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11. Money and Its Purchasing Power > 5. The Demand for Money

C. Secular Influences on the Demand for Money

Long-run influences on the demand for money in a progressing economy will tend to be manifold, and in both directions. On the one hand, an advancing economy provides ever more occasions for new exchanges as more and more commodities are offered on the market and as the number of stages of production increases. These greater opportunities tend greatly to increase the demand-for-money schedule. If an economy deteriorates, fewer opportunities for exchange exist, and the demand for money from this source will fall.

The major long-run factor counteracting this tendency and tending toward a fall in the demand for money is the growth of the clearing system.8 Clearing is a device by which money is economized and performs the function of a medium of exchange without being physically present in the exchange.

A simplified form of clearing may occur between two people. For example, A may buy a watch from B for three gold ounces; at the same time, B buys a pair of shoes from A for one gold ounce. Instead of two transfers of money being made, and a total of four gold ounces changing hands, they decide to perform a clearing operation. A pays B two ounces of money, and they exchange the watch and the shoes. Thus, when a clearing is made, and only the net amount of money is actually transferred, all parties can engage in the same transactions at the same prices, but using far less cash. Their demand for cash tends to fall.

There is obviously little scope for clearing, however, as long as all transactions are cash transactions. For then people have to exchange one another's goods at the same time. But the scope for clearing is vastly increased when credit transactions come into play. These credits may be quite short-term. Thus, suppose that A and B deal with each other quite frequently during a year or a month. Suppose they agree not to pay each other immediately in cash, but to give each other credit until the end of each month. Then B may buy shoes from A on one day, and A may buy a watch from B on another. At the end of the period, the debts are canceled and cleared, and the net debtor pays one lump sum to the net creditor.

Once credit enters the picture, the clearing system can be extended to as many individuals as find it convenient. The more people engage in clearing operations (often in places called “clearinghouses”) the more cancellations there will be, and the more money will be economized. At the end of the week, for example, there may be five people engaged in clearing, and A may owe B ten ounces, B owe C ten ounces, C owe D, etc., and finally E may owe A ten ounces. In such a case, 50 ounces’ worth of debt transactions and potential cash transactions are settled without a single ounce of cash being used.

Clearing, then, is a process of reciprocal cancellations of money debts. It permits a huge quantity of monetary exchanges without actual possession and transfer of money, thereby greatly reducing the demand for money. Clearing, however, cannot be all-encompassing, for there must be some physical money which could be used to settle the transaction, and there must be physical money to settle when there is no 100-percent cancellation (which rarely occurs).

  • 8. On the clearing system, see Mises, Theory of Money and Credit, pp. 281–86.