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Chapter 11—Money and Its Purchasing Power (continued)

11. Monetary Attributes of Goods

A. Quasi Money

     We saw in chapter 3 how one or more very easily market­able commodities were chosen by the market as media of ex­change, thereby greatly increasing their marketability and becom­ing more and more generally used until they could be called money. We have implicitly assumed that there are one or two media that are fully marketable—always salable—and other commodities that are simply sold for money. We have omitted men­tion of the degrees of marketability of these goods. Some goods are more readily marketable than others. And some are so easily marketable that they rise practically to the status of quasi moneys.



B. Bills of Exchange

     In previous sections we saw that bills of exchange are not money-substitutes, but credit instruments. Money-substitutes are claims to present money, equivalent to warehouse receipts. But some critics maintain that in Europe at the turn of the nineteenth century bills did circulate as money-substitutes. They cir­culated as final payment in advance of their due dates, their face value discounted for the period of time left for maturity. Yet these were not money-substitutes. The holder of a bill was a creditor. Each of the acceptors of the bill had to endorse its pay­ment, and the credit standing of each endorser had to be exam­ined to judge the soundness of the bill. In short, as Mises has stated:

The endorsement of the bill is in fact not a final payment; it liberates the debtor to a limited degree only. If the bill is not paid then his liability is revived in a greater degree than before.45]

Hence, the bills could not be classed as money-substitutes.

12. Exchange Rates of Coexisting Moneys

     Up to this point we have analyzed the market in terms of a single money and its purchasing power. This analysis is valid for each and every type of medium of exchange existing on the market. But if there is more than one medium coexisting on the market, what determines the exchange ratios between the various media? Although on an unhampered market there is a gradual tendency for one single money to be established, this tendency works very slowly. If two or more commodities offer good facilities and are both especially marketable, they may coexist as moneys. Each will be used by people as media of exchange.

     For centuries, gold and silver were two commodities that coexisted as moneys. Both had similar advantages in scarcity, desirability for nonmonetary purposes, portability, durability, etc. Gold, however, being relatively far more valuable per unit of weight, was found to be more useful for larger transactions, and silver better for smaller transactions.

     It is impossible to predict whether the market would have continued indefinitely to use gold and silver or whether one would have gradually ousted the other as a general medium of exchange. For, in the late nineteenth century, most Western countries con­ducted a coup d’etat against silver, to establish a monometallic standard by coercion.[46] Gold and silver could and did coexist side by side in the same countries or throughout the world market, or one could function as money in one country, and one in an­other. Our analysis of the exchange rate is the same in both cases.

     What determines the exchange rate between two (or more) moneys? Two different kinds of money will exchange in a ratio corresponding to the ratio of the purchasing power of each in terms of all the other economic goods. Thus, suppose that there are two coexisting moneys, gold and silver, and the purchasing power of gold is double that of silver, i.e., that the money price of every commodity is double in terms of silver what it is in terms of gold. One ounce of gold exchanges for 50 pounds of butter, and one ounce of silver exchanges for 25 pounds of butter. One ounce of gold will then tend to exchange for two ounces of silver; the exchange ratio of gold and silver will tend to be 1:2. If the rate at any time deviates from 1:2, market forces will tend to re-establish the parity between the purchasing powers and the exchange rate between them. This equilibrium exchange rate between two moneys is termed the purchasing power parity.

     Thus, suppose that the exchange rate between gold and silver is 1:3, three ounces of silver exchanging for one ounce of gold. At the same time, the purchasing power of an ounce of gold is twice that of silver. It will now pay people to sell commodities for gold, exchange the gold for silver, and then exchange the silver back into commodities, thereby making a clear arbitrage gain. For example, people will sell 50 pounds of butter for one ounce of gold, exchange the gold for three ounces of silver, and then exchange the silver for 75 pounds of butter, gain­ing 25 pounds of butter. Similar gains from this arbitrage action will take place for all other commodities.

     Arbitrage will restore the exchange rate between silver and gold to its purchasing power parity. The fact that holders of gold increase their demand for silver in order to profit by the arbi­trage action will make silver more expensive in terms of gold and, conversely, gold cheaper in terms of silver. The exchange rate is driven in the direction of 1:2. Furthermore, holders of commodities are increasingly demanding gold to take advantage of the arbitrage, and this raises the purchasing power of gold. In addition, holders of silver are buying more commodities to make the arbitrage profit, and this action lowers the purchasing power of silver. Hence the ratio of the purchasing powers moves from 1:2 in the direction of 1:3. The process stops when the exchange rate is again at purchasing power parity, when arbitrage gains cease. Arbitrage gains tend to eliminate themselves and to bring about equilibrium.

     It should be noted that, in the long run, the movement in the purchasing powers will probably not be important in the equi­librating process. With the arbitrage gains over, demands will probably revert back to what they were formerly, and the orig­inal ratio of purchasing powers will be restored. In the above case, the equilibrium rate will likely remain at 1:2.

     Thus, the exchange rate between any two moneys will tend to be at the purchasing power parity. Any deviation from the parity will tend to eliminate itself and re-establish the parity rate. This holds true for any moneys, including those used mainly in dif­ferent geographical areas. Whether the exchanges of moneys oc­cur between citizens of the same or different geographical areas makes no economic difference, except for the costs of transport. Of course, if the two moneys are used in two completely isolated geographical areas with no exchanges between the inhabitants, then there is no exchange rate between them. Whenever ex­changes do take place, however, the rate of exchange will always tend to be set at the purchasing power parity.

     It is impossible for economics to state whether, if the money market had remained free, gold and silver would have continued to circulate side by side as moneys. There has been in monetary history a curious reluctance to allow moneys to circulate at freely fluctuating exchange ratios. Whether one of the moneys or both would be used as units of account would be up to the market to decide at its convenience.[47]

13. The Fallacy of the Equation of Exchange

     The basis on which we have been explaining the purchasing power of money and the changes in and consequences of mone­tary phenomena has been an analysis of individual action. The behavior of aggregates, such as the aggregate demand for money and aggregate supply, has been constructed out of their indi­vidual components. In this way, monetary theory has been inte­grated into general economics. Monetary theory in American eco­nomics, however (apart from the Keynesian system, which we dis­cuss elsewhere), has been presented in entirely different terms—in the quasi-mathematical, holistic equation of exchange, derived especially from Irving Fisher. The prevalence of this fallacious approach makes a detailed critique worthwhile.

     The classic exposition of the equation of exchange was in Irving Fisher’s Purchasing Power of Money.[48] Fisher describes the chief purpose of his work as that of investigating “the causes determin­ing the purchasing power of money.” Money is a generally ac­ceptable medium of exchange, and purchasing power is rightly defined as the “quantities of other goods which a given quantity of goods will buy.”[49] He explains that the lower the prices of goods, the larger will be the quantities that can be bought by a given amount of money, and therefore the greater the purchas­ing power of money. Vice versa if the prices of goods rise. This is correct; but then comes this flagrant non sequitur: “In short, the purchasing power of money is the reciprocal of the level of prices; so that the study of the purchasing power of money is identical with the study of price levels.”[50]From then on, Fisher proceeds to investigate the causes of the “price level”; thus, by a simple “in short,” Fisher has leaped from the real world of an array of individual prices for an innumerable list of concrete goods into the misleading fiction of a “price level,” without dis­cussing the grave difficulties which any such concept must face. The fallacy of the “price level” concept will be treated further below.

     The “price level” is allegedly determined by three aggregative factors: the quantity of money in circulation, its “velocity of cir­culation”—the average number of times during a period that a unit of money is exchanged for goods—and the total volume of goods bought for money. These are related by the famous equa­tion of exchange: MV = PT. This equation of exchange is built up by Fisher in the following way: First, consider an individual exchange transaction—Smith buys 10 pounds of sugar for 7 cents a pound.[51] An exchange has been made, Smith giving up 70 cents to Jones, and Jones transferring 10 pounds of sugar to Smith. From this fact Fisher somehow deduces that “10 pounds of sugar have been regarded as equal to 70 cents, and this fact may be expressed thus: 70 cents = 10 pounds multiplied by 7 cents a pound.”[52] This off-hand assumption of equality is not self-evident, as Fisher apparently assumes, but a tangle of fallacy and irrelevance. Who has “regarded” the 10 pounds of sugar as equal to the 70 cents? Certainly not Smith, the buyer of the sugar. He bought the sugar precisely because he considered the two quantities as unequal in value; to him the value of the sugar was greater than the value of the 70 cents, and that is why he made the exchange. On the other hand, Jones, the seller of the sugar, made the exchange precisely because the values of the two goods were unequal in the opposite direction, i.e., he valued the 70 cents more than he did the sugar. There is thus never any equality of values on the part of the two participants. The assumption that an exchange presumes some sort of equality has been a delusion of economic theory since Aristotle, and it is sur­prising that Fisher, an exponent of the subjective theory of value in many respects, fell into the ancient trap. There is certainly no equality of values between two goods exchanged or, as in this case, between the money and the good. Is there an equality in anything else, and can Fisher’s doctrine be salvaged by finding such an equality? Obviously not; there is no equality in weight, length, or any other magnitude. But to Fisher, the equation rep­resents an equality in value between the “money side” and the “goods side”; thus, Fisher states:

[T]he total money paid is equal in value to the total value of the goods bought. The equation thus has a money side and a goods side. The money side is the total money paid. . . . The goods side is made up of the prod­ucts of quantities of goods exchanged multiplied by respec­tive prices.[53]

     We have seen, however, that even for the individual exchange, and setting aside the holistic problem of “total exchanges,” there is no such “equality” that tells us anything about the facts of economic life. There is no “value-of-money side” equaling a “value-of-goods side.” The equal sign is illegitimate in Fisher’s equation.

     How, then, account for the general acceptance of the equal sign and the equation? The answer is that, mathematically, the equation is of course an obvious truism: 70 cents = 10 pounds of sugar x 7 cents per pound of sugar. In other words, 70 cents = 70 cents. But this truism conveys no knowledge of economic fact whatsoever.[54] Indeed, it is possible to discover an endless number of such equations, on which esoteric articles and books could be published. Thus:


Then, we could say that the “causal factors” determining the quantity of money are: the number of grains of sand, the num­ber of students in the class, and the quantity of money. What we have in Fisher’s equation, in short, is two money sides, each identical with the other. In fact, it is an identity and not an equation. To say that such an equation is not very enlightening is self-evident. All that this equation tells us about economic life is that the total money received in a transaction is equal to the total money given up in a transaction—surely an uninteresting truism.

     Let us reconsider the elements of the equation on the basis of the determinants of price, since that is our center of interest. Fisher’s equation of exchange for an individual transaction can be rearranged as follows:

Fisher considers that this equation yields the significant informa­tion that the price is determined by the total money spent di­vided by the total supply of goods sold. Actually, of course, the equation, as an equation, tells us nothing about the determinants of price; thus, we could set up an equally truistic equation:

This equation is just as mathematically true as the other, and, on Fisher’s own mathematical grounds, we could argue cogently that Fisher has “left the important wheat price out of the equa­tion.” We could easily add innumerable equations with an in­finite number of complex factors that “determine” price.

     The only knowledge we can have of the determinants of price is the knowledge deduced logically from the axioms of praxeol­ogy. Mathematics can at best only translate our previous knowl­edge into relatively unintelligible form; or, usually, it will mis­lead the reader, as in the present case. The price in the sugar transaction may be made to equal any number of truistic equa­tions; but it is determined by the supply and demand of the participants, and these in turn are governed by the utility of the two goods on the value scales of the participants in exchange. This is the fruitful approach in economic theory, not the sterile mathematical one. If we consider the equation of exchange as revealing the determinants of price, we find that Fisher must be implying that the determinants are the “70 cents” and the “10 pounds of sugar.” But it should be clear that things cannot de­termine prices. Things, whether pieces of money or pieces of sugar or pieces of anything else, can never act; they cannot set prices or supply and demand schedules. All this can be done only by human action: only individual actors can decide whether or not to buy; only their value scales determine prices. It is this profound mistake that lies at the root of the fallacies of the Fisher equation of exchange: human action is abstracted out of the pic­ture, and things are assumed to be in control of economic life. Thus, either the equation of exchange is a trivial truism—in which case, it is no better than a million other such truistic equations, and has no place in science, which rests on simplicity and econ­omy of methods—or else it is supposed to convey some important truths about economics and the determination of prices. In that case, it makes the profound error of substituting for correct logi­cal analysis of causes based on human action, misleading assump­tions based on action by things. At best, the Fisher equation is superfluous and trivial; at worst, it is wrong and misleading, al­though Fisher himself believed that it conveyed important causal truths.

     Thus, Fisher’s equation of exchange is pernicious even for the individual transaction. How much more so when he extends it to the “economy as a whole”! For Fisher, this too was a simple step. “The equation of exchange is simply the sum of the equa­tions involved in all individual exchanges”[55] as in a period of time. Let us now, for the sake of argument, assume that there is noth­ing wrong with Fisher’s individual equations and consider his “summing up” to arrive at the total equation for the economy as a whole. Let us also abstract from the statistical difficulties in­volved in discovering the magnitudes for any given historical sit­uation. Let us look at several individual transactions of the sort that Fisher tries to build into a total equation of exchange:

A  exchanges 70 cents for 10 pounds of sugar
B  exchanges 10 dollars for 1 hat
C  exchanges 60 cents for 1 pound of butter
D exchanges 500 dollars for 1 television set.

What is the “equation of exchange” for this community of four? Obviously there is no problem in summing up the total amount of money spent: $511.30. But what about the other side of the equation? Of course, if we wish to be meaninglessly truistic, we could simply write $511.30 on the other side of the equation, without any laborious building up at all. But if we merely do this, there is no point to the whole procedure. Furthermore, as Fisher wants to get at the determination of prices, or “the price level,” he cannot rest content at this trivial stage. Yet he con­tinues on the truistic level:

This is what Fisher does, and this is still the same trivial truism that “total money spent equals total money spent.” This trivi­ality is not redeemed by referring to p x Q, p' x Q' , etc., with each p referring to a price and each Q referring to the quantity of a good, so that: E = Total money spent = pQ + p'Q' + p''Q'' + . . . etc. Writing the equation in this symbolic form does not add to its significance or usefulness.

     Fisher, attempting to find the causes of the price level, has to proceed further. We have already seen that even for the indi­vidual transaction, the equation p = (E/Q) (price equals total money spent divided by the quantity of goods sold) is only a trivial truism and is erroneous when one tries to use it to analyze the determinants of price. (This is the equation for the price of sugar in Fisherine symbolic form.) How much worse is Fisher’s attempt to arrive at such an equation for the whole community and to use this to discover the determinants of a mythical “price level”! For simplicity’s sake, let us take only the two transactions of A and B, for the sugar and the hat. Total money spent, E, clearly equals $10.70, which, of course, equals total money re­ceived, pQ +p'Q' . But Fisher is looking for an equation to ex­plain the price level; therefore he brings in the concept of an “average price level,” P, and a total quantity of goods sold, T, such that E is supposed to equal PT. But the transition from the trivial truism E =  pQ + p'Q' . . . to the equation E = PT can­not be made as blithely as Fisher believes. Indeed, if we are inter­ested in the explanation of economic life, it cannot be made at all.

     For example, for the two transactions (or for the four), what is T? How can 10 pounds of sugar be added to one hat or to one pound of butter, to arrive at T? Obviously, no such addition can be performed, and therefore Fisher’s holistic T, the total physical quantity of all goods exchanged, is a meaningless concept and cannot be used in scientific analysis. If T is a meaningless concept, then P must be also, since the two presumably vary inversely if E remains constant. And what, indeed, of P? Here, we have a whole array of prices, 7 cents a pound, $10 a hat, etc. What is the price level? Clearly, there is no price level here; there are only individual prices of specific goods. But here, error is likely to persist. Cannot prices in some way be “averaged” to give us a working definition of a price level? This is Fisher’s solution. Prices of the various goods are in some way averaged to arrive at P, then P = (E/T), and all that remains is the difficult “statistical” task of arriving at T. However, the concept of an average for prices is a common fallacy. It is easy to demonstrate that prices can never be averaged for different commodities; we shall use a simple average for our example, but the same conclusion applies to any sort of “weighted average” such as is recommended by Fisher or by anyone else.

     What is an average? Reflection will show that for several things to be averaged together, they must first be totaled. In order to be thus added together, the things must have some unit in com­mon, and it must be this unit that is added. Only homogeneous units can be added together. Thus, if one object is 10 yards long, a second is 15 yards long, and a third 20 yards long, we may ob­tain an average length by adding together the number of yards and dividing by three, yielding an average length of 15 yards. Now, money prices are in terms of ratios of units: cents per pound of sugar, cents per hat, cents per pound of butter, etc. Suppose we take the first two prices:

Can these two prices be averaged in any way? Can we add 1,000 and 7 together, get 1,007 cents, and divide by something to get a price level? Obviously not. Simple algebra demonstrates that the only way to add the ratios in terms of cents (certainly there is no other common unit available) is as follows:

Obviously, neither the numerator nor the denominator makes sense; the units are incommensurable.

     Fisher’s more complicated concept of a weighted average, with the prices weighted by the quantities of each good sold, solves the problem of units in the numerator but not in the denominator:

The pQ’s are all money, but the Q’s are still different units. Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate. Even pounds of sugar and pounds of butter cannot be added together, because they are two different goods and their valuation is completely different. And if one is tempted to use poundage as the common unit of quantity, what is the pound weight of a concert or a medical or legal service?[56]

     It is evident that PT, in the total equation of exchange, is a completely fallacious concept. While the equation E = pQ for an individual transaction is at least a trivial truism, although not very enlightening, the equation E = PT for the whole society is a false one. Neither P nor T can be defined meaningfully, and this would be necessary for this equation to have any validity. We are left only with E = pQ + p'Q', etc., which gives us only the useless truism, E = E.[57]

     Since the P concept is completely fallacious, it is obvious that Fisher’s use of the equation to reveal the determinants of prices is also fallacious. He states that if E doubles, and T remains the same, P—the price level—must double. On the holistic level, this is not even a truism; it is false, because neither P nor T can be meaningfully defined. All we can say is that when E doubles, E doubles. For the individual transaction, the equation is at least meaningful; if a man now spends $1.40 on 10 pounds of sugar, it is obvious that the price has doubled from 7 cents to 14 cents a pound. Still, this is only a mathematical truism, telling us nothing of the real causal forces at work. But Fisher never at­tempted to use this individual equation to explain the determi­nants of individual prices; he recognized that the logical analysis of supply and demand is far superior here. He used only the holistic equation, which he felt explained the determinants of the price level and was uniquely adapted to such an explanation. Yet the holistic equation is false, and the price level remains pure myth, an indefinable concept.

     Let us consider the other side of the equation, E = MV, the average quantity of money in circulation in the period, multi­plied by the average velocity of circulation. V is an absurd con­cept. Even Fisher, in the case of the other magnitudes, recognized the necessity of building up the total from individual exchanges. He was not successful in building up T out of the individual Q’s, P out of the individual p’s, etc., but at least he attempted to do so. But in the case of V, what is the velocity of an individual transaction? Velocity is not an independently defined variable. Fisher, in fact, can derive V only as being equal in every instance and every period to E/M. If I spend in a certain hour $10 for a hat, and I had an average cash balance (or M) for that hour of $200, then, by definition, my V equals 1/20. I had an average quantity of money in my cash balance of $200, each dollar turned over on the average of 1/20 of a time, and consequently I spent $10 in this period. But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation. Fisher compounds the ab­surdity by setting up M and V as independent determinants of E, which permits him to go to his desired conclusion that if M doubles, and V and T remain constant, P—the price level—will also double. But since V is defined as equal to E/M, what we actually have is: M x (E/M) = PT or simply, E = PT, our orig­inal equation. Thus, Fisher’s attempt to arrive at a quantity equa­tion with the price level approximately proportionate to the quan­tity of money is proved vain by yet another route.

     A group of Cambridge economists—Pigou, Robertson, etc.—has attempted to rehabilitate the Fisher equation by eliminating V and substituting the idea that the total supply of money equals the total demand for money. However, their equation is not a particular advance, since they keep the fallacious holistic concepts of P and T, and their k is merely the reciprocal of V, and suffers from the latter’s deficiencies.

     In fact, since V is not an independently defined variable, M must be eliminated from the equation as well as V, and the Fisherine (and the Cambridge ) equation cannot be used to dem­onstrate the “quantity theory of money.” And since M and V must disappear, there are an infinite number of other “equations of exchange” that we could, with equal invalidity, uphold as “determinants of the price level.” Thus, the aggregate stock of sugar in the economy may be termed S, and the ratio of E to the total stock of sugar may be called “average sugar turnover,” or U. This new “equation of exchange” would be: SU = PT, and the stock of sugar would suddenly become a major determinant of the price level. Or we could substitute A = number of salesmen in the country, and X = total expenditures per salesman, or “sales­men turnover,” to arrive at a new set of “determinants” in a new equation. And so on.

     This example should reveal the fallacy of equations in economic theory. The Fisherine equation has been popular for many years because it has been thought to convey useful economic knowledge. It appears to be demonstrating the plausible (on other grounds) quantity theory of money. Actually, it has only been misleading.

     There are other valid criticisms that could be made of Fisher: his use of index numbers, which even at best could only measure a change in a variable, but never define its actual position; his use of an index of T defined in terms of P and of P defined in terms of T; his denial that money is a commodity; the use of mathematical equations in a field where there can be no constants and therefore no quantitative predictions. In particular, even if the equation of exchange were valid in all other respects, it could at best only describe statically the conditions of an average period. It could never describe the path from one static condition to another. Even Fisher admitted this by conceding that a change in M would always affect V, so that the influence of M on P could not be isolated. He contended that after this “transition” period, V would revert to a constant and the effect on P would be propor­tional. Yet there is no reasoning to support this assertion. At any rate, enough has been shown to warrant expunging the equation of exchange from the economic literature.

14. The Fallacy of Measuring and Stabilizing the PPM

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]

B. Stabilization

     The knowledge that the purchasing power of money could vary led some economists to try to improve on the free market by creating, in some way, a monetary unit which would remain stable and constant in its purchasing power. All these stabiliza­tion plans, of course, involve in one way or another an attack on the gold or other commodity standard, since the value of gold fluctuates as a result of the continual changes in the supply of and the demand for gold. The stabilizers want the government to keep an arbitrary index of prices constant by pumping money into the economy when the index falls and taking money out when it rises. The outstanding proponent of “stable money,” Irving Fisher, revealed the reason for his urge toward stabiliza­tion in the following autobiographical passage: “I became in­creasingly aware of the imperative need of a stable yardstick of value. I had come into economics from mathematical physics, in which fixed units of measure contribute the essential starting point.”[61] Apparently, Fisher did not realize that there could be fundamental differences in the nature of the sciences of physics and of purposeful human action.

     It is difficult, indeed, to understand what the advantages of a stable value of money are supposed to be. One of the most frequently cited advantages, for example, is that debtors will no longer be harmed by unforeseen rises in the value of money, while creditors will no longer be harmed by unforeseen declines in its value. Yet if creditors and debtors want such a hedge against future changes, they have an easy way out on the free market. When they make their contracts, they can agree that repayment be made in a sum of money corrected by some agreed-upon index number of changes in the value of money. Such a voluntary tabu­lar standard for business contracts has long been advocated by stabilizationists, who have been rather puzzled to find that a course which appears to them so beneficial is almost never adopted in business practice. Despite the multitude of index numbers and other schemes that have been proposed to businessmen by these economists, creditors and debtors have somehow failed to take advantage of them. Yet, while stabilization plans have made no headway among the groups that they would supposedly benefit the most, the stabilizationists have remained undaunted in their zeal to force their plans on the whole society by means of State coercion.

     There seem to be two basic reasons for this failure of business to adopt a tabular standard: (a) As we have seen, there is no scientific, objective means of measuring changes in the value of money. Scientifically, one index number is just as arbitrary and bad as any other. Individual creditors and debtors have not been able to agree on any one index number, therefore, that they can abide by as a measure of change in purchasing power. Each, ac­cording to his own interests, would insist on including different commodities at different weights in his index number. Thus, a debtor who is a wheat farmer would want to weigh the price of wheat heavily in his index of the purchasing power of money; a creditor who goes often to nightclubs would want to hedge against the price of night-club entertainment, etc. (b) A second reason is that businessmen apparently prefer to take their chances in a speculative world rather than agree on some sort of arbitrary hedging device. Stock exchange speculators and commodity specu­lators are continually attempting to forecast future prices, and, indeed, all entrepreneurs are engaged in anticipating the un­certain conditions of the market. Apparently, businessmen are willing to be entrepreneurs in anticipating future changes in purchasing power as well as any other changes.

     The failure of business to adopt voluntarily any sort of tabular standard seems to demonstrate the complete lack of merit in compulsory stabilization schemes. Setting this argument aside, however, let us examine the contention of the stabilizers that somehow they can create certainty in the purchasing power of money, while at the same time leaving freedom and uncertainty in the prices of particular goods. This is sometimes expressed in the statement: “Individual prices should be left free to change; the price level should be fixed and constant.” This contention rests on the myth that some sort of general purchasing power of money or some sort of price level exists on a plane apart from specific prices in specific transactions. As we have seen, this is purely fallacious. There is no “price level,” and there is no way that the exchange-value of money is manifested except in specific purchases of goods, i.e., specific prices. There is no way of sepa­rating the two concepts; any array of prices establishes at one and the same time an exchange relation or objective exchange-value between one good and another and between money and a good, and there is no way of separating these elements quantita­tively.

     It is thus clear that the exchange-value of money cannot be quantitatively separated from the exchange-value of goods. Since the general exchange-value, or PPM, of money cannot be quan­titatively defined and isolated in any historical situation, and its changes cannot be defined or measured, it is obvious that it cannot be kept stable. If we do not know what something is, we cannot very well act to keep it constant.[62]

     We have seen that the ideal of a stabilized value of money is impossible to attain or even define. Even if it were attainable, however, what would be the result? Suppose, for example, that the purchasing power of money rises and that we disregard the problem of measuring the rise. Why, if this is the result of action on an unhampered market, should we consider it a bad result? If the total supply of money in the community has remained constant, falling prices will be caused by a general increase in the demand for money or by an increase in the supply of goods as a result of increased productivity. An increased demand for money stems from the free choice of individuals, say, in the ex­pectation of a more troubled future or of future price declines. Stabilization would deprive people of the chance to increase their real cash holdings and the real value of the dollar by free, mutu­ally agreed-upon actions. As in any other aspect of the free mar­ket, those entrepreneurs who successfully anticipate the increased demand will benefit, and those who err will lose in their specula­tions. But even the losses of the latter are purely the consequence of their own voluntarily assumed risks. Furthermore, falling prices resulting from increased productivity are beneficial to all and are precisely the means by which the fruits of industrial progress spread on the free market. Any interference with falling prices blocks the spread of the fruits of an advancing economy; and then real wages could increase only in particular industries, and not, as on the free market, over the economy as a whole.

     Similarly, stabilization would deprive people of the chance to decrease their real cash holdings and the real value of the dol­lar, should their demand for money fall. People would be pre­vented from acting on their expectations of future price increases. Furthermore, if the supply of goods should decline, a stabiliza­tion policy would prevent the price rises necessary to clear the various markets.

     The intertwining of general purchasing power and specific prices raises another consideration. For money could not be pumped into the system to combat a supposed increase in the value of money without distorting the previous exchange-values between the various goods. We have seen that money cannot be neutral with respect to goods and that, therefore, the whole price structure will change with any change in the supply of money. Hence, the stabilizationist program of fixing the value of money or price level without distorting relative prices is necessarily doomed to failure. It is an impossible program.

     Thus, even were it possible to define and measure changes in the purchasing power of money, stabilization of this value would have effects that many advocates consider undesirable. But the magnitudes cannot even be defined, and stabilization would de­pend on some sort of arbitrary index number. Whichever com­modities and weights are included in the index, pricing and production will be distorted.

     At the heart of the stabilizationist ideal is a misunderstanding of the nature of money. Money is considered either a mere numeraire or a grandiose measure of values. Forgotten is the truth that money is desired and demanded as a useful commodity, even when this use is only as a medium of exchange. When a man holds money in his cash balance, he is deriving utility from it. Those who neglect this fact scoff at the gold standard as a primi­tive anachronism and fail to realize that “hoarding” performs a useful social function.

[44] Cf. Mises, Human Action, pp. 459–61.

[45]Mises, Theory of Money and Credit, pp. 285–86.

[46]For recent evidence that this action in the United States was a deliberate “crime against silver,” and not sheer accident, see Paul M. O’Leary, “The Scene of the Crime of 1873 Revisited,” Journal of Political Economy, August, 1960, pp. 388–92. One argument in favor of such action holds that the government thereby simplified accounts in the economy. How­ever, the market could easily have done so itself by keeping all accounts in gold.

[47] See Mises, Theory of Money and Credit, pp. 179ff., and Jevons, Money and the Mechanism of Exchange, pp. 88–96. For advocacy of such parallel standards, see Isaiah W. Sylvester, Bullion Certificates as Currency (New York, 1882); and William Brough, Open Mints and Free Banking (New York: G.P. Putnam’s Sons, 1894). Sylvester, who also advocated 100-percent specie-reserve currency, was an official of the United States Assay Office.

     For historical accounts of the successful working of parallel standards, see Luigi Einaudi, “The Theory of Imaginary Money from Charlemagne to the French Revolution” in F.C. Lane and J.C. Riemersma, eds., Enterprise and Secular Change (Homewood, Ill.: Richard D. Irwin, 1953), pp. 229–61; Robert Sabatino Lopez, “Back to Gold, 1252,” Economic His­tory Review, April, 1956, p. 224; and Arthur N. Young, “Saudi Arabian Currency and Finance,” The Middle East Journal, Summer, 1953, pp. 361–80.

[48]Fisher, Purchasing Power of Money, especially pp. 13ff.

[49]Ibid., p. 13.

[50]Ibid., p. 14.

[51]We are using “dollars” and “cents” here instead of weights of gold for the sake of simplicity and because Fisher himself uses these expressions.

[52]Fisher, Purchasing Power of Money, p. 16.

[53]Ibid., p. 17.

[54]Greidanus justly calls this sort of equation “in all its absurdity the prototype of the equations set up by the equivalubrists,” in the modern mode of the “economics of the bookkeeper, not of the economist.” Greidanus, Value of Money, p. 196.

[55]Fisher, Purchasing Power of Money, p. 16.

[56]For a brilliant critique of the disturbing effects of averaging even when a commensurable unit does exist, see Louis M. Spadaro, “Averages and Aggregates in Economics” in On Freedom and Free Enterprise, pp. 140–60.­

[57]See Clark Warburton, “Elementary Algebra and the Equation of Ex­change,” American Economic Review, June, 1953, pp. 358–61. Also see Mises, Human Action, p. 396; B.M. Anderson, Jr., The Value of Money (New York: Macmillan & Co., 1926), pp. 154–64; and Greidanus, Value of Money, pp. 59–62.

[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.

[61]Irving Fisher, Stabilised Money (London: George Allen & Unwin, 1935), p. 375.

[62]The fact that the purchasing power of the monetary unit is not quantita­tively definable does not negate the fact of its existence, which is estab­lished by prior praxeological knowledge. It thereby differs, for example, from the “competitive price–monopoly price” dichotomy, which cannot be independently established by praxeological deduction for free-market conditions.

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