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11. Money and Its Purchasing Power

7. Gains and Losses During a Change in the Money Relation

A change in the money relation necessarily involves gains and losses because money is not neutral and price changes do not take place simultaneously. Let us assume—and this will rarely hold in practice—that the final equilibrium position resulting from a change in the money relation is the same in all respects (including relative prices, individual values, etc.) as the previous equilibrium, except for the change in the purchasing power of money. Actually, as we shall see, there will almost undoubtedly be many changes in these factors in the new equilibrium situation. But even if there are not, the movement of prices from one equilibrium position to the next will not take place smoothly and simultaneously. It will not take place according to the famous example of David Hume and John Stuart Mill, where everyone awakens to find his money supply doubled overnight. Changes in the demand for money or the stock of money occur in step-by-step fashion, first having their effect in one area of the economy and then in the next. Because the market is a complex interacting network, and because some people react more quickly than others, movements of prices will differ in the speed of reaction to the changed situation.

As we have intimated above, the following law can be enunciated: When a change in the money relation causes prices to rise, the man whose selling price rises before his buying prices gains, and the man whose buying prices rise first, loses. The one who gains the most from the transition period is the one whose selling price rises first and buying prices last. Conversely, when prices fall, the man whose buying prices fall before his selling price gains, and the man whose selling price falls before his buying prices, loses.

It should be evident, in the first place, that there is nothing about rising prices that causes gains or about falling prices that causes losses. In either situation, some people gain and some people lose from the change, the gainers being the ones with the greatest and lengthiest positive differential between their selling and their buying prices, and the losers the ones with the greatest and longest negative differential in these movements. Which people gain and which lose from any given change is an empirical question, dependent on the location of changes in elements of the money relation, institutional conditions, anticipations, speeds of reaction, etc.

Let us consider the gains and losses from an increase in money stock. Suppose that we start from a position of monetary equilibrium. Every person's money relation is in equilibrium, with his stock of and demand for money being equal. Now suppose that Mr. Jones finds some new gold never known before. A change in Jones’ data has taken place. He now has an excess stock of gold in his cash balance compared with his demand for it. Jones acts to spend his excess cash balance. This new money is spent, let us say, on the products of Smith. Smith now finds that his cash balance exceeds his demand for money, and he spends his excess on the products of someone else.

Jones’ increased supply also increases Smith's selling price and income. Smith's selling price has increased before his buying price. He spends the money on the products of Robinson, thus raising the latter's selling prices while most buying prices have not risen. As the money is transferred from hand to hand, buying prices rise more and more. Robinson's selling price increases, for example, but already one of the products he buys—Smith's—has gone up. As the process continues, more and more buying prices rise. The individuals who are far down “on the list” to receive the new money, therefore, find that their buying prices have increased while their selling prices have not yet done so.

Of course, the changes in the money supply and in prices may well be insignificant. But this process occurs, however large or small the change in the money stock. Obviously, the larger the increase in money stock, the greater, ceteris paribus, will be its impact on prices.

We have seen above that an increase in the stock of money leads to a fall in the PPM, and a decrease in the stock of money leads to a rise in the PPM. However, there is no simple and uneventful rise and fall in the PPM. For a change in the stock of money is not automatically simultaneous. New money enters the system at some specific point and then becomes diffused in this way throughout the economy. The individuals who receive the new money first are the greatest gainers from the increased money; those who receive it last are the greatest losers, since all their buying prices have increased before their selling prices. Monetarily, it is clear that the gains of the approximate first half of the recipients of new money are exactly counterbalanced by the losses of the second half. Conversely, if money should somehow disappear from the system, say through wear and tear or through being misplaced, the initial loser cuts his spending and suffers most, while the last who feel the impact of a decreased money supply gain the most. For a decrease in the money supply results in losses for the first owners, who suffer a cut in selling price before their buying prices are lowered, and gains for the last, who see their buying prices fall before their income is cut.38

This analysis bears out our assertion above that there is no social utility in an increased supply, nor any social disutility in a decreased supply, of money. This is true for the transition period as well. An increase in gold is socially useful (i.e., beneficial to some without demonstrably injuring others) only to the extent that it makes possible an increase in the nonmonetary, direct use of gold.

If, as we have been assuming, relative prices and valuations remain the same for all throughout, the new equilibrium will be identical with the old except for an all-round price change. In that case, the gains and losses will be temporary, disappearing upon the advent of the new equilibrium. Actually, however, this will almost never occur. For even if people's values remain frozen, the shift in relative money income during the transition itself changes the structure of demand. The gainers of wealth during the transition period will have a structure of preferences and demand different from that of the losers. As a result, demand itself will shift in structure, and the new equilibrium will have a different set of relative prices. Similarly, the change will probably not be neutral to time preferences. The permanent gainers will undoubtedly have a different structure of time preferences from that of the permanent losers, and, as a result, there may be a permanent shift in general time preferences. What the shift will be or in which direction, it is of course impossible for economics to say.

Money changes have this “driving force,” it may be noted, even in the fanciful case of the automatic overnight doubling of the supply of everyone's cash balance. For the fact that everyone's money stock doubles does not at all mean that all prices will automatically double! Each individual has a differently shaped demand-for-money schedule, and it is impossible to predict how each will be shaped. Some will spend proportionately more of their new money, and others will keep proportionately more in their cash balance. Many people will tend to spend their new cash balances on different goods from those they had bought with their old money. As a result, the structure of demand will change, and a decreased PPM will not double all prices; some will increase by more and some by less than double.39

  • 38. See Mises, Theory of Money and Credit, pp. 131–45.
  • 39. See Mises Human Action, pp. 413–16.