The Value of Money
[Excerpted from Theory of Money and Fiduciary Media edited by Jörg Guido Hülsmann, which celebrates the centennial of the great work by Ludwig von Mises, known in English-speaking countries as The Theory of Money and Credit.]
The second part of the Theorie des Geldes und der Umlaufsmittel deals with the “value of money” (Geldwert). This expression is shorthand for the cumbersome Mengerian concept of the “inner exchange value of money.” Following the classical economists and Thomas Malthus in particular, Menger developed his monetary analysis starting from the concrete phenomenon of money prices. He contended that the latter were directly determined by four factors: the demand for and supply of the non-monetary goods that were being traded for money; and the demand for and supply of money itself. All four factors colluded to entail the concrete purchasing power of money (PPM), which Menger called the “outer exchange value” (äusserer Tauschwert) of money. But from an analytical point it was possible to single out the monetary conditions (demand for and supply of money) and call their impact on the PPM the “inner exchange value” (innerer Tauschwert). Conceptually, according to Menger, it was even possible to stabilize the latter, whereas the stabilization of the PPM presupposed comprehensive government price controls.
Somewhat reluctantly, Mises endorsed this terminology. It was a fateful choice. With it came the heavy baggage of the analytical focus on the exchange value of money. With it too came the unfortunate focus on the possible stability of monetary conditions. And last but not least, it risked entailing utter confusion in Mises's readers, especially in those who became acquainted with his thought only through the English edition, for the nuance of the distinction between the exchange value of money and the “inner” exchange value of money was dropped in that edition. As a consequence, the Mengerian-Misesian vocabulary—especially “inflationism,” “monetary policy,” “inflation,” and “deflation”—was inaccurately translated.
Thus, Mises defines inflation as “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 inner objective exchange value of money must occur.” The same problem pertains to the entire final chapter of the second part of his book—the one dealing with “monetary policy”—in which Mises studies government interventions designed to influence the inner exchange value of money. Indeed, the original German title of that chapter is Geldwertpolitik (Policy designed to influence the value of money), and Mises defines it as follows: “Questions of currency policy are questions of the inner objective exchange value of money.”
Causes and Consequences of the Value of Money
Mises found that the traditional literature on the purchasing power of money (PPM) had entirely focused on analyzing the impact of changes in the supply of and demand for money. But before even getting to this question it was necessary to explain the level of PPM in the first place. Only in a second step could one set out to explain the transition from one level to another. Mises provided this missing foundational analysis, highlighting the central role of the subjective value of money and formulating what he would later call the “regression theorem.” He argued that the PPM is directly determined by the subjective value of money—that is, the relative importance of money as compared to the non-monetary goods for which it is being exchanged, in the eyes of all the partners to these exchanges. Thus the subjective value of money explains the equilibrium level of the PPM.
Mises refuted the objections formulated by Wicksell and Helffering against the very possibility of this approach, stressing that they had analyzed the PPM from an overall point of view, whereas the pricing process could only be adequately understood by adopting the subjective point of view of the exchange partners. The subjectivist approach was not unproblematic. The central difficulty was the interdependence between the subjective value of money (SVM) and the PPM. Money was valuable because it had purchasing power, but the purchasing power resulted from the SVM. This seemed to be an instance of circular reasoning, not of causal analysis. But Mises could solve this problem by developing an explanation which he found in Wieser: SVM and PPM did not determine one another simultaneously—which would have precluded causal analysis—but diachronically. Today’s SVM determined today’s PPM, which in turn determines tomorrow’s SVM, which determines tomorrows PPM, etc.
Mises then proceeded to analyze the consequences of changes in the demand for and supply of money. He first dealt with their impact on money prices, especially the price level, and then with their impact on the production and distribution wealth and income. He concluded this part of the book by discussing the policy implications of his findings. Let us highlight his chief contributions in turn.
Concerning the impact of changes in the demand for and supply of money on the price level, Mises made three contributions. First he delivered a subjectivist interpretation of the quantity theory of money, arguing that the money supply and the price level were positively correlated, but stressing at the same time that this relationship was not mechanical. There was no fixed quantitative relationship between an X% variation of the money supply and some Y% variation of the price level.
Second, then, Mises delivered an in-depth critique of the most important variants of the traditional rigid quantity theory, refuting the conceptions of Hume, Mill, and Fisher. Most notably, he argued that, even if one fictitiously assumed that increases in the money stock had no impact on the distribution of wealth and income, such increases would still modify individual value scales and therefore entail a different price structure than the one that had existed before. While the marginal value of money would diminish for each individual, it would not diminish in exactly the same proportion. Again, the mechanical quantity theory does not apply. In the 1924 edition (C168, B126f.), Mises added an additional paragraph to clarify this argument:
If we compare two static economic systems, which differ in no way from one another except that in one there is twice as much money as in the other, it appears that the purchasing power of the monetary unit in the one system must be equal to half that of the monetary unit in the other. Nevertheless, we may not conclude from this that a doubling of the quantity of money must lead to a halving of the purchasing power of the monetary unit; for every variation in the quantity of money introduces a dynamic factor into the static economic system. The new position of static equilibrium that is established when the effects of the fluctuations thus set in motion are completed cannot be the same as that which existed before the introduction of the additional quantity of money. Consequently in the new state of equilibrium the conditions of demand for money, given a certain exchange value of the monetary unit, will also be different. If the purchasing power of each unit of the doubled quantity of money were halved, the unit would not have the same significance for each individual under the new conditions as it had in the static system before the increase in the quantity of money. All those who ascribe to variations in the quantity of money an inverse proportionate effect on the value of the monetary unit are applying to dynamic conditions a method of analysis that is only suitable for static conditions.
Third, he discussed various complications, considering most notably the impact of changes in the demand for money on the PPM (neglected in the traditional theory), as well as inter-local price differences (he denied that they could exist in equilibrium) and the theory of exchange rates (he resuscitated Ricardo’s purchasing-power-parity theorem).
Mises here also briefly touches upon the impact of changes in the demand for and the supply of money on interest rates, but does not yet present his views on the matter, which would have led him to discuss his business cycle theory already in this second part of the book (where it in fact belonged from a systematic point of view). He merely points out that, traditionally, the problem of the purchasing power of money had been completely neglected in inter-temporal exchanges, both by theoreticians and by investors and other practitioners.
Mises proceeded to study the impact of changes in the demand for and supply of money on the production and distribution of wealth and income. Here he emphasizes right from the outset, and then repeatedly throughout the remainder of the book, that there is no relationship between the money supply and aggregate output. Increases of the money supply do not spur, and decreases of the money supply do not hamper the production of wealth. The first time he brings up this point is in the context of his discussion of the general differences between money and all other goods. Here he states:
Both changes in the available quantity of production goods or consumption goods and changes in the available quantity of money involve changes in values; but whereas the changes in the value of the production goods and consumption goods do not mitigate the loss or reduce the gain of satisfaction resulting from the changes in their quantity, the changes in the value of money are accommodated in such a way to the demand for it that, despite increases or decreases in its quantity, the economic position of mankind remains the same. An increase in the quantity of money can no more increase the welfare of the members of a community, than a diminution of it can decrease their welfare.
Thus right from the outset he makes three fundamental points. One, the real money supply (the aggregate purchasing power of all cash balances) tends to adjust to the real demand for cash balances. Two, as a consequence, the nominal money supply is irrelevant for the services provided by money. Three, as a further consequence, changes in the nominal money supply are equally irrelevant for those services. Only under exceptional circumstances could an increase of the nominal money supply, directly or indirectly, bring about advantages from the overall point of view. Increases of the money supply usually did not tend to increase the supply of consumers’ goods (see A227, A335). They had just an impact on the distribution of those goods. Mises reiterated this point again and again as the starting point for all reflection on the social effects of money.
However, Mises stressed almost in the same breath that any change in monetary conditions (demand for and supply of money) affects the distribution of income and wealth. In other words, although there is no causal relationship between the money supply level on the one hand and aggregate production on the other hand, any change in that level, and any change in the demand for money, entails a redistribution of real incomes and therefore also a redistribution of wealth. The reason is that any such change does not affect all prices at the same time and to the same extent. For example, the first users of newly produced money units tend to gain real revenue at the expense of later users, because they can spend these new units right away, while their purchasing power is still relatively high; whereas the later users have to spend them when their purchasing power has already somewhat decreased. These causal relations also play out in the international sphere and affect trade patterns and capital flows.
Based on these elements, Mises concludes the second part of his Theorie des Geldes und der Umlaufsmittel with an in-depth discussion of the nature and scope of monetary policy. He starts off by distinguishing between traditional and modern monetary policy (A246, B200). Traditional interventionism, which involved most notably the depreciation of silver and gold coins, had a purely fiscal motivation. By contrast, modern monetary policy does not necessarily have such a motivation. Rather, its characteristic feature is the hypothesis that changes in the “inner objective exchange value of money” (IOEVM)—especially a decreasing IOEVM—are beneficial. The explanation why they are beneficial varies from one author to another, but the common conviction is that such benefits exist. Thus modern monetary policy is from the outset at crossroads with classical economics à la Ricardo, which rejected the notion that the value of money had anything to do with the wealth of nations. Modern monetary policy seeks to pursue its objectives by modifying the money supply. This presupposes that the modification of the money supply is technically feasible in the first place. It follows, therefore, that the most important tool of modern monetary policy is the choice of the kind of money to be used within the country. In Mises’s words:
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. . . . 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.
The remainder of the chapter on monetary policy has undergone the most momentous changes in the second edition. We will highlight these changes in a subsequent section. In what follows we shall take a closer look at the flow of his initial argument, as presented in the first edition.
Policy Designed to Influence the Value of Money
In the first edition, Mises had approached the actual practice of monetary policy in a very peculiar manner. His discussion is very largely carried on from a historical point of view, and the policy conclusions almost appear as generalizations from the empirical record. This approach was probably motivated by the fact that the book was supposed to earn him a Habilitation degree. Mises had to demonstrate thorough acquaintance with the historical aspects of his field. But he also had to avoid antagonizing his examiners. A straightforward theoretical approach—in line with the previous chapters, as well as with the later ones—would have put his libertarian policy conclusions in stark relief and thus might have compromised his success. As a consequence, the thirteenth chapter of the first edition clashes in style and content with the rest of the book. On these pages Mises writes more like Adam Smith, rather than like Ricardo. The result is pleasant to read and contains many intellectual gems. In what follows we will largely focus on the elements pertaining to causal analysis.
In sections 3 and 4 of chapter 13 (§§3 and 4 of part two, chapter seven in the German editions) Mises presented a very detailed analysis of the history of deflationary (“restrictionist”) and inflationary policies. He especially focused on the nineteenth century, as well as on the history of thought relating to these policies. Mises first deals with the deflationary policies of Austria-Hungary (section 3, A251–58) and then delivers a theoretical explanation of the unpopularity of such policies in general. He argued that the lacking popularity of such policies was essentially due to two factors. One, deflationist policies are usually applied only in a part of the world economy, but this implies that the exports of this country will diminish, while its imports increase—a highly unpopular result. Two, such policies are not advantageous for the ruling classes. Rather, they benefit creditors and “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 people.”
Next (section 4) he turns to the history of inflationary policies, first dealing with the case of England (A264–68), then with the British colonies in North America and with the United States (A268–76), and finally with continental Europe (A276–79). Remarkably, Mises barely mentions the motivations for these policies, deeming them unworthy of discussion. By contrast, he stresses that the actual driving force of such policies was in fact not to be found in theoretical arguments, but rather in the observed stimulation of the economy that had resulted from them (A267).
He goes on (section 5) to discuss the case for inflationism and starts off with the observation that such a policy does not work one time for all, because its effects are only temporary (A279f.). It is therefore necessary to constantly reduce the IOEVM in order to realize the desired objectives. But this is not possible in practice, for three reasons (A280–86). One, the necessary knowledge about quantitative causal relations does not exist. Two, an inflationary policy would invariably wet the appetites of special-interest groups and thus be pushed to exaggerated levels. Three, such a policy would entail disadvantages in respect to international economic relations.
This result seems to suggest that the ideal monetary policy should seek to stabilize the IOEVM. But Mises refutes this conclusion with four related arguments (A287f.). One, such a policy could only be carried out with the help of fiat money and it would require permanent interventions. Two, the quantitative knowledge necessary to carry it out does not exist. Three, special-interest groups would constantly try to exploit this lack of knowledge to their advantage. Four, inflationary policy invites abuse by the state.
What is, then, the best monetary policy? Mises presents a surprising solution—surprising because nothing in his previous argument had prepared it. He argues that in light of his previous considerations “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.” He adds: “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.”
 See Menger (1968 , pp. 73–75, 80–91. In the English edition the distinction between inner and outer exchange value was completely dropped. In a footnote (on p. C146) Batson explains: “Since this distinction has not been usual in English terminology, it has been omitted from the present version; and, in what follows, wherever ‘the objective exchange value of money’ is referred to, it is the innere exchange value that is meant unless the contrary is explicitly stated.”
 He repeatedly referred to Mathus’s Principles of Political Economy. See especially Menger (1968 , p. 82).
 See Menger (1968 , p. 75.
 In a passage where he explained that distinction (not translated into English), he stated (A132f., B104): “Both expressions are somewhat odd. But they have become accepted in science ever since Menger used them. Therefore they shall be used where appropriate in the following investigations.” (Beide Ausdrücke sind nicht gerade glücklich gewählt. Aber sie haben einmal in der Wissenschaft das Bürgerrecht erlangt, seit Menger sie verwendet hat; darum sollen sie auch in den folgenden Untersuchungen dort gebraucht werden, wo dies mit Nutzen geschehen kann.)
 B200, my emphasis JGH. The word “inner” lacks in the English edition, see C272. Similarly, see the definition of the term “inflationism” on A265 (deleted from the second edition). Mises was reluctant to use the term inflation at all, referring to the reservations expressed by Pigou. He thought scientific analysis could do without them. For a penetrating history of the common definitions of the terms inflation and deflation see Bryan (1997).
 A246, B200. Again, the English edition lacks the words “inner” (see C248). The translator, Batson, also tried to make a distinction between Geldwertpolitik, Geldpolitik, and Währungspolitik (see C247, footnote), whereas Mises used all three terms synonymously, as is common in the German-language literature. Similarly, Mises stated that monetary policy in that sense is the “complement” or “corollary” (Gegenstück) of policies designed to influence the prices of single commodities or groups of commodities. Batson translates Gegenstück out of context as “antithesis.”
 Amadeus Gabriel highlights the interesting fact that the core idea of the regression theorem can be traced back to the contemporary German literature. See Gabriel (2012) in the present volume, chapter 2.
 See A154f., B122f., C164.
 In a passage deleted as from the second edition (see A244f.), Mises discusses Irving Fisher’s attempt to empirically validate his contention about the relationship between real and nominal interest rates. Mises points out that Fisher succeeded only in those cases in which the inter-temporal exchange (the credit) involved several currencies; but not in those cases in which the credit was given and returned in terms of a commodity money.
 A78, C101f. See also A263, A402f.
 At one point he almost justified his repetitiveness, stating: “This was not recognized for a long time and to a large extent it is not recognized even nowadays” (A403, C379).
 The monetary interventionism recommended by mercantilist authors such as John Law was therefore not modern monetary policy in Mises’s sense. The mercantilists wished to increase the money stock, but they did not wish to diminish the PPM (even though they might have accepted this consequence as a collateral effect of their policies). See A263f.
 C250, A250, B203.
 He points out that the monetary history of Austria-Hungary in the nineteenth century was one of the most important cases of deflationist policies (A257).
 C264, A261, B217. At this point he quotes Bentham’s In Defence of Usury (1790).
 In the second edition, too, he characterizes a stable inner objective exchange value of money as a—yet unattainable—ideal of monetary policy (see B401).
 C269f., B222, A288. Notice that the English text falsely translates Sachgeld (commodity money) as metallic money.
 C270, B222, A290.