And yet, few serious books have had such little impact on contemporary thought and policy as this treatise. The world continues to ignore or reject it while it is clinging to antiquated notions and practices. Of course, it is more pleasing and popular for governments to follow the advice of statists and inflationists than to heed the warnings of economists like Professor Ludwig von Mises.
Nearly all contemporary economists adhere to holistic theories that are utterly futile and sterile for an understanding of monetary phenomena. There is the popular “income-expenditure analysis,” which swayed economic thought during the 1930s with the publication of the General Theory of Employment, Interest, and Money by John Maynard Keynes.
According to Keynesian analysis, there is an ideal level of monetary expenditure at which the national economy achieves full employment under stable price conditions. In its search for this ideal level the income-expenditure analysis endeavors to trace the flow of money payments through the economy. As income is quantitatively the largest source of funds spent, an analysis of its determination and disposition is basic to the approach. In addition, funds for spending may be derived from existing reserves of currency and demand deposits, time deposits, and other liquid assets that are easily converted to cash.
And finally, when the ideal level of total spending has not yet been reached, newly created money, preferably demand deposits created through bank credit expansion, may be used to achieve the desired total. In short, it is the principal role of monetary authorities to ensure growth in the monetary reserve base sufficient to facilitate credit expansion for full employment.
As a holistic theory (from the standpoint of the whole rather than the parts) it does not profess to be concerned with individual economic actions, merely with policy guidelines for governments seeking economic growth and full employment. But even in this limited objective it has failed conspicuously wherever it was tried. For massive unemployment continues to be with us after more than 30 years of Keynesian policies.
And finally, there are the “monetarists” of the Chicago School, whose holistic theories resemble the Keynesian doctrines. The famous “equation of exchange,” as developed by Professors Fisher, Marshall, and Pigou, provides their starting point (PT = MV, or P = MVIT). As the price level cannot be expected to remain stable for various reasons, which renders the market system rather unstable, they call on government to take measures to stabilize the level and thus cure the business cycle.
It is true, the economists of the Chicago School reject the compensatory fiscal policies prescribed by the Keynesians because they realize the futility of continuous fine tuning. But they recommend long term stabilization through a steady 3 to 4 percent expansion of the money supply. They have no special trade-cycle theory, merely the prescription for the government to “hold it steady.” “If there is a recession issue more money, and if there is inflation, take some out!”
Both schools of thought, the income-expenditure analysts as well as the monetarists, are unalterably opposed to the gold standard. Its discipline is rejected in favor of governmental power over money.
Von Mises’s subjective theory makes individual choice and action the center of his investigation. On the cornerstone laid by Carl Menger’s theory of the nature and origin of money, Professor Mises, in his Theory of Money and Credit, built a comprehensive and fully integrated structure. With the help of his notable regression theory he completed the subjective theory of money, which had frustrated other economists before him.
Professor Mises demonstrated that the individual demand for money springs from the fact that it is the most marketable good a person can acquire. It is true, money is not suitable to satisfy anyone’s needs directly. But its possession permits him to acquire consumers’ or producers’ goods in the near or more distant future. People want to keep a store of money to provide exchange power for an uncertain future.
Some are satisfied with relatively small holdings; others prefer to hoard larger supplies. And we all change frequently our holdings in accordance with our changing appraisals of future conditions. Money is never “idle,” nor is it just “in circulation”; it is always in the possession or under the control of someone.
The demand for money is subject to the same consideration as that for all other goods and services. People expend labor or forego the enjoyment of goods and services in order to acquire money. This is why individual demand and supply ultimately determine the purchasing power of money in the same way as they determine the mutual exchange ratios of all other goods.
The quantity theory of money as understood by Professor Mises is merely another case of the general theory of demand and supply. However, he rejects the quantity theory as commonly presented by the “monetarists” and other contemporary economists as a sterile aberration that proceeds holistically and arrives at empty equations and models.
Professor Mises’s trade-cycle theory integrates the sphere of money and that of real goods. If the monetary authorities expand credit and thereby lower the interest in the loan market below the natural rate of interest, economic production is distorted.
At first, it generates overinvestment in capital goods and causes their prices to rise while production of consumers’ goods is necessarily neglected. But because of lack of real capital the investment boom is bound to run aground. The boom causes factor prices to rise, which are business costs. When profit margins finally falter, a recession develops in the capital goods industry. During the recession a new readjustment takes place: the malinvestments are abandoned or corrected, and the long-neglected consumers’ goods industries attract more resources in accordance with the true state of public saving and spending.
Mises’s theory has explained numerous economic booms and busts ever since 1912, when the first edition of The Theory of Money and Credit appeared in print. And it continues to provide the only explanation of the rapid succession of booms and recessions that continue to plague our system.
The subjective theory of Professor Mises also points out the desirability of money that is not managed by government. The orthodox gold standard or gold-coin standard is such money, the value of which is independent of government. It is true, it cannot achieve the unattainable ideal of an absolutely stable currency. There is no such thing as stability and unchangeability of purchasing power.
But the gold standard protects the monetary system from the influence of governments as the quantity of gold in existence is utterly independent of the wishes and manipulations of government officials and politicians, parties and pressure groups. There are no “rules of the game;” no arbitrary rules that people must learn to observe. It is a social institution that is controlled by inexorable economic law.
For nearly 60 years of worldwide inflation and credit expansion, depreciations and devaluations, feverish booms and violent busts, Ludwig von Mises’s Theory of Money and Credit has given light in the growing darkness of monetary thought and policy. The world should be grateful that the light is maintained through a new printing of this remarkable analysis.
This review originally appeared in the Freeman, Vol. 21 (1971), pp. 253–256.
