Mises Daily Articles

Home | Mises Library | The Theory of Money

The Theory of Money

Tags Monetary TheoryValue and Exchange

08/31/2012Percy L. Greaves, Jr.

[Understanding the Dollar Crisis (1973)]

The subject of this fifth lecture is the theory of money and its value.

Money is the most important commodity in a market economy. A sum of money is at least one side of every market transaction. Sums of money are both sides of many transactions. In all transactions involving annuities, life insurance, bank accounts, bond buying, and other loans of money, a sum of money is on each side of each transaction. Therefore, anything that affects the value of money affects every market transaction. The value of money affects not only the transactions of the moment but also all transactions over periods of time.

The Function of Money

The role of money is to make trade easier. Without money, there would be the awkwardness of barter. The use of money leaves more time for production and helps to boost the number of transactions which are expected to increase the satisfaction of each participant. Its use thus permits the increased division of labor and mass production for mass consumption. Money helps men to help others as they help themselves. Money might, therefore, be called a catalyst for the Golden Rule. A sound and simple monetary system is probably the greatest material tool available to men for the multiplication of human satisfactions.

In the earliest days of voluntary social cooperation, one man probably hunted while another fished or picked fruit. Then, they exchanged some of the products of their toil. Such simple exchanges were not difficult. However, as the production of wealth and division of labor increased, direct exchanges, or barter, became more complicated. If you were a fisherman and wanted a house, it would be difficult for you to find a carpenter or house builder who would take your fresh-caught fish in payment for a house. Before long, those fish would smell, and the builder would have little use for most of them.

So, before barter became so involved, men decided to exchange something they had for something that was in more popular demand, something that was more acceptable to others. Then, they would take this commodity which was in greater demand and exchange it for the things they wanted. If we raise chickens, we do not drive up to a gasoline station and say: "Here is a chicken. Please give me a gallon of gasoline." We could lose a lot of time finding someone with gasoline who wanted chickens. Long before barter became so awkward, men learned to exchange what they had or produced for a more marketable commodity, a more acceptable commodity, and then to exchange this more marketable commodity for what they wanted. It was traders, not governments, who originated media of exchange.

Diversity in Demand

Every commodity has a different marketability, a different acceptability. Some things have a wider marketability or acceptability than others. For example, there was a classified advertisement in an Ohio paper a few years ago which read:

FOR SALE: Second-Hand Tombstone.
Good buy for a person named Murphy.

Not many people would want that tombstone. Another example appeared in a newspaper clipping a short while ago. It told about an airplane carrier that the British Navy no longer wanted. It had cost millions to build during World War II. In relation to its cost of production, you could get that carrier at a bargain price, because not many people want airplane carriers.

There are many factors which co ntribute to the different marketabilities of different things. First, there is the number of persons who might want them for their own satisfaction. Many people want bread, but few people want books in Swahili. Many people would like to buy the Mona Lisa, but few people would buy our family photographs.

Next, there is the question of their portability. Some things are heavy and bulky and difficult to move around, like cement and lumber, as compared with diamonds and the precious metals.

There is also a question of the quantity desired. There are some things we want, but we want only one or two units, like a furnace or an air-conditioning machine for a house or a room. We would not normally want many of them, or a new one every day, as in the case of loaves of bread. There are some things, like bananas, that are very perishable. There are clothes that get out of date in a year or two. There are yesterday's newspapers and last week's programs for the theatre or sports events. There are other things you could not sell at any price, such as a used toothbrush or an individual's eyeglasses or dentures.

By trial and error, men soon learned the commodities that were the most marketable in their communities. Over the years, the most marketable commodity has been many different things in many different places. The most marketable commodity for the early Romans was cattle. The Latin word for money is pecunia, which comes from pecus, Latin for cattle. At times it has been shells. It has been beads. It has been furs. The Aztecs used cocoa beans and cotton handkerchiefs. In World War II, United States troops in Europe used cigarettes. The most acceptable commodity has been many other things at different times and places.

How Money Developed

At first, only a few people in the community saw the advantage of using some specific commodity in a double or indirect exchange rather than putting up with the time-wasting clumsiness of barter or direct exchange. They exchanged their products for a more acceptable "medium of exchange," and then later exchanged this medium of exchange for the things they wanted. Others observed, noted the advantages, and adopted the same procedures. Please note, it was not governments that invented this system. Men did it of their own free will. They found it improved their situation from their point of view.

As economies progressed, the number of generally acceptable media of exchange decreased. And as they did, it became easier to trade, and easier to calculate in advance the expected gains from the contemplated exchanges. It became easier to find out where you could get what you wanted at the lowest cost and easier to exchange what you had for the highest return. This opened the door to a great expansion of trade and division of labor, with the benefits from the increased transactions shared by all who participated. Remember, no one trades unless he expects to improve his situation.

Over the years it was found that the intermediate, more marketable, more acceptable commodity had to be one that didn't spoil, that was easily recognized, that could be divided or combined without loss of value, and that had a high value in small quantities, making it easy to transport without great expense.

Over the years, the media of exchange gradually narrowed down to the metals. At first copper was used. Then came the other metals, and with their use people developed a market system of prices in terms of the locally selected medium of exchange, whatever it was. First a metal was used locally, in one small area. Then its use spread until it included nationwide markets, and finally an international world market. This permitted greater and greater division of labor and greater and greater efficiency in increasing the satisfactions of men through exchanges that benefited all who participated. This is how the use of money developed.

Differences in Economic Goods

Economic goods can be divided into three classes or groups: (1) producers' or production goods, sometimes called capital goods. These are goods used to produce ultimately the second group: (2) consumers' goods and services. The third group comprises: (3) the media of exchange, more popularly known as moneys.

Group 3, the media of exchange, or moneys, are not consumed in their ordinary usage, which is to exchange them for other economic goods. Money is a part of private capital, but an increase in the quantity of money does not help society, only the individuals receiving some of the increase. This is something that we are going to discuss at great length. Money is neither a producers' good nor a consumers' good. It is merely a medium for facilitating exchanges.

Any increase in the available quantities of producers' goods or consumers' goods represents a net gain in human satisfaction. As a result, every market participant can have more. Any loss or destruction of a producers' good or consumers' good results in a loss to mankind. It is not only a loss to the former owner, or the insurance company; it is also a loss to all of us, because there are fewer goods competing for the limited sum of money in the hands of each and every buyer.

More Goods Mean Lower Prices

Let me expand a bit here. The more goods and services there are in the market, the more each of us can buy with his limited supply of money. The competition of more available goods and services results in lower prices. As each of us has only a limited supply of money, this means that any increase in production helps not only the producer but all of us. If Mr. Ford makes more Fords, not only is he richer, but every one of us is also richer, because there are more Fords. With more automobiles, there are more goods in the market competing for our money. Prices will thus be lower. As a result, we can each buy more.

Likewise, when there is an accident and something is destroyed, as when a house burns, or a plane falls to the ground, this is a loss to all of us. Society has to divert the scarce goods (raw materials) and services (labor) needed to reproduce what has been lost or destroyed. The scarce raw materials and scarce labor so used cannot be used to produce the things that could have been produced, if they did not have to be consumed in reproducing the lost or destroyed assets.

This applies not only to the loss of goods but also to the loss of men. In my country, every time a boy is killed in Vietnam, we all feel the loss in our hearts. But we also suffer an economic loss. The nation, and his family in particular, have invested much in bringing that boy to the age where he can make contributions to society. All his potential contributions are lost forever. Besides the fact of his loss, there are the pensions and other funds that have to go to the loved ones he left behind.

Likewise there are great losses to society when people who want to work and produce remain unemployed. The fact that they are not producing means that there are fewer goods competing in the market than there could have been. As a result, prices are higher than they would have been.

So on the one hand, every increase in consumers' goods and producers' goods helps all of us, and on the other hand, every decrease, every loss, in consumers' goods and producers' goods, every potential producer kept unemployed, hurts all of us. There are fewer goods and services available in the marketplace. Consequently more people have to go without goods and services they could have had if the production available had been greater.

More Money Means Higher Prices

Now, this is not true in regard to money. If the total quantity of money is changed, there is neither a gain nor a loss to mankind. Changes in the quantity of money involve only changes in prices, in the ratios of the various goods and services to the money commodity. The welfare of mankind remains unchanged. It is not money that we want. It is what we can buy with money that we want. Making more money does not create more of the things that men really want. No increase in the quantity of money can increase the welfare of mankind as can the increase in the quantity of any other economic good. An increase in the quantity of money merely helps some people at the expense of others. In this sense, money differs from all other economic goods.

As mentioned before, it is not money that men want; they want what they can buy with money. The only ones who want money per se, and as much as they can get, are misers and coin collectors. All other men want purchasing power. If someone were to give you a million dollars tonight, you would get rid of it within 48 hours. You would either buy something you wanted or invest the money. It is not the money you want; it is the money's purchasing power. This purchasing power of money is, of course, greatly affected by the quantity of money available and the demand for it.

We should always look at the problem of money from the viewpoint of the individual. Each individual has a demand for a quantity of money, and it is this demand of individuals for money that is the basis of the total demand of the whole community. It is important that we remember that all knowledge of money starts from the view of the individual and not of society. For it is the subjective values of individuals that determine all human actions, and it is their differing subjective values that determine all market transactions.

The demands of individuals for money are the most important factors in determining its value. No matter how unlimited our demand for goods and services may be, we do not demand unlimited quantities of money. Every one of us determines how much money he wants to have in his pockets and in his bank account. When he has too much, he knows how to get rid of it. When he does not have enough, he does what he can to sell his goods or services, until he has what he considers an ideal quantity. No one keeps more money than he wants in his cash holdings.

A consumer uses his cash holdings to bid for one product in competition with other products, and in competition with other persons for that particular good. It is this concatenation, this coming together in the market, that produces market prices, as we tried to explain in lecture 3. These market processes "objectivize" the subjective values of the individual participants, and increase our efficiency in increasing our satisfactions.

An exchange takes place in the market when units of two commodities are placed in different relative orders on the value scales of two different persons. In the market economy, one of those commodity units is always money, a specific quantity of money.

Multiple Moneys Complicate Trade

As economies progressed and as the number of moneys decreased, it became easier for all people to trade and to calculate prospective gains. It became easier for all people to compare prices and find out where it was cheapest to buy what they each wanted, and where they could each get the highest price for what they had to sell. But even in modern times, different countries have had different moneys. However, by the 19th century, civilized nations had narrowed down their moneys to the precious metals — gold and silver.

But even then, if one country was on a gold standard, as many countries were, its traders had difficulties in selling their products to a country which was on a silver standard, to India for instance. Between the time the order was placed and the time the payment was received, the market ratios between gold and silver might have changed. This change created an unanticipated loss or gain for the traders involved.

Most businessmen are knowledgeable in their own business, but they do not like to take risks in areas on which they are not informed. To assume these risks of changes in exchange rates or ratios, foreign traders employed specialists, called arbitrageurs by the French. Under such conditions these foreign exchange specialists were useful. For a price, they assumed the speculative burden and eliminated exchange losses for businessmen not familiar with foreign exchange problems. However, where there is only one money, these men are not needed, and they would be released to produce goods and services that men want more than they want two different kinds of money.

Problems of Bimetallism

At the end of the 18th century, some countries used gold for money, while other countries used silver. Still other countries used both gold and silver as money, with the result that they had two sets of prices, a set of gold prices and a set of silver prices. These two sets of prices caused confusion. Many governments, trying to be helpful, then stepped in and attempted to set a permanent ratio between all gold prices and all silver prices, usually with some point between 15 and 16 ounces of silver considered the legal equivalent of 1 ounce of gold.

Gold and silver could then be exchanged for each other at this officially set ratio at the Treasury or at a bank. It was a form of what we would today call price control for gold in terms of silver, and vice versa, for silver in terms of gold. The purpose was to have the prices in one metal easily convertible to prices in the other metal, and thus eliminate any exchange losses. As with many other interventionist ideas, the sponsors had the best of intentions. Unfortunately, as so often happens, the results were not those anticipated.

This bimetallism, as it was called, started late in the 18th century. The world market ratio of silver to gold at that time fluctuated around 15.7 to 1. (See table 14.) Spain, Portugal, and most of South America set their official rates at 16 to 1, that is, 16 ounces of silver and 1 ounce of gold were always exchangeable for each other at the nation's treasury. Cuba set her official rate at 17 to 1. In the United States of America, Alexander Hamilton, our first Secretary of the Treasury, set the official rate in 1792 at 15 to 1. For every ounce of gold our Treasury offered only 15 ounces of silver, while the world market offered 15.7 ounces of silver. The results were easy to foresee. Gold flowed into world market uses and most Americans used silver for money. Although we were officially on a bimetallic system, in reality we went on the silver standard.

In 1803, France adopted an official rate of 15½ to 1. After the Napoleonic Wars, Great Britain went back on gold in 1816, with subsidiary silver coins valued at 16 to 1. As you can see, all of these countries had different rates. Then, in 1834, the United States changed its official rate from 15 to 1 to 16 to 1. This reversed the previously existing situation, by making it profitable for silver, rather than gold, to flow into world market uses. As a result, we went on a de facto gold standard. Then, as you know, in the 1850s and 1860s there were great discoveries of gold on the West Coast in California, and later in Alaska and Australia.

In 1866, at a time when gold production was increasing rapidly, the Latin Monetary Union was formed with a set ratio of 15½ to 1. This Union, spurred on by Napoleon III, included France, Belgium, Switzerland, Italy, and later Greece. Austria, Spain, Portugal, most Balkan nations, and many of the countries of Latin America conformed informally, but never actually joined the Union. Then, in 1873, the United States of America demonetized silver, and Germany, upon receipt of a French war indemnity of 5 billion gold francs, announced a shift from the silver standard to the gold standard. These events increased world market supplies of silver, reducing its market value, so that in 1874, the Latin Monetary Union was forced to restrict silver coinage and the free exchange of one ounce of gold for every 15½ ounces of silver presented.

Table 14


With Spain, Portugal and South America at 16 oz. silver to 1 oz. gold (Cuba 17 to 1) and the world market at about 15.7 to 1 —

1792 — Hamilton set US silver-gold ratio at 15 to 1 — on de facto silver standard.

1803 — France set ratio at 15½ to 1.

1816 — Great Britain returned to gold standard, with subsidiary silver coins at 16 to 1.

1834 — US went to 16 to 1 — on de facto gold standard.

1850s and 1860s — Gold discoveries in California, Alaska and Australia.

1866 — Latin Monetary Union formed at 15½ to 1.

1873 — US demonetized silver and Germany announced shift from silver to gold.

1874 — Latin Monetary Union restricted silver coinage.

Economic Laws Ignored

Now, these governments had all thought that both metals would continuously circulate as money at the official ratio. They had failed to take the immutable laws of economics into consideration. They had thought, as many people do today, that governmental laws can replace economic laws. Among those who thought along these lines was a recent President of the United States, who officially stated that he had signed into law a statute that had superseded some economic laws he did not like.1 Such advocates of political intervention do not realize that the laws of human action, economics, are unalterable.

One of the economic laws that advocates of bimetallism did not take into account was the fact that values change. Values are no more constant than the minds of men. They do not stay put. They constantly fluctuate, and no man-made law can keep them constant. The relative values of any two commodities rarely remain constant over any extended period of time. Every change in the demand for, or the supply of, either commodity must change the relative exchange values of one for the other. As the demand for, and the supply of, both gold and silver are constantly changing, the relative values of the two commodities, gold and silver, in terms of each other, are also constantly changing, government's laws notwithstanding. These legal experiments with a bimetallic monetary standard were the first attempts of modern governments to regulate the value of money. They failed miserably.

The other law they ignored is known as Gresham's Law, which is popularly stated as: "Bad money drives out good money." Some now jest that bad politicians, like bad money, are overvalued, and tend to drive out or replace good ones.

Stated more fully, Gresham's Law is a law of human action which holds that in a market economy free men will always tend to allocate the available units of every economic good to those uses where they are expected to perform the most valuable services known to men, and thus to provide the greatest possible human satisfactions. The market never allocates any scarce good to perform a function for which it is known that a cheaper article would serve as well. When a government sets a legal ratio between two monetary metals, men, operating through the market, will always select the cheaper metal for money and release the dearer metal for its more valuable functions. As long as men are free to exchange one metal for the other, they will do so, using the cheaper for the monetary function that either metal can legally serve.

How Bimetallism Works

Let us look for a moment at what happens in such a situation, so that we can better understand how Gresham's Law operates. First, let us assume that Country A establishes a legal ratio of 15 ounces of silver to 1 of gold, while Country B establishes a ratio of 16 to 1, and the world market price or ratio is somewhere between 15 and 16 to 1.

Under these conditions, Country A will use only silver for money, while Country B will use only gold. The treasuries and the taxpayers will lose on all transactions. Under such conditions, human beings who have or can get an ounce of gold will present it to Country B, where they can exchange it for 16 ounces of silver. Then, they can go to Country A and with only 15 ounces of silver replace their ounce of gold, retaining a profit of one ounce of silver on every such transaction. This loss will be borne by the treasury, and ultimately by the taxpayers, of Country A, whose treasury must replenish its supply of silver at world market prices. Likewise, the treasury of Country B must meet the demand for gold by replenishing its supply of gold at world market prices.

Next, let us assume that the world market ratio rises to 16 plus to 1. Then both countries, A and B, will use silver for money. They will both allocate gold to its other more valuable uses. People with gold will not spend it as money. It is worth more in the marketplace for its other uses.

Lastly, let us assume that the world market ratio falls below 15 to 1. Then we shall have the opposite situation. Both countries will use gold for money, while silver will be allocated to its other uses where it is considered more valuable. People with silver will dispose of it in the world market, where they can get an ounce of gold for less than 15 ounces of silver.

This is not how I say it should be! This is not how I want it to be! This is how men act, when left free. It would take an all-powerful dictatorship to prevent these results.

Left alone, each country uses for money the commodity best suited and least expensive for that purpose. When the government interferes successfully, it diverts goods to uses where they give less satisfaction. Such governmental actions are restrictions on the first choices of men. Men must then be satisfied with their secondary or lesser choices. Only a free and flexible economy permits goods and services to flow unhampered to those persons and places where they can give the highest human satisfactions. This is as true for money as it is for every other economic good.

The Market Chose Gold

About 1900, gold became the universally accepted money for international trade. It is still money for international trade today. It is still the money that every nation in the world wants and values most. Despite what is being said against gold by more and more people, nobody is refusing gold. Under the conditions existing at the end of the 19th century, gold was selected by the market as the most suitable commodity to perform the functions of money.

Gold was not selected as money by governments. They had sought bimetallism by every method they knew. Their policies, along with the new gold discoveries, created conditions which, at that time, legally overvalued gold in terms of silver. Market traders, operating in accordance with Gresham's Law, then selected gold as money.

With all world prices quoted in gold, it became easy for traders to calculate all costs, including transportation, and then decide where in the world it was best to buy or sell those things that people were most interested in buying or selling. Under a gold standard, goods move with the greatest dispatch to those areas and persons where they attract the highest prices, and where they are expected to provide the highest relative human satisfactions. Likewise, holders of gold, that is, money, can most easily calculate where in the world they can get the most for their earned or saved money. Since all prices and calculations are in terms of the same commodity, gold, it is immediately evident which of many prices are the cheapest. This is not so with the use of multiple moneys.

In a free market society, everything, including money, tends to flow quickly to those places and persons where each unit is expected to serve the highest human satisfaction that it is capable of serving. Money is the most marketable commodity in a market society. It is the commodity for which, in a market society, there is the greatest demand. Consequently, it tends to move faster than any other commodity. However, people do not want money for consumption. They want it primarily to exchange for other things they do want for consumption. People want money for its purchasing power.

There are, of course, many, many fallacies concerning money. However, most sponsors of popular monetary errors fall into two groups: (1) those who think that money is more than a commodity, and (2) those who think it is less than a commodity. Money is neither more nor less than a commodity. Money is merely the most marketable commodity in a market society.

The use of money presupposes an economic order based on private property, the division of labor, and the exchange of private property for the expected gain of all parties. Its use helps to direct production and consumption into those channels which are expected to furnish the highest possible human satisfaction.

A Socialist Society Is Priceless

In a socialist society, where the government owns or controls all the means of production, there is no need or use for money. Since the government owns all the factors of production, there cannot be any competitive market bidding with money for capital goods, or with capital goods for money. Government officials, not the market, determine what is produced and who gets what. The use of money presupposes that there must be private property being bought and sold in the market. Money must take its value from the valuations of independent economic agents competing with each other in valuing things and exchanging whenever they find it is to their mutual advantage.

This is quite evident when you study what happens in the areas under socialist domination today. Soviet Russia would not be able to function at all, if she could not refer to prices outside her borders. She has no other way of knowing which is the cheapest material to use to make anything. Without a domestic market, she must look beyond her borders to see whether tin, iron, steel, aluminum, or what not is the cheapest metal for a particular use. She must first find out their relative values in the world markets; and it should be remembered that these prices cannot reflect the demand and supply conditions within her country. So the Soviet Union is steering her economy down a road without any helpful signposts. She lacks the price signs that guide all production in a market economy.

Let me refer to a news item in the New York Times of April 19, 1966. It reports on an East German trade treaty with the Union of Soviet Socialist Republics. At that time, about 50 percent of East Germany's foreign trade was with the Soviet Union, and only 10 percent with West Germany, which had refused to give her long-term credits. East Germany got 90 percent of its steel and 100 percent of its crude oil and iron ore from Soviet Russia. The gentleman who negotiated this trade treaty for East Germany, a Dr. Erik Apel, committed suicide because of complaints that this trade treaty was not fair to his country. It had been alleged that the treaty was too favorable to the Soviets and too costly to the people of East Germany.

After Dr. Apel had committed suicide, he was succeeded by a Mrs. Elsa Bauer. She defended the trade treaty by saying: "There is no unfairness in the terms of trade with the Soviet Union. The terms are considered correct. Prices have been based on the average world market prices over the last three years."

How would you like to buy goods at the average prices of the last three years? How would you like to sell goods at the average prices of the last three years? This is how a socialist society has to operate. If the whole world were socialist, there would not be any market prices of either the present or "the last three years" to use in calculating production costs of different things and processes. Without prices, all decisions on what and how to produce must be completely arbitrary.

Money Permits Complicated Calculations

The objective or exchange value, or ratio, of any given commodity may be expressed in units of every other kind of a commodity. Nowadays it is expressed in units of the commodity we call money. The market permits any commodity to be turned into money, and likewise the money commodity may be turned back to its other commodity uses when it is no longer more useful or more valuable as money. We have recently seen this happen in the case of silver. With one commodity used as a medium for expressing the relative values of all market goods and services we can compare our different value scales more easily. This is why and how men operating in the market develop the value of money.

The value of money is subjective. Prices are ratios expressed as quantities of the money commodity. Prices are comparisons. They are for one time and place. They are flexible and subject to instant change. They cannot be added any more than we can add our love for different people. However, it is easier for all of us if the ratios are expressed in just one commodity. It makes comparisons easier and calculations possible.

Goethe, the great German genius, once called double entry bookkeeping one of the greatest inventions of mankind. It permits nationwide and even worldwide division of labor and the use of complicated production processes over long periods of time. With the use of prices, businessmen can calculate the results of completed transactions and the anticipated, but uncertain, results from any future transactions they may be contemplating. They will select for future operation those transactions which their calculations indicate may be most profitable. These are the uses of available labor and capital that are expected to bring the highest prices over costs, from consumers.

On the Value of Money

All consumers' goods and producers' goods have both use values and market values. Their use value is the value they provide the owner in satisfying his own personal wants or needs. Their exchange value is the value they provide others in satisfying their wants or needs, that is, the price that others will offer to pay for them. Thus, these consumers' goods and producers' goods have both subjective use and objective exchange or market values. However, in the case of money, these two values coincide. The expected use of money is the possibility of exchanging it for other economic goods. The value of money always depends on the subjective use value of the economic goods for which it can be exchanged. Its exchange value is, in the end, the anticipated use value of the things that can be obtained for it.

The original value of any money was the use value that commodity had in its other uses before it was first used as a medium of exchange. It then had an objective exchange value based on some other use or uses. This historical link is absolutely necessary, not only for commodity money, but also for every legally sanctioned credit or fiat money. No fiat money ever came into use without first satisfying this requirement. It is absolutely impossible to start a new money without an historical use value, or without its being related to some previous money or commodity with a prior use value. Before an economic good or a "paper money" begins to function as money, it must possess, or be given, an exchange value based on some use or good other than its own monetary value. The legal tender values of paper money are today always tied, or related, to gold, or to another monetary unit that in turn is related to gold.

Thus, there is a continuous historical component in the value, or purchasing power, of every money. We tend to think of the value of any money in terms of what it was worth in the most recent past, yesterday or an hour ago. We start all our valuations of money from its most recent, or current, purchasing power. Then, we try to forecast what may change its purchasing power in the future. Our actions in regard to money are always guided by these appraisals of its past value and its expected future value. So the immediately prior value of a money has an influence on the future market or objective value of that money. People start their present valuations of money from the instant just passed, and then make up their present values by their estimates of what they think is going to be the net effect of expected changes in its market conditions.

If people think that the purchasing power of money is going down, they will tend to spend more of it immediately or in the very near future. On the other hand, if they think its value is going up, they are likely to hold on to more of it than otherwise. So the original starting point of the value of any money is found in the immediate past subjective valuations of the marginal utility of the units under consideration. As in valuing other economic goods, we never consider the value of the total supply of money. We always consider the value of a specific number of units of money, the value of the marginal units. We either want to spend certain units of money, or we want to acquire certain units in exchange for something we have to offer. So at any particular time, the value of money is the result of the coming together in the market of the subjective valuations of all the individual market participants, who each value it according to the use value to them of the marginal units of what they can buy with a unit of money.

Changes in the purchasing power, and thus in the value, of money can arise either from the money side, or from the goods and services side, of market transactions. Such changes can arise from new data or information affecting either (1) the demand for, or (2) the supply of, money, or (3) the demand for, or (4) the supply of, the vendible goods of the marketplace. However, a general rise or fall in the demand for all goods and services, or for most of them, can only arise from the side of money. When all, or the great majority of, prices are going up or down, we know something is happening to the quantity of money.

On Government and Money

The original aim and intent of government in getting into the money situation was to release individuals from the need to test the weight and fineness of monetary metals. By coining or minting money, governments guaranteed that the metallic coins contained a certain quantity and quality of the monetary metal. Individuals no longer had to employ experts to assay and weigh them. This was a valuable service.

However, the most important function that governments have today concerning money, the one that has to exist in a free market society, is the duty to decide disputes in courts. Governmental courts have to decide the meaning of disputed contracts. When a private contract calls for the payment of a certain amount of money, that money must be paid. Suppose one party offers something he calls money in payment of a debt. The other party disagrees. He claims that what is offered is not money and does not satisfy the contract. They must then take their dispute to the courts of law. Then, the government must decide what was meant by the term "money" as used in that contract. So governments have the legal duty to define what is money. There is no way that this monetary function of government can be eliminated. The peaceful settlement of disputes is one of the primary functions of government. If people quarrel about what is money, the government must settle those disputes if it is to maintain order. So ultimately governments must define the monetary unit.

Money is always scarce. Otherwise it would not be an economic good. It would not have any value. If everyone had all the money he thought he wanted, money would be worthless. There is no need for the government to interfere in the quantity of money. It cannot be helpful. Whenever the government increases the quantity of money it helps some at the expense of others. It cannot be otherwise.

Quantity of Money Must Be Limited

The service that money renders to society cannot be improved by changing the quantity. All individuals in a market society need a certain amount of ready purchasing power. They hold it in the form of cash holdings. We never leave the house without some cash holdings. How much cash each person holds depends primarily on its purchasing power. It may appear to an individual that he has an excess or deficiency in his cash holdings. He then quickly takes steps to adjust it. He can either reduce his cash holdings by spending or investing some of his money, or increase his cash holdings by trying to sell his services or some of his goods. However, the quantity of money available in any society is always sufficient to perform for everybody all the functions that money can perform — i.e., the efficient comparison of individual value scales in order to locate and facilitate transactions which may be mutually advantageous.

Under the gold standard, the determination of the quantity and value of money is dependent upon the profitability of gold production. The value of gold as money is not the fact that it glitters. It is the fact that the quantity of gold cannot be easily increased by the arbitrary acts of men. The cost of mining gold keeps it scarce and a valuable "economic good." Gold cannot be printed. It cannot be manufactured, although we hear today of governments creating all the "paper gold" they want. This will be one to watch. The alchemists could not produce gold, and it is doubtful that calling certain pieces of paper "paper gold" will endow them with the value of gold.

The value of gold is affected by the quantity mined. However, the biggest variations in the value of money during the last century have not originated in the area of gold production. They have sprung from the policies of governments and their central banks of issue. Under the gold standard proper, the value of money is independent of the politics of the hour. However, the actions of governments can lower the value of money by political interventions that reduce the human satisfactions that could be obtained by the more efficient operations of a free market.

Some Popular Fallacies

One of the most important popular fallacies concerning money is the spurious idea of the supposed neutrality of money, and the corollary idea that its value can somehow be kept constant by political manipulation. In this world there is no such thing as constancy of values. Change is ever with us, and changes in the values of money will be with us as long as men's minds change their individual value scales. There is no governmental law, edict, or regulation that can make or hold the value of money rigid or settled for all time. Our valuations of the same and differing units of money are constantly changing and always will. Changes in the value of money, far from being neutral, affect every market transaction.

One of the other related fallacies concerning money is the crude quantity of money theory, the idea that there is a constant relationship between the quantity of money and its value in the market exchanges. This idea is that a certain proportional increase in the quantity of money will produce a certain proportional increase either in all prices, or in "average prices." This idea is usually interpreted to mean that an increase in production requires an offsetting increase in the quantity of money. This is not so. An increase in the quantity of money produces different changes in the prices of different goods. The changes are neither proportional nor all at the same time. Such increases are inflation, which we shall discuss in the lectures that follow; so we shall not go off in that direction now.

The purchasing power of money is the same everywhere. The market reflects this purchasing power and market participants soon wipe out any discrepancies that appear. Before the development of the subjective marginal theory of value, not even economists were aware that the value of money is constantly changing. Most of you in this country have learned this lesson. Unfortunately, many in my country still think, with apologies to Gertrude Stein, that a dollar is a dollar is a dollar, always. Variations in the quantity, and thus the value, of money do not affect the market values, or prices, of all economic goods and services in the same way. Some prices change before others, and some prices change more than others.

The value of money is not a legal proposition. Contracts may provide for the payment of certain quantities of money, but they cannot, and do not, provide that any specified sum of money will retain equal value over periods of time. Legal definitions deal with physical quantities and qualities, and not with market values. These physical quantities and qualities of a money can be kept constant, but the value of any money constantly fluctuates, and no government is powerful enough to stop this fluctuation except by making the money worthless.

In a market economy, money is distributed among individuals, and hence among nations, according to the extent and intensity of their respective demands for money. Money, like other goods, flows quickly, when permitted, to those who place the highest value on it. International movements of money are the cause, not the effects, of favorable and unfavorable trade balances. Money moves only when and because both a buyer and a seller want it to move. It moves from person to person, or from nation to nation, because the value scales of the interested parties place higher values on what they get than on what they surrender. People export money because they prefer the imports, or whatever else they buy, to the sums of money exported.

Government controls on the shipments of money are unnecessary, and as inappropriate as controls to insure a sufficiency of coal, iron, or wheat. In a free society, no person, group, or nation need fear the lack of a sufficient money supply. Any quantity of money can be divided and subdivided to reflect the market ratios or prices, which will keep increased supplies of scarce goods and services moving to those who place the higher values on them.

Textbook Fallacies

In many textbooks, the authors speak of three functions of money. They usually mention first that money has the function of a medium of exchange. It does, and this is what we have been discussing. But many textbook authors also think of money as a "measure of value." There is no such thing as a measure of value. Measurement standards, like ounces, pounds, and tons, or yards, meters, and miles, are always constants. Values are in the minds of men and, like the minds of men, they are never constant. There is no standard by which ever-fluctuating values can be measured. There are no constant units, and never can be any, with which to measure values. The same economic good has different values for different people, and different market values at different times.

The third function frequently attributed to money in textbooks is that of a "store of value." Money can be a "store of value," as any other commodity can be, but it is not a store of a constant value as is so often implied in these textbooks. If anyone puts a certain sum of money in a sound bank, that sum should be there later, but the value of that sum will not be the same. Its value will always be fluctuating. With governments increasing the quantity of money, the value of that money tends to fall. Many people have learned this the hard way in recent years. So it does not need much emphasis here.

Actually, money is a medium of exchange, and only a medium of exchange. It completely fulfills its function when exchanges of goods and services are carried on more easily with its help than is possible under barter.

Storing or hoarding money is one way of using wealth. If no one wanted to hold money, it would be without value. The uncertainty of the future always makes it advisable for everyone to have some money on hand. How much one has on hand depends on his own estimate or appraisal of future conditions. Urgent demands for money to spend, as well as money to take advantage of profit possibilities that may arise unexpectedly, have to be considered. In deciding how much cash to hold, people must also weigh what they expect to happen to the value of money as the result of deflation or inflation. All these factors contribute to the future purchasing power of money and help explain why people want to hold some money.

Effect of Changes in the Quantity of Money

Changes in the quantity of money affect different people differently. There is just no way in which money can be introduced into, or taken out of, an economy so as to affect all people equally. The injection of new money into a society adds no new wealth. It merely redistributes purchasing power, and thus the titles to existing wealth. Those who receive some of the new money can buy more of the existing goods before prices rise, while others find prices rising before their incomes do. So some can thus take what a free market, with an unmanipulated quantity of money, would allocate to others. Every increase in the quantity of money therefore helps some at the expense of others.

Changes in the quantity of money produce changes in the value of money. An increase in the quantity of money, like an increase in the quantity of any other economic good, causes the value of every existing unit to fall. However, changes in the value or purchasing power of money do not affect all persons and prices evenly or at the same time. Changes in the value of money always start at some given point and then spread gradually through the whole market community.

When the quantity of money is increased, the recipients of the newly created money immediately place a lower subjective value on each unit of money they possess. They are then more apt to spend money than they were before their supply of it was increased. They might even pay higher prices than they previously would. As they spend more money, some of the increased money reaches new recipients, who, in turn, place a lower value on each unit of money. Thus a lower subjective value for money is passed step by step from person to person, and more and more persons become willing to pay higher prices because they have more money. This process continues until the full effect of each increase in the quantity of money is completely dissipated. Those who receive some of the increased money early in the process are benefited, while those who do not receive any of the increased money until the later stages are hurt. It cannot be otherwise.

The economic consequences from changes in the value of money are determined not by what causes the increase in the quantity of money, but by the nature of the slow progress of the new money from person to person, from one commodity price to another commodity price, and from one country to another. Anything that changes the demand for, or supply of, any marketable good or service affects the value of money. Everything that changes the supply of, or demand for, money must also affect the patterns of prices for the various marketable goods and services. Changes in the supply of, or demand for, money also shift wealth among different individuals. Some become richer, while others become poorer.

Despite the teachings of economics, many still think that economic activity can be permanently stimulated by an artificial increase in the quantity of money or credit. An increase in the quantity of money or credit adds no new wealth to a society. It merely redistributes previously existing wealth. Some benefit as the early receivers of the newly created money. With more money, they can buy more of the available supply of goods and services, leaving less for those whose money holdings have not been increased. Thus, some gain at the expense of others.

Such an increase in the quantity of money also misdirects production in a manner that cannot be maintained. People who get the new money become bigger spenders. Businessmen produce for those who spend money. They cannot tell the difference between money spent by workers and savers, and money spent by those who have received some of the newly created money. So production facilities are increasingly shifted to produce more for those who are spending the artificially created increased quantity of money.

Inflation Not Permanent

Sales to these buyers cannot be continued forever. As the quantity of money is increased and prices rise, injections of larger and larger quantities of money are required to produce the same effects. If the quantity of money increases in ever larger quantities, prices will rise faster and faster as the value of each monetary unit falls. Sooner or later, the increases must be stopped. If they are not stopped before the value of the monetary unit falls to zero, people will eventually run away from the money and spend it on anything they can get, because, in their minds, anything will soon be worth more than a constantly depreciating money.

When governments increase the quantity of money, the effects tend to follow a certain pattern. Of course, the inflation can be stopped at any point. The first stage of inflation is when housewives say: "Prices are going up. I think I had better put off buying whatever I can. I need a new vacuum cleaner, but with prices going up, I'll wait until they come down." During this stage, prices do not rise as fast as the quantity of money is being increased. This period in the great German inflation lasted nine years, from the outbreak of war in 1914 until the summer of 1923.

During the second period of inflation, housewives say: "I shall need a vacuum cleaner next year. Prices are going up. I had better get it now before prices go any higher." During this stage, prices rise at a faster rate than the quantity of money is being increased. In Germany this period lasted a couple of months.

If the inflation is not stopped, the third stage follows. In this third stage, housewives say: "I don't like flowers. They bother me. They are a nuisance. But I would rather have even this pot of flowers than hold on to this money a moment longer." People then exchange their money for anything they can get. This period may last from 24 hours to 48 hours.


As we said earlier, the role of money is to make trade easier. Without money, there would be the awkwardness of barter. The use of money also tends to minimize human errors, and thus unnecessary losses. The use of money makes economic calculation possible. This helps to increase the division of labor and encourages more complicated mass production for mass consumption. It results in increasing the transactions that are expected to increase the satisfaction of each participant. The increased production is distributed by market processes to all who contribute to the joint production, in accordance with what the individual participants value most among all the many alternative purchases open to them.

Money thus helps men to help others as they help themselves. Money might be called a catalyst for the Golden Rule. A sound and simple monetary system is probably the greatest material tool available to man for the multiplication of human satisfactions.

The question that men face today is: Who should choose the money? The government? Or the people buying and selling on the market? It was the market, not governments, that developed the precious metals as money. Few would maintain that present-day government interferences in the field of money have been helpful.

The value of money is always the anticipated use value of what it will buy. Permitting politicians to manipulate the quantity of money permits them to affect indirectly the values involved in every market transaction. In fact, it permits them to disrupt, prevent, and otherwise hamper transactions that would increase the satisfaction of every member of the society. Increasing the quantity of money does not increase the quantity of goods people want to buy. It only helps some at the expense of others.

If men are to remain free and if Western civilization is to continue, people must regain the right to limit the political expansion of the quantity of money and/or credit. We must never again permit politicians to print money or get their hands on the money we put in banks and think is always there. A free market economy cannot permanently operate on a politically manipulated paper money standard. Free men need a market-selected money. Under present conditions, this means a gold standard.

Questions and Answers

Price Changes Helpful

Q. Will you define the stability of prices?

A. The value of prices, as we tried to show, is that they are ratios expressed in quantities of one commodity. They permit the easy comparison of different values. They reflect the things which are most in demand, and price changes reflect changes in both demand and supply. We as individuals are not interested in all prices, or in low prices, or in high prices. We are interested in individual prices. If prices were constant there would never be any changes in demand and supply, and there are such changes. Prices serve to indicate the changes in production that are desired as the wishes of consumers change. As consumers want more of some good, the price of that good goes up, while the price of the good they switched from goes down. Prices have to move as people's values change. They cannot be stable. If they were stable, they would reflect no change in market conditions. If prices were unchanged from those in the 1870s, we would live and die the same as people did a century ago. We would have both production and population stabilized. As the population is never stabilized and consumers' desires are constantly changing, prices must constantly change. As long as markets exist and men's minds change, stable prices will remain an impossibility.

Steps to a Gold Standard

Q. What are the fundamental steps that a country must take to go to a gold standard?

A. My great teacher, Ludwig von Mises, wrote a supplement on "Monetary Reconstruction" for the 1953 edition of his Theory of Money and Credit. He stated that two things must be done instantly. One is to stop the artificial increase in the quantity of money, and the other is to take the government out of the gold market. Then, we should permit a free market in gold. After a period of time the free market in gold will tend to stabilize at some ratio of the monetary unit to gold. Then that ratio should be adopted into law, and that ratio should be defended from then on out, with all of the paper monetary units convertible into gold upon demand. The paper money would then be interchangeable with the agreed legal quantity of gold.

Gold in One Country

Q. Can you establish a gold standard in just one country?

A. Yes, it would be helpful to that country. That one country would never have to worry about people refusing to take its money. But the more countries the better.

Why Socialists Cannot Calculate

Q. Please explain a little more about economic calculation in a socialist society.

A. We spent an evening on the formation of prices last week. In a socialist society, you cannot have this formation of prices. You do not have private ownership of the means of production. In answer to a question after that lecture, we talked about how one bureau in Moscow built ships to go south on the Volga, while another bureau built a fleet to go north on the Volga, because there was no market, there were no classified ads, to show that one set of ships could have handled the cargoes going in both directions. The Communists have to consider these things. They have to watch the values in the newspapers of other countries. They have no market. They have no competition. In that same lecture we tried to show how iron is allocated by market competition to the highest bidders — those who think that their use of iron in the products they are going to make will bring the highest return from consumers. It is this bidding of businessmen, independent economic agents, from which prices emerge. Where you do not have private ownership of the means of production, there is no competition. There is no way to determine the relative values or the economic allocations of the factors available, because there is no competitive bidding for them. As a result, the socialists have to operate by relying blindly on the whims or values of one man, and these are of no use for calculation. They are just pure guesses, and do not reflect the relative demands of consumers.

Hoarding Helpful to Others

Q. Do you think that if a man keeps money out of circulation it is harmful to his country?

A. No, sir. It is helpful to everybody else, because that money is not bidding for the goods and services available in the marketplace. As a result, everybody else can buy more with their limited quantity of money.

Milton Friedman, Inflationist

Q. What do you think of Milton Friedman's monetary theories?

A. This would take at least a book. Milton Friedman is an advocate of inflation. Milton Friedman wants the government to increase the quantity of money by some regular percent every year. He changes this percent from time to time. He does not realize that stability in prices or stability of a general average price is neither desirable nor helpful. He holds the fallacy, along with many others, that it is unfair, in the case of long-term borrowings, if the purchasing power of the money changes. In a free market, expected changes in the purchasing power of money are reflected in the market interest rate. The market interest rate is composed of three factors: (1) The first factor is time preference — that is, you will pay 5 percent interest because you prefer to buy something now for $1,000 and pay out $1,050 a year from now. That is your time preference. The person lending the money to you will have a different valuation of money over those two time periods. He will prefer $1,050 a year from now to $ 1000 now. That would be his time preference. (2) The second factor or component of the market interest rate is the possibility that the loan may not be repaid. This will differ in each case. (3) The third factor is the expected change in the purchasing power of the monetary unit during the time span of the loan. If, when the loan is made, it is thought that the purchasing power of money will go down during the period of the loan, the market interest rate will take this into consideration and thus will be higher. On the other hand, if the production of goods and services is expected to increase, with no foreseen increase in the quantity of money, a rise in the purchasing power of the monetary unit will be reflected in a lower interest rate. This third factor, known as the "price premium," is the attempt of lenders and borrowers to neutralize the effect of expected price changes, that is, changes in the purchasing power of money. The market interest rate is a sum of these three factors. It fully reflects and discounts the effects of any expected inflation or deflation.

The inflation that Milton Friedman advocates is an attempt to prevent a recession that would correct the misdirection of the economy brought about by prior inflation. More inflation is never a cure for prior inflation. It merely delays the correction, misdirects the economy still further, and prevents the benefits of lower prices.

Milton Friedman also ignores the fact that when you increase the quantity of money you hurt some people while helping others. He does not deal with this problem. He ignores it. There are other things. One of the great problems in our country is that Milton Friedman is popularly represented as one of the believers in a free market economy. He is a good economist in many areas, particularly in the field of labor, but in this one area, he does not have a sufficient understanding of the theory of money as I have tried to explain it tonight.

Effects of Gold Production

Q. Under the gold standard system, is a country which produces gold in a better situation than others?

A. Not particularly. Under this situation they are working and producing nothing that satisfies men's wants. When gold was found in California, goods were shipped from the Eastern part of the United States for the consumption of the miners. The Eastern parts of the United States had to get along with less, while those men out in California got these things; and all they did was add to the quantity of money. When you add to the quantity of money, you do not increase the quantity of goods which give human satisfaction. Those people who were mining the gold were contributing nothing that people could use or consume. Therefore, they were not helping the community; they were simply lowering the value of every unit of money that people held. Consumers got less. Of course, to the extent that the newly mined gold went into jewelry and industrial uses, it did represent an increase in the quantity of useful goods.

Values Not Measurable

Q. Is money the measure of value?

A. Money is not a measure of value. There is no possibility of ever having a measure of value. Values are mental concepts incapable of being measured. They can only be compared. There is no standard, or constant, by which values can be measured.

Prices Are Ratios

Q. Can you say that a certain quantity of money, or a price, is an expression of value?

A. A price is only one part of a ratio. There are two things being compared: the money and the goods. This is a ratio. If the quantity of money, or price, is 100 pesos for some particular good, you buy it if it is worth more than 100 pesos to you. If it is worth less, you sell whatever quantity you have. Prices are a means for making easy comparisons.

Papal Encyclicals on Economics

Q. Over the last half century, the popes have issued encyclicals dealing with wages. Do you think they are consistent with the theory of how the free market should operate?

A. Up until the last economic one, all of them were open to a free market interpretation. They were also open to other interpretations. In other words, they were not clear. The last encyclical in the economic area certainly advocated governmental intervention and socialism. It was written for the pope by a gentleman who had no fundamental understanding of these problems.

On Oligopolies

Q. In your recent lectures you expressed strong views on the way unions interfere with the correct level of wages and upset the free market by imposing the burden of their privileges upon all the consumers, while reducing production. Would you say that in present days oligopolies operate in a somewhat similar way and produce the same effects?

A. If they have privileges from government, yes. However, it isn't a question of oligopoly. In such cases there are two or three companies competing. As long as there is competition, anti-consumer actions are not likely to occur. You do not have competition among labor unions in one area. Where there is a monopoly privilege granted by government, the consumers certainly suffer. The people who might be able to produce the good or service involved better or cheaper are not allowed to compete.

Inflation vs. Imports of Money

Q. What is the difference between inflation and exports?

A. Inflation will be defined in my next lecture as an increase in the quantity of money. Exports are, of course, the sale of goods abroad.

Q. After an export operation you have more gold and less goods available. Haven't you the same effect as inflation in that you get more gold in from selling exports?

A. You will have the same effect in that you'll get higher domestic prices, yes, but the higher prices are not brought about by a government or a bank increasing the wealth of one person at the expense of others. The increased money goes to the exporter who sold his goods or his services, and who earned the more money he received.

Special Drawing Rights

Q. What is your opinion of SDRs (Special Drawing Rights)?

A. It would seem to be getting close to the end of the inflation line. In our country we started with FDR and now we are up to SDR. There is paper and there is gold, but the two are two different products. The SDRs are apparently an attempt to get all governments to inflate at the same rate. An international body will allocate the increase in the quantity of paper money. In this way, if all countries are inflating at the same rate, it will not be easy for people within one country to see what is happening to their money. This program will be extremely difficult to carry out. I expect that it will fail. Of course, no one knows the future, and I certainly do not. It is largely a question of how long the people can be fooled by the claim that paper has the same value as a commodity which has other uses. The reactions of the people in the different countries are unquestionably going to be different.

  • 1. "The Employment Act of 1946 is one of the most fundamental compacts in domestic affairs which the people through their Government have made during my tenure as President.… It is the purpose of the Employment Act — the one most widely recognized at the time of its passage — to prevent depressions.… The Act rejects the idea that we are victims of unchangeable economic laws, that we are powerless to do more than forecast what will happen to us under the operation of such laws." Harry S. Truman, The Economic Report of the President, January 14, 1953, pp. 8, 10, 17.

Percy L. Greaves, Jr.

Percy L. Greaves, Jr. (1906–1984) was a free-market economist for US News (the forerunner of US News and World Report) and authored several books on economics, including Understanding the Dollar Crisis and Mises Made Easier. He was also a seminar speaker and discussion leader with the Foundation for Economic Education. Percy and his wife Bettina Bien Greaves were long-time associates and friends of Ludwig von Mises, and regular attendants at Mises's New York University seminar.

Shield icon library