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In Motivational Podcasts most economists are in agreement that the inflation in the United States during the past three years has been the worst since the early 1940′s, taking account of both severity and duration. But they cannot agree on the nature of the inflation that is engulfing the American economy. To some, inflation denotes a spectacular rise in consumer prices; to others, an excessive aggregate demand; and to at least one economist, it is the creation of new money by our monetary authorities.
This disagreement among economists is more than an academic difference in the meaning of a popular term. It reflects professional confusion as to the cause of the inflation problem and the policies that might help to correct it. A review of some basic principles of economics that are applicable to money may shed light on the problem.
Two basic questions need to be answered: (1) What are the factors that originally afforded value to money, and (2) What are the factors that affect changes in the “objective exchange value of money” or its purchasing power?
Money is a medium of exchange that facilitates trade in goods and services. Wherever people progressed beyond simple barter, they began to use their most marketable goods as media of exchange. In primitive societies, they used cattle, or measures of grain, salt, or fish. In early civilizations where the division of labour extended to larger areas, gold or silver emerged as the most marketable good and finally as the only medium of exchange, called money. It is obvious that the chieftains, kings, and heads of state did not invent the use of money. But they frequently usurped control over it whenever they suffered budget deficits and could gain revenue from currency debasement.
When an economic good is sought and wanted, not only for its use in consumption or production but also for purposes of exchange, to be held in reserve for later exchanges, the demand for it obviously increases. We may then speak of two partial demands which combine to raise its value in exchange—its purchasing power.
The Origin of Money Value
People seek money because it has purchasing power, and part of this purchasing power is generated by the people’s demand for money. But is this not reasoning in a vicious circle?
It is not! According to Ludwig von Mises’ “regression theory,” we must be mindful of the time factor. Our quest for cash holdings is conditioned by money purchasing power in the immediate past, which in turn was affected by earlier purchasing power, and so on until we arrive at the very inception of the monetary demand. At that particular moment, the purchasing power of a certain quantity of gold or silver was determined by its nonmonetary uses only.
This leads to the interesting conclusion that the universal use of paper monies today would be inconceivable without their prior use as “substitutes” for real money, such as gold and silver, for which there was a nonmonetary demand. Only when a man grew accustomed to these substitutes, and governments deprived him of his freedom to employ gold and silver as media of exchange, did government tender paper emerge as the legal or “fiat money.” It has value and purchasing power, although it lacks any nonmonetary demand because the people now direct their monetary demand toward government tender paper. If for any reason this public demand should cease or be redirected toward real goods as media of exchange, the fiat money would lose its entire value. The Continental Dollar and various foreign currencies over the years illustrate the point.
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