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[Editor’s note: this essay was found among Bettina Bien Greaves’s files. A note in her handwriting indicates that it was written in 1944 and that Mises used it in his 1959 seminar. In this short essay, Mises in his characteristically lucid and forceful manner goes over the basics of monetary theory and shows why the concept of velocity of circulation is useless for understanding changes in the purchasing power of the monetary unit. The original text is reproduced here with the inclusion of some minor edits in Bettina Greaves’s hand.1 ]
Within the fictitious concept of a uniformly turning economic system2 there is no change at all. All economic data remain unchanged and consequently today repeats only what happened yesterday and the day before yesterday, and tomorrow will repeat what happened today. In such an imaginary world there is no uncertainty about the future. Nobody is under the necessity of providing anything for unforeseen events because no such events can possibly occur.
In such a world there is no need for cash holding. Everybody knows in advance what amounts of money he will have to pay at any future date. He can therefore convert all his liquid funds into time deposits with the banks. The sole bank or the whole banking system of such a world does not need any reserves because the total amount becoming due at any date corresponds exactly to the total amount of new time deposits deposited with them on the same date. The banks can therefore sell their total gold reserves to people who employ the metal for non-monetary uses. Money evaporates into a merely nominal unit of accounting, a kind of counter of the character which some economists erroneously ascribed to the actual money of a living and changing economic system. There is, in such a world, neither “liquidity” nor “liquidity preference” in the Keynesian sense of these terms. If we were to apply the misleading popular terminology which calls such a uniformly turning economic system a system of static equilibrium, we would have to say: money is not an element of a static system, it is necessarily always an element of dynamism. But it should be remembered, money is dynamic not because it changes hands, but because it lies—“idle,” as people say mistakenly—in the cash holdings of various individuals and corporate bodies.
The service that money renders does not consist in its turnover. It consists in its being ready in cash holdings for any future use.
Money is never “idle.” It always renders to somebody the only service that it can render, namely being a part of a man’s cash holdings.
Cash holdings are sometimes greater and sometimes smaller with the same individual. But nobody ever has cash holdings greater than he wants to have. If he thinks that his cash holdings are excessive, he invests the surplus either by buying (producers’ or consumers’ goods) or by lending it. (Time deposits are one method of lending money.) It is a judgment of value to call somebody’s cash holding “hoarding.” The individual concerned believes that under the given state of affairs the best policy (or let us say: the minor evil) is to increase his cash holdings. It does not matter whether I approve of his behavior or not. His behavior—not my subjective opinion about its expediency—is a factor influencing the formation of market prices.
It is futile to distinguish between “circulating” money and “idle” money. Money changes hands without being ownerless for any fraction of time. Money may be in the process of transportation, travelling in railroad cars or in other means of transportation. But it is, even from the legal point of view, always in somebody’s possession.
In a changing world everybody is under the necessity of keeping an amount of ready cash on hand. This desire creates the demand for money and makes people willing to sell goods and services in exchange for money. A realistic theory of the value and the purchasing power of money must therefore start from a recognition of these desires. The changes in the purchasing power of the monetary unit are brought about by changes arising in the relation between the demand for money, i.e., the demand for money for cash holding, and the quantity of money available.
The main deficiency of the velocity of circulation concept is that it does not start from the actions of individuals but looks at the problem from the angle of the whole economic system. This concept is one of the elements in the so called equation of exchange which in itself is a vicious mode of approaching the problem of prices and purchasing power. It is assumed that, other things being equal, prices must change in proportion to the changes occurring in the total quantity of money available. This is not true.
Mathematical economics disregards the actions of the individual members of a market society. It looks upon the affairs of a market society in which the individuals and the corporate bodies formed by them are the only agents as if the system were totalitarian with the dictator as the only agent. Of course, such a totalitarian system is to some extent thinkable, although thinking it through to its ultimate logical consequences must needs lead to insoluble contradictions. But at any rate in such a system there are neither prices and wage rates nor money. There are only rations allotted to the subjects for their consumption. The technical tools of this allotment—for instance: rationing cards, assignments of definite quantities of goods and so on—are not money. Nobody would call a railroad ticket “money” and handing it over to the conductor “payment.”
The only method appropriate for dealing with the problems of a market society is the step by step method. It asks in our case: who gets the additional money, when and to what amount? And further: how does this affect cash holdings, prices, and wage rates? In answering this question we must discover that changes in the quantity of money available can never change prices and wage rates proportionately.
Money is of course a social institution. But it is an institution of a society based on the division of labor, private ownership of the means of production and market exchange. In such a society the individuals—not a holistic entity—determine values and prices. A method that disregards the actions of the individuals and operates with holistic concepts is inadequate for the study of such a society.
