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**Chapter 11—Money and Its
Purchasing Power** (continued)

*11.
Monetary Attributes of Goods*

**A.
Quasi Money**

We saw in chapter 3 how one or more very easily marketable
commodities were chosen by the market as media of exchange,
thereby greatly increasing their marketability and becoming
more and more generally used until they could be called money. We have
implicitly assumed that there are one or two media that are fully
marketable—always salable—and other commodities
that are simply sold for money. We have omitted mention of the
*degrees* of marketability of these goods. Some goods
are more readily marketable than others. And some are so easily
marketable that they rise practically to the status of *quasi
moneys.*

Quasi moneys do not form part of the nation’s money supply. The conclusive test is that they are not used to settle debts, nor are they claims to such means of payment at par. However, they are held as assets by individuals and are considered so readily marketable that an extra demand arises for them on the market. Their existence lowers the demand for money, since holders can economize on money by keeping them as assets. The price of these goods is higher than otherwise because of their quasi-monetary status.

In Oriental countries jewels have traditionally been held as quasi
moneys. In advanced countries quasi moneys are usually short-term debts
or securities that have a broad market and are readily salable at the
highest price the market will yield. Quasi moneys include high-grade
debentures, some stocks, and some wholesale commodities. Debentures
used as quasi moneys have a higher price than otherwise and therefore a
*lower interest yield than will accrue on other investments.*[44]

In previous sections we saw that bills of exchange are not
money-substitutes, but *credit* instruments.
Money-substitutes are claims to *present* money,
equivalent to warehouse receipts. But some critics maintain that in
Europe
at the turn of the
nineteenth century bills *did* circulate as
money-substitutes. They circulated as final payment in advance
of their due dates, their face value discounted for the period of time
left for maturity. Yet these were not money-substitutes. The holder of
a bill was a creditor. Each of the acceptors of the bill had to endorse
its payment, and the credit standing of each endorser had to
be examined to judge the soundness of the bill. In short, as
Mises has stated:

The endorsement of the bill is in fact not a final payment; it liberates the debtor to a limited degree only. If the bill is not paid then his liability is revived in a greater degree than before.45]

Hence, the bills could not be classed as money-substitutes.

**12.
Exchange Rates of Coexisting Moneys**

Up to this point we have analyzed the market in terms of a single money
and its purchasing power. This analysis is valid for each and every
type of medium of exchange existing on the market. But if there is *more*
than one medium coexisting on the market, what determines the exchange
ratios between the various media? Although on an unhampered market
there is a gradual tendency for one single money to be established,
this tendency works very slowly. If two or more commodities offer good
facilities and are both especially marketable, they may
coexist as moneys. Each will be used by people as media of exchange.

For centuries, gold and silver were two commodities that coexisted as moneys. Both had similar advantages in scarcity, desirability for nonmonetary purposes, portability, durability, etc. Gold, however, being relatively far more valuable per unit of weight, was found to be more useful for larger transactions, and silver better for smaller transactions.

It is impossible to predict whether the market would have
continued indefinitely to use gold and silver or whether one
would have gradually ousted the other as a general medium of exchange.
For, in the late nineteenth century, most Western countries
conducted a *coup d’etat* against
silver, to establish a monometallic standard by coercion.[46]
Gold and silver could and
did coexist side by side in the same countries or throughout the world
market, or one could function as money in one country, and one in
another. Our analysis of the exchange rate is the same in both
cases.

What determines the exchange rate between two (or more) moneys? Two
different kinds of money will exchange in a ratio corresponding *to
the ratio of the purchasing power of each in terms of all the other
economic goods*. Thus, suppose that there are two coexisting
moneys, gold and silver, and the purchasing power of gold is double
that of silver, i.e., that the money price of every commodity is double
in terms of silver what it is in terms of gold. One ounce of gold
exchanges for 50 pounds of butter, and one ounce of silver exchanges
for 25 pounds of butter. One ounce of gold will then tend to exchange
for two ounces of silver; the exchange ratio of gold and silver will
tend to be 1:2. If the rate at any time deviates from 1:2, market
forces will tend to re-establish the parity between the purchasing
powers and the exchange rate between them. This equilibrium exchange
rate between two moneys is termed the *purchasing power parity.*

Thus, suppose that the exchange rate between gold and silver is 1:3,
three ounces of silver exchanging for one ounce of gold. At the same
time, the purchasing power of an ounce of gold is *twice*
that of silver. It will now pay people to sell commodities for gold,
exchange the gold for silver, and then exchange the silver back into
commodities, thereby making a clear arbitrage gain. For example, people
will sell 50 pounds of butter for one ounce of gold, exchange the gold
for three ounces of silver, and then exchange the silver for 75 pounds
of butter, gaining 25 pounds of butter. Similar gains from
this arbitrage action will take place for all other commodities.

Arbitrage will restore the exchange rate between silver and gold to its purchasing power parity. The fact that holders of gold increase their demand for silver in order to profit by the arbitrage action will make silver more expensive in terms of gold and, conversely, gold cheaper in terms of silver. The exchange rate is driven in the direction of 1:2. Furthermore, holders of commodities are increasingly demanding gold to take advantage of the arbitrage, and this raises the purchasing power of gold. In addition, holders of silver are buying more commodities to make the arbitrage profit, and this action lowers the purchasing power of silver. Hence the ratio of the purchasing powers moves from 1:2 in the direction of 1:3. The process stops when the exchange rate is again at purchasing power parity, when arbitrage gains cease. Arbitrage gains tend to eliminate themselves and to bring about equilibrium.

It should be noted that, in the long run, the movement in the purchasing powers will probably not be important in the equilibrating process. With the arbitrage gains over, demands will probably revert back to what they were formerly, and the original ratio of purchasing powers will be restored. In the above case, the equilibrium rate will likely remain at 1:2.

Thus, the exchange rate between any two moneys will tend to be at the
purchasing power parity. Any deviation from the parity will tend to
eliminate itself and re-establish the parity rate. This holds true for
any moneys, including those used mainly in different
geographical areas. Whether the exchanges of moneys occur
between citizens of the same or different geographical areas makes no
economic difference, except for the costs of transport. Of course, if
the two moneys are used in two completely isolated geographical areas
with no exchanges between the inhabitants, then there is no exchange
rate between them. Whenever exchanges *do*
take place, however, the rate of exchange will always tend to be set at
the purchasing power parity.

It is impossible for economics to state whether, if the money market had remained free, gold and silver would have continued to circulate side by side as moneys. There has been in monetary history a curious reluctance to allow moneys to circulate at freely fluctuating exchange ratios. Whether one of the moneys or both would be used as units of account would be up to the market to decide at its convenience.[47]

**13.
The Fallacy of the Equation of Exchange**

The basis on which we have been explaining the purchasing power of money and the changes in and consequences of monetary phenomena has been an analysis of individual action. The behavior of aggregates, such as the aggregate demand for money and aggregate supply, has been constructed out of their individual components. In this way, monetary theory has been integrated into general economics. Monetary theory in American economics, however (apart from the Keynesian system, which we discuss elsewhere), has been presented in entirely different terms—in the quasi-mathematical, holistic equation of exchange, derived especially from Irving Fisher. The prevalence of this fallacious approach makes a detailed critique worthwhile.

The classic exposition of the equation of exchange was in Irving
Fisher’s *Purchasing Power of Money*.[48]
Fisher describes the chief
purpose of his work as that of investigating “the causes
determining the purchasing power of money.” Money is
a generally acceptable medium of exchange, and purchasing
power is rightly defined as the “quantities of other goods
which a given quantity of goods will buy.”[49]
He explains that the lower
the prices of goods, the larger will be the quantities that can be
bought by a given amount of money, and therefore the greater the
purchasing power of money. *Vice versa* if
the prices of goods rise. This is correct; but then comes this flagrant
*non sequitur:* “In short, the purchasing
power of money is the reciprocal of the level of prices; so that the
study of the purchasing power of money is identical with the study of
price levels.”[50]From then on, Fisher proceeds to
investigate the causes of the “price level”; thus,
by a simple “in short,” Fisher has leaped from the
real world of an array of individual prices for an innumerable list of
concrete goods into the misleading fiction of a “price
level,” without discussing the grave difficulties
which any such concept must face. The fallacy of the “price
level” concept will be treated further below.

The “price level” is allegedly determined by three
aggregative factors: the quantity of money in circulation, its
“velocity of circulation”—the
average number of times during a period that a unit of money is
exchanged for goods—and the total volume of goods bought for
money. These are related by the famous equation of exchange: *MV*
= *PT*. This equation of exchange is built up by
Fisher in the following way: First, consider an individual exchange
transaction—Smith buys 10 pounds of sugar for 7 cents a pound.[51]
An exchange has been made,
Smith giving up 70 cents to Jones, and Jones transferring 10 pounds of
sugar to Smith. From this fact Fisher somehow deduces that
“10 pounds of sugar have been regarded as *equal*
to 70 cents, and this fact may be expressed thus: 70 cents = 10 pounds
multiplied by 7 cents a pound.”[52]
This off-hand assumption
of equality is not self-evident, as Fisher apparently assumes, but a
tangle of fallacy and irrelevance. *Who* has
“regarded” the 10 pounds of sugar as equal to the
70 cents? Certainly not Smith, the buyer of the sugar. He bought the
sugar precisely because he considered the two quantities as *unequal*
in value; to him the value of the sugar was greater than the value of
the 70 cents, and that is why he made the exchange. On the other hand,
Jones, the seller of the sugar, made the exchange precisely because the
values of the two goods were *unequal in the opposite direction*,
i.e., he valued the 70 cents more than he did the sugar. There is thus
never any equality of values on the part of the two participants. The
assumption that an exchange presumes some sort of equality has been a
delusion of economic theory since Aristotle, and it is
surprising that Fisher, an exponent of the subjective theory
of value in many respects, fell into the ancient trap. There is
certainly no equality of values between two goods exchanged or, as in
this case, between the money and the good. Is there an equality in
anything else, and can Fisher’s doctrine be salvaged by
finding such an equality? Obviously not; there is no equality in
weight, length, or any other magnitude. But to Fisher, the equation
represents an equality in value between the “money
side” and the “goods side”; thus, Fisher
states:

[T]he total money paid is equal in value to the total value of the goods bought. The equation thus has a money side and a goods side. The money side is the total money paid. . . . The goods side is made up of the products of quantities of goods exchanged multiplied by respective prices.[53]

We have seen, however, that even for the individual exchange, and setting aside the holistic problem of “total exchanges,” there is no such “equality” that tells us anything about the facts of economic life. There is no “value-of-money side” equaling a “value-of-goods side.” The equal sign is illegitimate in Fisher’s equation.

How, then, account for the general acceptance of the equal sign and the equation? The answer is that, mathematically, the equation is of course an obvious truism: 70 cents = 10 pounds of sugar x 7 cents per pound of sugar. In other words, 70 cents = 70 cents. But this truism conveys no knowledge of economic fact whatsoever.[54] Indeed, it is possible to discover an endless number of such equations, on which esoteric articles and books could be published. Thus:

Then,
we could say that the “causal factors” determining
the quantity of money are: the number of grains of sand, the
number of students in the class, and the quantity of money.
What we have in Fisher’s equation, in short, is *two*
money sides, each identical with the other. In fact, it is an *identity*
and not an equation. To say that such an equation is not very
enlightening is self-evident. All that this equation tells us about
economic life is that the *total money received in a
transaction is equal to the total money given up in a transaction*—surely
an uninteresting truism.

Let us reconsider the elements of the equation on the basis of the determinants of price, since that is our center of interest. Fisher’s equation of exchange for an individual transaction can be rearranged as follows:

Fisher
considers that this equation yields the significant
information that the price is *determined*
by the total money spent divided by the total supply of goods
sold. Actually, of course, the equation, as an equation, tells us
nothing about the determinants of price; thus, we could set up an
equally truistic equation:

This equation is just as mathematically true as the other, and, on Fisher’s own mathematical grounds, we could argue cogently that Fisher has “left the important wheat price out of the equation.” We could easily add innumerable equations with an infinite number of complex factors that “determine” price.

The *only* knowledge we can have of the determinants
of price is the knowledge deduced logically from the axioms of
praxeology. Mathematics can at best only translate our
previous knowledge into relatively *un*intelligible
form; or, usually, it will mislead the reader, as in the
present case. The price in the sugar transaction may be made to equal
any number of truistic equations; but it is determined by the
supply and demand of the participants, and these in turn are governed
by the utility of the two goods on the value scales of the participants
in exchange. *This* is the fruitful approach in
economic theory, not the sterile mathematical one. If we consider the
equation of exchange as revealing the determinants of price, we find
that Fisher must be implying that the determinants are the
“70 cents” and the “10 pounds of
sugar.” But it should be clear that *things*
cannot determine prices. *Things*, whether
pieces of money or pieces of sugar or pieces of anything else, can
never act; they cannot set prices or supply and demand schedules. All
this can be done only by *human action*: only
individual actors can decide whether or not to buy; only their value
scales determine prices. It is this profound mistake that lies at the
root of the fallacies of the Fisher equation of exchange: human action
is abstracted out of the picture, and *things*
are assumed to be in control of economic life. Thus, either the
equation of exchange is a trivial truism—in which case, it is
no better than a million other such truistic equations, and has no
place in science, which rests on simplicity and economy of
methods—or else it is supposed to convey some important
truths about economics and the determination of prices. In that case,
it makes the profound error of substituting for correct
logical analysis of causes based on human action, misleading
assumptions based on action by things. At best, the Fisher
equation is superfluous and trivial; at worst, it is wrong and
misleading, although Fisher himself believed that it conveyed
important causal truths.

Thus, Fisher’s equation of exchange is pernicious even for the individual transaction. How much more so when he extends it to the “economy as a whole”! For Fisher, this too was a simple step. “The equation of exchange is simply the sum of the equations involved in all individual exchanges”[55] as in a period of time. Let us now, for the sake of argument, assume that there is nothing wrong with Fisher’s individual equations and consider his “summing up” to arrive at the total equation for the economy as a whole. Let us also abstract from the statistical difficulties involved in discovering the magnitudes for any given historical situation. Let us look at several individual transactions of the sort that Fisher tries to build into a total equation of exchange:

A exchanges 70 cents for 10 pounds of sugar

B exchanges 10 dollars for 1 hat

C exchanges 60 cents for 1 pound of butter

D exchanges 500 dollars for 1 television set.

What is the “equation of exchange” for this community of four? Obviously there is no problem in summing up the total amount of money spent: $511.30. But what about the other side of the equation? Of course, if we wish to be meaninglessly truistic, we could simply write $511.30 on the other side of the equation, without any laborious building up at all. But if we merely do this, there is no point to the whole procedure. Furthermore, as Fisher wants to get at the determination of prices, or “the price level,” he cannot rest content at this trivial stage. Yet he continues on the truistic level:

This
is what Fisher does, and this is still the same trivial truism that
“total money spent equals total money spent.” This
triviality is not redeemed by referring to *p*
x *Q, p'* x *Q**'*
, etc., with each *p* referring to a price and each *Q*
referring to the quantity of a good, so that: *E =*
Total money spent = *pQ* + *p'**Q'*
+ *p''**Q''* + . . . etc. Writing
the equation in this symbolic form does not add to its significance or
usefulness.

Fisher, attempting to find the causes of the price level, has to
proceed further. We have already seen that even for the
individual transaction, the equation *p = (E/Q)*
(price equals total money spent divided by the quantity of goods sold)
is only a trivial truism and is erroneous when one tries to use it to
analyze the *determinants* of price. (This is the
equation for the price of sugar in Fisherine symbolic form.) How much
worse is Fisher’s attempt to arrive at such an equation for
the whole community and to use this to discover the *determinants*
of a mythical “price level”! For
simplicity’s sake, let us take only the two transactions of A
and B, for the sugar and the hat. Total money spent, *E,*
clearly equals $10.70, which, of course, equals total money
received, *pQ +p'Q' .* But Fisher is
looking for an equation to explain the price level; therefore
he brings in the concept of an “average price
level,” *P*, and a total quantity of goods
sold, *T*, such that *E* is
supposed to equal *PT*. But the transition from the
trivial truism *E = pQ + p**'Q**'*
. . . to the equation *E = PT* cannot be
made as blithely as Fisher believes. Indeed, if we are
interested in the explanation of economic life, it cannot be
made at all.

For example, for the two transactions (or for the four), *what*
is *T*? How can 10 pounds of sugar be added to one
hat or to one pound of butter, to arrive at *T*?
Obviously, no such addition can be performed, and therefore
Fisher’s holistic *T*, the total physical
quantity of all goods exchanged, is a meaningless concept and cannot be
used in scientific analysis. If *T* is a meaningless
concept, then *P* must be also, since the two
presumably vary inversely if *E* remains constant.
And what, indeed, of *P*? Here, we have a whole array
of prices, 7 cents a pound, $10 a hat, etc. What is the price *level*?
Clearly, there is no price level here; there are only individual prices
of specific goods. But here, error is likely to persist. Cannot prices
in some way be “averaged” to give us a working
definition of a price level? This is Fisher’s solution.
Prices of the various goods are in some way averaged to arrive at *P*,
then *P* = (*E/T*), and all that
remains is the difficult “statistical” task of
arriving at *T.* However, the concept of an average
for prices is a common fallacy. It is easy to demonstrate that *prices
can never be averaged* for different commodities; we shall use
a simple average for our example, but the same conclusion applies to
any sort of “weighted average” such as is
recommended by Fisher or by anyone else.

What is an average? Reflection will show that for several things to be
averaged together, they must first be totaled. In order to be thus
added together, the things must have some *unit in
common,* and it must be this unit that is added. Only
homogeneous units can be added together. Thus, if one object is 10
yards long, a second is 15 yards long, and a third 20 yards long, we
may obtain an average length by adding together the number of
yards and dividing by three, yielding an average length of 15 yards.
Now, money prices are in terms of ratios of units: cents per pound of
sugar, cents per hat, cents per pound of butter, etc. Suppose we take
the first two prices:

Can these two prices be averaged in any way? Can we add 1,000 and 7 together, get 1,007 cents, and divide by something to get a price level? Obviously not. Simple algebra demonstrates that the only way to add the ratios in terms of cents (certainly there is no other common unit available) is as follows:

Obviously, neither the numerator nor the denominator makes sense; the units are incommensurable.

Fisher’s more complicated concept of a weighted average, with
the prices weighted by the quantities of each good sold, solves the
problem of units in the numerator but *not* in the
denominator:

The
*pQ’*s are all money, but the *Q’*s
are still different units. Thus, any concept of average price level
involves adding or multiplying quantities of completely different units
of goods, such as butter, hats, sugar, etc., and is therefore
meaningless and illegitimate. Even pounds of sugar and pounds of butter
cannot be added together, because they are two different goods and
their valuation is completely different. And if one is tempted to use
poundage as the common unit of quantity, what is the pound weight of a
concert or a medical or legal service?[56]

It is evident that *PT*, in the total equation of
exchange, is a completely fallacious concept. While the equation *E
= pQ* for an individual transaction is at least a trivial
truism, although not very enlightening, the equation *E = PT*
for the whole society is a *false* one. Neither *P*
nor *T* can be defined meaningfully, and this would
be necessary for this equation to have any validity. We are left only
with *E = pQ + p**'Q**'*,
etc., which gives us only the useless truism, *E* = *E*.[57]

Since the *P* concept is completely fallacious, it is
obvious that Fisher’s use of the equation to reveal the
determinants of prices is also fallacious. He states that if *E*
doubles, and *T* remains the same, *P*—the
price level—must double. On the holistic level, this is not
even a truism; it is false, because neither *P* nor *T*
can be meaningfully defined. All we can say is that when *E*
doubles, *E* doubles. For the individual transaction,
the equation is at least meaningful; if a man now spends $1.40 on 10
pounds of sugar, it is obvious that the price has doubled from 7 cents
to 14 cents a pound. Still, this is only a mathematical truism, telling
us nothing of the real causal forces at work. But Fisher never
attempted to use this individual equation to explain the
determinants of individual prices; he recognized that the
logical analysis of supply and demand is far superior here. He used
only the *holistic* equation, which he felt explained
the determinants of the price level and was uniquely adapted to such an
explanation. Yet the holistic equation is false, and the price level
remains pure myth, an indefinable concept.

Let us consider the other side of the equation, *E* =
*MV*, the average quantity of money in circulation in
the period, multiplied by the average velocity of circulation.
*V* is an absurd concept. Even Fisher, in the
case of the other magnitudes, recognized the necessity of building up
the total from individual exchanges. He was not successful in building
up *T* out of the individual *Q’*s,
*P* out of the individual *p’*s,
etc., but at least he *attempted* to do so. But in
the case of *V,* *what is the velocity of an
individual transaction?* Velocity is not an independently
defined variable. Fisher, in fact, can derive *V*
only as being equal in every instance and every period to *E/M.*
If I spend in a certain hour $10 for a hat, and I had an average cash
balance (or *M*) for that hour of $200, then, by
definition, my *V* equals ^{1}/20.
I had an average quantity of money in my cash balance of $200, each
dollar turned over on the average of ^{1}/20 of a
time, and consequently I spent $10 in this period. But it is absurd to
dignify any quantity with a place in an equation *unless it
can be defined independently of the other terms in the equation*.
Fisher compounds the absurdity by setting up *M*
and *V* as independent determinants of *E*,
which permits him to go to his desired conclusion that if *M*
doubles, and *V* and *T* remain
constant, *P*—the price
level—will also double. But since *V* is
defined as equal to *E/M*, what we actually have is: *M*
x (*E/M*) = *PT* or simply, *E*
= *PT*, our original equation. Thus,
Fisher’s attempt to arrive at a quantity equation
with the price level approximately proportionate to the
quantity of money is proved vain by yet another route.

A group of Cambridge economists—Pigou, Robertson,
etc.—has attempted to rehabilitate the Fisher equation by
eliminating *V* and substituting the idea that the
total supply of money equals the total demand for money. However, their
equation is not a particular advance, since they keep the fallacious
holistic concepts of *P* and *T*,
and their *k* is merely the reciprocal of *V*,
and suffers from the latter’s deficiencies.

In fact, since *V* is not an independently defined
variable, *M* must be eliminated from the equation as
well as *V*, and the Fisherine (and the
Cambridge
) equation cannot be used to
demonstrate the “quantity theory of
money.” And since *M* and *V*
must disappear, there are an infinite number of other
“equations of exchange” that we could, with equal
invalidity, uphold as “determinants of the price
level.” Thus, the aggregate stock of sugar in the economy may
be termed *S*, and the ratio of *E*
to the total stock of sugar may be called “average sugar
turnover,” or *U*. This new
“equation of exchange” would be: *SU*
= *PT*, and the stock of sugar would suddenly become
a major determinant of the price level. Or we could substitute *A*
= number of salesmen in the country, and *X* = total
expenditures per salesman, or “salesmen
turnover,” to arrive at a new set of
“determinants” in a new equation. And so on.

This example should reveal the fallacy of equations in economic theory.
The Fisherine equation has been popular for many years because it has
been thought to convey useful economic knowledge. It *appears*
to be demonstrating the plausible (on *other*
grounds) quantity theory of money. Actually, it has only been
misleading.

There are other valid criticisms that could be made of Fisher: his use
of index numbers, which even at best could only measure a change in a
variable, but never define its actual position; his use of an index of *T*
defined in terms of *P* and of *P*
defined in terms of *T*; his denial that money is a
commodity; the use of mathematical equations in a field where there can
be no constants and therefore no quantitative predictions. In
particular, even if the equation of exchange were valid in all other
respects, it could at best only describe statically the conditions of
an average period. It could never describe the path from one static
condition to another. Even Fisher admitted this by conceding that a
change in *M* would always affect *V*,
so that the influence of *M* on *P*
could not be isolated. He contended that after this
“transition” period, *V* would
revert to a constant and the effect on *P* would be
proportional. Yet there is no reasoning to support this
assertion. At any rate, enough has been shown to warrant expunging the
equation of exchange from the economic literature.

**14.
The Fallacy of Measuring and Stabilizing the PPM**

**A.
Measurement**

In olden times, before the development of economic science, people naively assumed that the value of money remained always unchanged. “Value” was assumed to be an objective quantity inhering in things and their relations, and money was the measure, the fixed yardstick, of the values of goods and their changes. The value of the monetary unit, its purchasing power with respect to other goods, was assumed to be fixed.[58]The analogy of a fixed standard of measurement, which had become familiar to the natural sciences (weight, length, etc.), was unthinkingly applied to human action.

Economists then discovered and made clear that money does not remain
stable in value, that the PPM does not remain fixed. The PPM can and
does vary, in response to changes in the supply of or the demand for
money. These, in turn, can be resolved into the stock of goods and the
total demand for money. Individual money prices, as we have seen in
section 8 above, are determined by the stock of and demand for money as
well as by the stock of and demand for each good. It is clear, then,
that the money relation and the demand for and the stock of each
individual good are intertwined in each particular price transaction.
Thus, when Smith decides whether or not to purchase a hat for two gold
ounces, he weighs the utility of the hat against the utility of the two
ounces. Entering into every price, then, is the stock of the good, the
stock of money, and the demand for money and the good (both ultimately
based on individuals’ utilities). The money relation is *contained*
*in* particular price demands and supplies
and cannot, in practice, be separated from them. If, then, there is a
change in the supply of or demand for money, the change will *not*
be neutral, but will affect different specific demands for
goods and different prices in varying proportions. There is no way of
separately measuring changes in the PPM and changes in the specific
prices of goods.

The fact that the use of money as a medium of exchange enables us to calculate relative exchange ratios between the different goods exchanged against money has misled some economists into believing that separate measurement of changes in the PPM is possible. Thus, we could say that one hat is “worth,” or can exchange for, 100 pounds of sugar, or that one TV set can exchange for 50 hats. It is a temptation, then, to forget that these exchange ratios are purely hypothetical and can be realized in practice only through monetary exchanges, and to consider them as constituting some barter-world of their own. In this mythical world, the exchange ratios between the various goods are somehow determined separately from the monetary transactions, and it then becomes more plausible to say that some sort of method can be found of isolating the value of money from these relative values and establishing the former as a constant yardstick. Actually, this barter-world is a pure figment; these relative ratios are only historical expressions of past transactions that can be effected only by and with money.

Let us now assume that the following is the array of prices in the PPM on day one:

10 cents per pound of sugar

10 dollars per hat

500 dollars per TV set

5 dollars per hour legal service of Mr. Jones, lawyer.

Now suppose the following array of prices of the same goods on day two:

15 cents per pound of sugar

20 dollars per hat

300 dollars per TV set

8 dollars per hour of Mr. Jones’ legal service.

Now what can economics say has happened to the PPM over these two
periods? All that we can legitimately say is that now one dollar can
buy ^{1}/20 of a hat instead of ^{1}/10
of a hat, ^{1}/300 of a TV set instead of ^{1}/500
of a set, etc. Thus, we can describe (if we know the figures) what
happened to each individual price in the market array. But how much of
the price rise of the hat was due to a rise in the demand for hats and
how much to a fall in the demand for money? There is no way of
answering such a question. *We do not even know for certain
whether the PPM has risen or declined.* All we do know is that
the purchasing power of money has fallen in terms of sugar, hats, and
legal services, and risen in terms of TV sets. Even if all the prices
in the array had risen we would not know by *how much*
the PPM had fallen, and we would not know how much of the change was
due to an increase in the demand for money and how much to
changes in stocks. If the supply of money changed during this interval,
we would not know how much of the change was due to the increased
supply and how much to the other determinants.

Changes are taking place all the time in each of these
determinants. In the real world of human action, there is no
one determinant that can be used as a fixed benchmark; the
whole situation is changing in response to changes in stocks of
resources and products and to the changes in the valuations of
all the individuals on the market. In fact, one lesson above all should
be kept in mind when considering the claims of the various groups of
mathematical economists: *in human action there are no
quantitative constants*.[59]
As a necessary corollary,
all praxeological-economic laws are qualitative, not
quantitative.

The *index-number* method of measuring changes in the
PPM attempts to conjure up some sort of totality of goods whose
exchange ratios remain constant among themselves, so that a
kind of general averaging will enable a separate measurement of changes
in the PPM itself. We have seen, however, that such separation or
measurement is impossible.

The only attempt to use index numbers that has any
plausibility is the construction of fixed-quantity weights for
a base period. Each price is weighted by the quantity of the good sold
in the base period, these weighted quantities representing a typical
“market basket” proportion of goods bought in that
period. The difficulties in such a market-basket concept are
insuperable, however. Aside from the considerations mentioned above,
there is in the first place *no average buyer or housewife.*
There are only individual buyers, and each buyer has bought a different
proportion and type of goods. If one person purchases a TV
set, and another goes to the movies, each activity is the result of
differing value scales, and each has different effects on the various
commodities. There is no “average person” who goes
partly to the movies and buys part of a TV set. There is therefore no
“average housewife” buying some given
proportion of a totality of goods. Goods are not bought in their
totality against money, but only by individuals in individual
transactions, and therefore there can be no scientific method of
combining them.

Secondly, even if there were meaning to the market-basket concept, the utilities of the goods in the basket, as well as the basket proportions themselves, are always changing, and this completely eliminates any possibility of a meaningful constant with which to measure price changes. The nonexistent typical housewife would have to have constant valuations as well, an impossibility in the real world of change.

All sorts of index numbers have been spawned in a vain attempt to surmount these difficulties: quantity weights have been chosen that vary for each year covered; arithmetical, geometrical, and harmonic averages have been taken at variable and fixed weights; “ideal” formulas have been explored—all with no realization of the futility of these endeavors. No such index number, no attempt to separate and measure prices and quantities, can be valid.[60]

The knowledge that the purchasing power of money could vary led some economists to try to improve on the free market by creating, in some way, a monetary unit which would remain stable and constant in its purchasing power. All these stabilization plans, of course, involve in one way or another an attack on the gold or other commodity standard, since the value of gold fluctuates as a result of the continual changes in the supply of and the demand for gold. The stabilizers want the government to keep an arbitrary index of prices constant by pumping money into the economy when the index falls and taking money out when it rises. The outstanding proponent of “stable money,” Irving Fisher, revealed the reason for his urge toward stabilization in the following autobiographical passage: “I became increasingly aware of the imperative need of a stable yardstick of value. I had come into economics from mathematical physics, in which fixed units of measure contribute the essential starting point.”[61] Apparently, Fisher did not realize that there could be fundamental differences in the nature of the sciences of physics and of purposeful human action.

It is difficult, indeed, to understand what the advantages of a stable
value of money are supposed to be. One of the most frequently cited
advantages, for example, is that debtors will no longer be harmed by
unforeseen rises in the value of money, while creditors will no longer
be harmed by unforeseen declines in its value. Yet if creditors and
debtors want such a hedge against future changes, they have an easy way
out on the free market. When they make their contracts, they can agree
that repayment be made in a sum of money corrected by some agreed-upon
index number of changes in the value of money. Such a voluntary *tabular
standard* for business contracts has long been advocated by
stabilizationists, who have been rather puzzled to find that a course
which appears to them so beneficial is almost never adopted in business
practice. Despite the multitude of index numbers and other schemes that
have been proposed to businessmen by these economists, creditors and
debtors have somehow failed to take advantage of them. Yet, while
stabilization plans have made no headway among the groups that they
would supposedly benefit the most, the stabilizationists have remained
undaunted in their zeal to force their plans on the whole society by
means of State coercion.

There seem to be two basic reasons for this failure of business to
adopt a tabular standard: (*a*) As we have seen, there
is no scientific, objective means of measuring changes in the value of
money. Scientifically, one index number is just as arbitrary and bad as
any other. Individual creditors and debtors have not been able to agree
on any one index number, therefore, that they can abide by as a measure
of change in purchasing power. Each, according to his own
interests, would insist on including different commodities at different
weights in his index number. Thus, a debtor who is a wheat farmer would
want to weigh the price of wheat heavily in his index of the purchasing
power of money; a creditor who goes often to nightclubs would want to
hedge against the price of night-club entertainment, etc. (*b*)
A second reason is that businessmen apparently prefer to take their
chances in a speculative world rather than agree on some sort of
arbitrary hedging device. Stock exchange speculators and commodity
speculators are continually attempting to forecast future
prices, and, indeed, all entrepreneurs are engaged in anticipating the
uncertain conditions of the market. Apparently, businessmen
are willing to be entrepreneurs in anticipating future changes in
purchasing power as well as any other changes.

The failure of business to adopt voluntarily any sort of tabular
standard seems to demonstrate the complete lack of merit in compulsory
stabilization schemes. Setting this argument aside, however, let us
examine the contention of the stabilizers that somehow they can create
certainty in the purchasing power of money, while at the same time
leaving freedom and uncertainty in the prices of *particular
goods*. This is sometimes expressed in the statement:
“Individual prices should be left free to change; the price
level should be fixed and constant.” This contention rests on
the myth that some sort of general purchasing power of money or some
sort of price level exists on a plane apart from specific prices in
specific transactions. As we have seen, this is purely fallacious.
There is no “price level,” and there is no way that
the exchange-value of money is manifested except in specific purchases
of goods, i.e., specific prices. There is no way of separating
the two concepts; any array of prices establishes at one and the same
time an exchange relation or objective exchange-value between one good
and another and between money and a good, and there is no way of
separating these elements quantitatively.

It is thus clear that the exchange-value of money cannot be quantitatively separated from the exchange-value of goods. Since the general exchange-value, or PPM, of money cannot be quantitatively defined and isolated in any historical situation, and its changes cannot be defined or measured, it is obvious that it cannot be kept stable. If we do not know what something is, we cannot very well act to keep it constant.[62]

We have seen that the ideal of a stabilized value of money is
impossible to attain or even define. Even if it were attainable,
however, what would be the result? Suppose, for example, that the
purchasing power of money rises and that we disregard the problem of
measuring the rise. Why, if this is the result of action on an
unhampered market, should we consider it a *bad*
result? If the total supply of money in the community has remained
constant, falling prices will be caused by a general increase in the
demand for money or by an increase in the supply of goods as a result
of increased productivity. An increased demand for money stems from the
free choice of individuals, say, in the expectation of a more
troubled future or of future price declines. Stabilization would
deprive people of the chance to increase their *real*
cash holdings and the real value of the dollar by free,
mutually agreed-upon actions. As in any other aspect of the
free market, those entrepreneurs who successfully anticipate
the increased demand will benefit, and those who err will lose in their
speculations. But even the losses of the latter are purely the
consequence of their own voluntarily assumed risks. Furthermore,
falling prices resulting from increased productivity are beneficial to
all and are precisely the means by which the fruits of industrial
progress spread on the free market. Any interference with falling
prices blocks the spread of the fruits of an advancing economy; and
then real wages could increase only in particular industries, and not,
as on the free market, over the economy as a whole.

Similarly, stabilization would deprive people of the chance to *decrease*
their real cash holdings and the real value of the dollar,
should their demand for money fall. People would be prevented
from acting on their expectations of future price increases.
Furthermore, if the supply of goods should decline, a
stabilization policy would prevent the price rises necessary
to clear the various markets.

The intertwining of general purchasing power and specific prices raises another consideration. For money could not be pumped into the system to combat a supposed increase in the value of money without distorting the previous exchange-values between the various goods. We have seen that money cannot be neutral with respect to goods and that, therefore, the whole price structure will change with any change in the supply of money. Hence, the stabilizationist program of fixing the value of money or price level without distorting relative prices is necessarily doomed to failure. It is an impossible program.

Thus, even were it possible to define and measure changes in the purchasing power of money, stabilization of this value would have effects that many advocates consider undesirable. But the magnitudes cannot even be defined, and stabilization would depend on some sort of arbitrary index number. Whichever commodities and weights are included in the index, pricing and production will be distorted.

At the heart of the stabilizationist ideal is a misunderstanding of the
nature of money. Money is considered either a mere *numeraire*
or a grandiose measure of values. Forgotten is the truth that money is
desired and demanded as a useful commodity, even when this use is only
as a medium of exchange. When a man holds money in his cash balance, he
is deriving utility from it. Those who neglect this fact scoff at the
gold standard as a primitive anachronism and fail to realize
that “hoarding” performs a useful social function.

[44]
Cf. Mises, *Human
Action,* pp. 459–61.

[45]Mises, *Theory of Money
and Credit*, pp. 285–86.

[46]For recent evidence that this
action in the *see*
Paul M. O’Leary, “The Scene of the Crime of 1873
Revisited,” *Journal of Political Economy,*
August, 1960, pp. 388–92. One argument in favor of such
action holds that the government thereby simplified accounts in the
economy. However, the market could easily have done so itself
by keeping all accounts in gold.

[47]
*See*
Mises, *Theory of Money and Credit*, pp. 179ff., and
Jevons, *Money and the Mechanism of Exchange*, pp.
88–96. For advocacy of such parallel standards, *see*
Isaiah W. Sylvester, *Bullion Certificates as Currency*
(New York, 1882); and William Brough, *Open Mints and Free
Banking* (New York: G.P. Putnam’s Sons, 1894).
Sylvester, who also advocated 100-percent specie-reserve currency, was
an official of the United States Assay Office.

For historical accounts of the successful working of parallel
standards, *see* Luigi Einaudi, “The Theory
of Imaginary Money from Charlemagne to the French Revolution”
in F.C. Lane and J.C. Riemersma, eds., *Enterprise and Secular
Change* (Homewood, Ill.: Richard D. Irwin, 1953), pp.
229–61; Robert Sabatino Lopez, “Back to Gold,
1252,” *Economic History Review,*
April, 1956, p. 224; and Arthur N. Young, “Saudi Arabian
Currency and Finance,” *The Middle East Journal,*
Summer, 1953, pp. 361–80.

[48]Fisher, *Purchasing Power
of Money*, especially pp. 13ff.

[49]*Ibid.*, p. 13.

[50]*Ibid*., p. 14.

[51]We are using “dollars” and “cents” here instead of weights of gold for the sake of simplicity and because Fisher himself uses these expressions.

[52]Fisher, Purchasing Power of Money, p. 16.

[53]*Ibid.*, p. 17.

[54]Greidanus justly calls this sort
of equation “in all its absurdity the prototype of the
equations set up by the equivalubrists,” in the modern mode
of the “economics of the bookkeeper, not of the
economist.” Greidanus, *Value of Money*, p.
196.

[55]Fisher, *Purchasing Power
of Money*, p. 16.

[56]For a brilliant critique of the
disturbing effects of averaging even when a commensurable unit *does*
exist, *see* Louis M. Spadaro, “Averages
and Aggregates in Economics” in *On Freedom and Free
Enterprise*, pp. 140–60.

[57]*See* Clark
Warburton, “Elementary Algebra and the Equation of
Exchange,” *American Economic Review,*
June, 1953, pp. 358–61. *Also see* Mises, *Human
Action*, p. 396; B.M. Anderson, Jr., *The Value of
Money* (New York: Macmillan & Co., 1926), pp.
154–64; and Greidanus, *Value of Money*,
pp. 59–62.

[58]Conventional accounting practice is based on a fixed value of the monetary unit.

[59]Professor Mises has pointed out
that the assertion of the mathematical economists that their task is
made difficult by the existence of “many variables”
in human action grossly understates the problem; for the point is that *all* the
determinants are variables and that in contrast to the natural sciences
*there are no constants.*

[60]See the brilliant critique of
index numbers by Mises, *Theory of Money and Credit*,
pp. 187–94. *Also see* R.S. Padan,
“Review of C.M. Walsh’s *Measurement of
General Exchange Value*,” *Journal of
Political Economy,* September, 1901, p. 609.

[61]Irving Fisher, *Stabilised
Money* (London: George Allen & Unwin, 1935), p. 375.

[62]The fact that the purchasing power
of the monetary unit is not quantitatively definable does not
negate the fact of its *existence*, which is
established by prior praxeological knowledge. It thereby
differs, for example, from the “competitive
price–monopoly price” dichotomy, which cannot be
independently established by praxeological deduction for free-market
conditions.

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