Chapter 11—Money and Its Purchasing Power
(continued)
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Chapter 11—Money
and Its Purchasing Power (continued)
6.
The Supply of Money
A.
The Stock of the Money Commodity
The total stock of money in a society is the total number of ounces of
the money commodity available. Throughout this volume we have
deliberately used “gold ounces” instead of
“dollars” or any other name for money,
precisely because on the free market the latter would only be a
confusing term for units of weight of gold or
silver.
The total stock, from one period to another, will increase from new
production and decrease from being used up—either in
industrial production as a nonmonetary factor or from the wear
and tear of coins. Since one of the qualities of the money
commodity is its durability, the usual tendency is a long-run
increase in the money supply and a resulting gradual long-run decline
in the PPM. This furthers social utility only in so far as more gold or
silver is made available for nonmonetary purposes.
We saw in chapter 3 that the physical form of the monetary commodity
makes no difference. It can be in nonmonetary use as jewelry, in the
form of bars of bullion, or in the form of coins. On the free market,
transforming gold from one shape to another would be a business like
any other business, charging a market price for its service and earning
a pure interest return in the ERE. Since gold begins as bullion and
ends as coin, it would seem that the latter would command a small
premium over the equivalent weight of the former, the bullion often
being a capital good for coin. Sometimes, however, coins are remelted
back into bullion for larger transactions, so that a premium for coin
over bullion is not a certainty. If, as generally happens,
minting coins costs more than melting, coins will command the
equivalent premium over bullion. This premium is called brassage.
It is impossible for economics to predict the details of the structure
of any market. The market for privately issued gold bars or coins might
develop as homogeneous, like the market for wheat, or the coins might
be stamped and branded by the coinmakers to certify to the
quality of their product. Probably the public would buy only branded
coins to ensure accurate quality.
One argument against permitting free private coinage is that compulsory
standardization of the denominations of coins is more convenient than
the diversity of coins that would ensue under a free system. But if the
market finds it more convenient, private mints will be led by consumer
demand to mint certain standard denominations. On the other hand, if
greater variety is preferred, consumers will demand and obtain a more
varied number of coins.
B.
Claims to Money: The Money Warehouse
Chapter 2 described the difference between “claims to present
goods” and “claims to future goods.” The
same analysis applies to money as to barter. A claim to future money is
a bill of exchange—an
evidence of a credit transaction. The holder of the bill—the
creditor—redeems it at the date of redemption in
exchange for money paid by the debtor. A claim to present
money, however, is a completely different good. It is not
the evidence of an uncompleted transaction, an
exchange of a present for a future good, as is the bill; it is a simple
evidence of ownership of a present good. It is not
uncompleted, or an exchange on the time market. Therefore, to present
this evidence for redemption is not the completion
of a transaction or equivalent to a creditor’s calling his
loan; it is a simple repossessing of a
man’s own good. In chapter 2 we gave as examples of a claim
to present goods warehouse receipts and shares of stock. Shares of
stock, however, cannot be redeemed in parts of a company’s
fixed assets because of the rules of ownership that the companies
themselves set up in their co-operative venture. Furthermore, there is
no guarantee that such assets will have a fixed money value. We shall
therefore confine ourselves to warehouse receipts,
which are also more relevant to the supply of money.
When a man deposits goods at a warehouse, he is given a receipt and
pays the owner of the warehouse a certain sum for the service of
storage. He still retains ownership of the property; the owner of the
warehouse is simply guarding it for him. When the warehouse receipt is
presented, the owner is obligated to restore the good
deposited. A warehouse specializing in money is known as a
“bank.”
Claims to goods are often treated on the market as equivalent to the
goods themselves. If no fraud or theft is suspected, then evidence of
ownership of a good in a warehouse is considered as equivalent to the
good itself. In many cases, individuals will find it advantageous to
exchange the claims or evidences—the goods-substitutes—rather
than the goods themselves. Paper is more convenient to transfer from
person to person, and the expense of moving the goods is eliminated.
When Jones sells Smith his wheat, therefore, instead of moving the
wheat from one place to another, they may well agree simply to transfer
the warehouse receipt itself from Jones to Smith. The goods remain in
the same warehouse until Smith needs them or until the receipt is
transferred to someone else. Of course, Smith may prefer, for one
reason or another, to keep the goods in his own warehouse, in which
case they are moved from one to the other.
Let us take the case of a warehouse owned by the Trustee
Warehouse Company. It holds various goods in its vaults for
safekeeping. Suppose that this company has developed a
reputation for being very reliable and theft-free. Consequently, people
tend to leave their goods in the Trustee Warehouse for a considerable
length of time and, in the case of goods that they do not use
frequently, will even tend to transfer the goods-certificates
(the warehouse receipts, or evidences of ownership of the goods) and
not redeem the goods themselves. Thus, the goods-certificates act as
goods-substitutes in exchange. Suppose that the Trustee Company sees
this happening. It realizes that a good opportunity for fraud presents
itself. It can take the depositors’ goods, the goods that it
holds for safekeeping, and lend them out to people on the market. It
can earn interest on these loans, and as long as only a small
percentage of depositors ask to redeem their certificates at
any one time, no one is the wiser. Or, alternatively, it can issue
pseudo warehouse receipts for goods that are not there and lend these
on the market. This is the more subtle practice. The pseudo receipts
will be exchanged on the market on the same basis as the true receipts,
since there is no indication on their face whether they are legitimate
or not.
It should be clear that this practice is outright fraud. Someone
else’s property is taken by the warehouse and used for its
own money-making purposes. It is not borrowed,
since no interest is paid for the use of the money. Or, if spurious
warehouse receipts are printed, evidences of goods
are issued and sold or loaned without any such goods being in existence.
Money is the good most susceptible to these practices. For
money, as we have seen, is generally not used directly at all, but only
for exchanges. It is, furthermore, a widely homogeneous good, and
therefore one ounce of gold is interchangeable with any other. Since it
is convenient to transfer paper in exchange rather than carry gold,
money warehouses (or banks) that build up public confidence will find
that few people redeem their certificates. The banks will be
particularly subject to the temptation to commit fraud and
issue pseudo money certificates to circulate side by side with
genuine money certificates as acceptable money-substitutes. The fact
that money is a homogeneous good means that people do not care whether
the money they redeem is the original money they deposited. This makes
bank frauds easier to accomplish.
“Fraud” is a harsh term, but an accurate one to
describe this practice, even if not recognized as such in the law, or
by those committing it. It is, in fact, difficult to see the economic
or moral difference between the issuance of pseudo receipts and the
appropriation of someone else’s property or outright
embezzlement or, more directly, counterfeiting. Most present legal
systems do not outlaw this practice; in fact, it is considered basic
banking procedure. Yet the libertarian law of the free market would
have to prohibit it. The purely free market is, by definition, one
where theft and fraud (implicit theft) are illegal and do not exist.
To part with goods or money held in trust or to issue spurious
warehouse receipts is, of course, a dangerous business, even when the
law permits it. If the warehouse once failed to meet its
contractual obligations, its fraud would be discovered, and a
general panic “run” on the warehouse or bank would
ensue. It would then be quickly plunged into bankruptcy. Such a
bankruptcy, however, would not be similar to the failure of an ordinary
speculative business enterprise. It is rather similar to the
absconder who gets caught before he has returned the funds he
has “borrowed.”
Even if the receipt does not say on its face that the warehouse
guarantees to keep it in its vaults, such an agreement is implicit
in the very issuance of the receipt. For it is obvious that if any
pseudo receipts are issued, it immediately becomes impossible for the
bank to redeem all of them, and therefore fraud is immediately
being committed. If a bank has 20 pounds of gold in its vaults, owned
by depositors, and gold certificates redeemable on demand for 30
pounds, then notes to the value of 10 pounds are fraudulent. Which
particular receipts are fraudulent can be determined only after
a run on the bank has occurred and the later claimants are left
unsatisfied.
In a purely free market where fraud cannot, by definition, occur, all
bank receipts will be genuine, i.e., will represent only actual gold or
silver in the vaults. In that case, all the bank’s money-substitutes
(warehouse receipts) will also be money certificates,
i.e., each receipt genuinely certifies the actual existence of the
money in its vaults. The amount of gold kept in bank vaults for
redemption purposes is called its “reserves,” and
the policy of issuing only genuine receipts is therefore a policy of
“100-percent reserves” of cash to demand
liabilities (liabilities that must be paid on demand).
However, the term
“reserve” is a misleading one, because it assumes
that the bank owns the gold and
independently decides how much of it to keep on
hand. Actually, it is not the bank that owns the gold, but its
depositors.
An enormous literature has developed dealing with the physical
form of the money receipts, and yet the physical form is of no economic
importance. It may be in the form of a paper note,
a token coin (essentially a note stamped on coin
instead of paper), or a book credit (demand deposit)
in the bank. The demand deposit is not tangibly held by the
owner, but can be transferred to anyone he desires by written order to
the bank. This order is called a check. The
depositor has a choice of which form of receipt to take, according to
his convenience. Which form he chooses makes no economic difference.
C.
Money-Substitutes and the Supply of Money
Since money-substitutes exchange as money on the market, we must
consider them as part of the supply of money. It then becomes necessary
to distinguish between money (in the broader sense)—the
common medium of exchange—and money proper.
Money proper is the ultimate medium of exchange or standard
money—here the money commodity—while
the supply of money (in a broader sense) includes all the standard
money plus the money-substitutes that are held in
individuals’ cash balances. In the cases cited above, gold
was the money proper or standard money, while the
receipts—the demand claims to gold—were the
money-substitutes.
The relation between these elements may be illustrated as follows:
Assume a community of three persons, A, B, C, and three money
warehouses, X, Y, Z. Suppose that each person has 100 ounces of gold in
his possession and none on deposit at a warehouse. For the community,
then:
The
total supply of money is here identical with the total supply of money
proper.
Now
assume that A and B each deposits his 100 ounces of gold at warehouses
X and Y respectively, while C keeps his gold on hand. The total supply
of money is always equal to the total of individual cash balances. Its
composition now is:
A—100
ounces of X-Money-Substitute
B—100 ounces of Y-Money-Substitute
C—100 ounces of Gold Money Proper
Total supply of money (in the broader sense) = Total cash
balances = 200 ounces of money-substitutes + 100 ounces of
money proper.
The effect of the deposit of money proper in the warehouses or banks is
to change the composition of the total supply of
money in cash balances; the total amount, however, remains unchanged at
300 ounces. Money-substitutes of various banks have replaced most of
the standard money in individual cash holdings. Similarly, if A and B
were to redeem their deposits, the total amount would remain unchanged,
while the composition would revert to the original pattern.
What of the 200 ounces of gold deposited in the vaults of the banks?
These are no longer part of the money supply; they are held in reserve
against the outstanding money-substitutes. While in reserve, they form
no part of any individual’s cash balance; the cash balances
consist not of the gold, but of evidences of ownership of the gold.
Only the money proper outside of bank reserves forms part of
individuals’ cash balances and hence part of the
community’s supply of money.
Thus, as long as all money-substitutes are full money
certificates, an increase or decrease in the money-substitutes
outstanding can have no effect on the total supply of money. Only the composition
of that supply is affected, and such changes in composition are of no
economic importance.
However, when banks are legally permitted to abandon a 100-percent
reserve and to issue pseudo receipts, the economic effects are quite
different. We may call the money-substitutes that are not genuine money
certificates, uncovered money-substitutes, since
they do not genuinely represent money. The issue of uncovered
money-substitutes adds to individuals’ cash balances and
hence to the total supply of money. Uncovered money-substitutes are not
offset by new money deposits and so constitute net additions
to the total supply. Any increase or decrease in the supply
of uncovered money-substitutes increases or decreases to the same
extent the total supply of money (in the broader
sense).
Thus, the total supply of money is composed of the following elements: supply
of money proper outside reserves + supply of money
certificates + supply of uncovered money-substitutes.
The supply of money certificates has no effect on the size of the
supply of money; an increase in this factor only decreases the size of
the first factor. The supply of money proper and the factors
determining its size have already been discussed. It depends on annual
production compared to annual wear and tear, and thus, on the
unhampered market, the supply of money-proper changes only slowly. As
for uncovered money-substitutes, since they are essentially a
phenomenon of the hampered rather than the free market, factors
governing their supply will be further discussed below, in chapter 12.
In the meanwhile, however, let us analyze a little further the
difference between a 100-percent-reserve and a fractional- reserve
bank. The Star Bank, let us suppose, is a 100-percent-reserve bank; it
is established with 100 gold ounces of capital invested by its
stockholders in building and equipment. In the familiar balance sheet,
with assets on the left-hand side and liabilities and capital on the
right-hand side, the condition of the bank now appears as follows:
The Star Bank is ready to begin operations. Several people now come and
deposit gold in the bank, which in return issues warehouse
receipts giving the depositors (the true owners of the gold) the right
to redeem their property on demand at any time. Let us assume that
after a few months 5,000 gold ounces have been deposited and stored in
the bank’s vaults. Its balance sheet now appears as follows:
The warehouse receipts function and exchange as
money-substitutes, replacing, not adding
to, the gold stored in the bank. All the warehouse receipts are money
certificates, 100-percent reserve has been maintained, and no invasion
of the free market has occurred. The warehouse receipts may take the
form of printed tickets (notes) or book credit (demand deposits)
transferable by written order or “check.” The two
are economically identical.
But now suppose that law enforcement is lax and the bank sees that it
can make money easily by engaging in fraud, i.e., by lending some of
the depositors’ gold (or, rather, issuing pseudo warehouse
receipts for nonexistent gold and lending them) to people who wish to
borrow it.
Let us say that the Star
Bank, chafing at the mere interest return earned on its fees for
warehouse service, prints 1,000 ounces of pseudo warehouse
receipts and lends them on the credit market to businesses and
consumers who desire to borrow money. The balance sheet of the Star
Bank is now as follows:
The warehouse receipts still function as money-substitutes on the
market. And we see that new money has been created by the bank out of
thin air, as if by magic. This process of money creation has
also been called the “monetization of debt,” an apt
term since it describes the only instance where a liability
can be transformed into money—the supreme asset.
It is obvious that the more money the bank creates, the more profits it
will earn, for any income earned on newly created money is a pure
unalloyed gain. The bank has been able to alter the conditions of the
free market system, in which money can be obtained only by
purchase, mining, or gift. In each of these routes, productive
service—either one’s own or one’s
ancestor’s or benefactor’s—was necessary
in order to obtain money. The bank’s inflationary
intervention has created another route to money: the creation of new
money out of thin air, by issuing receipts for nonexistent gold.
D.
A Note on Some Criticisms of 100-Percent Reserve
One popular criticism of 100-percent bank reserves charges that the
bank could not then earn any income or cover costs of storage,
printing, etc. On the contrary, a bank is perfectly capable of
operating like any goods warehouse, i.e., by charging its
customers for its services to them and reaping the usual
interest return on its operations.
Another popular objection is that a 100-percent-reserve policy would
eliminate all credit. How would businessmen be able to borrow funds for
short-term investment? The answer is that businessmen can still borrow saved
funds from any individual or institution.
“Banks” may still lend their own saved funds
(capital stock and accumulated surplus) or they may borrow funds from
individuals and relend them to business firms, earning the interest
differential.
Borrowing money (e g.,
floating a bond) is a credit transaction; an individual
exchanges his present money for a bond—a claim on future
money. The borrowing bank pays him interest for this loan and in turn
exchanges the money thus gathered for promises by business borrowers to
pay money in the future. This is a further credit transaction, in this
case the bank acting as the lender and businesses as the borrowers. The
bank’s income is the interest differential between the two
types of credit transactions; the payment is for the services of the
bank as an intermediary, channeling the savings of the public into
investment. There is, furthermore, no particular reason why the short-term,
more than any other, credit market should be subsidized by money
creation.
Finally, an important criticism of a governmentally enforced policy of
100-percent reserves is that this measure, though beneficial in itself,
would establish a precedent for other governmental
intervention in the monetary system, including a change in
this very requirement by government edict. These critics advocate
“free banking,” i.e., no governmental interference
with banking apart from enforcing payment of obligations, the banks to
be permitted to engage in any fictitious issues they desire. Yet the
free market does not mean freedom to commit fraud or any other form of
theft. Quite the contrary. The criticism may be obviated by imposing a
100-percent-reserve requirement, not as an arbitrary administrative
fiat of the government, but as part of the general legal defense of
property against fraud. As Jevons stated: “It used to be held
as a general rule of law, that any present grant or assignment
of goods not in existence is without operation,”
and this general rule need
only be revived and enforced to outlaw fictitious money-substitutes.
Then banking could be left perfectly free and yet be without departure
from 100-percent reserves.
7.
Gains and Losses During a Change in the Money Relation
A change in the money relation necessarily involves gains and losses
because money is not neutral and price changes do not take place
simultaneously. Let us assume—and this will rarely hold in
practice—that the final equilibrium position resulting from a
change in the money relation is the same in all respects
(including relative prices, individual values, etc.) as the
previous equilibrium, except for the change in the purchasing
power of money. Actually, as we shall see, there will almost
undoubtedly be many changes in these factors in the new equilibrium
situation. But even if there are not, the movement
of prices from one equilibrium position to the next will not take place
smoothly and simultaneously. It will not
take place according to the famous example of David Hume and John
Stuart Mill, where everyone awakens to find his money supply doubled
overnight. Changes in the demand for money or the stock of money occur
in step-by-step fashion, first having their effect in one area of the
economy and then in the next. Because the market is a complex
interacting network, and because some people react more quickly than
others, movements of prices will differ in the speed of
reaction to the changed situation.
As we have intimated above, the following law can be
enunciated: When a change in the money relation causes prices
to rise, the man whose selling price rises before his buying prices
gains, and the man whose buying prices rise first, loses. The one who
gains the most from the transition period is the one whose selling
price rises first and buying prices last. Conversely, when prices fall,
the man whose buying prices fall before his selling price gains, and
the man whose selling price falls before his buying prices, loses.
It should be evident, in the first place, that there is nothing about
rising prices that causes gains or about falling prices that causes
losses. In either situation, some people gain and some people lose from
the change, the gainers being the ones with the greatest and lengthiest
positive differential between their selling and their buying
prices, and the losers the ones with the greatest and longest negative
differential in these movements. Which people gain and which lose from
any given change is an empirical question, dependent on the location of
changes in elements of the money relation, institutional
conditions, anticipations, speeds of reaction, etc.
Let us consider the gains and losses from an increase in money stock.
Suppose that we start from a position of monetary equilibrium. Every
person’s money relation is in equilibrium, with his stock of
and demand for money being equal. Now suppose that Mr. Jones finds some
new gold never known before. A change in Jones’ data has
taken place. He now has an excess stock of gold in his cash balance
compared with his demand for it. Jones acts to spend his excess cash
balance. This new money is spent, let us say, on the products of Smith.
Smith now finds that his cash balance exceeds his demand for money, and
he spends his excess on the products of someone else.
Jones’ increased supply also increases Smith’s
selling price and income. Smith’s selling price has increased
before his buying price. He spends the money on the products of
Robinson, thus raising the latter’s selling prices while most
buying prices have not risen. As the money is transferred from hand to
hand, buying prices rise more and more. Robinson’s selling
price increases, for example, but already one of the products
he buys—Smith’s—has gone up. As the
process continues, more and more buying prices rise. The individuals
who are far down “on the list” to receive the new
money, therefore, find that their buying prices have increased while
their selling prices have not yet done so.
Of course, the changes in the money supply and in prices may well be
insignificant. But this process occurs, however large or small the
change in the money stock. Obviously, the larger the increase in money
stock, the greater, ceteris paribus, will be its
impact on prices.
We have seen above that an increase in the stock of money leads to a
fall in the PPM, and a decrease in the stock of money leads to a rise
in the PPM. However, there is no simple and uneventful rise
and fall in the PPM. For a change in the stock of money is not
automatically simultaneous. New money enters the system at
some specific point and then becomes diffused in this way
throughout the economy. The individuals who receive the new money first
are the greatest gainers from the increased money; those who receive it
last are the greatest losers, since all their buying prices have
increased before their selling prices. Monetarily, it is clear
that the gains of the approximate first half of the recipients of new
money are exactly counterbalanced by the losses of the second half.
Conversely, if money should somehow disappear from the system,
say through wear and tear or through being misplaced, the initial loser
cuts his spending and suffers most, while the last who feel the impact
of a decreased money supply gain the most. For a decrease in the money
supply results in losses for the first owners, who suffer a cut in
selling price before their buying prices are lowered, and gains for the
last, who see their buying prices fall before their income is cut.
This analysis bears out our assertion above that there is no social
utility in an increased supply, nor any social disutility in a
decreased supply, of money. This is true for the transition period as
well. An increase in gold is socially useful (i.e., beneficial to some
without demonstrably injuring others) only to the extent that it makes
possible an increase in the nonmonetary, direct use of gold.
If, as we have been assuming, relative prices and valuations remain the
same for all throughout, the new equilibrium will be identical with the
old except for an all-round price change. In that case, the gains and
losses will be temporary, disappearing upon the advent of the new
equilibrium. Actually, however, this will almost never occur. For even
if people’s values remain frozen, the shift in relative money
income during the transition itself changes the structure of demand.
The gainers of wealth during the transition period will have a
structure of preferences and demand different from that of the losers.
As a result, demand itself will shift in structure, and the new
equilibrium will have a different set of relative prices.
Similarly, the change will probably not be neutral to time preferences.
The permanent gainers will undoubtedly have a different structure of
time preferences from that of the permanent losers, and, as a result,
there may be a permanent shift in general time preferences.
What the shift will be or in which direction, it is of course
impossible for economics to say.
Money changes have this “driving force,” it may be
noted, even in the fanciful case of the automatic overnight doubling of
the supply of everyone’s cash balance. For the fact that
everyone’s money stock doubles does not at all mean that all
prices will automatically double! Each individual has a
differently shaped demand-for-money schedule, and it is impossible to
predict how each will be shaped. Some will spend
proportionately more of their new money, and others will keep
proportionately more in their cash balance. Many people will tend to
spend their new cash balances on different goods from those they had
bought with their old money. As a result, the structure of demand will
change, and a decreased PPM will not double all prices; some will
increase by more and some by less than double.
8.
The Determination of Prices: The Goods Side and the Money Side
We are now in a position to draw together all the strands determining
the prices of goods. In chapters 4 through 9 we analyzed all
the determinants of the prices of particular goods. In this chapter we
have analyzed the determination of the purchasing power of
money. Now we can see how both sets of determinants blend
together.
A particular price, as we have seen, is determined by the total demand
for the good (exchange and reservation) and the stock of the good,
increasing as the former increases and decreasing as the latter
increases. We may therefore call the demand a “factor of
increase” of the price, and the stock a “factor of
decrease.” The exchange demand for each
good—the amount of money that will be spent in exchange for
the good—equals the stock of money in the society minus the
following: the exchange demands for all other goods and the reservation
demand for money. In short, the amount spent on X
good equals the total money supply minus the amount spent on other
goods and the amount kept in cash balances.
Suppose we overlook the difficulties involved and now consider the
price of “all goods,” i.e., the reciprocal of the
purchasing power of money. The price of goods-in-general will now be
determined by the monetary demand for all goods (factor of
increase) and the stock of all goods (factor of decrease).
Now, when all goods are considered, the exchange demand for goods
equals the stock of money minus the reservation demand for money. (In
contrast to any specific good, there is no need to subtract
people’s expenditures on other goods.)
The total demand for goods, then, equals the stock of money minus the
reservation demand for money, plus the reservation demand for all goods.
The ultimate determinants of the price of all goods are: the stock of
money and the reservation demand for goods (factors of increase), and
the stock of all goods and the reservation demand for money (factors of
decrease). Now let us consider the obverse side: the PPM. The PPM, as
we have seen, is determined by the demand for money (factor of
increase) and the stock of money (factor of decrease). The exchange
demand for money equals the stock of all goods minus the reservation
demand for all goods. Therefore, the ultimate determinants of the PPM
are: the stock of all goods and the reservation demand for money
(factors of increase), and the stock of money and the
reservation demand for goods (factors of decrease). We see that this is
the exact obverse of the determinants of the price of all goods, which,
in turn, is the reciprocal of the PPM.
Thus, the analysis of the money side and the goods side of prices is
completely harmonious. No longer is there need for an arbitrary
division between a barter-type analysis of relative
goods-prices and a holistic analysis of the PPM. Whether we
treat one good or all goods, the price or prices will increase,
ceteris paribus, if the stock of money increases; decrease
when the stock of the good or goods increases; decrease
when the reservation demand for money increases; and increase
when the reservation demand for the good or goods increases. For each
individual good, the price will also increase when the specific demand
for that good increases; but unless this is a reflection of a drop in
the social reservation demand for money, this changed demand will also
signify a decreased demand for some other good, and a consequent fall
in the price of the latter. Hence, changes in specific demands will not
change the value of the PPM.
In a progressing economy, the secular trend for the four
determining factors is likely to be: the money stock
increasing gradually as gold production adds to the previous total; the
stock of goods increasing as capital investment
accumulates; the reservation demand for goods
disappearing because short-run speculations disappear over the long
run, and this is the main reason for such a demand; the reservation
demand for money unknown, with clearing, for example, working
to reduce this demand over a period of time, and the greater number of
transactions tending to increase it. The result is that we cannot
precisely say how the PPM will move in a progressing economy, though
the best summary guess would be that it declines as a result
of the influence of the increased stock of goods. Certainly, the
influence of the goods side is in the direction of
falling prices; the money side we cannot predict.
Thus, the ultimate determinants of the PPM as well as of specific
prices are the subjective utilities of individuals
(the determinants of demand) and the given objective stocks of
goods—thereby vindicating the Austrian-Wicksteedian theory of
price for all aspects of the economic system.
A final note of warning: It is necessary to remember that money
can never be neutral. One set of conditions tending to raise
the PPM can never precisely offset another set of factors tending to
lower it. Thus, suppose that an increase in the stock of goods tends to
raise the PPM, while at the same time, an increase in the money supply
tends to lower it. One change can never offset the other; for one
change will lower one set of prices more than others, while the other
will raise a different set within the whole array of prices. The
degrees of change in the two cases will depend on the particular goods
and individuals affected and on their concrete valuations. Thus, even
if we can make an historical (not an
economic-scientific) judgment that the PPM has remained roughly the
same, the price relations have shifted within the array, and therefore
the judgment can never be exact.
9.
Interlocal Exchange
A.
Uniformity of the Geographic Purchasing Power of Money
The price of any commodity tends to be the same throughout the
entire area using it. We have seen that this rule is not violated by
the fact that cotton in Georgia, for example, is priced lower
than cotton in New
York. When
cotton in New
York
is a consumers’
good, cotton in Georgia
is a capital good
in relation to the former. Cotton in Georgia
is not the same commodity
as cotton in New
York
because goods must first
be processed in one location and then transported to the places where
they are consumed.
Money is no exception to the rule that the price of every
commodity will tend to be uniform throughout the entire area
in which it is used. In fact, the scope for the money commodity is
broader. Other commodities are produced in certain centers and must
then be transported to other centers where they are consumed.
They are therefore not the same “good” in different
geographical locations; in the producing centers they are capital
goods. Money, it is true, must first be mined and then
shipped to places of use. But, once mined, the money commodity is used
only for exchange. For these purposes, it is from then on shipped back
and forth throughout the world market. Therefore, there is no really
important capital-good location for money separate from a
consumers’-good location. Whereas all other goods are first
produced and then moved to the place where they are used and consumed,
money is used interchangeably throughout the entire market area, moving
back and forth. Therefore, the tendency toward geographical
uniformity in the purchasing power of money holds true for the physical
commodity gold or silver, and there is no need for that commodity to be
treated as a different good in one place or another.
The purchasing power of money will therefore be identical over the
entire area. Should the PPM be lower in New York
than in Detroit, the supply of money for the
exchange of goods will diminish in New York
and increase in
Detroit. Prices of goods being higher in
New
York than in
Detroit, people will spend less in
New
York and
more in Detroit
than heretofore, this
shift being reflected in the movement of money. This action will tend
to raise the purchasing power of money in New York
and lower it in
Detroit, until its purchasing power in
the two places is equal. The purchasing power of money will, in this
way, tend to remain equal in all places where the money is used,
whether or not national boundaries happen to intervene.
Some people contend that, on the contrary, there do
exist permanent differences in the purchasing power of money
from place to place. For example, they point to the fact that prices
for food in restaurants are higher in New York City
than in Peoria. For most people, however,
New
York has
certain definite advantages
over Peoria. It has a vastly wider range of
goods and services available to the consumer, including theaters,
concerts, colleges, high-quality jewelry and clothing, and
stockbrokerage houses. There is a great difference between the
commodity “restaurant service in New York” and the commodity
“restaurant service in Peoria.” The former allows the
purchaser to remain in New
York
and to enjoy its various
advantages. Thus, the two are distinct goods, and the fact that the
price of restaurant service is greater in New York
signifies that the
preponderance of individuals on the market value the former more highly
and consider it a commodity of higher quality.
Costs of transport, however, do introduce a qualification into this
analysis. Suppose that the PPM in Detroit
is slightly higher than in
Rochester. We would expect gold to flow from
Rochester
to Detroit, spending relatively more on
goods in the latter place, until the PPM’s are equalized. If,
however, the PPM in Detroit is higher by an amount smaller than the
transport cost of shipping the gold from Rochester, then relative
PPM’s have a leeway to differ within the zone of shipping
costs of gold. It would then be too expensive to ship gold to
Detroit
to take advantage of the
higher PPM. The interspatial PPM’s may vary in either
direction within this cost-of-transport margin.
Many critics allege that the PPM cannot be uniform
throughout the world because some goods are not transferable from one
locale to another. Times
Square
or Niagara Falls, for example, cannot be
transferred from one region to another; they are specific to their
locale. Therefore, it is alleged, the equalization process can take
place only for those goods which “enter into interregional
trade”; it does not apply to the general PPM.
Plausible as it seems, this objection is completely fallacious. In the
first place, disparate goods like Times Square
and other main streets are
different goods, so that there is no reason to
expect them to have the same price. Secondly, so long as one
commodity can be traded, the PPM can be equalized. The composition
of the PPM may well be changed, but this does not refute the fact of
equalization. The process of equalization can be deduced from
the fact of human action, even though, as we shall see, the PPM cannot
be measured, since its composition does not remain
the same.
Finally, since any good can be traded, what is
there to prevent, for example, Oshkosh
capital from buying a
building on Times
Square? The
Oshkosh
capitalists need not
literally transport a good back to Oshkosh
in order to buy it and
make money from their investment. Every good, then, “enters
into interregional trade”; no distinction between
“domestic” and “interregional”
(or “international”) goods can be made.
Thus, suppose the PPM is higher in Oshkosh
than in New York. New Yorkers tend to buy more in
Oshkosh, and Oshkoshians will buy less in
New
York. This
does not only mean that
New
York will
buy more Oshkosh
wheat, or that
Oshkosh
will buy less
New
York clothing.
It also means that New
Yorkers will invest in real estate or theaters in Oshkosh, while Oshkoshians will sell some
of their New
York
holdings.
B.
Clearing in Interlocal Exchange
Clearing is particularly appropriate for interlocal
transactions, since costs of transporting money from one
locale to another are likely to be heavy. Bills of exchange on each
town (i.e., I.O.U.’s owed by each town) can be reciprocally
canceled. Suppose that there are two traders, A and B, in Detroit, and two in Rochester, C and D. A sells C a
refrigerator for 200 gold grams, and D sells B a TV set for 200 grams.
The two debts can be cleared, and no money need be shipped from one
place to the other. On the other hand, D’s sale of a TV set
may total 120 grams. Suppose for a moment that these are the only
traders in the two communities. Then 80 grams will have to be
shipped from Rochester
to Detroit. In the latter case, the citizens
of Detroit
have, on net balance,
decided to add to their cash holdings, while the
Rochesterites have decided to diminish their cash holdings.
Economists have often described interlocal trade in terms of
“gold export points” and “gold import
points.” The use of such expressions assumes, however, that
even though two localities both use gold money, it makes sense to talk
of an “exchange rate” of the money of one locality
for that of another. This exchange rate is set between the margins
fixed by the cost of transporting money—the “gold
import” and “gold export” points. This
does not hold true on the free market, however. On
such a market, all coins and bullion are expressed in terms of weight
of gold, and it makes no sense whatever to speak of an
“exchange rate” of the money of one place for the
same money in another. How can there be an “exchange
rate” of an ounce of gold for an ounce of gold? There will be
no legal tender or other laws to separate the value of the coins of one
area from those of another. Therefore, there may be slight
variations in the PPM in each locale, within the limits of the cost of
transporting gold, but there could never be deviations from par in
interlocal “exchange rates.” For there are no
exchange rates on the free market, except for two or more coexisting
money commodities.
10.
Balances of Payments
In chapter 3 above, we engaged in an extensive analysis of the
individual’s balance of payments. We saw there that an
individual’s income can be
called his exports, and the physical sources of his income his goods
exported; while his expenditures can be termed his imports,
and the goods purchased his goods imported.
We also saw that it is
nonsensical to call a man’s balance of trade
“favorable” if he chooses to use some of his
income to add to his cash balance, or
“unfavorable” if he decides to draw down his cash
balance, so that expenditures are greater than income. Every
action and exchange is favorable from the point of view of the person
performing the action or exchange; otherwise he would not have engaged
in it. A further conclusion is that there is no need for
anyone to worry about anyone else’s balance of trade.
A person’s income and expenditure constitute his
“balance of trade,” while his credit transactions,
added to this balance, comprise his “balance of
payment.” Credit transactions may complicate the
balance, but they do not alter its essentials. When a creditor makes a
loan, he adds to his “money paid” column to the
extent of the loan—for purchase of a promise to pay in the
future. He has purchased the debtor’s promise to pay in
exchange for transferring part of his present cash balance to the
debtor. The debtor adds to his “money receipts”
column—from the sale of a promise to pay in the future. These
promises to pay may fall due at any future date decided upon by the
creditor and the debtor; generally they range from a day to many years.
On that date the debtor repays the loan and transfers part of his cash
balance to the creditor. This will appear in the debtor’s
“money paid” column—for repayment of
debt—and in the creditor’s
“money received” column—from repayment of
debt. Interest payments made by the debtor to the creditor
will be similarly reflected in the respective balances of
payments.
More nonsense has been written about balances of payments than about
virtually any other aspect of economics. This has been caused by the
failure of economists to ground and build their analysis on individual
balances of payments. Instead they have employed such cloudy, holistic
concepts as the “national” balance of
payment without basing them on individual actions and balances.
Balances of payments may be consolidated for many individuals,
and any number of groupings may be made. In these cases, the balances
of payments only record the monetary transactions between
individuals of the group and other individuals, but fail to record the
exchanges of individuals within the group.
For example, suppose that we take the consolidated balance of payments
for the Antlers Lodge of Jonesville for a certain period of
time. There are three lodge members A, B, and C. Suppose their
individual balances of payments are as indicated in Table 16.
In
the consolidated balance sheet of the Antlers Lodge, the money payments
between the members must of necessity cancel out. Thus,
The consolidated balance tells less about the activities of the members
of the group than do the individual balances, since the exchanges within
the group are not revealed. This discrepancy grows as the number of
people grouped in the consolidated balance increases. The
consolidated balance of the citizens of a large nation such as the
United
States
conveys less information
about their economic activities than is revealed by the consolidated
balance of the citizens of Cuba. Finally, if we lump together all
the citizens of the world engaged in exchange, their consolidated
balance of payments is precisely zero. All the exchanges are
internal within the group, and the consolidated balance conveys no
information whatever about them. Taken together, the people of
the world have zero income from “outside” and zero
expenditures on “outside goods.”
Fallacies in thinking about foreign trade will disappear if we
understand that balances of payment are merely built upon
consolidated individual transactions and
that national balances are merely an arbitrary stopping point between
individual balances on the one hand and the simple zeros of a world
balance of payments on the other. There is, for example, the
perennial worry that a balance of trade will be permanently
“unfavorable” so that gold will drain out of the
region in question until none is left. Drains of gold, however, are not
mysterious acts of God. They are willed by people,
who, on net balance, wish for one reason or another to reduce their
cash balances of gold. The state of the balance is simply the visible
manifestation of a voluntary reduction in the cash balance in
a certain region or among a certain group.
Worries about national balances of payment are the
fallacious residue of the accident that statistics of exchange are far
more available across national boundaries than elsewhere. It should be
clear that the principles applying to the balance of payment of the
United
States
are the same for one
region of the country, for one state, for one city, for one block, one
house, or one person. Obviously no person or group can suffer
because of an “unfavorable” balance; he or
the group can suffer only because of a low level of income or assets.
Seemingly plausible cries that money “be kept in”
the United States, that Americans not be flooded with the
“products of cheap foreign labor,” etc., take on a
new perspective when we apply it, say, to a family of three Jones
brothers. Imagine each brother exhorting the others to “buy
Jones,” to “keep the money circulating within
the Jones family,” to abstain from buying products made by
others who earn less than the Jones family! Yet the principle of the
argument is precisely the same in both cases.
Another popular argument is that a debtor group or nation cannot
possibly repay its debt because its “balance of trade is in
fundamental disequilibrium, being inherently unfavorable.”
This is taken seriously in international affairs; yet how would we
regard the individual debtor who used this excuse for
defaulting on his loan? The creditor would be justified in bluntly
telling the debtor that all he is saying is that he would much rather
spend his money income and assets on enjoyable goods and
services than on repayment of his debt. Except for the usual
holistic analysis, we would see that the same holds true for an
international debt.
For an exposition of the
feasibility of private coinage, see Spencer, Social
Statics, pp. 438–39; Charles A. Conant, The
Principles of Money and Banking (New York: Harper &
Bros., 1905), I, 127–32; Lysander Spooner, A Letter
to Grover Cleveland (Boston: B.R. Tucker, 1886), p. 79; B.W.
Barnard, “The Use of Private Tokens for Money in the United
States,” The Quarterly Journal of Economics,
1916–17, pp. 617–26.
Recent writers favorable to private coinage include: Everett Ridley
Taylor, Progress Report on a New Bill of Rights
(Diablo, Calif.: the author, 1954); Oscar B. Johannsen,
“Advocates Unrestricted Private Control over Money
and Banking,” The Commercial
and Financial Chronicle, June 12, 1958, pp. 2622f.; and
Leonard E. Read, Government—An Ideal Concept
(Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1954),
pp. 82ff. An economist hostile to market-controlled commodity money has
recently conceded the feasibility of private coinage under a commodity
standard. Milton Friedman, A Program for Monetary Stability
(New York: Fordham University Press, 1960), p. 5.
Time deposits are, legally, future
claims, since banks have a legal right to delay payment 30 days.
Moreover, they do not pass as final media of exchange. The latter fact
is not determining, however, since a secure claim to a
money-substitute is itself part of the money supply.
“Idle” cash balances are kept as “time
deposits,” just as gold bullion is a more
“idle” form of money than coins. The deciding
factor, perhaps, is that the 30-day limit is virtually a dead letter,
for if a “savings” bank should impose it, a
bankrupting “run” on the bank would ensue.
Furthermore, actual payments are sometimes made by
“cashiers’ checks” on time deposits.
Thus, “time” deposits now function as demand
deposits and should be treated as part of the money supply. If
banks wished to act as genuine savings banks,
borrowing and lending credit, they could issue
I.O.U’s for specified lengths of time, due at definite future
dates. Then no confusion or possible
“counterfeiting” could arise.
Such items as bills of lading,
pawn tickets, and dock warrants have been warehouse receipts rooted in
the specific objects deposited, in contrast to the loose
“general deposits” where a homogeneous good can be
returned. See W. Stanley
Jevons, Money
and the Mechanism of Exchange (16th ed.; London: Kegan Paul, Trench,
Trübner & Co., 1907), pp. 201–11.
We might ask why the owners of the
bank do not really reap the spoils and lend the money to themselves.
The answer is that they once did so profusely, as the history of early
American banking shows. Legal regulations forced the banks to abandon
this practice.
This discussion is not meant to
imply that bankers, particularly at the present time, are always
knowingly engaged in fraudulent practices. So embedded, indeed, have
these practices become, and always with the sanction of law as well as
of sophisticated but fallacious economic doctrines, that it is
undoubtedly a rare banker who regards his standard occupational
procedure as fraudulent.
For a brilliant discussion of
fractional-reserve banking, see Amasa Walker, The
Science of Wealth (3rd ed.; Boston: Little, Brown & Co.,
1867), pp. 138–68, 184–232.
Swiss banks have successfully and
for a long time been issuing debentures to the public at varying
maturities, and banks in Belgium
and Holland
have recently followed
suit. On the purely free market, such practices would undoubtedly be
greatly extended. Cf. Benjamin H. Beckhart, “To Finance Term
Loans,” The New York Times, May 31, 1960.
Jevons, Money and the
Mechanism of Exchange, pp. 211–12.
Jevons stated:
If
pecuniary promises were always of a special character, there could be
no possible harm in allowing perfect freedom in the issue of promissory
notes. The issuer would merely constitute himself a warehouse keeper
and would be bound to hold each special lot of coin ready to pay each
corresponding note. (Ibid., p. 208)
See Mises,
Theory of Money and Credit, pp. 131–45.
See Mises
Human Action, pp. 413–16.
For an appreciation of
Mises’ achievement in clarifying this problem, see
Wu, An Outline of International Price Theories, pp.
127, 232–34.
As we shall see below, however,
interlocal clearing can greatly narrow these limits.
To say that “exports pay
for imports” is simply to say that income pays for
expenditures.
For an excellent and original
analysis of balances of payments along these lines, see
Mises, Human Action, pp. 447–49.
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