Ludwig von Mises’s contributions stood out against the background we outlined previously in mainstream international economic theory. Mises did not employ an analytical distinction between domestic and international trade, and unlike his contemporary scholars, he did not separate the real and monetary realms of the economy in his analysis. Quite the contrary, his lifelong research program was centered on bridging what he believed to be an artificial theoretical separation. Moreover, Mises also focused on placing entrepreneurship — understood as judgment, or decision-making under uncertainty, a view fully reconcilable with the classical principles of international trade—at the heart of his analysis of international economic phenomena. Albeit scattered throughout his works and weaved into the general economic analysis — thus falling short in terms of systematic and orderly presentation — Mises’s contributions to international economics are nevertheless original, wide-ranging, and eloquent.
Mises began his analysis of the particular aspects of international economics from the fundamental and overarching economic phenomenon of the division of labor. Throughout his works, numerous references were made to the merits of the principle of comparative advantage and the economic benefits of international trade, first explained by Adam Smith and David Ricardo. However, Mises stressed the fact that the adherents of the classical school were mistaken in their belief that the law of comparative costs represented the starting point for a separate theory of value in international trade. In accord with 19th century French liberals, Mises argued that
with regard to the determination of value and of prices there is no difference between domestic and foreign trade. What makes people distinguish between the home market and markets abroad is only a difference in the data, i.e. varying institutional conditions restricting the mobility of factors of production and of products (Mises 1998 [1949], 163).
Consequently, in Human Action, Mises revised the principle of comparative advantage into the law of association, a broader concept that incorporated the more particular law presented by Ricardo. The Misesian law of association indicated that unrestricted production and market exchange take advantage of the more propitious conditions, leading to the specialization of individuals and geographical areas according to their comparatively more suitable characteristics for one branch of production or another. If capital and labor are bound to the national soil, it is goods that move across borders; when capital and labor are free to move between countries,
the tendency inheres to draw labor forces and capital to the locations of the most favorable natural conditions of production without regard to political and national boundaries. [Therefore], unrestricted free trade must lead to a change in the conditions of settlement on the entire surface of the earth: from the countries with less favorable conditions of production capital and labor flow to the countries with more favorable conditions of production” (Mises 1983 [1919], 92).
The analytical coup of Mises’s revised version of the principle of comparative advantage lay primarily in the incorporation of money prices into the analysis of comparative costs, and thus in placing monetary calculation at the heart of understanding cost differences and trade pattern tendencies in international trade. Mises argued that
Monetary calculation… affords us a guide through the oppressive plenitude of economic potentialities. It enables us to extend to all goods of a higher order the judgment of value, which is bound up with and clearly evident in, the case of goods ready for consumption, or at best of production goods of the lowest order. It renders their value capable of computation and thereby gives us the primary basis for all economic operations with goods of a higher order. Without it, all production involving processes stretching well back in time and all the longer roundabout processes of capitalistic production would be groping in the dark” ( Mises 1990 [1920], 14).
This set the foundation for Mises’s overall approach to economic phenomena, both in their domestic and international aspects, which put the concept of money at the heart of the matter. As a result, Mises also explained in detail the causes and consequences of a change in the supply of or the demand for money, and thus gave a complex but operational definition of Cantillon effects, with its manifold aspects concerning prices, production, wealth, and business cycles. Mises wrote:
The essence of monetary theory is the cognition that cash-induced changes in the money relation affect the various prices, wage rates, and interest rates neither at the same time nor to the same extent. If this unevenness were absent, money would be neutral; changes in the money relation would not affect the structure of business, the size and direction of production in the various branches of industry, consumption, and the wealth and income of the various strata of the population. Then the gross market rate of interest too would not be affected either temporarily or lastingly by changes in the sphere of money and circulation credit. The fact that such changes can modify the rate of originary interest is caused by the changes which this unevenness brings about in the wealth and income of various individuals. The fact that, apart from these changes in the rate of originary interest, the gross market rate is temporarily affected is in itself a manifestation of this unevenness (Mises 1998 [1949], 552-3).
As a result of their gradual progress through the economy, from one individual cash balance to another, changes in the money relation thus affect the structure of prices, the structure of production (size and direction of production, and by extension, the size, direction, and composition of trade), the pattern of consumption, and the distribution of income and wealth in an economy. One particularly important instance of these effects is thus the case of the business cycle, when the change in the money relation first takes place on loan markets. In this case, the initial decrease in the gross market interest rates leads primarily to the unsustainable lengthening of the structure of production, which reallocates labor and resources toward the higher order stages of production, but which also revolutionizes prices and redistributes wealth among different groups of the population.
Money occupies in international transactions the same position as all other commodities being exchanged: once a general medium of exchange is selected on the market, barter exchange ratios between the goods imported and exported disappear in a monetary economy, superseded by money prices.
Internationally, therefore, Mises pointed out that “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” (Mises 1953, 182). Consequently, “the volume of foreign trade is completely dependent upon [money] prices; neither exportation nor importation can occur if there are no differences in prices to make trade profitable” (Mises 1953, 250). By extension, Mises also reached the conclusion that the balance of payments is consequently determined “by the price level and the purchases and sales induced by the price margins” (Mises 1953, 244 ), making money the active element of the balance of payments, and not an accommodating flow of the movement of ‘real’ goods across borders.
By exposing this indelible connection between the demand for money and the demand for goods (sides of the same coin) which drive the equilibration of the international monetary system through changes in individual cash-balances, Mises was able to argue that the separation between the monetary and real economy in the economic analysis was both artificial and pernicious. Throughout the 20th century, Mises remained one of the singular voices to argue that “money without a driving force of its own [...] would not be money at all” and that “money is neither neutral nor stable in purchasing power” (Mises 1998 [1949], 415-6).
What happens then with the purchasing power of money, and subsequently with the exchange rate, when there is a change in the demand for or supply of money? Mises based his arguments—and his definition of money non-neutrality, or Cantillon effects—on the insight that any changes in the supply and demand for money cannot run their course through the economy without first and foremost modifying the levels of individual cash-balances. He argued that if individual cash-balances cannot be increased or decreased simultaneously, the purchasing power of money also cannot be altered instantaneously following a change in the money relation. For example, an increase in the supply money is necessarily distributed step-by-step, from one individual money holder to another, spent and re-spent within and across borders “in a sequence of monetary changes” (Salerno 2010, 155) which drive down the purchasing power of the monetary unit. This process goes on until cash balances, the purchasing power array, and the exchange rate between currencies are established, uno acto, at the new levels. Consequently, argued Mises, individual prices never change at the same time and to the same extent following a change in the money supply. The economic and social consequences taking place during this adjustment process represent the Cantillon effects of a monetary expansion.
What are the welfare effects of change in the money supply? According to Mises, such monetary changes will necessarily lead to the redistribution of wealth on a general scale. The reason for these social changes, Mises argued, is twofold: on the one hand, “all economic agents are in a sense dealers” in currency (Mises 1953, 206), such that changes in its value affect the economic position of every individual. On the other hand, he continued,
the economic consequences of variations in the value of money are determined by the nature of their slow progress, from person to person, from class to class, and from country to country. [...] The fact that these variations occur one after the other is the sole reason for their remarkable economic effects (Mises 1953, 210; emphasis in the original).
First, only some people will initially have higher cash-balances (the first receivers of the new money); given decreasing marginal utility, they will value each currency unit less, so they will be willing to pay higher prices for the goods they prefer. As “a lower subjective valuation of money [will be] then passed on from person to person” (Mises 1953, 208), individual money prices will rise or fall depending on the path in which the additional money is spent, thus depending on the pattern consumer preferences. This process, which gradually drives the equilibration of the purchasing power array to the new money relation, does not affect commodity prices at the same date and to the same extent, i.e. prices do not change simultaneously or proportionally to the change in the money relation.
As a result, argued Mises, “while the process is under way, some people enjoy the benefit of higher prices for the goods and services they sell, while the prices of the things they buy have not yet risen to the same extent” (Mises 1998 [1949], 409-10). Wealth is thereby necessarily redistributed towards the first receivers of money from those who receive it last, or never, and who have to pay higher prices in the meantime. In other words, Mises defined Cantillon effects as the economic phenomenon in which modifications of the money supply gradually and unevenly percolate through the structure of money prices, and more importantly, modify the distribution of resources and wealth in an economy in the short run and on the long term.
More importantly, this changes are permanent. Each change in the money supply takes a different course through the economy toward establishing the new purchasing power array, such that the process will arbitrarily create winners and losers, i.e. benefitting and affecting different individuals each time, and to different extents. This means that the social changes brought about by monetary changes cannot be undone: the redistribution of wealth caused by an increase in the money supply cannot be offset by a subsequent decrease, or by a concurrent increase in the money demand.
Mises’s contributions represented a serious blow to the theoretical integrity of the classical dichotomy—which he often referred to as the ‘barter fiction’—, and implicitly to that of the money neutrality postulate. First, his analysis showed that once a commodity surfaces as the general medium of exchange in an economy, there no longer exist barter transactions and thus barter prices cannot exist either. All exchange ratios are necessarily money prices. Second, it illuminated the fact that the geographical equalization of the purchasing power of money throughout the world is accomplished as part of the same market process that creates the structure of money prices, and brings about the division of labor, thereby making monetary analysis an integral element of economic analysis. Third, it underscored the insight that money is redistributed among individuals according to their individual preferences for cash holdings in a sequential process of monetary exchanges, dispensing with the classical aggregate approach to monetary matters and proposing a disaggregate, ‘microeconomic’ approach.
For international trade in particular, Mises’s insights showed that money is embedded in the economic phenomenon of cross-border exchange. Money makes economic calculation possible by overcoming the drawbacks of direct and indirect exchange, and allows entrepreneurs to judge and plan transactions and extensive production processes (Mises 1990 [1920]). International movements of goods, services, and factors of production are necessarily guided by monetary calculation, and require above all the use of money and the judgement of the entrepreneurs. As Mises pointed out in Socialism, “in foreign trade, just as in internal trade—there is no difference between them—no rational production could proceed without money reckoning and the formation of prices for the means of production” (Mises 1951, 232). A general medium of exchange begets complex and roundabout division of labor, within and across national borders.
Last but not least, Mises’s contribution showed there is no difference in the effects on the distribution of income and wealth whether the variations in the purchasing power of money occur within a single national economy or within internationally connected market economies, or whether it’s the case of metallic money or fiat money (Mises 1953, 208). Just like in the case of a single national currency, the “interrelated variations in the complex of individual cash balances, incomes and prices” (Salerno 2010, 156 ) drive toward the equilibration of the purchasing power of money internationally as well, in a sequence of monetary changes — and it is these individual, microeconomic changes which constitute the focus point of an analysis of Cantillon effects on a national and global level. In other words, the process which brings the balance of payments to its equilibrium, works in a similar way in the case of a change in the money supply: money will move, internationally, from one money holder to another until the new purchasing power array is established together with the desired level of individual cash-balances. Therefore, the inherent social transformations accompanying all such monetary changes will concurrently take place across borders as well: wealth will be redistributed towards the first receivers of money from the last receivers, as the transfer of wealth is parallel, and of opposite sense, to the inflow of new money in the global economy.
