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2. Monetary Stabilization and Cyclical Policy (1928)

Part A: Stabilization of the Purchasing Power of the Monetary Unit


1. “Stable Value” Money

Gold and silver had already served mankind for thousands of years as generally accepted media of exchange—that is, as money—before there was any clear idea of the formation of the exchange relationship between these metals and consumers’ goods, i.e., before there was an understanding as to how money prices for goods and services are formed. At best, some attention was given to fluctuations in the mutual exchange relationships of the two precious metals. But so little understanding was achieved that men clung, without hesitation, to the naïve belief that the precious metals were “stable in value” and hence a useful measure of the value of goods and prices. Only much later did the recognition come that supply and demand determine the exchange relationship between money, on the one hand, and consumers’ goods and services, on the other. With this realization, the first versions of the Quantity Theory, still somewhat imperfect and vulnerable, were formulated. It was known that violent changes in the volume of production of the monetary metals led to all-round shifts in money prices. When “paper money” was used along side “hard money,” this connection was still easier to see. The consequences of a tremendous paper inflation could not be mistaken.

From this insight, the doctrine of monetary policy emerged that the issue of “paper money” should be avoided completely. However, before long other authors made still further stipulations. They called the attention of politicians and businessmen to the fluctuations in the purchasing power of the precious metals and proposed that the substance of monetary claims be made independent of these variations. Side by side with money as the standard of deferred payments,3 or in place of it, there should be a tabular, index, or multiple commodity standard. Cash transactions, in which the terms of both sides of the contract are fulfilled simultaneously, would not be altered. However, a new procedure would be introduced for credit transactions. Such transactions would not be completed in the sum of money indicated in the contract. Instead, either by means of a universally compulsory legal regulation or else by specific agreement of the two parties concerned, they would be fulfilled by a sum with the purchasing power deemed to correspond to that of the original sum at the time the contract was made. The intent of this proposal was to prevent one party to a contract from being hurt to the other's advantage. These proposals were made more than one hundred years ago by Joseph Lowe (1822) and repeated shortly thereafter by G. Poulett Scrope (1833).4 Since then, they have cropped up repeatedly but without any attempt having been made to put them into practice anywhere.

2. Recent Proposals

One of the proposals, for a multiple commodity standard, was intended simply to supplement the precious metals standard. Putting it into practice would have left metallic money as a universally acceptable medium of exchange for all transactions not involving deferred monetary payments. (For the sake of simplicity in the discussion that follows, when referring to metallic money we shall speak only of gold.) Side by side with gold as the universally acceptable medium of exchange, the index or multiple commodity standard would appear as a standard of deferred payments.

Proposals have been made in recent years, however, which go still farther. These would introduce a “tabular,” or “multiple commodity,” standard for all exchanges when one commodity is not exchanged directly for another. This is essentially Keynes's proposal. Keynes wants to oust gold from its position as money. He wants gold to be replaced by a paper standard, at least for trade within a country's borders. The government, or the authority entrusted by the government with the management of monetary policy, should regulate the quantity in circulation so that the purchasing power of the monetary unit would remain unchanged.5

The American, Irving Fisher, wants to create a standard under which the paper dollar in circulation would be redeemable, not in a previously specified weight of gold, but in a weight of gold which has the same purchasing power the dollar had at the moment of the transition to the new currency system. The dollar would then cease to represent a fixed amount of gold with changing purchasing power and would become a changing amount of gold supposedly with unchanging purchasing power. It was Fisher's idea that the amount of gold which would correspond to a dollar should be determined anew from month to month, according to variations detected by the index number.6 Thus, in the view of both these reformers, in place of monetary gold, the value of which is independent of the influence of government, a standard should be adopted which the government “manipulates” in an attempt to hold the purchasing power of the monetary unit stable.

However, these proposals have not as yet been put into practice anywhere, although they have been given a great deal of careful consideration. Perhaps no other economic question is debated with so much ardor or so much spirit and ingenuity in the United States, as that of stabilizing the purchasing power of the monetary unit. Members of the House of Representatives have dealt with the problem in detail. Many scientific works are concerned with it. Magazines and daily papers devote lengthy essays and articles to it, while important organizations seek to influence public opinion in favor of carrying out Fisher's ideas.


1. The Demand for Money

Under the gold standard, the formation of the value of the monetary unit is not directly subject to the action of the government. The production of gold is free and responds only to the opportunity for profit. All gold not introduced into trade for consumption or for some other purpose flows into the economy as money, either as coins in circulation or as bars or coins in bank reserves. Should the increase in the quantity of money exceed the increase in the demand for money, then the purchasing power of the monetary unit must fall. Likewise, if the increase in the quantity of money lags behind the increase in the demand for money, the purchasing power of the monetary unit will rise.7

There is no doubt about the fact that, in the last generation, the purchasing power of gold has declined. Yet earlier, during the two decades following the German monetary reform and the great economic crisis of 1873, there was widespread complaint over the decline of commodity prices. Governments consulted experts for advice on how to eliminate this generally prevailing “evil.” Powerful political parties recommended measures for pushing prices up by increasing the quantity of money. In place of the gold standard, they advocated the silver standard, the double standard [bimetallism] or even a paper standard, for they considered the annual production of gold too small to meet the growing demand for money without increasing the purchasing power of the monetary unit. However, these complaints died out in the last five years of the nineteenth century, and soon men everywhere began to grumble about the opposite situation, i.e., the increasing cost of living. Just as they had proposed monetary reforms in the 1880s and 1890s to counteract the drop in prices, they now suggested measures to stop prices from rising.

The general advance of the prices of all goods and services in terms of gold is due to the state of gold production and the demand for gold, both for use as money as well as for other purposes. There is little to say about the production of gold and its influence on the ratio of the value of gold to that of other commodities. It is obvious that a smaller increase in the available quantity of gold might have counteracted the depreciation of gold. Nor need anything special be said about the industrial uses of gold. But the third factor involved, the way demand is created for gold as money, is quite another matter. Very careful attention should be devoted to this problem, especially as the customary analysis ignores most unfairly this monetary demand for gold.

During the period for which we are considering the development of the purchasing power of gold, various parts of the world, which formerly used silver or credit money (“paper money”) domestically, have changed over to the gold standard. Everywhere, the volume of money transactions has increased considerably. The division of labor has made great progress. Economic self-sufficiency and barter have declined. Monetary exchanges now play a role in phases of economic life where earlier they were completely unknown. The result has been a decided increase in the demand for money. There is no point in asking whether this increase in the demand for cash holdings by individuals, together with the demand for gold for nonmonetary uses, was sufficient to counteract the effect on prices of the new gold flowing into the market from production. Statistics on the height and fluctuations of cash holdings are not available. Even if they could be known, they would tell us little because the changes in prices do not correspond with changes in the relationship between supply and demand for cash holdings. Of greater importance, however, is the observation that the increase in the demand for money is not the same thing as an increase in the demand for gold for monetary purposes.

As far as the individual's cash holding is concerned, claims payable in money, which may be redeemed at any time and are universally considered safe, perform the service of money. These money substitutes—small coins, banknotes and bank deposits subject to check or similar payment on demand (checking accounts)—may be used just like money itself for the settlement of all transactions. Only a part of these money substitutes, however, is fully covered by stocks of gold on deposit in the banks’ reserves. In the decades of which we speak, the use of money substitutes has increased considerably more than has the rise in the demand for money and, at the same time, its reserve ratio has worsened. As a result, in spite of an appreciable increase in the demand for money, the demand for gold has not risen enough for the market to absorb the new quantities of gold flowing from production without lowering its purchasing power.

2. Economizing on Money

If one complains of the decline in the purchasing power of gold today, and contemplates the creation of a monetary unit whose purchasing power shall be more constant than that of gold in recent decades, it should not be forgotten that the principal cause of the decline in the value of gold during this period is to be found in monetary policy and not in gold production itself. Money substitutes not covered by gold, which we call fiduciary media, occupy a relatively more important position today in the world's total quantity of money8 than in earlier years. But this is not a development which would have taken place without the cooperation, or even without the express support, of governmental monetary policies. As a matter of fact, it was monetary policy itself which was deliberately aimed at a “saving” of gold and, which created, thereby, the conditions that led inevitably to the depreciation of gold.

The fact that we use as money a commodity like gold, which is produced only with a considerable expenditure of capital and labor, saddles mankind with certain costs. If the amount of capital and labor spent for the production of monetary gold could be released and used in other ways, people could be better supplied with goods for their immediate needs. There is no doubt about that! However, it should be noted that, in return for this expenditure, we receive the advantage of having available, for settling transactions, a money with a relatively steady value and, what is more important, the value of which is not directly influenced by governments and political parties. However, it is easy to understand why men began to ponder the possibility of creating a monetary system that would combine all the advantages offered by the gold standard with the added virtue of lower costs.

Adam Smith drew a parallel between the gold and silver which circulated in a land as money and a highway on which nothing grew, but over which fodder and grain were brought to market. The substitution of notes for the precious metals would create, so to speak, a “wagon-way through the air,” making it possible to convert a large part of the roads into fields and pastures and, thus, to increase considerably the yearly output of the economy. Then in 1816, Ricardo devised his famous plan for a gold exchange standard. According to his proposal, England should retain the gold standard, which had proved its value in every respect. However, gold coins should be replaced in domestic trade by banknotes, and these notes should be redeemable, not in gold coins, but in bullion only. Thus the notes would be assured of a value equivalent to that of gold and the country would have the advantage of possessing a monetary standard with all the attributes of the gold standard but at a lower cost.

Ricardo's proposals were not put into effect for decades. As a matter of fact, they were even forgotten. Nevertheless, the gold exchange standard was adopted by a number of countries during the 1890s—in the beginning usually as a temporary expedient only, without intending to direct monetary policy on to a new course. Today it is so widespread that we would be fully justified in describing it as “the monetary standard of our age.”9 However, in a majority, or at least in quite a number of these countries, the gold exchange standard has undergone a development which entitles it to be spoken of rather as a flexible gold exchange standard.10 Under Ricardo's plan, savings would be realized not only by avoiding the costs of coinage and the loss from wearing coins thin in use, but also because the amount of gold required for circulation and bank reserves would be less than under the “pure” gold standard.

Carrying out this plan in a single country must obviously, ceteris paribus, reduce the purchasing power of gold. And the more widely the system is adopted, the more must the purchasing power of gold decline. If a single land adopts the gold exchange standard, while others maintain a “pure” gold standard, then the gold exchange standard country can gain an immediate advantage over costs in the other areas. The gold, which is surplus under the gold exchange standard as compared with the gold which would have been called for under the “pure” gold standard, may be spent abroad for other commodities. These additional commodities represent an improvement in the country's welfare as a result of introducing the gold exchange standard. The gold exchange standard renders all the services of the gold standard to this country and also brings an additional advantage in the form of this increase of goods.

However, should every country in the world shift at the same time from the “pure” gold standard to a similar gold exchange standard, no gain of this kind would be possible. The distribution of gold throughout the world would remain unchanged. There would be no country where one could exchange a quantity of gold, made superfluous by the adoption of the new monetary system, for other goods. Embracing the new standard would result only in a universally more severe reduction in the purchasing power of gold. This monetary depreciation, like every change in the value of money, would bring about dislocations in the relationships of wealth and income of the various individuals in the economy. As a result, it could also lead indirectly, under certain circumstances, to an increase in capital accumulation. However, this indirect method will make the world richer only insofar as (1) the demand for gold for other uses (industrial and similar purposes) can be better satisfied and (2) a decline in profitability leads to a restriction of gold production and so releases capital and labor for other purposes.

3. Interest on “idle” Reserves

In addition to these attempts toward “economy” in the operation of the gold standard, by reducing the domestic demand for gold, other efforts have also aimed at the same objective. Holding gold reserves is costly to the banks of issue because of the loss of interest. Consequently, it was but a short step to the reduction of these costs by permitting noninterest-bearing gold reserves in bank vaults to be replaced by interest-bearing credit balances abroad, payable in gold on demand, and by bills of exchange payable in gold. Assets of this type enable the banks of issue to satisfy demands for gold in foreign trade just as the possession of a stock of gold coins and bars would. As a matter of fact, the dealer in arbitrage who presents notes for redemption will prefer payment in the form of checks, and bills of exchange—foreign financial paper—to redemption in gold because the costs of shipping foreign financial papers are lower than those for the transport of gold. The banks of smaller and poorer lands especially converted a part of their reserves into foreign bills of exchange. The inducement was particularly strong in countries on the gold exchange standard, where the banks did not have to consider a demand for gold for use in domestic circulation. In this way, the gold exchange standard [Goldkernwährung] became the flexible gold exchange standard [Golddevisenkernwährung], i.e., the flexible standard.

Nevertheless, the goal of this policy was not only to reduce the costs involved in the maintenance and circulation of an actual stock of gold. In many countries, including Germany and Austria, this was thought to be a way to reduce the rate of interest. The influence of the Currency Theory had led, decades earlier, to banking legislation intended to avoid the consequences of a paper money inflation. These laws, limiting the issue of banknotes not covered by gold, were still in force. Reared in the Historical-Realistic School of economic thinking, the new generation, insofar as it dealt with these problems, was under the spell of the Banking Theory, and thus no longer understood the meaning of these laws.

Lack of originality prevented the new generation from embarking upon any startling reversal in policy. In line with currently prevailing opinion, it abolished the limitation on the issue of banknotes not covered by metal. The old laws were allowed to stay on the books essentially unchanged. However, various attempts were made to reduce their effect. The most noteworthy of these measures was to encourage, systematically and purposefully, the settlement of transactions without the use of cash. By supplanting cash transactions with checks and other transfer payments, it was expected not only that there would be a reduction in the demand for banknotes but also a flow of gold coins back to the bank and, consequently, a strengthening of the bank's cash position. As German, and also Austrian, banking legislation prescribed a certain percentage of gold cover for notes issued, gold flowing back to the bank meant that more notes could be issued—up to three times their gold value in Germany and two and a half times in Austria. During recent decades, the banking theory has been characterized by a belief that this should result in a reduction in the rate of interest.

4. Gold Still Money

If we glance, even briefly, at the efforts of monetary and banking policy in recent years, it becomes obvious that the depreciation of gold may be traced in large part to political measures. The decline in the purchasing power of gold and the continual increase in the gold price of all goods and services were not natural phenomena. They were consequences of an economic policy which aimed, to be sure, at other objectives, but which necessarily led to these results. As has already been mentioned, accurate quantitative observations about these matters can never be made. Nevertheless, it is obvious that the increase in gold production has certainly not been the cause, or at least not the only cause, of the depreciation of gold that has been observed since 1896. The policy directed toward displacing gold in actual circulation, which aimed at substituting the gold exchange standard and the flexible standard for the older “pure” gold standard, forced the value of gold down or at least helped to depress it. Perhaps, if this policy had not been followed, we would hear complaints today over the increase, rather than the depreciation, in the value of gold.

Gold has not been demonetized by the new monetary policy, as silver was a short time ago, for it remains the basis of our entire monetary system. Gold is still, as it was formerly, our money. There is no basis for saying that it has been de-throned, as suggested by scatterbrained innovators of catchwords and slogans who want to cure the world of the “money illusion.” Nevertheless, gold has been removed from actual use in transactions by the public at large. It has disappeared from view and has been concentrated in bank vaults and monetary reserves. Gold has been taken out of common use and this must necessarily tend to lower its value.

It is wrong to point to the general price increases of recent years to illustrate the inadequacy of the gold standard. It is not the old style gold standard, as recommended by advocates of the gold standard in England and Germany, which has given us a monetary system that has led to rising prices in recent years. Rather these price increases have been the results of monetary and banking policies which permitted the “pure” or “classical” gold standard to be replaced by the gold exchange and flexible standards, leaving in circulation only notes and small coins and concentrating the gold stocks in bank and currency reserves.


1. Monetary Policy and Purchasing Power of Gold

Most important for the old, “pure,” or classical gold standard, as originally formulated in England and later, after the formation of the Empire, adopted in Germany, was the fact that it made the formation of prices independent of political influence and the shifting views which sway political action. This feature especially recommended the gold standard to liberals11 who feared that economic productivity might be impaired as a result of the tendency of governments to favor certain groups of persons at the expense of others.

However, it should certainly not be forgotten that under the “pure” gold standard governmental measures may also have a significant influence on the formation of the value of gold. In the first place, governmental actions determine whether to adopt the gold standard, abandon it, or return to it. However, the effect of these governmental actions, which we need not consider any further here, is conceived as very different from those described by the various “state theories of money”—theories which, now at long last, are generally recognized as absurd. The continual displacement of the silver standard by the gold standard and the shift in some countries from credit money to gold added to the demand for monetary gold in the years before the World War [1914–1918]. War measures resulted in monetary policies that led the belligerent nations, as well as some neutral states, to release large parts of their gold reserves, thus releasing more gold for world markets. Every political act in this area, insofar as it affects the demand for, and the quantity of, gold as money, represents a “manipulation” of the gold standard and affects all countries adhering to the gold standard.

Just as the “pure” gold, the gold exchange and the flexible standards do not differ in principle, but only in the degree to which money substitutes are actually used in circulation, so is there no basic difference in their susceptibility to manipulation. The “pure” gold standard is subject to the influence of monetary measures—on the one hand, insofar as monetary policy may affect the acceptance or rejection of the gold standard in a political area and, on the other hand, insofar as monetary policy, while still clinging to the gold standard in principle, may bring about changes in the demand for gold through an increase or decrease in actual gold circulation or by changes in reserve requirements for banknotes and checking accounts. The influence of monetary policy on the formation of the value [i.e., the purchasing power] of gold also extends just that far and no farther under the gold exchange and flexible standards. Here again, governments and those agencies responsible for monetary policy can influence the formation of the value of gold by changing the course of monetary policy. The extent of this influence depends on how large the increase or decrease in the demand for gold is nationally, in relation to the total world demand for gold.

If advocates of the old “pure” gold standard spoke of the independence of the value of gold from governmental influences, they meant that once the gold standard had been adopted everywhere (and gold standard advocates of the last three decades of the nineteenth century had not the slightest doubt that this would soon come to pass, for the gold standard had already been almost universally accepted) no further political action would affect the formation of monetary value. This would be equally true for both the gold exchange and flexible standards. It would by no means disturb the logical assumptions of the perceptive “pure” gold standard advocate to say that the value of gold would be considerably affected by a change in United States Federal Reserve Board policy, such as the resumption of the circulation of gold or the retention of larger gold reserves in European countries. In this sense, all monetary standards may be “manipulated” under today's economic conditions. The advantage of the gold standard—whether “pure” or “gold exchange”—is due solely to the fact that, if once generally adopted in a definite form, and adhered to, it is no longer subject to specific political interferences.

War and postwar actions, with respect to monetary policy, have radically changed the monetary situation throughout the entire world. One by one, individual countries are now [1928] reverting to a gold basis and it is likely that this process will soon be completed. Now, this leads to a second problem: Should the exchange standard, which generally prevails today, be retained? Or should a return be made once more to the actual use of gold in moderate-sized transactions as before under the “pure” gold standard? Also, if it is decided to remain on the exchange standard, should reserves actually be maintained in gold? And at what height? Or could individual countries be satisfied with reserves of foreign exchange payable in gold? (Obviously, the flexible standard cannot become entirely universal. At least one country must continue to invest its reserves in real gold, even if it does not use gold in actual circulation.) Only if the state of affairs prevailing at a given instant in every single area is maintained and, also, only if matters are left just as they are, including of course the ratio of bank reserves, can it be said that the gold standard cannot be manipulated in the manner described above. If these problems are dealt with in such a way as to change markedly the demand for gold for monetary purposes, then the purchasing power of gold must undergo corresponding changes.

To repeat for the sake of clarity, this represents no essential disagreement with the advocates of the gold standard as to what they considered its special superiority. Changes in the monetary system of any large and wealthy land will necessarily influence substantially the creation of monetary value. Once these changes have been carried out and have worked their effect on the purchasing power of gold, the value of money will necessarily be affected again by a return to the previous monetary system. However, this detracts in no way from the truth of the statement that the creation of value under the gold standard is independent of politics, so long as no essential changes are made in its structure, nor in the size of the area where it prevails.

2. Changes in Purchasing Power of Gold

Irving Fisher, as well as many others, criticize the gold standard because the purchasing power of gold has declined considerably since 1896, and especially since 1914. In order to avoid misunderstanding, it should be pointed out that this drop in the purchasing power of gold must be traced back to monetary policy—monetary policy which fostered the reduction in the purchasing power of gold through measures adopted between 1896 and 1914, to “economize” gold and, since 1914, through the rejection of gold as the basis for money in many countries. If others denounce the gold standard because the imminent return to the actual use of gold in circulation and the strengthening of gold reserves in countries on the exchange standard would bring about an increase in the purchasing power of gold, then it becomes obvious that we are dealing with the consequences of political changes in monetary policy which transform the structure of the gold standard.

The purchasing power of gold is not “stable.” It should be pointed out that there is no such thing as “stable” purchasing power, and never can be. The concept of “stable value” is vague and indistinct. Strictly speaking, only an economy in the final state of rest—where all prices remain unchanged—could have a money with fixed purchasing power. However, it is a fact which no one can dispute that the gold standard, once generally adopted and adhered to without changes, makes the formation of the purchasing power of gold independent of the operations of shifting political efforts.

As gold is obtained only from a few sources, which sooner or later will be exhausted, the fear is repeatedly expressed that there may someday be a scarcity of gold and, as a consequence, a continuing decline in commodity prices. Such fears became especially great in the late 1870s and the 1880s. Then they quieted down. Only in recent years have they been revived again. Calculations are made indicating that the placers and mines currently being worked will be exhausted within the foreseeable future. No prospects are seen that any new rich sources of gold will be opened up. Should the demand for money increase in the future, to the same extent as it has in the recent past, then a general price drop appears inevitable, if we remain on the gold standard.12

Now one must be very cautious with forecasts of this kind. A half century ago, Eduard Suess, the geologist, claimed—and he sought to establish this scientifically—that an unavoidable decline in gold production should be expected.13 Facts very soon proved him wrong. And it may be that those who express similar ideas today will also be refuted just as quickly and just as thoroughly. Still we must agree that they are right in the final analysis, that prices are tending to fall [1928] and that all the social consequences of an increase in purchasing power are making their appearance. What may be ventured, given the circumstances, in order to change the economic pessimism, will be discussed at the end of the second part of this study.


1. Imaginary Constructions

All proposals to replace the commodity money, gold, with a money thought to be better, because it is more “stable” in value, are based on the vague idea that changes in purchasing power can somehow be measured. Only by starting from such an assumption is it possible to conceive of a monetary unit with unchanging purchasing power as the ideal and to consider seeking ways to reach this goal. These proposals, vague and basically contradictory, are derived from the old, long since exploded, objective theory of value. Yet they are not even completely consistent with that theory. They now appear very much out of place in the company of modern, subjective economics.

The prestige which they still enjoy can be explained only by the fact that, until very recently, studies in subjective economics have been restricted to the theory of direct exchange (barter). Only lately have such studies been expanded to include also the theory of intermediate (indirect) exchange, i.e., the theory of a generally accepted medium of exchange (monetary theory) and the theory of fiduciary media (banking theory) with all their relevant problems.14 It is certainly high time to expose conclusively the errors and defects of the basic concept that purchasing power can be measured.

Exchange ratios on the market are constantly subject to change. If we imagine a market where no generally accepted medium of exchange, i.e., no money, is used, it is easy to recognize how nonsensical the idea is of trying to measure the changes taking place in exchange ratios. It is only if we resort to the fiction of completely stationary exchange ratios among all commodities, other than money, and then compare these other commodities with money, that we can envisage exchange relationships between money and each of the other individual exchange commodities changing uniformly. Only then can we speak of a uniform increase or decrease in the monetary price of all commodities and of a uniform rise or fall of the “price level.” Still, we must not forget that this concept is pure fiction, what Vaihinger termed an “as if.”15 It is a deliberate imaginary construction, indispensable for scientific thinking.

Perhaps the necessity for this imaginary construction will become somewhat more clear if we express it, not in terms of the objective exchange value of the market, but in terms of the subjective exchange valuation of the acting individual. To do that, we must imagine an unchanging man with never-changing values. Such an individual could determine, from his never-changing scale of values, the purchasing power of money. He could say precisely how the quantity of money, which he must spend to attain a certain amount of satisfaction, had changed. Nevertheless, the idea of a definite structure of prices, a “price level,” which is raised or lowered uniformly, is just as fictitious as this. However, it enables us to recognize clearly that every change in the exchange ratio between a commodity, on the one side, and money, on the other, must necessarily lead to shifts in the disposition of wealth and income among acting individuals. Thus, each such change acts as a dynamic agent also. In view of this situation, therefore, it is not permissible to make such an assumption as a uniformly changing “level” of prices.

This imaginary construction is necessary, however, to explain that the exchange ratios of the various economic goods may undergo a change from the side of one individual commodity. This fictional concept is the ceteris paribus of the theory of exchange relationships. It is just as fictitious and, at the same time, just as indispensable as any ceteris paribus. If extraordinary circumstances lead to exceptionally large and hence conspicuous changes in exchange ratios, data on market phenomena may help to facilitate sound thinking on these problems. However, then even more than ever, if we want to see the situation at all clearly, we must resort to the imaginary construction necessary for an understanding of our theory.

The expressions, “inflation” and “deflation,” scarcely known in German economic literature several years ago, are in daily use today. In spite of their inexactness, they are undoubtedly suitable for general use in public discussions of economic and political problems.16 But in order to understand them precisely, one must elaborate with rigid logic that fictional concept [the imaginary construction of completely stationary exchange ratios among all commodities other than money], the falsity of which is clearly recognized.

Among the significant services performed by this fiction is that it enables us to distinguish and determine whether changes in exchange relationships between money and other commodities arise on the money side or the commodity side. In order to understand the changes which take place constantly on the market, this distinction is urgently needed. It is still more indispensable for judging the significance of measures proposed or adopted in the field of monetary and banking policy. Even in these cases, however, we can never succeed in constructing a fictional representation that coincides with the situation which actually appears on the market. The imaginary construction makes it easier to understand reality, but we must remain conscious of the distinction between fiction and reality.17

2. Index Numbers

Attempts have been made to measure changes in the purchasing power of money by using data derived from changes in the money prices of individual economic goods. These attempts rest on the theory that, in a carefully selected index of a large number, or of all consumers’ goods, influences from the commodity side affecting commodity prices cancel each other out. Thus, so the theory goes, the direction and extent of the influence on prices of factors arising on the money side may be discovered from such an index. Essentially, therefore, by computing an arithmetical mean, this method seeks to convert the price changes emerging among the various consumers’ goods into a figure which may then be considered an index to the change in the value of money. In this discussion, we shall disregard the practical difficulties which arise in assembling the price quotations necessary to serve as the basis for such calculations and restrict ourselves to commenting on the fundamental usefulness of this method for the solution of our problem.

First of all it should be noted that there are various arithmetical means. Which one should be selected? That is an old question. Reasons may be advanced for, and objections raised against, each. From our point of view, the only important thing to be learned in such a debate is that the question cannot be settled conclusively so that everyone will accept any single answer as “right.”

The other fundamental question concerns the relative importance of the various consumer goods. In developing the index, if the price of each and every commodity is considered as having the same weight, a 50 percent increase in the price of bread, for instance, would be offset in calculating the arithmetical average by a drop of one-half in the price of diamonds. The index would then indicate no change in purchasing power, or “price level.” As such a conclusion is obviously preposterous, attempts are made in fabricating index numbers, to use the prices of various commodities according to their relative importance. Prices should be included in the calculations according to the coefficient of their importance. The result is then known as a “weighted” average.

This brings us to the second arbitrary decision necessary for developing such an index. What is “importance”? Several different approaches have been tried and arguments pro and con each have been raised. Obviously, a clear-cut, all-round satisfactory solution to the problem cannot be found. Special attention has been given the difficulty arising from the fact that, if the usual method is followed, the very circumstances involved in determining “importance” are constantly in flux; thus the coefficient of importance itself is also continuously changing.

As soon as one starts to take into consideration the “importance” of the various goods, one forsakes the assumption of objective exchange value—which often leads to nonsensical conclusions as pointed out above—and enters the area of subjective values. Since there is no generally recognized immutable “importance” to various goods, since “subjective” value has meaning only from the point of view of the acting individual, further reflection leads eventually to the subjective method already discussed—namely the inexcusable fiction of a never-changing man with never-changing values. To avoid arriving at this conclusion, which is also obviously absurd, one remains indecisively on the fence, midway between two equally nonsensical methods—on the one side the un-weighted average and on the other the fiction of a never-changing individual with never-changing values. Yet one believes he has discovered something useful. Truth is not the halfway point between two untruths. The fact that each of these two methods, if followed to its logical conclusion, is shown to be preposterous, in no way proves that a combination of the two is the correct one.

All index computations pass quickly over these unanswerable objections. The calculations are made with whatever coefficients of importance are selected. However, we have established that even the problem of determining “importance” is not capable of solution, with certainty, in such a way as to be recognized by everyone as “right.”

Thus the idea that changes in the purchasing power of money may be measured is scientifically untenable. This will come as no surprise to anyone who is acquainted with the fundamental problems of modern subjectivistic catallactics and has recognized the significance of recent studies with respect to the measurement of value18 and the meaning of monetary calculation.19

One can certainly try to devise index numbers. Nowadays nothing is more popular among statisticians than this. Nevertheless, all these computations rest on a shaky foundation. Disregarding entirely the difficulties which, from time to time, even thwart agreement as to the commodities whose prices will form the basis of these calculations, these computations are arbitrary in two ways—first, with respect to the arithmetical mean chosen and, secondly, with respect to the coefficient of importance selected. There is no way to characterize one of the many possible methods as the only “correct” one and the others as “false.” Each is equally legitimate or illegitimate. None is scientifically meaningful.

It is small consolation to point out that the results of the various methods do not differ substantially from one another. Even if that is the case, it cannot in the least affect the conclusions we must draw from the observations we have made. The fact that people can conceive of such a scheme at all, that they are not more critical, may be explained only by the eventuality of the great inflations, especially the greatest and most recent one.

Any index method is good enough to make a rough statement about the extremely severe depreciation of the value of a monetary unit, such as that wrought in the German inflation. There, the index served an instructional task, enlightening a people who were inclined to the “State Theory of Money” idea. Nevertheless, a method that helps to open the eyes of the people is not necessarily either scientifically correct or applicable in actual practice.


1. Political Problem

The superiority of the gold standard consists in the fact that the value of gold develops independent of political actions. It is clear that its value is not “stable.” There is not, and never can be, any such thing as stability of value. If, under a “manipulated” monetary standard, it was government's task to influence the value of money, the question of how this influence was to be exercised would soon become the main issue among political and economic interests. Government would be asked to influence the purchasing power of money so that certain politically powerful groups would be favored by its intervention, at the expense of the rest of the population. Intense political battles would rage over the direction and scope of the edicts affecting monetary policy. At times, steps would be taken in one direction, and at other times in other directions—in response to the momentary balance of political power. The steady, progressive development of the economy would continually experience disturbances from the side of money. The result of the manipulation would be to provide us with a monetary system which would certainly not be any more stable than the gold standard.

If the decision were made to alter the purchasing power of money so that the index number always remained unchanged, the situation would not be any different. We have seen that there are many possible ways, not just one single way, to determine the index number. No single one of these methods can be considered the only correct one. Moreover, each leads to a different conclusion. Each political party would advocate the index method which promised results consistent with its political aims at the time. Since it is not scientifically possible to find one of the many methods objectively right and to reject all others as false, no judge could decide impartially among groups disputing the correct method of calculation.

In addition, however, there is still one more very important consideration. The early proponents of the Quantity Theory believed that changes in the purchasing power of the monetary unit caused by a change in the quantity of money were exactly inversely proportional to one another. According to this Theory, a doubling of the quantity of money would cut the monetary unit's purchasing power in half. It is to the credit of the more recently developed monetary theory that this version of the Quantity Theory has been proved untenable. An increase in the quantity of money must, to be sure, lead ceteris paribus to a decline in the purchasing power of the monetary unit. Still the extent of this decrease in no way corresponds to the extent of the increase in the quantity of money. No fixed quantitative relationship can be established between the changes in the quantity of money and those of the unit's purchasing power.20 Hence, every manipulation of the monetary standard will lead to serious difficulties. Political controversies would arise not only over the “need” for a measure, but also over the degree of inflation or restriction, even after agreement had been reached on the purpose the measure was supposed to serve.

All this is sufficient to explain why proposals for establishing a manipulated standard have not been popular. It also explains—even if one disregards the way finance ministers have abused their authority—why credit money (commonly known as “paper money”) is considered “bad” money. Credit money is considered “bad money” precisely because it may be manipulated.

2. Multiple Commodity Standard

Proposals that a multiple commodity standard replace, or supplement, monetary standards based on the precious metals—in their role as standards of deferred payments—are by no means intended to create a manipulated money. They are not intended to change the precious metals standard itself nor its effect on value. They seek merely to provide a way to free all transactions involving future monetary payments from the effect of changes in the value of the monetary unit. It is easy to understand why these proposals were not put into practice. Relying as they do on the shaky foundation of index number calculations, which cannot be scientifically established, they would not have produced a stable standard of value for deferred payments. They would only have created a different standard with different changes in value from those under the gold metallic standard.

To some extent Fisher's proposals parallel the early ideas of advocates of a multiple commodity standard. These forerunners also tried to eliminate only the influence of the social effects of changes in monetary value on the content of future monetary obligations. Like most Anglo-American students of this problem, as well as earlier advocates of a multiple commodity standard, Fisher took little notice of the fact that changes in the value of money have other social effects also.

Fisher, too, based his proposals entirely on index numbers. What seems to recommend his scheme, as compared with proposals for introducing a “multiple standard,” is the fact that he does not use index numbers directly to determine changes in purchasing power over a long period of time. Rather he uses them primarily to understand changes taking place from month to month only. Many objections raised against the use of the index method for analyzing longer periods of time will perhaps appear less justified when considering only shorter periods. But there is no need to discuss this question here, for Fisher did not confine the application of his plan to short periods only. Also, even if adjustments are always made from month to month only, they were to be carried forward, on and on, until eventually calculations were being made, with the help of the index number, which extended over long periods of time. Because of the imperfection of the index number, these calculations would necessarily lead in time to errors of very considerable proportions.

3. Price Premium

Fisher's most important contribution to monetary theory is the emphasis he gave to the previously little noted effect of changes in the value of money on the formation of the interest rate.21 Insofar as movements in the purchasing power of money can be foreseen, they find expression in the gross interest rate—not only as to the direction they will take but also as to their approximate magnitude. That portion of the gross interest rate which is demanded, and granted, in view of anticipated changes in purchasing power is known as the purchasing-power-change premium or price-change premium. In place of these clumsy expressions we shall use a shorter term—“price premium.” Without any further explanation, this terminology leads to an understanding of the fact that, given an anticipation of general price increases, the price premium is “positive,” thus raising the gross rate of interest. On the other hand, with an anticipation of general price decreases, the price premium becomes “negative” and so reduces the gross interest rate.

The individual businessman is not generally aware of the fact that monetary value is affected by changes from the side of money. Even if he were, the difficulties which hamper the formation of a halfway reliable judgment, as to the direction and extent of anticipated changes, are tremendous, if not outright insurmountable. Consequently, monetary units used in credit transactions are generally regarded rather naïvely as being “stable” in value. So, with agreement as to conditions under which credit will be applied for and granted, a price premium is not generally considered in the calculation. This is practically always true, even for long-term credit. If opinion is shaken as to the “stability of value” of a certain kind of money, this money is not used at all in long-term credit transactions. Thus, in all nations using credit money, whose purchasing power fluctuated violently, long-term credit obligations were drawn up in gold, whose value was held to be “stable.”

However, because of obstinacy and pro-government bias, this course of action was not employed in Germany, nor in other countries during the recent inflation. Instead, the idea was conceived of making loans in terms of rye and potash. If there had been no hope at all of a later compensating revaluation of these loans, their price on the exchange in German marks, Austrian crowns and similarly inflated currencies would have been so high that a positive price premium corresponding to the magnitude of the anticipated further depreciation of these currencies would have been reflected in the actual interest payment.

The situation is different with respect to short-term credit transactions. Every businessman estimates the price changes anticipated in the immediate future and guides himself accordingly in making sales and purchases. If he expects an increase in prices, he will make purchases and postpone sales. To secure the means for carrying out this plan, he will be ready to offer higher interest than otherwise. If he expects a drop in prices, then he will seek to sell and to refrain from purchasing. He will then be prepared to lend out, at a cheaper rate, the money made available as a result. Thus, the expectation of price increases leads to a positive price premium, that of price declines to a negative price premium.

To the extent that this process correctly anticipates the price movements that actually result, with respect to short-term credit, it cannot very well be maintained that the content of contractual obligations are transformed by the change in the purchasing power of money in a way which was neither foreseen nor contemplated by the parties concerned. Nor can it be maintained that, as a result, shifts take place in the wealth and income relationship between creditor and debtor. Consequently, it is unnecessary, so far as short-term credit is concerned, to look for a more perfect standard of deferred payments.

Thus we are in a position to see that Fisher's proposal actually offers no more than was offered by any previous plan for a multiple standard. In regard to the role of money as a standard of deferred payments, the verdict must be that, for long-term contracts, Fisher's scheme is inadequate. For short-term commitments, it is both inadequate and superfluous.

4. Changes in Wealth and Income

However, the social consequences of changes in the value of money are not limited to altering the content of future monetary obligations. In addition to these social effects, which are generally the only ones dealt with in Anglo-American literature, there are still others. Changes in money prices never reach all commodities at the same time, and they do not affect the prices of the various goods to the same extent. Shifts in relationships between the demand for, and the quantity of, money for cash holdings generated by changes in the value of money from the money side do not appear simultaneously and uniformly throughout the entire economy. They must necessarily appear on the market at some definite point, affecting only one group in the economy at first, influencing only their judgments of value in the beginning and, as a result, only the prices of commodities these particular persons are demanding. Only gradually does the change in the purchasing power of the monetary unit make its way throughout the entire economy.

For example, if the quantity of money increases, the additional new quantity of money must necessarily flow first of all into the hands of certain definite individuals—gold producers, for example, or, in the case of paper money inflation, the coffers of the government. It changes only their incomes and fortunes at first and, consequently, only their value judgments. Not all goods go up in price in the beginning, but only those goods which are demanded by these first beneficiaries of the inflation. Only later are prices of the remaining goods raised, as the increased quantity of money progresses step by step throughout the land and eventually reaches every participant in the economy.22 But even then, when finally the upheaval of prices due to the new quantity of money has ended, the prices of all goods and services will not have increased to the same extent. Precisely because the price increases have not affected all commodities at one time, shifts in the relationships in wealth and income are effected which affect the supply and demand of individual goods and services differently. Thus, these shifts must lead to a new orientation of the market and of market prices.

Suppose we ignore the consequences of changes in the value of money on future monetary obligations. Suppose further that changes in the purchasing power of money occur simultaneously and uniformly with respect to all commodities in the entire economy. Then, it becomes obvious that changes in the value of money would produce no changes in the wealth of the individual entrepreneurs. Changes in the value of the monetary unit would then have no more significance for them than changes in weights and measures or in the calendar.

It is only because changes in the purchasing power of money never affect all commodities everywhere simultaneously that they bring with them (in addition to their influence on debt transactions) still other shifts in wealth and income. The groups which produce and sell the commodities that go up in price first are benefited by the inflation, for they realize higher profits in the beginning and yet they can still buy the commodities they need at lower prices, reflecting the previous stock of money. So during the inflation of the World War [1914–1918], the producers of war materiel and the workers in war industries, who received the output of the printing presses earlier than other groups of people, benefited from the monetary depreciation. At the same time, those whose incomes remained nominally the same suffered from the inflation, as they were forced to compete in making purchases with those receiving war inflated incomes. The situation became especially clear in the case of government employees. There was no mistaking the fact that they were losers. Salary increases came to them too late. For some time they had to pay prices, already affected by the increase in the quantity of money, with money incomes related to previous conditions.

5. Uncompensatable Changes

In the case of foreign trade, it was just as easy to see the consequences of the fact that price changes of the various commodities did not take place simultaneously. The deterioration in the value of the monetary unit encourages exports because a part of the raw materials, semi-produced factors of production and labor needed for the manufacture of export commodities, were procured at the old lower prices. At the same time the change in purchasing power, which for the time being has affected only a part of the domestically-produced commodities, has already had an influence on the rate of exchange on the Bourse. The result is that the exporter realizes a specific monetary gain.

The changes in purchasing power arising on the money side are considered disturbing not merely because of the transformation they bring about in the content of future monetary obligations. They are also upsetting because of the uneven timing of the price changes of the various goods and services. Can Fisher's dollar of “stable value” eliminate these price changes?

In order to answer this question, it must be restated that Fisher's proposal does not eliminate changes in the value of the monetary unit. It attempts instead to compensate for these changes continuously—from month to month. Thus the consequences associated with the step-by-step emergence of changes in purchasing power are not eliminated. Rather they materialize during the course of the month. Then, when the correction is made at the end of the month, the course of monetary depreciation is still not ended. The adjustment calculated at that time is based on the index number of the previous month when the full extent of that month's monetary depreciation had not then been felt because all prices had not yet been affected. However, the prices of goods for which demand was forced up first by the additional quantity of money undoubtedly reached heights that may not be maintained later.

Whether or not these two deviations in prices correspond in such a way that their effects cancel each other out will depend on the specific data in each individual case. Consequently, the monetary depreciation will continue in the following month, even if no further increase in the quantity of money were to appear in that month. It would continue to go on until the process finally ended with a general increase in commodity prices, in terms of gold, and thus with an increase in the value of the gold dollar on the basis of the index number. The social consequences of the uneven timing of price changes would, therefore, not be avoided because the unequal timing of the price changes of various commodities and services would not have been eliminated.23

So there is no need to go into more detail with respect to the technical difficulties that stand in the way of realizing Fisher's Plan. Even if it could be put into operation successfully, it would not provide us with a monetary system that would leave the disposition of wealth and income undisturbed.


1. The Inherent Instability of Market Ratios

Changes in the exchange ratios between money and the various other commodities may originate either from the money side or from the commodity side of the transaction. Stabilization policy does not aim only at eliminating changes arising on the side of money. It also seeks to prevent all future price changes, even if this is not always clearly expressed and may sometimes be disputed.

It is not necessary for our purposes to go any further into the market phenomena which an increase or decrease in commodities must set in motion if the quantity of money remains unchanged.24 It is sufficient to point out that, in addition to changes in the exchange ratios among individual commodities, shifts would also appear in the exchange ratios between money and the majority of the other commodities in the market. A decrease in the quantity of other commodities would weaken the purchasing power of the monetary unit. An increase would enhance it. It should be noted, however, that the social adjustments which must result from these changes in the quantity of other commodities will lead to a reorganization in the demand for money and hence cash holdings. These shifts can occur in such a way as to counteract the immediate effect of the change in the quantity of goods on the purchasing power of the monetary unit. Still for the time being, we may ignore this situation.

The goal of all stabilization proposals, as we have seen, is to maintain unchanged the original content of future monetary obligations. Creditors and debtors should neither gain nor lose in purchasing power. This is assumed to be “just.” Of course, what is “just” or “unjust” cannot be scientifically determined. That is a question of ultimate purpose and ethical judgment. It is not a question of fact.

It is impossible to know just why the advocates of purchasing power stabilization see as “just” only the maintenance of an unchanged purchasing power for futuremonetary obligations. However, it is easy to understand that they do not want to permit either debtor or creditor to gain or lose. They want contractual liabilities to continue in force as little altered as possible in the midst of the constantly changing world economy. They want to transplant contractual liabilities out of the flow of events, so to speak, and into a timeless existence.

Now let us see what this means. Imagine that all production has become more fruitful. Goods flow more abundantly than ever before. Where only one unit was available for consumption before, there are now two. Since the quantity of money has not been increased, the purchasing power of the monetary unit has risen and with one monetary unit it is possible to buy, let us say, one-and-a-half times as much merchandise as before. Whether this actually means, if no “stabilization policy” is attempted, that the debtor now has a disadvantage and the creditor an advantage is not immediately clear.

If you look at the situation from the viewpoint of the prices of the factors of production, it is easy to see why this is the case. For the debtor could use the borrowed sum to buy at lower prices factors of production whose output has not gone up; or if their output has gone up, their prices have not risen correspondingly. It might now be possible to buy for less money, factors of production with a productive capacity comparable to that of the factors of production one could have bought with the borrowed money at the time of the loan. There is no point in exploring the uncertainties of theories which do not take into consideration the influence that ensuing changes exert on entrepreneurial profit, interest and rent.

However, if we consider changes in real income due to increased production, it becomes evident that the situation may be viewed very differently from the way it appears to those who favor “stabilization.” If the creditor gets back the same nominal sum, he can obviously buy more goods. Still, his economic situation is not improved as a result. He is not benefited relative to the general increase of real income which has taken place. If the multiple commodity standard were to reduce in part the nominal debt, his economic situation would be worsened. He would be deprived of something that, in his view, in all fairness belonged to him. Under a multiple commodity standard, interest payable over time, life annuities, subsistence allowances, pensions, and the like, would be increased or decreased according to the index number. Thus, these considerations cannot be summarily dismissed as irrelevant from the viewpoint of consumers.

We find, on the one hand, that neither the multiple commodity standard nor Irving Fisher's specific proposal is capable of eliminating the economic concomitants of changes in the value of the monetary unit due to the unequal timing in appearance and the irregularity in size of price changes. On the other hand, we see that these proposals seek to eliminate the repercussions on the content of debt agreements, circumstances permitting, in such a way as to cause definite shifts in wealth and income relations, shifts which appear obviously “unjust,” at least to those on whom their burden falls. The “justice” of these proposed reforms, therefore, is somewhat more doubtful than their advocates are inclined to assume.

2. The Misplaced Partiality to Debtors

It is certainly regrettable that this worthy goal cannot be attained, at least not by this particular route. These and similar efforts are usually acknowledged with sympathy by many who recognize their fallacy and their unworkability. This sympathy is based ultimately on the intellectual and physical inclination of men to be both lazy and resistant to change at the same time. Surely everyone wants to see his situation improved with respect to his supply of goods and the satisfaction of his wants. Surely everyone hopes for changes which would make him richer. Many circumstances make it appear that the old and the traditional, being familiar, are preferable to the new. Such circumstances would include distrust of the individual's own powers and abilities, aversion to being forced to adapt in thought and action to new situations and, finally, the knowledge that one is no longer able, in advanced years of life, to meet his obligations with the vitality of youth.

Certainly, something new is welcomed and gratefully accepted, if the something new is beneficial to the individual's welfare. However, any change which brings disadvantages or merely appears to bring them, whether or not the change is to blame, is considered “unjust.” Those favored by the new state of affairs through no special merit on their part quietly accept the increased prosperity as a matter of course and even as something already long due. Those hurt by the change, however, complain vociferously. From such observations, there developed the concepts of a “just price” and a ‘’just wage.” Whoever fails to keep up with the times and is unable to comply with its demands, becomes a eulogist of the past and an advocate of the status quo. However, the ideal of stability, of the stationary economy, is directly opposed to that of continual progress.

For some time popular opinion has been in sympathy with the debtor. The picture of the rich creditor, demanding payment from the poor debtor, and the vindictive teachings of moralists dominate popular thinking on indebtedness. A byproduct of this is to be found in the contrast, made by the contemporaries of the Classical School and their followers, between the “idle rich” and the “industrious poor.” However, with the development of bonds and savings deposits, and with the decline of small-scale enterprise and the rise of big business, a reversal of the former situation took place. It then became possible for the masses, with their increasing prosperity, to become creditors. The “rich man” is no longer the typical creditor, nor the “poor man” the typical debtor. In many cases, perhaps even in the majority of cases, the relationship is completely reversed. Today, except in the lands of farmers and small property owners, the debtor viewpoint is no longer that of the masses. Consequently it is also no longer the view of the political demagogues. Once upon a time inflation may have found its strongest support among the masses, who were burdened with debts. But the situation is now very different. A policy of monetary restriction would not be unwelcome among the masses today, for they would hope to reap a sure gain from it as creditors. They would expect the decline in their wages and salaries to lag behind, or at any rate not to exceed, the drop in commodity prices.

It is understandable, therefore, that proposals for the creation of a “stable value” standard of deferred payments, almost completely forgotten in the years when commodity prices were declining, have been revived again in the twentieth century. Proposals of this kind are always primarily intended for the prevention of losses to creditors, hardly ever to safeguard jeopardized debtor interests. They cropped up in England when she was the great world banker. They turned up again in the United States at the moment when she started to become a creditor nation instead of a land of debtors, and they became quite popular there when America became the great world creditor.

Many signs seem to indicate that the period of monetary depreciation [due to inflation] is coming to an end. Should this actually be the case, then the appeal which the idea of a manipulated standard now enjoys among creditor nations also would abate.


1. Liberalism25 and the Gold Standard

Monetary policy of the preliberal era was either crude coin debasement, for the benefit of financial administration (only rarely intended as Seisachtheia,26 i.e., to nullify outstanding debts), or still more crude paper money inflation. However, in addition to, sometimes even instead of, its fiscal goal, the driving motive behind paper money inflation very soon became the desire to favor the debtor at the expense of the creditor.

In opposing the depreciated paper standard, liberalism frequently took the position that after an inflation the value of paper money should be raised, through contraction, to its former parity with metallic money. It was only when men had learned that such a policy could not undo or reverse the “unfair” changes in wealth and income brought about by the previous inflationary period and that an increase in the purchasing power per unit [by contraction or deflation] also brings other unwanted shifts of wealth and income, that the demand for return to a metallic standard at the debased monetary unit's current parity gradually replaced the demand for restoration at the old parity.

In opposing a single precious metal standard, monetary policy exhausted itself in the fruitless attempt to make bimetallism an actuality. The results which must follow the establishment of a legal exchange ratio between the two precious metals, gold and silver, have long been known, even before Classical economics developed an understanding of the regularity of market phenomena. Again and again Gresham's Law, which applied the general theory of price controls to the special case of money, demonstrated its validity. Eventually, efforts were abandoned to reach the ideal of a bimetallic standard. The next goal then became to free international trade, which was growing more and more important, from the effects of fluctuations in the ratio between the prices of the gold standard and the suppression of the alternating [bimetallic] and silver standards. Gold then became the world's money.

With the attainment of gold monometallism, liberals believed the goal of monetary policy had been reached. (The fact that they considered it necessary to supplement monetary policy through banking policy will be examined later in considerable detail.) The value of gold was then independent of any direct manipulation by governments, political policies, public opinion or Parliaments. So long as the gold standard was maintained, there was no need to fear severe price disturbances from the side of money. The adherents of the gold standard wanted no more than this, even though it was not clear to them at first that this was all that could be attained.

2. “Pure” Gold Standard Disregarded

We have seen how the purchasing power of gold has continuously declined since the turn of the century. That was not, as frequently maintained, simply the consequence of increased gold production. There is no way to know whether the increased production of gold would have been sufficient to satisfy the increased demand for money without increasing its purchasing power, if monetary policy had not intervened as it did. The gold exchange and flexible standards were adopted in a number of countries, not the “pure” gold standard as its advocates had expected. “Pure” gold standard countries embraced measures which were thought to be, and actually were, steps toward the exchange standard. Finally, since 1914, gold has been withdrawn from actual circulation almost everywhere. It is primarily due to these measures that gold declined in value, thus generating the current debate on monetary policy.

The fault found with the gold standard today is not, therefore, due to the gold standard itself. Rather, it is the result of a policy which deliberately seeks to undermine the gold standard in order to lower the costs of using money and especially to obtain “cheap money,” i.e., lower interest rates for loans. Obviously, this policy cannot attain the goal it sets for itself. It must eventually bring not low interest on loans but rather price increases and distortion of economic development. In view of this, then, isn't it simply enough to abandon all attempts to use tricks of banking and monetary policy to lower interest rates, to reduce the costs of using and circulating money and to satisfy “needs” by promoting paper inflation?

The “pure” gold standard formed the foundation of the monetary system in the most important countries of Europe and America, as well as in Australia. This system remained in force until the outbreak of the World War [1914]. In the literature on the subject, it was also considered the ideal monetary policy until very recently. Yet the champions of this “pure” gold standard undoubtedly paid too little attention to changes in the purchasing power of monetary gold originating on the side of money. They scarcely noted the problem of the “stabilization” of the purchasing power of money, very likely considering it completely impractical. Today we may pride ourselves on having grasped the basic questions of price and monetary theory more thoroughly and on having discarded many of the concepts which dominated works on monetary policy of the recent past. However, precisely because we believe we have a better understanding of the problem of value today, we can no longer consider acceptable the proposals to construct a monetary system based on index numbers.

3. The Index Standard

It is characteristic of current political thinking to welcome every suggestion which aims at enlarging the influence of government. If the Fisher and Keynes27 proposals are approved on the grounds that they are intended to use government to make the formation of monetary value directly subservient to certain economic and political ends, this is understandable. However, anyone who approves of the index standard, because he wants to see purchasing power “stabilized,” will find himself in serious error.

Abandoning the pursuit of the chimera of a money of unchanging purchasing power calls for neither resignation nor disregard of the social consequences of changes in monetary value. The necessary conclusion from this discussion is that stability of the purchasing power of the monetary unit presumes stability of all exchange relationships and, therefore, the absolute abandonment of the market economy.

The question has been raised again and again: What will happen if, as a result of a technological revolution, gold production should increase to such an extent as to make further adherence to the gold standard impossible? A changeover to the index standard must follow then, it is asserted, so that it would only be expedient to make this change voluntarily now. However, it is futile to deal with monetary problems today which may or may not arise in the future. We do not know under what conditions steps will have to be taken toward solving them. It could be that, under certain circumstances, the solution may be to adopt a system based on an index number. However, this would appear doubtful. Even so, an index standard would hardly be a more suitable monetary standard than the one we now have. In spite of all its defects, the gold standard is a useful and not inexpedient standard.

  • 3. [In the German text Mises uses the English term, “Standard of deferred payments,” commenting in a footnote: “Standard of deferred payments is ‘Zahlungsmittel’ in German. Unfortunately this German expression must be avoided nowadays. Its meaning has been so compromised through its use by Nominalists and Chartists that it brings to mind the recently exploded errors of the state theory of money.” See above for comments on “state theory of money,” p. 12, n. 9, and “chartism,” p. 20, n. 15.—Ed.]
  • 4. William Stanley Jevons, Money and the Mechanism of Exchange, 13th ed. (London, 1902), pp. 328ff.
  • 5. John Maynard Keynes, A Tract on Monetary Reform (London, 1923; New York, 1924), pp. 177ff.
  • 6. Irving Fisher, Stabilizing the Dollar (New York, 1925), pp. 79ff.
  • 7. [This is not the place to examine further the theory of the formation of the purchasing power of the monetary unit. In this connection, see The Theory of Money and Credit; 1953, pp. 97–165; 1980, pp. 117–85.—Ed.]
  • 8. The quantity of “money in the broader sense” is equal to the quantity of money proper [i.e., commodity money] plus the quantity of fiduciary media [i.e., notes, bank deposits not backed by metal, and subsidiary coins].
  • 9. Fritz Machlup, Die Goldkernwährung (Halberstadt, 1925), p. xi.
  • 10. [A monetary standard based on a unit with a flexible gold parity; Golddevisenkernwährung, literally a standard based on convertibility into a foreign monetary unit, in effect a “flexible gold exchange standard.” In later writings, Professor Mises shortened this to “flexible standard” and this term will be used henceforth in this translation. See Human Action (1949; 3rd rev. ed. (New Haven, Conn.: Yale University Press, 1966); Scholar's Edition (Auburn, Ala.: Ludwig von Mises Institute, 1998), chapter XXXI, section 3.—Ed.]
  • 11. I employ the term “liberal” in the sense attached to it everywhere in the nineteenth century and still today in the countries of continental Europe. This usage is imperative because there is simply no other term available to signify the political and intellectual movement that substituted free enterprise and the market economy for the precapitalistic methods of production; constitutional representative government from the absolutism of kings or oligarchies; and freedom of all individuals from slavery, serfdom, and other forms of bondage. (“Foreword to the Third Edition,” Human Action [New Haven, Conn.: Yale University Press, 1963], p. v)
  • 12. Gustav Cassell, Währungsstabilisierung als Weltproblem (Leipzig, 1928), p. 12.
  • 13. [Eduard Suess (1831–1914) published a study in German (1877) on “The Future of Gold.”—Ed.]
  • 14. [The Theory of Money and Credit, 1953, pp. 116ff.; 1980, pp. 138ff.—Ed.]
  • 15. Hans Vaihinger (1852–1933), author of The Philosophy of As If (German, 1911; English translation, 1924).
  • 16. [The Theory of Money and Credit, 1953, pp. 239ff; 1980, pp. 271ff.—Ed.]
  • 17. [At this point, in a footnote, Professor Mises commented on a controversy he had had with a student over terminology. He again recommended, as he had in 1923 (see above, p. 1, n. 1), continuing to use Menger's terms which enjoyed general acceptance. The simpler English terms, which Mises developed and adopted later—notably in Human Action (3rd rev. ed., 1966, pp. 419–24; 1998, pp. 416–21), where he describes “goods-induced” or “cash-induced” changes in the value of the monetary unit—are used in this translation. For those who may be interested in this controversy, the original footnote follows: Carl Menger referred to the nature and extent of the influence exerted on money/goods exchange ratios [prices] by changes from the money side as the problem of the “internal” exchange value (innere Tauschwert) of money [translated in this volume as “cash-induced changes”]. He referred to the variations in the purchasing power of the monetary unit due to other causes as changes in the “external” exchange value (aussere Tauschwert) of money [translated as “goods-induced changes”]. I have criticized both expressions as being rather unfortunate—because of possible confusion with the terms “extrinsic and intrinsic value” as used in Roman canon doctrine, and by English authors of the seventeenth and eighteenth centuries. (See the German editions of my book on The Theory of Money and Credit, 1912, p. 132; 1924, p. 104). Nevertheless, this terminology has attained scientific acceptance through its use by Menger and it will be used in this study when appropriate. There is no need to discuss an expression which describes a useful and indispensable idea. It is the concept itself, not the term used to describe it, which is important. Serious mischief is done if an author chooses a new term unnecessarily to express a concept for which a name already exists. My student, Gottfried Haberler, has criticized me severely for taking this position, reproaching me for being a slave to semantics. (See Haberler, Der Sinn der Indexzahlen [Tübingen, 1927], pp. 109ff.). However, in his relevant remarks on this problem, Haberler says nothing more than I have. He too distinguishes between price changes arising on the goods and money sides. Beginners should seek to expand knowledge and avoid spending time on useless terminological disputes. As Haberler points out, it would obviously be wasted effort to “seek internal and external exchange values of money in the real world.” Ideas do not belong to the “real world” at all, but to the world of thought and knowledge. It is even more astonishing that Haberler finds my critique of attempts to measure the value of the monetary unit “inexpedient,” especially as his analysis rests entirely on mine.—Ed.]
  • 18. [See The Theory of Money and Credit, 1953, pp. 38ff.; 1980, pp. 51ff.—Ed.]
  • 19. [See Socialism (New Haven, Conn.: Yale University Press, 1951), pp. 121ff. and (Indianapolis, Ind.: Liberty Fund, 1981), pp. 104.—Ed.]
  • 20. [See The Theory of Money and Credit, 1953, pp. 139ff.; 1980, pp. 161ff.—Ed.]
  • 21. Irving Fisher, The Rate of Interest (New York, 1907), pp. 77ff.
  • 22. Hermann Heinrich Gossen, Entwicklung der Gesetze des menschlichen Verkehrs und der daraus fliessenden Regeln für menschliches Handeln (new ed.; Berlin, 1889), p. 206.
  • 23. See also my critique of Fisher's proposal in The Theory of Money and Credit, pp. 403ff.; 1980, pp. 442ff.
  • 24. Whether this is considered a change of purchasing power from the money side or from the commodity side is purely a matter of terminology.
  • 25. I.E., “classical liberalism.” See above, p. 68, note 11.
  • 26. [In conversation, Professor Mises explained that this is a Greek term, meaning “shaking off of burdens.” It was used in the seventh century B.C. and later to describe measures enacted to cancel public and private debts, completely or in part. Creditors then had to bear the burden, except to the extent that they might be indemnified by the government.—Ed.]
  • 27. Keynes's 1923 proposal, A Tract on Monetary Reform.