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11. Money and Its Purchasing Power > 14. The Fallacy of Measuring and Stabilizing the...

A. Measurement

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

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

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

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

  • 10 cents per pound of sugar
  • 10 dollars per hat
  • 500 dollars per TV set
  • 5 dollars per hour legal service of Mr. Jones, lawyer.

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

  • 15 cents per pound of sugar
  • 20 dollars per hat
  • 300 dollars per TV set
  • 8 dollars per hour of Mr. Jones’ legal service.

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

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

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

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

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

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

  • 58. Conventional accounting practice is based on a fixed value of the monetary unit.
  • 59. Professor Mises has pointed out that the assertion of the mathematical economists that their task is made difficult by the existence of “many variables” in human action grossly understates the problem; for the point is that all the determinants are variables and that in contrast to the natural sciences there are no constants.
  • 60. See the brilliant critique of index numbers by Mises, Theory of Money and Credit, pp. 187–94. Also see R.S. Padan, “Review of C.M. Walsh's Measurement of General Exchange Value,” Journal of Political Economy, September, 1901, p. 609.