outward, and of the consequences of this process. Until now we have investigated these consequences only so far as they occur within an area with a uniform monetary standard; but now we must trace up the further consequences involved in commercial relations with areas in which other sorts of money are employed. One thing that was found to be true of the former case can be predicated of this also: if the variations in the objective exchange value of the money occurred uniformly and simultaneously throughout the whole community then such social consequences could not appear at all. The fact that these variations always occur one after another is the sole reason for their remarkable economic effects.

Variations in the objective exchange value of a given kind of money do not affect the determination of the exchange ratio between this and other kinds of money until they begin to affect commodities that either are already objects of commercial relations between the two areas or at least are able to become such upon a moderate change in prices. The point of time at which this situation arises determines the effects upon the commercial relations of the two areas that will result from variations in the objective exchange value of money. These vary according as the prices of the commodities concerned in international trade are adjusted to the new value of money before or after those of other commodities. Under the modern organization of the monetary system this adjustment is usually first made on the stock exchanges. Speculation on the foreign-exchange and security markets anticipates coming variations in the exchange ratios between the different kinds of money at a time when the variations in the value of money have by no means completed their course through the community, perhaps when they have only just begun it, but in any case before they have reached the commodities that play a decisive part in foreign trade. He would be a poor speculator who did not grasp the course of events in time and act accordingly. But as soon as the variation in the foreign-exchange rate has been brought about, it reacts upon foreign trade in a peculiar manner until the prices of all goods and services have been adjusted to the new objective exchange value of money. During this interval the margins between the different prices and wages constitute a fund that somebody must receive and somebody surrender. In a word, we are here again confronted with a redistribution, which is noteworthy in that its influence extends beyond the are where the good whose objective exchange value is changing is employed as domestic money. It is clear that this is the only sort of consequence that can follow from variations in the value of money. The social stock of goods has in no way been increased; the total quantity that can be distributed has remained the same.

As soon as an uncompleted change in the objective exchange value of any particular kind if money becomes expressed in the foreign-exchange rates, a new opportunity of making a profit is opened up, either for exporters or for importers according as the purchasing power of money is decreasing or increasing. Let us take the former case, that of the diminution in the value of money. Since, according to our assumptions, the changes in domestic prices are not yet finished, exporters derive an advantage from the circumstance that the commodities that they market already fetch the new higher prices whereas the commodities and services that they want themselves and, what is of particular importance, the material and personal factors of production that they employ, are still obtainable at the old lower prices. Who the “exporter” is who pockets this gain, whether it is the producer or the dealer, is impertinent to our present inquiry; all that we need to know is that in the given circumstances transactions will result in profit for some and loss for others.

In any case the exporter shares his profit with the foreign importer and foreign consumer And it is even possible—this depends upon the organization of the export trade—that the profits which the exporter retains are only apparent, not real.

Thus the result is always that the gains of foreign buyers, which in certain cases are shared with home exporters, are counterbalanced by losses that are borne entirely at home. It is clear that what was said of the promotion of exportation by the falsification of monetary accounting applies also to the “export premium” arising from a diminution of the value of money.

1. Monetary Policy Defined1

The economic consequences of fluctuations in the objective exchange value of money have such important bearings on the life of the community and of the individual that as soon as the state had abandoned the attempt to exploit for fiscal ends its authority in monetary matters, and as soon as the large-scale development of the modern economic community had enabled the state to exert a decisive influence on the kind of money chosen by the market, it was an obvious step to think of attaining certain sociopolitical aims by influencing these consequences in a systematic manner Modern currency policy is something essentially new; it differs fundamentally from earlier state activity in the monetary sphere. Previously, good government in monetary matters—from the point of view of the citizen—consisted in conducting the business of minting so as to furnish commerce with coins which could be accepted by everybody at their face value; and bad government in monetary matters—again from the point of view of the citizen—amounted to the betrayal by the state of the general confidence in it. But when states did debase the coinage, it was always from purely fiscal motives. The government needed financial help, that was all; it was not concerned with questions of currency policy.

Questions of currency policy are questions of the objective exchange value of money. The nature of the monetary system affects a currency policy only insofar as it involves these particular problems of the value of money; it is only insofar as they bear upon these questions that the legal and technical characteristics of money are pertinent. Measures of currency policy are intelligible only in the light of their intended influence on the objective exchange value of money. They consequently comprise the antithesis of those acts of economic policy which aim at altering the money prices of single commodities or groups of commodities.

Not every value problem connected with the objective exchange value of money is a problem of currency policy. In conflicts of currency policy there are also interests involved which are not primarily concerned with the alteration of the value of money for its own sake. In the great struggle that was involved in the demonetization of silver and the consequent movement of the relative exchange ratio of the two precious metals gold and silver, the owners of the silver mines and the other protagonists of the double standard or of the silver standard were not actuated by the same motives. While the latter wanted a change in the value of money in order that there might be a general rise in the prices of commodities, the former merely wished to raise the price of silver as a commodity by securing, or more correctly regaining, an extensive market for it. Their interests were in no way different from those of producers of iron or oil in trying to extend the market for iron or oil so as to increase the profitability of their businesses. It is true that this is a value problem, but it is a commodity-value problem—that of increasing the exchange value of the metal silver—and not a problem of the value of money.2

But although this motive has played a part in currency controversy, it has been a very subordinate part. Even in the United States, the most important silver-producing area, it has been of significance only inasmuch as the generous practical encouragement of the silver magnates has been one of the strongest supports of the bimetallistic agitation. But most of the recruits to the silver camp were attracted, not by the prospect of an increase in the value of the mines, which was a matter of indifference to them, but by the hope of a fall in the purchasing power of money, from which they promised themselves miraculous results. If the increase in the price of silver could have been brought about in any other way than through the extension of its use as money, say by the creation of a new industrial demand, then the owners of the mines would have been just as satisfied; but the farmers and industrialists who advocated a silver currency would not have benefited from it in any way. And then they would undoubtedly have transferred their allegiance to other currency policies. Thus, in many states, paper inflationism was advocated, partly as a forerunner of bimetallism and partly in combination with it.

But even though questions of currency policy are never more than questions of the value of money, they are sometimes disguised so that their true nature is hidden from the uninitiated. Public opinion is dominated by erroneous views on the nature of money and its value, and misunderstood slogans have to take the place of clear and precise ideas. The fine and complicated mechanism of the money and credit system is wrapped in obscurity, the proceedings on the stock exchange are a mystery, the function and significance of the banks elude interpretation. So it is not surprising that the arguments brought forward in the conflict of the different interests often missed the point altogether. Counsel was darkened with cryptic phrases whose meaning was probably hidden even from those who uttered them. Americans spoke of “the dollar of our fathers” and Austrians of “our dear old gulden note”; silver, the money of the common man, was set up against gold, the money of the aristocracy. Many a tribune of the people, in many a passionate dis course, sounded the loud praises of silver, which, hidden in deep mines, lay awaiting the time when it should come forth into the light of day to ransom miserable humanity languishing in its wretchedness. And while some thus regarded gold as nothing less than the embodiment of the very principle of evil, all the more enthusiastically did others exalt the glistening yellow metal which alone was worthy to be the money of rich and mighty nations. It did not seem as if men were disputing about the distribution of economic goods; rather it was as if the precious metals were contending among themselves and against paper for the lordship of the market. All the same, it would be difficult to claim that these Olympic struggles were engendered by anything but the question of altering the purchasing power of money.

• 1The author uses the term Geldwertpolitik in the technical sense defined in the above section. I have reserved the term monetary policy for this special meaning. Currency policy is the term I have used to translate Währungspolitik. H.E.B.]
• 2Similar interests, say those of the printers, lithographers, and the like, may play a part in the production of paper money also. Perhaps such motives had something to do with Benjamin Franklin’s recommendation of an increase of paper money in his first political writing, which was published (anonymously) in Philadelphia in 1729: “A Modest Inquiry into the Nature and Necessity of a Paper Currency” (in The Works of Benjamin Franklin, ed. Sparks [Chicago, 1882], vol. 2, pp. 253-77). Shortly before—as he relates in his autobiography (ibid., vol. 1, p. 73)—he had printed the notes for New Jersey, and when his pamphlet led to the decision to issue more notes in Pennsylvania, despite the opposition of the “rich men,” he got the order to print the notes. He remarks on this in his autobiography: “A very profitable job, and a great help to me. This was another advantage gained by me being able to write” (ibid., p. 92).

The principal instrument of monetary policy at the disposal of the state is the exploitation of its influence on the choice of the kind of money. It has been shown above that the position of the state as controller of the mint and as issuer of money substitutes has allowed it in modern times to exert a decisive influence over individuals in their choice of the common medium of exchange. If the state uses this power systematically in order to force the community to accept a particular sort of money whose employment it desires for reasons of monetary policy then it is actually carrying through a measure of monetary policy. The states which completed the transition to a gold standard a generation ago, did so from motives of monetary policy. They gave up the silver standard or the credit-money standard because they recognized that the behavior of the value of silver or of credit money was unsuited to the economic policy they were following. They adopted the gold standard because they regarded the behavior of the value of gold as relatively the most suitable for carrying out their monetary policies.

If a country has a metallic standard, then the only measure of currency policy that it can carry out by itself is to go over to another kind of money. It is otherwise with credit money and fiat money. Here the state is able to influence the movement of the objective exchange value of money by increasing or decreasing its quantity. It is true that the means is extremely crude, and that the extent of its consequences can never be foreseen. But it is easy to apply and popular on account of its drastic effects.

Inflationism is that monetary policy that seeks to increase the quantity of money.

Naive inflationism demands an increase in the quantity of money without suspecting that this will diminish the purchasing power of the money. It wants more money because in its eyes the mere abundance of money is wealth. Fiat money! Let the state “create” money, and make the poor rich, and free them from the bonds of the capitalists! How foolish to forgo the opportunity of making everybody rich, and consequently happy, that the state’s right to create money gives it! How wrong to forgo it simply because this would run counter to the interests of the rich! How wicked of the economists to assert that it is not within the power of the state to create wealth by means of the printing press!—You statesmen want to build railways, and complain of the low state of the exchequer? Well, then, do not beg loans from the capitalists and anxiously calculate whether your railways will bring in enough to enable you to pay interest and amortization on your debt. Create money, and help yourselves.3

Other inflationists realize very well that an increase in the quantity of money reduces the purchasing power of the monetary unit. But they endeavor to secure inflation nonetheless, because of its effect on the value of money; they want depreciation, because they want to favor debtors at the expense of creditors and because they want to encourage exportation and make importation difficult. Others, again, recommend depreciation for the sake of its supposed property of stimulating production and encouraging the spirit of enterprise.

Depreciation of money can benefit debtors only when it is unforeseen. If inflationary measures and a reduction of the value of money are expected, then those who lend money will demand higher interest in order to compensate their probable loss of capital, and those who seek loans will be prepared to pay the higher interest because they have a prospect of gaining on capital account. Since, as we have shown, it is never possible to foresee the extent of monetary depreciation, creditors in individual cases may suffer losses and debtors make profits, in spite of the higher interest exacted. Nevertheless, in general it will not be possible for any inflationary policy, unless it takes effect suddenly and unexpectedly, to alter the relations between creditor and debtor in favor of the latter by increasing the quantity of money.4  Those who lend money will feel obliged, in order to avoid losses, either to make their loans in a currency that is more stable in value than the currency of their own country, or to include in the rate of interest they ask, over and above the compensation that they reckon for the probable depreciation of money and the loss to be expected on that account, an additional premium for the risk of a less probable further depreciation. And if those who were seeking credit were inclined to refuse to pay this additional compensation, the diminution of supply in the loan market would force them to it. During the inflation after the war it was seen how savings deposits decreased because savings banks were not inclined to adjust interest rates to the altered conditions of the variations in the purchasing power of money.

It has already been shown in the preceding chapter that it is a mistake to think that the depreciation of money stimulates production. If the particular conditions of a given case of depreciation are such that wealth is transferred to the rich from the poor, then admittedly saving (and consequently capital accumulation) will be encouraged, production will consequently be stimulated, and so the welfare of posterity increased. In earlier epochs of economic history a moderate inflation may sometimes have had this effect. But the more the development of capitalism has made money loans (bank and savings-bank deposits and bonds, especially bearer bonds and mortgage bonds) the most important instruments of saving, the more has depreciation necessarily imperiled the accumulation of capital, by decreasing the motive for saving. How the depreciation of money leads to capital consumption through falsification of economic calculation, and how the appearance of a boom that it creates is an illusion, and how the depreciation of the money really reacts on foreign trade have similarly been explained already in the preceding chapter.

A third group of inflationists do not deny that inflation involves serious disadvantages. Nevertheless, they think that there are higher and more important aims of economic policy than a sound monetary system. They hold that although inflation may be a great evil, yet it is not the greatest evil, and that the state might under certain circumstances find itself in a position where it would do well to oppose greater evils with the lesser evil of inflation. When the defense of the fatherland against enemies, or the rescue of the hungry from starvation is at stake, then, it is said, let the currency go to ruin whatever the cost.

Sometimes this sort of conditional inflation is supported by the argument that inflation is a kind of taxation that is advisable in certain circumstances. Under some conditions, according to this argument, it is better to meet public expenditure by a fresh issue of notes than by increasing the burden of taxation or by borrowing. This was the argument put forward during the war when the expenditure on the army and navy had to be met; and this was the argument put forward in Germany and Austria after the war when a part of the population had to be provided with cheap food, the losses on the operation of the railways and other public undertakings met, and reparations payments made. The assistance of inflation is invoked whenever a government is unwilling to increase taxation or unable to raise a loan; that is the truth of the matter The next step is to inquire why the two usual methods of raising money for public purposes cannot or will not be employed.

It is only possible to levy high taxes when those who bear the burden of the taxes assent to the purpose for which the resources so raised are to be expended. It must be observed here that the greater the total burden of taxation becomes, the harder it is to deceive public opinion as to the impossibility of placing the whole burden of taxation upon the small richer class of the community. The taxation of the rich or of property affects the whole community, and its ultimate consequences for the poorer classes are often more severe than those of taxation levied throughout the community. These implications may perhaps be harder to grasp when taxation is low; but when it is high they can hardly fail to be recognized. There can, moreover, be no doubt that it is scarcely possible to carry the system of relying chiefly upon “taxation of ownership” any farther than it has been carried by the inflating countries, and that the incidence of further taxation could not have been concealed in the way necessary to guarantee continued popular support.

Who has any doubt that the belligerent peoples of Europe would have tired of war much more quickly if their governments had clearly and candidly laid before them at the time the account of their war expenditure? In no European country did the war party dare to impose taxation on the masses to any considerable extent for meeting the cost of the war. Even in England, the classical country of “sound money,” the printing presses were set in motion. Inflation had the great advantage of evoking an appearance of economic prosperity and of increase of wealth, of falsifying calculations made in terms of money, and so of concealing the consumption of capital. Inflation gave rise to the pseudo-profits of the entrepreneur and capitalist which could be treated as income and have specially heavy taxes imposed upon them without the public at large—or often even the actual taxpayers themselves—seeing that portions of capital were thus being taxed away. Inflation made it possible to divert the fury of the people to “speculators” and “profiteers.” Thus it proved itself an excellent psychological resource of the destructive and annihilist war policy.

What war began, revolution continued. The socialistic or semi-socialistic state needs money in order to carry on undertakings which do not pay, to support the unemployed, and to provide the people with cheap food. It also is unable to secure the necessary resources by means of taxation. It dare not tell the people the truth. The state-socialist principle of running the railways as a state institution would soon lose its popularity if it was proposed, say, to levy a special tax for covering their running losses. And the German and Austrian people would have been quicker in realizing where the resources came from that made bread cheaper if they themselves had to supply them in the form of a bread tax. In the same way, the German government that decided for the “policy of fulfillment” in opposition to the majority of the German people, was unable to provide itself with the necessary means except by printing notes. And when passive resistance in the Ruhr district gave rise to a need for enormous sums of money, these, again for political reasons, were only to be procured with the help of the printing press.

A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, i.e., of antidemocratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism.

The various aims pursued by inflationists demand that the inflationary measures shall be carried through in various special ways. If depreciation is wanted in order to favor the debtor at the expense of the creditor, then the problem is to strike unexpectedly at creditor interests. As we have shown, to the extent to which it could be foreseen, an expected depreciation would be incapable of altering the relations between creditors and debtors. A policy aiming at a progressive diminution of the value of money does not benefit debtors.

If, on the other hand, the depreciation is desired in order to “stimulate production” and to make exportation easier and importation more difficult in relation to other countries, then it must be borne in mind that the absolute level of the value of money—its purchasing power in terms of commodities and services and its exchange ratio against other kinds of money—is without significance for external (as for internal) trade; the variations in the objective exchange value of money have an influence on business only so long as they are in progress. The “beneficial effects” on trade of the depreciation of money only last so long as the depreciation has not affected all commodities and services. Once the adjustment is completed, then these “beneficial effects” disappear. If it is desired to retain them permanently, continual resort must be had to fresh diminutions of the purchasing power of money. It is not enough to reduce the purchasing power of money by one set of measures only, as is erroneously supposed by numerous inflationist writers; only the progressive diminution of the value of money could permanently achieve the aims which they have in view.5  But a monetary system that corresponds to these requirements can never be actually realized.

Of course, the real difficulty does not lie in the fact that a progressive diminution of the value of money must soon reach amounts so small that they would no longer meet the requirements of commerce. Since the decimal system of calculation is customary in the majority of present-day monetary systems, even the more stupid sections of the public would find no difficulty in the new reckoning when a system of higher units was adopted. We could quite easily imagine a monetary system in which the value of money was constantly falling at the same proportionate rate. Let us assume that the purchasing power of this money, through variations in the determinants that lie on the side of money, sinks in the course of a year by one-hundredth of its amount at the beginning of the year The levels of the value of the money at each new year then constitute a diminishing geometrical series. If we put the value of the money at the beginning of the first year as equivalent to 100, then the ratio of diminution is equivalent to 0.99, and the value of money at the end of the nth year is equivalent to 100 × 0.99n-1. Such a convergent geometrical progression gives an infinite series, any member of which is always to the next following member in the ratio of 100 : 99. We could quite easily imagine a monetary system based on such a principle; perhaps even more easily still if we increased the ratio, say, to 0.995 or even 0.9975.

But however clearly we may be able to imagine such a monetary system, it certainly does not lie in our power actually to create one like it. We know the determinants of the value of money, or think we know them. But we are not in a position to bend them to our will. For we lack the most important prerequisite for this; we do not so much as know the quantitative significance of variations in the quantity of money. We cannot calculate the intensity with which definite quantitative variations in the ratio of the supply of money and the demand for it operate upon the subjective valuations of individuals and through these indirectly upon the market. This remains a matter of very great uncertainty. In employing any means to influence the value of money we run the risk of giving the wrong dose. This is all the more important since in fact it is not possible even to measure variations in the purchasing power of money. Thus even though we can roughly tell the direction in which we should work in order to obtain the desired variation, we still have nothing to tell us how far we should go, and we can never find out where we are already, what effects our intervention has had, or how these are proportioned to the effects we desire.

Now the danger involved in overdoing an arbitrary influence—a political influence; that is, one arising from the conscious intervention of human organizations—upon the value of money must by no means be underestimated, particularly in the case of a diminution of the value of money. Big variations in the value of money give rise to the danger that commerce will emancipate itself from the money which is subject to state influence and choose a special money of its own. But without matters going so far as this it is still possible for all the consequences of variations in the value of money to be eliminated if the individuals engaged in economic activity clearly recognize that the purchasing power of money is constantly sinking and act accordingly. If in all business transactions they allow for what the objective exchange value of money will probably be in the future, then all the effects on credit and commerce are finished with. In proportion as the Germans began to reckon in terms of gold, so was further depreciation rendered incapable of altering the relationship between creditor and debtor or even of influencing trade. By going over to reckoning in terms of gold, the community freed itself from the inflationary policy, and eventually even the government was obliged to acknowledge gold as a basis of reckoning.

A danger necessarily involved in all attempts to carry out an inflationary policy is that of excess. Once the principle is admitted that it is possible, permissible, and desirable, to take measures for “cheapening” money, then immediately the most violent and bitter controversy will break out as to how far this principle is to be carried. The interested parties will differ not merely about the steps still to be taken, but also about the results of the steps that have been taken already. It would be impossible for any inflationary measures to be taken without violent controversy. It would be practically impossible so much as to consider counsels of moderation. And these difficulties arise even in the case of an attempt to secure what the inflationists call the beneficial effects of a single and isolated depreciation. Even in the case, say, of assisting “production” or debtors after a serious crisis by a single depreciation of the value of money, the same problems remain to be solved. They are difficulties that have to be reckoned with by every policy aiming at a reduction of the value of money.

Consistently and uninterruptedly continued inflation must eventually lead to collapse. The purchasing power of money will fall lower and lower, until it eventually disappears altogether. It is true that an endless process of depreciation can be imagined. We can imagine the purchasing power of money getting continually lower without ever disappearing altogether, and prices getting continually higher without it ever becoming impossible to obtain commodities in exchange for notes. Eventually this would lead to a situation in which even retail transactions were in terms of millions and billions and even higher figures; but the monetary system itself would remain.

But such an imaginary state of affairs is hardly within the bounds of possibility. In the long run, a money which continually fell in value would have no commercial utility. It could not be used as a standard of deferred payments. For all transactions in which commodities or services were not exchanged for cash, another medium would have to be sought. In fact, a money that is continually depreciating becomes useless even for cash transactions. Everybody attempts to minimize his cash reserves, which are a source of continual loss. Incoming money is spent as quickly as possible, and in the purchases that are made in order to obtain goods with a stable value in place of the depreciating money even higher prices will be agreed to than would otherwise be in accordance with market conditions at the time. When commodities that are not needed at all or at least not at the moment are purchased in order to avoid the holding of notes, then the process of extrusion of the notes from use as a general medium of exchange has already begun. It is the beginning of the “demonetization” of the notes. The process is hastened by its paniclike character. It may be possible once, twice, perhaps even three or four times, to allay the fears of the public; but eventually the affair must run its course and then there is no longer any going back. Once the depreciation is proceeding so rapidly that sellers have to reckon with considerable losses even if they buy again as quickly as is possible, then the position of the currency is hopeless.

In all countries where inflation has been rapid, it has been observed that the decrease in the value of the money has occurred faster than the increase in its quantity. If m represents the nominal amount of money present in the country before the beginning of the inflation, P the value of the monetary unit then in terms of gold, M the nominal amount of money at a given point of time during the inflation, and p the value in gold of the monetary unit at this point of time; then, as has often been shown by simple statistical investigations, mP > Mp. It has been attempted to prove from this that the money has depreciated “too rapidly” and that the level of the rate of exchange is not “justified.” Many have drawn from it the conclusion that the quantity theory is obviously not true and that depreciation of money cannot be a result of an increase in its quantity. Others have conceded the truth of the quantity theory in its primitive form and argued the permissibility or even the necessity of continuing to increase the quantity of money in the country until its total gold value is restored to the level at which it stood before the beginning of the inflation, that is, until Mp = mP.

The error that is concealed in all of this is not difficult to discover. We may completely ignore the fact already referred to that the exchange rates (including the bullion rate) move in advance of the purchasing power of the money unit as expressed in the prices of commodities, so that the gold value must not be taken as a basis of operations, but purchasing power in terms of commodities, which as a rule will not have decreased to the same extent as the gold value. For this form of calculation too, in which P and p do not represent value in terms of gold but purchasing power in terms of commodities, would still as a rule give the result mP > Mp. But it must be observed that as the depreciation of money proceeds, the demand for money (that is, for the kind of money in question) gradually begins to fall. When loss of wealth is suffered in proportion to the length of time money is kept on hand, endeavors are made to reduce cash holdings as much as possible. Now if every individual, even if his circumstances are otherwise unchanged, no longer wishes to maintain his cash holding at the same level as before the beginning of the inflation, the demand for money in the whole community, which can only be the sum of the individuals’ demands, decreases too. There is also the additional fact that as commerce gradually begins to use foreign money and actual gold in place of notes, individuals begin to hold part of their reserves in foreign money and in gold and no longer in notes.

An expected fall in the value of money is anticipated by speculation so that the money has a lower value in the present than would correspond to the relationship between the immediate supply of it and demand for it. Prices are asked and given that are not related to the present amount of money in circulation nor to present demands for money, but to future circumstances. The panic prices paid when the shops are crowded with buyers anxious to pick up something or other while they can, and the panic rates reached on the exchange when foreign currencies and securities that do not represent a claim to fixed sums of money rise precipitously, anticipate the march of events. But there is not enough money available to pay the prices that correspond to the presumable future supply of money and demand for it. And so it comes about that commerce suffers from a shortage of notes, that there are not enough notes on hand for fulfilling commitments that have been entered into. The mechanism of the market that adjusts the total demand and the total supply to each other by altering the exchange ratio no longer functions as far as the exchange ratio between money and other economic goods is concerned. Business suffers sensibly from a shortage of notes. This bad state of affairs, once matters have gone as far as this, can in no way be helped. Still further to increase the note issue (as many recommend) would only make matters worse. For, since this would accelerate the growth of the panic, it would also accentuate the maladjustment between depredation and circulation. Shortage of notes for transacting business is a symptom of an advanced stage of inflation; it is the reverse aspect of panic purchases and panic prices, the reflection of the “bullishness” of the public that will finally lead to catastrophe.

The emancipation of commerce from a money which is proving more and more useless in this way begins with the expulsion of the money from hoards. People begin at first to hoard other money instead so as to have marketable goods at their disposal for unforeseen future needs—perhaps precious-metal money and foreign notes, and sometimes also domestic notes of other kinds which have a higher value because they cannot be increased by the state (for example, the Romanoff ruble in Russia or the “blue” money of communist Hungary); then ingots, precious stones, and pearls; even pictures, other objects of art, and postage stamps. A further step is the adoption of foreign currency or metallic money (that is, for all practical purposes, gold) in credit transactions. Finally, when the domestic currency ceases to be used in retail trade, wages as well have to be paid in some other way than in pieces of paper which are then no longer good for anything.

The collapse of an inflation policy carried to its extreme—as in the United States in 1781 and in France in 1796—does not destroy the monetary system, but only the credit money or fiat money of the state that has overestimated the effectiveness of its own policy. The collapse emancipates commerce from etatism and establishes metallic money again.

It is not the business of science to criticize the political aims of inflationism. Whether the favoring of the debtor at the expense of the creditor, whether the facilitation of exports and the hindrance of imports, whether the stimulation of production by transferring wealth and income to the entrepreneur, are to be recommended or not, are questions which economics cannot answer. With the instruments of monetary theory alone, these questions cannot even be elucidated as far as is possible with other parts of the apparatus of economics. But there are nevertheless three conclusions that seem to follow from our critical examination of the possibilities of inflationary policy.

In the first place, all the aims of inflationism can be secured by other sorts of intervention in economic affairs, and secured better, and without undesirable incidental effects. If it is desired to relieve debtors, moratoria may be declared or the obligation to repay loans may be removed altogether; if it is desired to encourage exportation, export premiums may be granted; if it is desired to render importation more difficult, simple prohibition may be resorted to, or import duties levied. All these measures permit discrimination between classes of people, branches of production, and districts, and this is impossible for an inflationary policy. Inflation benefits all debtors, including the rich, and injures all creditors, including the poor; adjustment of the burden of debts by special legislation allows of differentiation. Inflation encourages the exportation of all commodities and hinders all importation; premiums, duties, and prohibitions can be employed discriminatingly.

Second, there is no kind of inflationary policy the extent of whose effects can be foreseen. And finally, continued inflation must lead to a collapse.

Thus we see that, considered purely as a political instrument, inflationism is inadequate. It is, technically regarded, bad policy, because it is incapable of fully attaining its goal and because it leads to consequences that are not, or at least are not always, part of its aim. The favor it enjoys is due solely to the circumstance that it is a policy concerning whose aims and intentions public opinion can be longest deceived. Its popularity, in fact, is rooted in the difficulty of fully understanding its consequences.

• 3On the naive inflationary proposals that have been made in recent years by the motor-car manufacturer Henry Ford, the famous inventor Edison, and the American senator Ladd, see Yves Guyot, Les problèmes de la déflation (Paris, 1923), pp. 281 f.
• 4This had been urged as early as 1740 by William Douglass in his anonymous writing A Discourse Concerning the Currencies in the British Plantations in America (Boston, 1740). See also Fisher, The Rate of Interest, p. 356.
• 5See Hertzka, Währung und Handel (Vienna, 1876), p. 42.

That policy which aims at raising the objective exchange value of money is called, after the most important means at its disposal, restrictionism or deflationism. This nomenclature does not really embrace all the policies that aim at an increase in the value of money. The aim of restrictionism may also be attained by not increasing the quantity of money when the demand for it increases, or by not increasing it enough. This method has quite often been adopted as a way of increasing the value of money in face of the problems of a depreciated credit-money standard; further increase of the quantity of money has been stopped, and the policy has been to wait for the effects on the value of money of an increasing demand for it. In the following discussion, following a widespread custom, we shall use the terms restrictionism and deflationism to refer to all policies directed to raising the value of money.

The existence and popularity of inflationism is due to the circumstance that it taps new sources of public revenue. Governments had inflated from fiscal motives long before it occurred to anybody to justify their procedure from the point of view of monetary policy. Inflationistic arguments have always been well supported by the fact that inflationary measures not only do not impose any burden on the national exchequer, but actually bring resources to it. Looked at from the fiscal point of view, inflationism is not merely the cheapest economic policy; it is also at the same time a particularly good remedy for a low state of the public finances. Restrictionism, however, demands positive sacrifices from the national exchequer when it is carried out by the withdrawal of notes from circulation (say through the issue of interest-bearing bonds or through taxation) and their cancellation; and at the least it demands from it a renunciation of potential income by forbidding the issue of notes at a time when the demand for money is increasing. This alone would suffice to explain why restrictionism has never been able to compete with inflationism.

Nevertheless, the unpopularity of restrictionism has other causes as well. Attempts to raise the objective exchange value of money, in the circumstances that have existed, have necessarily been limited either to single states or to a few states and at the best have had only a very small prospect of simultaneous realization throughout the whole world. Now as soon as a single country or a few countries go over to a money with a rising purchasing power, while the other countries retain a money with a falling or stationary exchange value, or one which although it may be rising in value is not rising to the same extent, then, as has been demonstrated above, the conditions of international trade are modified. In the country whose money is rising in value, exportation becomes more difficult and importation easier. But the increased difficulty of exportation and the increased facility of importation, in brief the deterioration of the balance of trade, have usually been regarded as an unfavorable situation and consequently been avoided. This alone would provide an adequate explanation of the unpopularity of measures intended to raise the purchasing power of money.

But furthermore, quite apart from any consideration of foreign trade, an increase in the value of money has not been to the advantage of the ruling classes. Those who get an immediate benefit from such an increase are all those who are entitled to receive fixed sums of money. Creditors gain at the expense of debtors. Taxation, it is true, becomes more burdensome as the value of money rises; but the greater part of the advantage of this is secured, not by the state, but by its creditors. Now policies favoring creditors at the expense of debtors have never been popular. Lenders of money have been held in odium, at all times and among all peoples.6

Generally speaking, the class of persons who draw their income exclusively or largely from the interest on capital lent to others has not been particularly numerous or influential at any time in any country. A not insignificant part of the total income from the lending of capital is received by persons whose incomes chiefly arise from other sources, and in whose budgets it plays only a subordinate part. This is the case, for instance, not only of the laborers, peasants, small industrialists, and civil servants, who possess savings that are invested in savings deposits or in bonds, but also of the numerous big industrialists, wholesalers, or shareholders, who also own large amounts of bonds. The interests of all of these as lenders of money are subordinate to their interests as landowners, merchants, manufacturers, or employees. No wonder, then, that they are not very enthusiastic about attempts to raise the level of interest.7

Restrictionistic ideas have never met with any measure of popular sympathy except after a time of monetary depreciation when it has been necessary to decide what should take the place of the abandoned inflationary policy. They have hardly ever been seriously entertained except as part of the alternative: “Stabilization of money at the present value or revaluation at the level that it had before the inflation.”

When the question arises in this form, the reasons that are given for the restoration of the old metal parity start from the assumption that notes are essentially promises to pay so much metallic money. Credit money has always originated in a suspension of the convertibility into cash of Treasury notes or banknotes (sometimes the suspension was even extended to token coins or to bank deposits) that were previously convertible at any time on the demand of the bearer and were already in circulation. Now whether the original obligation of immediate conversion was expressly laid down by the law or merely founded on custom, the suspension of conversion has always taken on the appearance of a breach of the law that could perhaps be excused, but not justified; for the coins or notes that became credit money through the suspension of cash payment could never have been put into circulation otherwise than as money substitutes, as secure claims to a sum of commodity money payable on demand. Consequently, the suspension of immediate convertibility has always been decreed as a merely temporary measure, and a prospect held out of its future rescission. But if credit money is thought of only as a promise to pay, “devaluation” cannot be regarded as anything but a breach of the law, or as meaning anything less than national bankruptcy.

Yet credit money is not merely an acknowledgment of indebtedness and a promise to pay. As money, it has a different standing in the transactions of the market. It is true that it could not have become a money-substitute unless it had constituted a claim. Nevertheless, at the moment when it became actual money—credit money—(even if through a breach of the law), it ceased to be valued with regard to the more or less uncertain prospect of its future full conversion and began to be valued for the sake of the monetary function that it performed. Its far lower value as an uncertain claim to a future cash payment has no significance so long as its higher value as a common medium of exchange is taken into account.

It is therefore quite beside the point to interpret devaluation as national bankruptcy. The stabilization of the value of money at its present—lower—level is, even when regarded merely with a view to its effects on existing debt relations, something other than this; it is both more and less than national bankruptcy. It is more, for it affects not merely public debts, but also all private debts; it is less, for one thing because it also affects those claims of the state that are in terms of credit money while not affecting such of its obligations as are in terms of cash (metallic money) or foreign currency, and for another thing because it involves no modification of the relations of the parties to any contract of indebtedness in terms of credit money made at a time when the currency stood at a low level, without the parties having reckoned on an increase of the value of money. When the value of money is increased, then those are enriched who at the time possess credit money or claims to credit money. Their enrichment must be paid for by debtors, among them the state (that is, the taxpayers). Yet those who are enriched by the increase in the value of money are not the same as those who were injured by the depreciation of money in the course of the inflation; and those who must bear the cost of the policy of raising the value of money are not the same as those who benefited by its depreciation. To carry out a deflationary policy is not to do away with the consequences of inflation. You cannot make good an old breach of the law by committing a new one. And as far as debtors are concerned, restriction is a breach of the law.

If it is desired to make good the injury which has been suffered by creditors during the inflation, this can certainly not be done by restriction. In the simpler circumstances of an undeveloped credit system, the attempt has been made to find a way out of the difficulty by conversion of the debts contracted before and during the period of inflation, every debt being recalculated in the devaluated money according to the value of the credit money in terms of metallic money on the day of origin. Supposing, for instance, that the metallic money had been depreciated to one-fifth of its former value, a borrower of 100 gulden before the inflation would have to pay back after the stabilization, not 100 gulden, but 500, together with interest on the 500; and a borrower of 100 gulden at a time when the credit money had already sunk to half of its nominal value, would have to pay interest on and pay back 250 gulden.8  This, however, only covers debt obligations which are still current; the debts which have already been settled in the depreciated money are not affected. No notice is taken of sales and purchases of bonds and other claims to fixed sums of money; and, in an age of bearer bonds, this is a quite particularly serious shortcoming. Finally, this sort of regulation is inapplicable to current-account transactions.

It is not our business here to discuss whether something better than this could have been thought of. In fact, if it is possible to make any sort of reparation of the damage suffered by creditors at all, it must clearly be sought by way of some such methods of recalculation. But in any case, increasing the purchasing power of money is not a suitable means to this end.

Considerations of credit policy also are adduced in favor of increasing the value of money to the metal parity that prevailed before the beginning of the period of inflation. A country that has injured its creditors through depreciation brought about by inflation, it is said, cannot restore the shattered confidence in its credit otherwise than by a return to the old level of prices. In this way alone can those from whom it wishes to obtain new loans be satisfied as to the future security of their claims; the bondholders will be able to assume that any possible fresh inflation would not ultimately reduce their claims, because after the inflation was over the original metal parity would presumably be returned to. This argument has a peculiar significance9  for England, among whose most important sources of income is the position of the city of London as the world’s banker. All those who availed themselves of the English banking system, it is said, ought to be satisfied as to the future security of the English deposits, in order that the English banking business should not be diminished by mistrust in the future of the English currency. As always in the case of considerations of credit policy like this, a good deal of rather dubious psychology is assumed in this argument. It may be there are more effectual ways of restoring confidence in the future than by measures that do not benefit some of the injured creditors at all—those who have already disposed of their claims—and do benefit many creditors who have not suffered any injury—those who acquired their claims after the depreciation began.

In general, therefore, it is impossible to regard as decisive the reasons that are given in favor of restoring the value of money at the level that it had before the commencement of the inflationary policy, especially as consideration of the way in which trade is affected by a rise in the value of money suggests a need for caution. Only where and so far as prices are not yet completely adjusted to the relationship between the stock of money and the demand for it which has resulted from the increase in the quantity of money, is it possible to proceed to a restoration of the old parity without encountering a too violent opposition.

• 6See Bentham, Defense of Usury, 2d ed. (London, 1790), pp. 102 ff.
• 7See Wright and Harlow, The Gemini Letters (London, 1844), pp. 51 ff.
• 8See Hofmann, “Die Devalvierung des österreichischen Papiergeldes im Jahre 1811,” Schriften des Vereins für Sozialpolitik 165, Part I.
• 9[It should be remembered that the German edition from which the present version is translated was published in 1926. See, however, the discussion of British policy, p. 14 above. H.E.B.]

Thus, endeavors to increase or decrease the objective exchange value of money prove impracticable. A rise in the value of money leads to consequences which as a rule seem to be desired by only a small section of the community; a policy with this aim is contrary to interests which are too great for it to be able to hold its own against them in the long run. The kinds of intervention which aim at decreasing the value of money seem more popular; but their goal can be more easily and more satisfactorily reached in other ways, while their execution meets with quite insuperable difficulties.

Thus nothing remains but to reject both the augmentation and the diminution of the objective exchange value of money. This suggests the ideal of a money with an invariable exchange value, so far as the monetary influences on its value are concerned. But, this is the ideal money of enlightened statesmen and economists, not that of the multitude. The latter thinks in far too confused a manner to be able to grasp the problems here involved. (It must be confessed that they are the most difficult in economics.) For most people (so far as they do not incline to inflationistic ideas), that money seems to be the best whose objective exchange value is not subject to any variation at all, whether originating on the monetary side or on the commodity side.

The ideal of a money with an exchange value that is not subject to variations due to changes in the ratio between the supply of money and the need for it—that is, a money with an invariable innere objektive Tauschwert10 —demands the intervention of a regulating authority in the determination of the value of money; and its continued intervention. But here immediately most serious doubts arise from the circumstance, already referred to, that we have no useful knowledge of the quantitative significance of given measures intended to influence the value of money. More serious still is the circumstance that we are by no means in a position to determine with precision whether variations have occurred in the exchange value of money from any cause whatever, and if so to what extent, quite apart from the question of whether such changes have been effected by influences working from the monetary side. Attempts to stabilize the exchange value of money in this sense must therefore be frustrated at the outset by the fact that both their goal and the road to it are obscured by a darkness that human knowledge will never be able to penetrate. But the uncertainty that would exist as to whether there was any need for intervention to maintain the stability of the exchange value of money, and as to the necessary extent of such intervention, would inevitably give full license again to the conflicting interests of the inflationists and restrictionists. Once the principle is so much as admitted that the state may and should influence the value of money, even if it were only to guarantee the stability of its value, the danger of mistakes and excesses immediately arises again.

These possibilities, and the remembrance of very recent experiments in public finance and inflation, have subordinated the unrealizable ideal of a money with an invariable exchange value to the demand that the state should at least refrain from exerting any sort of influence on the value of money. A metallic money, the augmentation or diminution of the quantity of metal available for which is independent of deliberate human intervention, is becoming the modern monetary ideal.

The significance of adherence to a metallic-money system lies in the freedom of the value of money from state influence that such a system guarantees. Beyond doubt, considerable disadvantages are involved in the fact that not only fluctuations in the ratio of the supply of money and the demand for it, but also fluctuations in the conditions of production of the metal and variations in the industrial demand for it, exert an influence on the determination of the value of money. It is true that these effects, in the case of gold (and even in the case of silver), are not immoderately great, and these are the only two monetary metals that need be considered in modern times. But even if the effects were greater, such a money would still deserve preference over one subject to state intervention, since the latter sort of money would be subject to still greater fluctuations.

• 10[See p. 124 n.]

The results of our investigation into the development and significance of monetary policy should not surprise us. That the state, after having for a period used the power which it nowadays has of influencing to some extent the determination of the objective exchange value of money in order to affect the distribution of income, should have to abandon its further exercise, will not appear strange to those who have a proper appreciation of the economic function of the state in that social order which rests upon private property in the means of production. The state does not govern the market; in the market in which products are exchanged it may quite possibly be a powerful party, but nevertheless it is only one party of many, nothing more than that. All its attempts to transform the exchange ratios between economic goods that are determined in the market can only be undertaken with the instruments of the market. It can never foresee exactly what the result of any particular intervention will be. It cannot bring about a desired result in the degree that it wishes, because the means that the influencing of demand and supply place at its disposal only affect the pricing process through the medium of the subjective valuations of individuals; but no judgment as to the intensity of the resulting transformation of these valuations can be made except when the intervention is a small one, limited to one or a few groups of commodities of lesser importance, and even in such a case only approximately. All monetary policies encounter the difficulty that the effects of any measures taken in order to influence the fluctuations of the objective exchange value of money can neither be foreseen in advance, nor their nature and magnitude be determined even after they have already occurred.

Now the renunciation of intervention on grounds of monetary policy that is involved in the retention of a metallic commodity currency is not complete. In the regulation of the issue of fiduciary media there is still another possibility of influencing the objective exchange value of money. The problem that this gives rise to must be investigated (in the following part) before we can discuss certain plans that have recently been announced for the establishment of a monetary system under which the value of money would be more stable than that of a gold currency.

Observant readers may perhaps be struck by the fact that in this book no precise definition is given of the terms inflation and deflation (or restriction or contraction); that they are in fact hardly employed at all, and then only in places where nothing in particular depends upon their precision. Only inflationism and deflationism (or restrictionism) are spoken of, and an exact definition is given of the concepts implied by these expressions.11  Obviously this procedure demands special justification.

I am by no means in agreement with those unusually influential voices that have been raised against the employment of the expression inflation altogether.12  But I do think that it is an expression that it is possible to do without, and that it would be highly dangerous, on account of a serious difference between its meaning in the pure economic theory of money and banking and its meaning in everyday discussions of currency policy, to make use of it where a sharp scientific precision of the words employed is desirable.

In theoretical investigation there is only one meaning that can rationally be attached to the expression inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange value of money must occur Again, deflation (or restriction, or contraction) signifies a diminution of the quantity of money (in the broader sense) which is not offset by a corresponding diminution of the demand for money (in the broader sense), so that an increase in the objective exchange value of money must occur If we so define these concepts, it follows that either inflation or deflation is constantly going on, for a situation in which the objective exchange value of money did not alter could hardly ever exist for very long. The theoretical value of our definition is not in the least reduced by the fact that we are not able to measure the fluctuations in the objective exchange value of money, or even by the fact that we are not able to discern them at all except when they are large.

If the variations in the objective exchange value of money that result from these causes are so great that they can no longer remain unobserved, it is usual in discussions of economic policy to speak of inflation and deflation (or restriction, or contraction). Now in these discussions, whose practical significance is extraordinarily great, it would be very little to the purpose to use those precise concepts which alone come up to a strictly scientific standard. It would be ridiculous pedantry to attempt to provide an economist’s contribution to the controversy as to whether in this or the other country inflation has occurred since 1914 by saying: “Excuse me, there has probably been inflation throughout the whole world since 1896, although on a small scale.” In politics, the question of degree is sometimes the whole point, not, as in theory, the question of principle.

But once the economist has acknowledged that it is not entirely nonsensical to use the expressions inflation and deflation to indicate such variations in the quantity of money as evoke big changes in the objective exchange value of money, he must renounce the employment of these expressions in pure theory. For the point at which a change in the exchange ratio begins to deserve to be called big is a question for political judgment, not for scientific investigation.

It is incontrovertible that ideas are bound up with the popular usage of the terms inflation and deflation that must be combated as altogether inappropriate when they creep into economic investigation. In everyday usage, these expressions are based upon an entirely untenable idea of the stability of the value of money, and often also on conceptions that ascribe to a monetary system in which the quantity of money increases and decreases pari passu with the increase and decrease of the quantity of commodities the property of maintaining the value of money stable. Yet however worthy of condemnation this mistake may be, it cannot be denied that the first concern of those who wish to combat popular errors with regard to the causes of the recent tremendous variations in prices should not so much be the dissemination of correct views on the problems of the nature of money in general, as the contradiction of those fundamental errors which, if they continue to be believed, must lead to catastrophic consequences. Those who in the years 1914-24 contested the balance-of-payments theory in Germany in order to oppose the continuation of the policy of inflation may claim the indulgence of their contemporaries and successors if they were not always quite strictly scientific in their use of the word inflation. In fact, it is this very indulgence that we are bound to exercise toward the pamphlets and articles dealing with monetary problems that obliges us to refrain from using these misleading expressions in scientific discussion.

• 11Cp. pp. 219 and 231 above.
• 12Especially Pigou, The Economics of Welfare (London, 1921), pp. 665 ff.

Etatism, as a theory, is the doctrine of the omnipotence of the Estate, and, as a policy, the attempt to regulate all mundane affairs by authoritative commandment and prohibition. The ideal society of etatism is a particular sort of socialistic community; it is usual in discussions involving this ideal society to speak of state socialism, or, in some connections, of Christian socialism. Superficially regarded, the etatistic ideal society does not differ very greatly from the outward form assumed by the capitalistic organization of society. Etatism by no means aims at the formal transformation of all ownership of the means of production into state ownership by a complete overthrow of the established legal system. Only the biggest industrial, mining, and transport enterprises are to be nationalized; in agriculture, and in medium- and small-scale industry, private property is nominally to continue. Nevertheless, all enterprises are to become state undertakings in fact. Owners are to be left the title and dignity of ownership, it is true, and to be given a right to the receipt of a “reasonable” income, “in accordance with their position”; but, in fact, every business is to be changed into a government office and every livelihood into an official profession. There is no room at all for independent enterprise under any variety of state socialism. Prices are to be regulated authoritatively; authority is to fix what is to be produced, and how, and in what quantities. There is to be no speculation, no “excessive” profit, no loss. There is to be no innovation unless it be decreed by authority. The official is to direct and supervise everything.1

It is one of the peculiarities of etatism that it is unable to conceive of human beings living together in society otherwise than in accordance with its own particular socialistic ideal. The superficial similarity that exists between the socialist state that is its ideal and pattern and the social order based upon private property in the means of production causes it to overlook the fundamental differences that separate the two. Everything that contradicts the assumption that the two kinds of social order are similar is regarded by the etatist as a transient anomaly and a culpable transgression of authoritative decrees, as evidence that the state has let slip the reins of government and only needs to take them more firmly in hand for everything to be beautifully in order again. That the social life of human beings is subject to definite limitations; that it is governed by a set of laws that are comparable with those of Nature; these are notions that are unknown to the etatist. For the etatist, everything is a question of Macht—power, force, might. And his conception of Macht is crudely materialistic.

Every word of etatistic thought is contradicted by the doctrines of sociology and economics; this is why etatists endeavor to prove that these sciences do not exist. In their opinion, social affairs are shaped by the state. To the law, all things are possible; and there is no sphere in which state intervention is not omnipotent.

For a long time the modern etatists shrank from an explicit application of their principles to the theory of money. It is true that some, Adolf Wagner and Lexis in particular, expressed views on the domestic and foreign value of money and on the influence of the balance of payments on the condition of the exchanges that contained all the elements of an etatistic theory of money; but always with great caution and reserve. The first to attempt an explicit application of etatistic principles in the sphere of monetary doctrine, was Knapp.

The policy of etatism had its heyday during the period of the world war, which itself was the inevitable consequence of the dominance of etatistic ideology. In the “war economy” the postulates of etatism were realized.2  The war economy and the transition economy showed what etatism is worth and what the policy of etatism is able to achieve.

An examination of etatistic monetary doctrine and monetary policy has a significance that is not limited to the history of ideas. For in spite of all its ill success, etatism is still the ruling doctrine, at least on the continent of Europe. It is, at any rate, the doctrine of the rulers; its ideas prevail in monetary policy. However convinced we may be that it is scientifically valueless, it will not do for us nowadays to ignore it.3

• 1On this, see my book, Die Gemeinwirtschaft, 2d ed., (Jena, 1922), pp. 211 ff.
• 2See my book, Nation, Staat und Wirtschaft (Vienna, 1919), pp. 108 ff.
• 3Cassel rightly says: “A perfectly clear understanding of the monetary problem, brought about by the world war, can never be attained until officialdom’s interpretation of affairs has been disproved point by point, and full light thrown on all the delusions with which the authorities attempted as long as possible to obsess the public mind” (Cassel, Money and Foreign Exchange After 1914 [London, 1922], pp. 7 ff.). See Gregory’s criticism of the most important etatistic arguments in his Foreign Exchange Before, During and After the War (London, 1921), esp. pp. 65 ff.

For the etatist, money is a creature of the state, and the esteem in which money is held is the economic expression of the respect or prestige enjoyed by the state. The more powerful and the richer the state, the better its money. Thus, during the war, it was asserted that “the monetary standard of the victors” would ultimately be the best money. Yet victory and defeat on the battlefield can exercise only an indirect influence on the value of money. Generally speaking, a victorious state is more likely than a conquered one to be able to renounce the aid of the printing press, for it is likely to find it easier to limit its expenditure on the one hand and to obtain credit on the other hand. But the same considerations suggest that increasing prospects of peace will lead to a more favorable estimation of the currency even of the defeated country. In October 1918 the mark and the krone rose; it was believed that even in Germany and Austria a cessation of inflation might be counted upon—an expectation which admittedly was not fulfilled.

History likewise shows that sometimes the “monetary standard of the victors” can prove to be very bad. There have seldom been more brilliant victories than those eventually achieved by the American insurgents under Washington against the English troops. But the American “continental” dollar did not benefit from them. The more proudly the star-spangled banner rose on high, the lower did the exchange rate fall, until, at the very moment when the victory of the rebels was secured, the dollar became entirely valueless. The course of events was no different not long afterward in France. In spite of the victories of the revolutionary army, the metal premium rose continually, until at last in 1796 the value of money touched zero point. In both cases the victorious state had carried inflation to its extreme.

Neither has the wealth of a country any bearing on the valuation of its money. Nothing is more erroneous than the widespread habit of regarding the monetary standard as something in the nature of the shares of the state or the community. When the German mark was quoted at ten centimes in Zurich, bankers said: “Now is the time to buy marks. The German community is indeed poorer nowadays than before the war, so that a low valuation of the mark is justified. Nevertheless, the wealth of Germany is certainly not reduced to a twelfth of what it was before the war; so the mark is bound to rise.” And when the Polish mark had sunk to five centimes in Zurich, other bankers said: “This low level is inexplicable. Poland is a rich country; it has a flourishing agriculture, it has wood, coal and oil; so its rate of exchange ought to be incomparably higher.”4  Such observers fail to recognize that the valuation of the monetary unit depends not upon the wealth of the country, but upon the ratio between the quantity of money and the demand for it, so that even the richest country may have a bad currency and the poorest country a good one.

• 4A leader of the Hungarian Soviet republic said to the author in the spring of 1919: “The paper money issued by the Soviet republic ought really to have the highest exchange rate next to the Russian money, for, through the socialization of the private property of all Hungarians, the Hungarian state has become next to Russia the richest state in the world, and consequently the most deserving of credit.”

The oldest and most popular instrument of etatistic monetary policy is the official fixing of maximum prices. High prices, thinks the etatist, are not a consequence of an increase in the quantity of money but a consequence of reprehensible activity on the part of “bulls” and “profiteers”; it will suffice to suppress their machinations in order to ensure the cessation of the rise of prices. Thus it is made a punishable offense to demand, or even to pay; “excessive” prices.

Like most other governments, the Austrian government during the war began this kind of criminal-law contest with price raising on the same day that it put the printing press in motion in the service of the national finances. Let us suppose that it had at first been successful in this. Let us completely disregard the fact that the war had also diminished the supply of commodities, and suppose that there had been no forces at work on the commodity side to alter the exchange ratio between commodities and money. We must further disregard the fact that the war, by increasing the period of time necessary for transporting money, and by limiting the operation of the clearing system, and also in other ways, had increased the demand for money of individual economic agents. Let us merely discuss the question, what consequences would necessarily follow if, ceteris paribus, with an increasing quantity of money, prices were restricted to the old level by official compulsion?

An increase in the quantity of money leads to the appearance in the market of new desire to purchase, which had previously not existed; “new purchasing power,” it is usual to say, has been created. If the new would-be purchasers compete with those that are already in the market, then, so long as it is not permissible to raise prices, only part of the total purchasing power can be exercised. This means that there are would-be purchasers who leave the market without having effected their object although they were ready to agree to the price demanded, would-be purchasers who return home with the money with which they set out in order to purchase. Whether or not a would-be purchaser who is prepared to pay the official price gets the commodity that he desires depends upon all sorts of circumstances, which are, from the point of view of the market, quite inessential; for example, upon whether he was on the spot in time, or has personal relations with the seller, or other similar accidents. The mechanism of the market no longer works to make a distinction between the would-be purchasers who are still able to buy and those who are not; it no longer brings about a coincidence between supply and demand through variations in price. Supply lags behind demand. The play of the market loses its meaning; other forces have to take its place.

But the government that puts the newly created notes in circulation does so because it wishes to draw commodities and services out of their previous avenues in order to direct them into some other desired employment. It wishes to buy these commodities and services; not, as is also a quite conceivable procedure, to commandeer them by force. It must, therefore, desire that everything should be obtainable for money and for money alone. It is not to the advantage of the government that a situation should arise in the market that makes some of the would-be purchasers withdraw without having effected their object. The government desires to purchase; it desires to use the market, not to disorganize it. But the officially fixed price does disorganize the market in which commodities and services are bought and sold for money. Commerce, so far as it is able, seeks relief in other ways. It redevelops a system of direct exchange, in which commodities and services are exchanged without the instrumentality of money. Those who are forced to dispose of commodities and services at the fixed prices do not dispose of them to everybody, but merely to those to whom they wish to do a favor Would-be purchasers wait in long queues in order to snap up what they can get before it is too late; they race breathlessly from shop to shop, hoping to find one that is not yet sold out.

For once the commodities have been sold that were already on the market when their price was authoritatively fixed at a level below that demanded by the situation of the market, then the emptied storerooms are not filled again. Charging more than a certain price is prohibited, but producing and selling have not been made compulsory. There are no longer any sellers. The market ceases to function. But this means that economic organization based on division of labor becomes impossible. The level of money prices cannot be fixed without overthrowing the system of social division of labor

Thus official fixing of prices, which is intended to establish them and wages generally below the level that they would attain in a free market, is completely impracticable. If the prices of individual kinds of commodities and services are subjected to such restrictions, then disturbances occur that are settled again by the capacity for adjustment possessed by the economic order based on private property sufficiently to make the continuance of the system possible. If such regulations are made general and really put into force, then their incompatibility with the existence of a social order based upon private property becomes obvious. The attempt to restrain prices within limits has to be given up. A government that sets out to abolish market prices is inevitably driven toward the abolition of private property; it has to recognize that there is no middle way between the system of private property in the means of production combined with free contract, and the system of common ownership of the means of production, or socialism. It is gradually forced toward compulsory production, universal obligation to labor, rationing of consumption, and, finally, official regulation of the whole of production and consumption.

This is the road that was taken by economic policy during the war. The etatist, who had jubilantly proclaimed the state’s ability to d o everything it wanted to do, discovered that the economists had nevertheless been quite right and that it was not possible to manage with price regulation alone. Since they wished to eliminate the play of the market, they had to go farther than they had originally intended. The first step was the rationing of the most important necessaries; but soon compulsory labor had to be resorted to and eventually the subordination of the whole of production and consumption to the direction of the state. Private property existed in name only; in fact, it had been abolished.

The collapse of militarism was the end of wartime socialism also. Yet no better understanding of the economic problem was shown under the revolution than under the old regime. All the same experiences had to be gone through again.

The attempts that were made with the aid of the police and the criminal law to prevent a rise of prices did not come to grief because officials did not act severely enough or because people found ways of avoiding the regulations. They did not suffer shipwreck because the entrepreneurs were not public spirited, as the socialist-etatistic legend has it. They were bound to fail because the economic organization based upon division of labor and private property in the means of production can function only so long as price determination in the market is free. If the regulation of prices had been successful, it would have paralyzed the whole economic organism. They only thing that made possible the continued functioning of the social apparatus of production was the incomplete enforcement of the regulations that was due to the paralysis of the efforts of those who ought to have executed them.

During thousands of years, in all parts of the inhabited earth, innumerable sacrifices have been made to the chimera of just and reasonable prices. Those who have offended against the laws regulating prices have been heavily punished; their property has been confiscated, they themselves have been incarcerated, tortured, put to death. The agents of etatism have certainly not been lacking in zeal and energy. But, for all this, economic affairs cannot be kept going by magistrates and policemen.

According to the current view, the maintenance of sound monetary conditions is only possible with a “credit balance of payments.” A country with a “debit balance of payments” is supposed to be unable permanently to stabilize the value of its money; the depreciation of the currency is supposed to have an organic basis and to be irremediable except by the removal of the organic defects.

The confutation of this and related objections is implicit in the quantity theory and in Gresham’s law. The quantity theory shows that money can never permanently flow abroad from a country in which only metallic money is used (the “purely metallic currency” of the currency principle). The tightness in the domestic market called forth by the efflux of part of the stock of money reduces the prices of commodities, and so restricts importation and encourages exportation, until there is once more enough money at home. The precious metals which perform the function of money are distributed among individuals, and consequently among separate countries, according to the extent and intensity of the demand of each for money. State intervention to assure to the community the necessary quantity of money by regulating its international movements is supererogatory. An undesired efflux of money can never be anything but a result of state intervention endowing money of different values with the same legal tender All that the state need do, and can do, in order to preserve the monetary system undisturbed, is to refrain from such intervention. That is the essence of the monetary theory of the Classical economists and their immediate successors, the Currency School. It is possible to refine and amplify this doctrine with the aid of the modern subjective theory; but it is impossible to overthrow it, and impossible to put anything else in its place. Those who are able to forget it only show that they are unable to think as economists.

When a country has substituted credit money or fiat money for metallic money because the legal equating of the overissued paper and the metallic money sets in motion the mechanism described by Gresham’s law, it is often asserted that the balance of payments determines the rate of exchange. But this also is a quite inadequate explanation. The rate of exchange is determined by the purchasing power possessed by a unit of each kind of money; it must be determined at such a level that it makes no difference whether commodities are purchased directly with the one kind of money or indirectly, through money of the other kind. If the rate of exchange moves away from the position that is determined by the purchasing-power parity, which we call the natural or equilibrium rate, then certain sorts of transaction would become profitable. It would become lucrative to purchase commodities with the money that was undervalued by the rate of exchange as compared with the ratio given by its purchasing power, and to sell them for the money that was overvalued in the rate of exchange in comparison with its purchasing power And because there were such opportunities of profit, there would be a demand on the foreign-exchange market for the money that was undervalued by the exchanges and this would raise the rate of exchange until it attained its equilibrium position. Rates of exchange vary because the quantity of money varies and the prices of commodities vary. As has already been remarked, it is solely owing to market technique that this basic relationship is not actually expressed in the temporal sequence of events. In fact, the determination of foreign-exchange rates, under the influence of speculation, anticipates the expected variations in the prices of commodities.

The balance-of-payments theory forgets that the volume of foreign trade is completely dependent upon prices; that neither exportation nor importation can occur if there are no differences in prices to make trade profitable. The theory clings to the superficial aspects of the phenomena it deals with. It cannot be doubted that if we simply look at the daily or hourly fluctuations on the exchanges we shall only be able to discover that the state of the balance of payments at any moment does determine the supply and the demand in the foreign-exchange market. But this is a mere beginning of a proper investigation into the determinants of the rate of exchange. The next question is, What determines the state of the balance of payments at any moment? And there is no other possible answer to this than that it is the price level and the purchases and sales induced by the price margins that determine the balance of payments. Foreign commodities can be imported, at a time when the rate of exchange is rising, only if they are able to find purchasers despite their high prices.

One variety of the balance-of-payments theory attempts to distinguish between the importation of necessaries and the importation of articles that can be dispensed with. Necessaries, it is said, have to be bought whatever their price is, simply because they cannot be done without. Consequently there must be a continual depreciation in the currency of a country that is obliged to import necessaries from abroad and itself is able to export only relatively dispensable articles. To argue thus is to forget that the greater or less necessity or dispensability of individual goods is fully expressed in the intensity and extent of the demand for them in the market, and thus in the amount of money which is paid for them. However strong the desire of the Austrians for foreign bread, meat, coal, or sugar may be, they can only get these things if they are able to pay for them. If they wish to import more, they must export more; if they cannot export manufactured and semimanufactured goods, then they must export shares, bonds, and securities of various kinds. If the note circulation were not increased, then the prices of the objects that were offered for sale would have to decrease if the demand for import goods and hence their prices were to rise. Or else the upward movement of the prices of necessaries would have to be opposed by a fall in the price of the dispensable articles the purchase of which was restricted so as to permit the purchase of the necessaries. There could be no question of a general rise of prices. And the balance of payments would be brought into equilibrium, either by the export of securities and the like, or by an increased export of dispensable goods. It is only when the above assumption does not hold good, only when the quantity of notes in circulation is increased, that foreign commodities can still be imported in the same quantities in spite of a rise in the foreign exchange; it is only because this assumption does not hold good that the rise in the foreign exchange does not throttle importation and encourage exportation until there is again a credit balance of payments.

Ancient Mercantilist error therefore involved a specter of which we need not be afraid. No country, not even the poorest, need abandon the hope of sound currency conditions. It is not the poverty of individuals and the community, not indebtedness to foreign nations, not the unfavorableness of the conditions of production, that force up the rate of exchange, but inflation.

It follows that all the means that are employed for hindering a rise in the exchange rate are useless. If the inflationary policy continues, they remain ineffective; if there is no inflationary policy, then they are superfluous. The most important of these methods is the prohibition or limitation of the importation of certain goods that are deemed dispensable, or at least less indispensable than others. This causes the sums of domestic money that would have been used for the purchase of these commodities to be used for other purchases and naturally the only goods here concerned are those that would otherwise have been sold abroad. These will now be purchased at home for prices that are higher than those offered for them abroad. Thus the reduction of imports and so of the demand for foreign exchange is balanced on the other side by an equal reduction of exports and so of the supply of foreign exchange. Imports are in fact paid for by exports and not by money, as Neo-Mercantilist dilettantism still continues to believe. If it is really desired to dam up the demand for foreign exchange, then the amount of money to the extent of which it is desired to stop importation must be taken away from those at home—say by taxation—and kept out of circulation altogether; that is, not used for state purposes, but destroyed. That is to say, a deflationary policy must be followed. Instead of the importation of chocolate, wine, and lemonade being limited, the members of the community must be deprived of the money that they would otherwise spend on these commodities. Then they must limit their consumption either of these or of some other commodities. In the former case, less foreign exchange will be wanted, in the latter more foreign exchange offered, than previously.

It is not easy to determine whether there are any who still adhere in good faith to the doctrine that traces back the depreciation of money to the activity of speculators. The doctrine is an indispensable instrument of the lowest form of demagogy; it is the resource of governments in search of a scapegoat. There are scarcely any independent writers nowadays who defend it; those who support it are paid to do so. Nevertheless, a-few words must be devoted to it, for the monetary policy of the present day is based largely upon it.

Speculation does not determine prices; it has to accept the prices that are determined in the market. Its efforts are directed to correctly estimating future price situations, and to acting accordingly. The influence of speculation cannot alter the average level of prices over a given period; what it can do is to diminish the gap between the highest and the lowest prices. Price fluctuations are reduced by speculation, not aggravated, as the popular legend has it.

It is true that the speculator may happen to go astray in his estimate of future prices. What is usually overlooked in considering this possibility is that under the given conditions it is far beyond the capacities of most people to foresee the future any more correctly. If this were not so, the opposing group of buyers or sellers would have got the upper hand in the market. The fact that the opinion accepted by the market has later proved to be false is lamented by nobody with more genuine sorrow than by the speculators who held it. They do not err of malice prepense; after all, their object is to make profits, not losses.

Even prices that are established under the influence of speculation result from the cooperation of two parties, the bulls and the bears. Each of the two parties is always equal to the other in strength and in the extent of its commitments. Each has an equal responsibility for the determination of prices. Nobody is from the outset and for all time bull or bear; a dealer becomes a bull or a bear only on the basis of a summing up of the market situation, or, more correctly, on the basis of the dealings that follow on such a summing up. Anybody can change his role at any moment. The price is determined at that level at which the two parties counterbalance each other. The fluctuations of the foreign-exchange rate are not determined solely by bears selling but just as much by bulls buying.

The etatistic view traces back the rise in the price of foreign currencies to the machinations of enemies of the state at home and abroad. These enemies, it is asserted, dispose of the national currency with a speculative intent and purchase foreign currencies with a speculative intent. Two cases are conceivable. Either these enemies are actuated in their dealings by the hope of making a profit, when the same is true of them as of all other speculators. Or they wish to damage the reputation of the state of which they are enemies by depressing the value of its currency, even though they themselves are injured by the operations that lead to this end. To consider the possibility of such enterprises is to forget that they are hardly practicable. The sales of the bears, if they ran against the feeling of the market, would immediately start a contrary movement; the sums disposed of would be taken up by the bulls in expectation of a coming reaction without any effect on the rate of exchange worth mentioning.

In truth, these self-sacrificing bear maneuvers that are undertaken, not to make a profit, but to damage the reputation of the state, belong to the realm of fables. It is true that operations may well be undertaken on foreign-exchange markets that have as their aim, not the securing of a profit, but the creation and maintenance of a rate that does not correspond to market conditions. But this sort of intervention always proceeds from governments, who hold themselves responsible for the currency and always have in view the establishment and maintenance of a rate of exchange above the equilibrium rate. These are artificial bull, not bear, maneuvers. Of course, such intervention also must remain ineffective in the long run. In fact, there is only one way in the last resort to prevent a further fall in the value of money—ceasing to increase the note circulation; and only one way of raising the value of money—reducing the note circulation. Any intervention, such as that of the German Reichsbank in the spring of 1923, in which only a small part of the increasing note expansion was recovered by the banks through the sale of foreign bills, would necessarily be unsuccessful.

Led by the idea of opposing speculation, inflationistic governments have allowed themselves to become involved in measures whose meaning is hardly intelligible. Thus at one time the importation of notes, then their exportation, then again both their exportation and importation, have been prohibited. Exporters have been forbidden to sell for their own country’s notes, importers to buy with them. All trade in terms of foreign money and precious metals has been declared a state monopoly. The quotation of rates for foreign money on home exchanges has been forbidden, and the communication of information concerning the rates determined at home outside the exchanges and the rates negotiated on foreign exchanges made severely punishable. All these measures have proved useless and would probably have been more quickly set aside than actually was the case if there had not been important factors in favor of their retention. Quite apart from the political significance already referred to attaching to the maintenance of the proposition that the fall in the value of money was only to be ascribed to wicked speculators, it must not be forgotten that every restriction of trade creates vested interests that are from then onward opposed to its removal.

An attempt is sometimes made to demonstrate the desirability of measures directed against speculation by reference to the fact that there are times when there is nobody in opposition to the bears in the foreign-exchange market so that they alone are able to determine the rate of exchange. That, of course, is not correct. Yet it must be noticed that speculation has a peculiar effect in the case of a currency whose progressive depreciation is to be expected while it is impossible to foresee when the depreciation will stop, if at all. While, in general, speculation reduces the gap between the highest and lowest prices without altering the average price level, here, where the movement will presumably continue in the same direction, this naturally cannot be the case. The effect of speculation here is to permit the fluctuation, which would otherwise proceed more uniformly, to proceed by fits and starts with the interposition of pauses. If foreign-exchange rates begin to rise, then, to those speculators who buy in accordance with their own view of the circumstances, are added large numbers of outsiders. These camp followers strengthen the movement started by the few that trust to an independent opinion and send it farther than it would have gone under the influence of the expert professional speculators alone. For the reaction cannot set in so quickly and effectively as usual. Of course, it is the general assumption that the depreciation of money will go still farther But eventually sellers of foreign money must make an appearance, and then the rising movement of the exchanges comes to a standstill; perhaps even a backward movement sets in for a time. Then, after a period of “stable money,” the whole thing begins again.

The reaction admittedly begins late, but it must begin as soon as rates of exchange have run too far ahead of commodity prices. If the gap between the equilibrium rate of exchange and the market rate is big enough to give play for profitable commodity transactions, then there will also arise a speculative demand for the domestic paper money. Not until the scope for such transactions has again disappeared owing to a rise in commodity prices will a new rise in the price of foreign exchange set in.

Etatism eventually comes to regard the possession of foreign money, balances as such, and foreign bills, as behavior reprehensible in itself. From this point of view, it is the duty of citizens—not that this is asserted in so many words, but it is the tone of all official declarations—to put up with the harmful consequences of the depreciation of money to their private property and to make no attempt to avoid this by acquiring such possessions as are not eaten up by the depreciation of money. From the point of view of the individual, they declare, it may indeed appear profitable for him to save himself from impoverishment by a flight from the mark, but from the point of view of the community this is harmful and therefore to be condemned. This demand really comes to a cool request on the part of those who enjoy the benefits of the inflation that everybody else should render up his wealth for sacrifice to the destructive policy of the state. In this case, as in all others in which similar assertions are made, it is not true that there exists an opposition between the interests of the individual and the interests of the community. The national capital is composed of the capital of the individual members of the state, and when the latter is consumed nothing remains of the former either. The individual who takes steps to invest his property in such a way that it cannot be eaten up by the depreciation of money does not injure the community; on the contrary, in taking steps to preserve his private property from destruction he also preserves some of the property of the community from destruction. If he surrendered it without opposition to the effects of the inflation all he would do would be to further the destruction of part of the national wealth and enrich those to whom the inflationary policy brings profit.

It is true that not inconsiderable sections of the best classes of the German people have given credit to the asseverations of the inflationists and their press. Many thought that they were doing a patriotic act when they did not get rid of their marks or kronen and mark or kronen securities, but retained them. By so doing, they did not serve the Fatherland. That they and their families have as a consequence sunk into poverty only means that some of the members of those classes of the German people from which the cultural reconstruction of the nation was to be expected are reduced to a condition in which they are able to help neither the community nor themselves.