A Critical Review of Ludwig Von Mises's ‘Theory if Money and Credit” [Part II/VII']

 

Complied by Chinedu Okoye

 

Mises on Purchasing Power of Money:

"The purchasing power of money can be different in different markets at the same time." This he describes as a fallacy for it leaves out the account of a positional factor in the nature of economic goods.

It is not permissible he says to "deduce a difference in the purchasing power of money in Germany and in Russia from the fact that the price of wheat is different in these countries" for the commodity in both countries are indeed two different species of goods.

This seems yet another self contradictory statement, for if transportation is a production good, then it's safe to say that the purchasing of money with regards wheat in both countries is indeed different for extra cost component involved in bringing it to the intended market.

Mises attacks the "connexion" between the assertion that local differences in purchasing power and the widespread belief in local differences in the cost of living.

He argues tht the idea that living costs are cheaper elsewhere does not imply that "the purchasing power is different". He follows with the idea that individuals in different localities face uneven costs considerations in securing the same level of satisfaction.

An example he gave was an upper class Englishman living in the continent would spend lesser to achieve the same satisfaction than if he lived at home where there are social obligations on him. Likewise urban dwellers spend more than rural dwellers on tastes acquired eg theatres, Cinemas etc that rural dwellers aren't accustomed to.

The problem with this is that for certain consumption goods, the cost increases with distance and availability. A good produced in a particular country and only derivable there would be more expensive in other countries, making the purchasing power with regards that good different.

His assertions that "purchasing power is the same everywhere; only the commodities offered are different" is tautological to say the least as the purchasing power of money depends on the exchange-value for said commodities.

Mises also assumes by this logic that the value of money is the same in every territory. This can not be further from the truth, as the value of a country's currency depends to no small degree on the demand for its goods and services on the international market. As countries rack up trade deficits or surpluses so does the currency depreciate or appreciate in value, with a dampening effect on purchasing power.

The exchange-ratio subsisting between commodities and money is everywhere the same. But men and their wants are not everywhere the same, and neither are commodities."

Only if the distinctions are ignored is it possible to speak of local differences in the purchasing power of money or to say that living is dearer  in one place than in another.

This assumes wages and currency are the same. But even if we are to work with that assumption, and you convert the world's currency into a vommone one –eithet amongst the various goats or other forms of money– the purchasing power will still not be equal per individual in each territory.

Purchasing Power is based on earnings –real disposable income, and even if you take away the taxable portion thereby increasing the average disposable income, all individuals will not have equal purchasing power as claimed by Mises. This is for the most basic of goods and services consumed by both the rich and the poor.

Data proves this, so it is inconceivable to assume that purchasing power is the same for all countries at any point in time in history.

Part 2 Chapter 3: The Exchange-Ratio Between Money of Different Kinds:

The existence of an exchange-ratio between two different of money is dependent on both being used side by side. A country that uses gold as currency in trade relations with a country that uses silver as currency cannot possibly exclude silver as part of its media of exchange.

Thus, "the existence of trade relations results in the consequence that money of each of the single areas concerned is money also for all other areas."

The price of each countries currency in terms of another would then be dependent on the objective exchange-value of the respective currency's for commodities traded.

If one currency emerges higher in terms of the commodity, then it becomes disadvantageous for the country to sell that commodity –at the same rice– by the instrumentality of money compared to a direct exchange for a desired commodity from the other country.

This implies that changes in the value of a currency can lead to a trade surplus or deficit in money terms. From this he fallaciously concludes that, international movements of money are not a consequence of the state of trade but the cause (of favorable or unfavorable trade-balances.)

A point I disagree with, for even though currency values may affect trade, it is the demand for goods and services that drive the value of the currency where supply is fixed, and speculative demand eliminated. Though monetary policy can affect trade balances, the effects are usually unsustainable without sufficient resources or assets to back it up.

The movement of goods, drive the movement and value of money in the long-run. And international movement of goods and services are the primary reason for international movements of money not the other way around.

The problem of the classical doctrine he said is that they focused too much on the point of view of the technique of the monetary system and too little from the exchange of goods. For goods are only exchanged for goods through the monetary medium. He says that an acknowledgement of the latter view would make it apparent that the "balance of trade between two areas with different currencies must always be in equilibrium".

This takes out the possibilities of changes in market conditions and the value addition in production. The earlier thread pointed that though two countries may have need for a particular commodity, but transform and process it into a distinctive finished good, from some new technology. Productivity in this scenario now causes trade imbalances.

So even where goods are exchanged directly, technique, know-how and distinct value addition from a process involving a combination of other resources could make for trade imbalances, negating the idea of an equilibrium in the value of the currencies between trasidng partners.

Unlike the chapter would suggest, goods and services —in their broadest sense— drive currency exchange values, and there is no long term equilibrium between trading partners so far as the position process remains evolving, as it is in the real world, making for a productivity driven valuation changes, absent speculative activities that is.

Mises' argument seems once again to oversimplify the intricate relationship between economic goods in the broadest sense and currency values by attributing trade imbalances to the mechanics of money movement.

 

Chapter 5: The Problem of Measuring The Objective Exchange-Value Of Money and Variations in it:

Mises states that the issue above attracted more attention than it warrants. This follows from his position in they previous chapter than purchasing power is the same everywhere.

The most important results of research in social sciences, he says "leave the multitude apathetic, but any set of figures awakens it's interest. It history then becomes a series of dates it's economics a collection of data.

By this he attacks  the quantitative method of measruing the value of money against another, reducing statistical quotes to history, and this futile in explaining the non-existent —in his view—differences in the objective exchange-value of different kinds of money.

"The objective exchange-value of the monetary unit can be expressed in units of any individual commodity." This money has a commodity-price just as commodity have money-prices. However he states that these expressions leave the question of Measuring the objective exchange-value of money.he adds that there are two parts to the problem.

(i). Obtaining numerical demonstrations of the fact of variations in the objective exchange-value of money,

(ii). The possibility of making a quantitative examination of the causes of particular price movements. And if it is indeed possible to procure evidence of such variations in the purchasing power of money.

For the first one, he says it is "self-evident that it's solution must assume the existence of a good or complex of goods, of unchanging exchange-value." But such goods are non-existent.

The invariability of the measure makes it impossible to measure the variations in commodity objective exchange-values, he argues, (and this follows from his argument against a "price levels").

And so it is impossible to measure the variations in the objective exchange-value of two different kinds of money. For "if one is proven soluble, then so also is the other; and proof of insolubility of one is also proof of insolubility of the other".

But money is measurable in terms of their respective objective exchange-value for Commodities (or non-monetary economic goods). To say that there are no variations is false as every currency has an underlying amount of "value" (goods and services produced within the territory) attached to it.

To say that it is impossible to accurately measure the variations in the objective exchange-value of various kids of monies, is fair however there are sophisticated methods of tracking these statistical methods tracking these changes which act as a guide.

He dismisses the idea of tracking price movements and this Money's commodity-price because exchange-ratios between other economic goods aren't constant.

He says that "as long as the determinants of the objective exchange-value of money are not satisfactorily elucidated in some way, the sole possible reliable guide through the tangle of statistical material is lacking".

This may have been infact true in the early 20th century, but history would show that these determinants have been satisfactorily elucidated to a very reasonable extent.

Though the examination of the influence exerted by separate determinants can not be fully able to undertake numerical imputations among different factors, an acceptable method of estimating  the most important factors (acceptable by the market) has been deviced over the years, by a combination of historical subjective and objective valuation or pricing mechanisms.

But according to Mises', all determinants of price have their effects only through subjective estimates of individuals. And the extent to which one facto influences these subjective estimates can never be predicted.

This I reject as an acceptance would negate the reality that these valuations don't change rapidly, or spontaneously, but overtime, and that there are other objective elements to pricing, that makes it possible to calculate acceptable measured differences in objective exchange-value of the various kinds of money.

 

Index as A Measure of the Objective Exchange-value of Money:

Mises admits that the technical difficulties in employing the price index method of adjusting for real wages (and real stock of money) are insurmountable —in it's entirety.

Saying, It would only attain its goal if it is supposed that exchange-ratios between economic goods excluding money were constant, and that only the exchange ratios between between money and other economic goods are liable to fluctuation.

This is true for price indexes as an measure of the real objective exchange-value of money, but the disgrunt here is the aim and interpretation of said measure. For the price of money in terms of other economic goods will invariably move in the same direction as a computern "general" price level. So it can guide economic thinking to a reasonable extent,.even though it is far from absolute.

The world has long evolved from Wieser's Indexing System to more sophisticated indexing tht makes for a more accurate "guide" as opposed to"quantitative represention" on the directional movements in prices from which an acceptable objective exchange-value of money can be derived and applied when traded against each other. (That is Fiat v Fiat, or Liquid savings for Fixed Deposits).

Because the value of money thrives on acceptability, the medium of valuation also thrives on global acceptability. Thereby imposing it's influence on the decision making it economic agents.

Mises concedes at the end of the chapter that " the practical utility of all these calculations for certain purposes is beyond doubt" but that we should should be wary in demanding more from them than they are able t perform".

This here is a line of thought I can fall behind, but implies that the indexes perhaps, cannot be relied on in adjudging the variations in objective exchange-value of monies f different kinds. A point negated by the acceptability of these indexes for the aforementioned items and purposes.

 

Part 2 Chapter 6 - The Social Consequence of Variations in the Objective Exchange-Value and if Money:

These variations cause displacements in the distribution of income and property as individuals are apt to overlook the variability in the value of money and because these variations do not affect all economic goods at once or in equal proportion.

But, variations in the objective exchange-value of money can be induced by monetary factors. And prior economic theories overlooked that fact, explaining price variations from the commodity side alone. Lenders and borrowers he says 'are not in the habit of allowing for for possible future fluctuations in the objective exchange-value of money".

In this, he disregards the interest charge as insufficient to cover for fluctuations and exposed to risks (inflation and interest rate risks). In that case it is an appropriate notion. It would also seem so in the scenario he painted for credit sales on direct exchanges.

Anyone, he says, entering into a long-term futures contract, will "carefully weigh the chances of future variations in prices, and often take steps, by means of insurance or hedging transactions such as the technique of modern era has developed, to reduce aleatory factors in his dealings".

We can think of this "steps" or considerations as interest rates in monetary terms, or adjusted exchange-ratios in commodity (direct exchange) terms. The hedge against fluctuations is not full proof as rates could lag price increases during the period, but the existence reduces the loss (of objective exchange-value) incurred.

 

Individuals Consciousness to the Variability in the Objective Exchange-value of Money:

He follows that, Individuals are conscious of the fluctuations in the variability of the objective exchange-value of money but they are only conscious of it with regards certain kinds of money.

Gold money was thought stable even though gold price fluctuations affect the value of gold money. But others aren't and so far as the variations can be forseen or to the extent that it can be anticipated, it influences the terms of credit transactions.

Thus, as far as depreciation in Fiat money is to be reckoned with, lenders would always charge a higher interest rates and borrowers will be willing to pay these rates.

 

Theoretical Terms Recommended by Economists who Understood that even the 'best' money is Variable:

If at all it is possible to take into account the value of money for all economic goods, these prior economist suggested that;

"In credit transactions the outstanding obligations would be discharged, not by the payment of the nominal sum of money if the specified contract, but by the payment of a sum of money with the purchasing power that the original sum has at the time when the contract was made."

Where the objective exchange-value of money has increased the amount should be smaller, where it has fallen, then amount bigger.

 

The Fundamental Inadequacy in measuring variations:

Mises argues that the argument devoted to this problem of measuring variations in the value of money against all economic goods, show fundamental inadequacy. For if the prices of all God's are given eua weightings in the parity determination, without consideration of their relative quantities, the "Tabular Standard" would make the content of long term contracts more uncertain.

This is agreeable as mot all economic goods have equal significance. There are some goods that must be consumed regardless of income, and by all households and others consumed by a specified group.

Surely the price changes in the former group would have a more significant effect on the objective exchange-value of "social money".

But he argues against using a weighted average to show significance. Saying that "the same consequences will still follow as the conditions of production and consumption alter."

This is true, but neglects the reality that consumer subjective values of goods and services is not a spontaneous change but a gradual one. So a weighed average pricing index modified overtime, will to no small extent, minimize the chances of an uneven representation, and improve accuracy.

The existence of objective valuation elements makes for an even slower change, as there are goods that are essential and extremely demand and supply inelastic.

 

Tying the Value Of Credit Money to Gold: A critique of the Tabular Standard:

A proposal brought forward at tht time was that contractual debt obligations be settled in terms of gold and not according o the nominal amount. Such that for every unit of Fiat lent the pay ale sumat the day of settlement should match whatever unit that would be able t purchase the same amount of gold as o I'mn the day it was Lent

This represents the first proposition of the legal tender that didn't take into account the sentiments of the national exchequer.

Mises states that the Tabular Standard which Irving Fischer seeks to solve his proposals for stabilizing purchasing power of money is a different one entirely –of dealing with the variations in the value of gold (in terms of other goods)

Social Consequences of Variations in the Value of Money When Only One Kind of Money is Employed:

So far Mises' has taken into account different forms of money,. Now he narrows it down to one kind of money. Disregarding the exchange of present goods for future gods (or money), and assume a case where exchanges are done strictly between present goods and present money.

It will result in an isolated variation of a single commodity price emanating from the commodity side, whilst the effects of the variation or changes in Money's exchange-ratio stemming from the monetary side.

But where money a concerned, all economic agents are dealers to a certain extent and each "maintains a stock f money that corresponds to the extent and intensity with which he is able to express his demand for it in the market.

If all prices rise and fall uniformly, there would be no change in the relative wealth of every economic agent (in monetary terms). Such is the folly of classical theorists in assuming a proportionate linear relationship between money supply and prices.

This assumption never holds good and in rejecting it one inadvertently accepts the notion that social displacements do infact occur as consequences of variations in the value of money.

As earlier pointed, in the chapter dealing with the objective exchange-value of money, these variations often start out gradually and spread out through different goods and the whole community at large but to different degrees. This alone sufficiently explains why "such variations have an effect on the social distribution of income".

Price changes, for whatever reason affect economic agents differently m, depending on their position in the market and the strenght their earnings. The fall in the price of a commodity amounts to a re-arrangement of income and property.

He gave an example with coal prices falling from an increased supply where demand stays unchanged, prices fall, this affects the retailer who has to sell his exisorong inventory at lower prices (exchange-ratio), but the consumers of coal —the community at large— are better off.

But the national dividend (output) also increases as "many have gained what none has lost". There was simply more coal available that either boosts production, or enables consumption of other economic goods. But the case of money is different.

For money's exchange-value the most important and indeed dominant causes is an increase in the "stock of money" or money supply in modern economic speak, where the demand for it remains the same, falls off or increases less than the new supply.

A lower subjective valuation is then passed on from the owners of capital down through to the community as those who come in contact with an additional money will.be inclined to consent to higher prices.

This then trickles down to more production, wages and so, a fall in the value of money is mistakenly considered to be "an extra-ordinarily effective means of increasing income. The view is faulted rightly by Mises aas there is no increase in the quantity of goods available for consumption at the time of the money supply increment.

Though he admits that money supply can bring about an increased output indirectly, the concern here is the was limited to whether the variations in the value of money has any other economic significance tan it's effects on the distribution of goods and services. With no other long-run significance, the prosperity is accompanied by a corresponding loss on the other side of the economy.

 

The consequences of variations in the Exchange-ratio between Two kinds of Money:

As commercial relations grow between nations, monetary standards of individual States became increasingly diverse, employing different forms of money. Changes in objective values of different money forms would definitely affect direct exchange ratios of said currencies, but this effect would be equally slow and gradual.

But variations do not affect the determination of the exchange-ratio between currencies until they begin to affect commodities that are objects of commercial relations between the two countries ie goods concerned with international trade.

During the interval of currency price adjustments is a margin which constitutes a fund that one party must receive and another surrender. As soon as the objective exchange-value of a currency is quoted, a new opportunity of making profit (or losses) arises for the importer or exporter and for the consuming or producing country.

So wealth has been created at the expense of another yet again, with no increase in the available stock of goods. Real gains in global output would therefore depend not on monetary factors or monetary expressions of transaction values but on comparative productivity gains, as there is a limit to what industry can produce with abundant (artificial) capital in any money form.

Chapter 7: Monetary Policy

This chapter is broadly categorized in two parts. Inflationism and Deflationism, both making up the broad partitioning of the chapter.

We begin with his definition of monetary policy and it's evolution.

Modern currency policy differs fundamentally from earlier State activity in the monetary sphere. Good governance from the citizens point of view "consisted of the business of minting so as to furnish commerce with coins which could be acceptable by everybody at their face value." Consequently bad government in monetary matters from the same citizens point of view "amounted to the betrayal by the State of the general confidence in it."

When states started the debasement of coinage it was purely fiscally motivated, as the governments "needed financial help" . That to him was all the reason for it as the government wasn't concerned with question of currency policy.

The question of currency policy essentially are those relating to the objective exchange-value of money. "Measures of currency policy are intelligible only in the light of their intended influence on the objective exchange-value of money".

He points that "not every value problem is connected with the objective exchange-value of money". And "in the conflicts of currency policy there are also interests involved which are not primarily concerned with the alteration of the value of money for its own sake".

Ths means value isn't always a consequence of monetary policy and monetary policy doesn't always intended to alter the exchange value of money. But ideally when it comes down to it, monetary policy is really a question of the value of money.

The fine mechanisms of the monetary and credit system he argued is "wrapped in obscurity". But ultimately discussions around currency were "engendered by anything but the question of altering the purchasing power of money".

 

Instruments of Monetary Policy:

Though more sophisticated now, the "principal instrument of monetary policy at the disposal of the state is the exploitation of its influence on the choice of the kind of money".

So, the position of the State exerts influence on the individual choices of a medium of exchange. The transition from silver and credit money to gold money was done because gold was seen as more stable and the latter two unsuited behaviorally to the economic policy of the time.

Inflationism: Policy that seems to increase the quantity of money. A "naive" form demands quantity of money increases without suspicion in its effects on the purchasing power of money. For abundance of money isn't necessarily wealth, and so it is impossible to create wealth by increasing the quantity of money.

If inflationary policies are expected and the depreciation of money by extension also expected, lenders and sellers of other economic goods would demand a higher premium (interest rate/money-price), to compenesate for a probable loss of capital. If those who demand these loanable funds are not inclined to pay these higher rates then the diminution of capital would force them to it.

 

Arguments against Stimulating Growth via Depreciation Policies:

Mises states that it will be a mistake to assume that depreciation of money (from an increase in the supply of total money stock), would invariably stimulate production. This has been stated before to which my opinion was that it could depending on the nature of the demand for money chasing the increased supply. If it is transactionary, and used I the procurement of production gos outut can definitely be stimulated from an increased money supply.

He agrees that "if particular conditions of a given depreciation can lead to production and increased societal welfare. However the more capitalism has made money-loans available, the more depreciation that ensure from that has imperilled real output growth, by reducing the motive for savings.

This is because the more credit being supplied in the market, the less price (interest rates) the borrower is willing to pay, and this could decline to a point where the saver has no incentive to commit his excess funds. As the rate of interest lags the rate of depreciation.

This is true only to the points that one thinks the essence of savings is to beat inflation and not merely store as much value as possible in a less liquid form of money. It also limits the financial intermediation process toma handful of banking instruments. For in the modern day, there exist a sophisticated system that allows for capital mobilization for long-term projects, on agreeable and mutually beneficial terms.

So as much as there are limits to what monetary policy can achieve, there are scenarios where it could stimulate growth without reducing the willingness of capital suppliers.

 

On the Limitations to Monetary Policy:

From the understanding that increases in the money supply leads to decreased in the value of money, it becomes quite possible to imagine a scenario of money diminishing in value in a geometrical series –i.e., over years. But that logical imagination doesn't necessarily mean we have the ability to create one.

This is true as we can only observe and forecast but the former does us no good and the latter's accuracy is suspect.

So, it is impossible as we do not know "the quantitative significance of variations in the quantity of money". This remains a matter of great uncertainty. And "in employing any means to influence the value of money we run the risk of giving the wrong dose".

Thus, if we rely upon any estimates of the future value of money, we will either under represent or over represent the calculated variations in the objective exchange-value of money, thereby leading to erroneous monetary policy which have grave long-term consequences.

Additionally we could be over expanding money supply, or over  contracting money supply leading to disruptions in output.

Dangers of Inflationism:

He adds that "even if we can roughly  tell the direction in which we should work in order to obtain the desired variation, we still have nothing to tell us how far we should go, and we can never find out where we are already, what effects our intervention has had, or how these are proportioned to the effects we desire."

This appeals to me for I am of the opinion against over reliance, and appreciative of monetary policy limitations. Mises is right that we can't know these limitations, but we can limit the objectives of the employment of monetary policy, to be more realistic and less controlling.

Mises's claim thatbig variations in money supply can lead to maket emancipation from State money. A notion that hasn't been fulfilled yet. However it doesn't have to get that bad if all business transactions take into account the ever sinking nature of the objective exchange-value of money.

This is because the danger involved in all inflationary policy attempts, is that of excess.

Inflation, interrupted would eventually lead to a collapse. Mises argues that the purchasing power of money can basically evaporate entirely. This holds some weight, if you think extreme scenarios like the Zimbabwean Dollars. But, money has always evolved, and this speaks to that evolution. This is evidenced in lessons learned in that scenario and the country is gradually decoupling from the dollar with its new currency the Zimbabwean Gold (ZiG), is tied to the yellow metal and so of restricted supply.

So inflationism can only lead to a systemic change, in the event that we arrive at that extreme case, as Mises' notes that inflationism carried out to its extreme destroys not the monetary system, but the credit or Fiat money of the State that has "overestimated the effectiveness of its own policy".

The collapse in the States money's objective exchange-value leads commerce to the adoption of a more stable money (metallic or foreign money). For "acceptance" by the market is a prerequisite to the success of any money, and the States influence can only go on so far as the market has faith in its stability.

 

Mises draws three conclusion of the possibilities of inflation;

Inflationary policies favor the dentist and punishes the creditor and encouraged expires whilst hindering imports.

The effects of inflationary policies can never be foreseen, and uninterrupted policies of the sort must eventually lead to a collapse of the states monetary system.

To Mises inflationism is a bad policy and depends on constant deception of public perception. In contrast, I think, any policy enacted without adequate consideration of its effects, or without recourse to moderation would always be unsustainable. Monetary policy needs to be applied in appreciation of its limitations, and with realistic objectives.

For it is impossible to grow an economy by simply expanding money supply. However , it isn't also impossible to do so, without any form of monetary regulations.