I. The Purchasing Power Controversy A. Is Money “Neutral”?

The older economists believed that — other things being equal — changes in the supply or demand of money make all commodity prices and wage rates simultaneously rise or fall in exact proportion to these changes. The price “level” changes, but the relations among the prices of individual commodities and services remain the same. Those mathematical economists whose theorizing culminates in the formulation of an equation of exchange still maintain this thesis.

Modern economic analysis rejects this assumption. The changes in the supply or demand of money do not affect all individuals at the same time and to the same extent. In the case of inflation, for instance, the additional quantity of money does not find its way at first into the pockets of all individuals, nor does every individual of those benefited first with the increase in the quantity of money get the same amount; and not every individual reacts to the same additional quantity in the same way. Consequently, the prices of various commodities and services rise neither at the same time nor to the same extent. The nonsimultaneous appearance and unevenness of the price changes brought about by increases in the quantity of money results in a shift of income and wealth from some groups of the population to other groups. Monetary fluctuations are not neutral, even apart from their repercussions on all contracts stipulating some form of deferred payments. Monetary changes are a source of economic and social change.

B. Are Changes in the Purchasing Power of Money Measurable?

Even if we were prepared to leave out consideration of the nonsimultaneous appearance and unevenness of the price changes brought about by changes in the supply of or demand for money, we must realize that the index-number method does not provide a faithful criterion for the measurement of changes in the purchasing power of the monetary unit. Economic conditions are not rigid; they are — also apart from any changes occurring in monetary matters — continuously changing. New commodities appear, old commodities disappear. The quality of the various commodities is subject to change. Tastes, wants, and desires are changing and with them the valuation of the various goods offered on the market. A motorcar of 1920 and a motorcar of 1940 are entirely different things. Twenty-five years ago, where were vitamins, refrigerators, and talking pictures? How different is the role played today in the average American household by canned food, rayon, and radio sets? How much do clothes and shoes change from one year to the next? Even standard foods like milk, butter, meat, and vegetables have in the last decades improved in quality to such an extent that it is impermissible to take them as equivalent with those marketed in the past. A method which tacitly assumes that nothing else had changed in the economic system than the available quantity of money is utterly illusory. The chairman of our committee has provided us with the results of an investigation undertaken in his corporation. According to this information, only a fraction of the products manufactured today are of the same kind as the goods manufactured a few years ago. This is a typical case, more or less representative for all American processing industries.

Besides, mathematics provides us with various methods for the computation of averages from a given set of figures. Each of these methods has, with regard to the problem in question, some merits and some defects. Each of them yields different results. As it is impossible to declare one of these methods as the only adequate one and to discard all the others as manifestly unsuitable, it is obvious that the index-number approach does not provide an indisputable and uncontested solution that could command general acceptance.

C. Is It Possible to Adjust Monetary Manipulation to a Nonarbitrary Standard?

The advocates of a manipulated currency pretend to aim at the stability of the monetary unit’s purchasing power. They fail, however, to realize that in a changing economic world, the concept of a stable purchasing power is devoid of any real meaning.

There are three main objections to be raised against the proposals for a manipulated currency.

1. The various methods suggested for a measurement of changes in the monetary unit’s purchasing power are arbitrary. Their results are contested by all those whose material interests would be hurt if they were to be used as a basis of monetary manipulation. In advocating the application of a certain index-number system, the results of which happen at the moment to provide a quasi-scientific justification of their particular interests, every pressure group and political party will always be in a position to cite the doctrine of some economists and statisticians. On the other hand, their adversaries will quote dissenting opinions of no less renowned experts. There is no means to free a tabular standard from the faults of purely arbitrary and party-ridden bias.

2. It is impossible to know beforehand to what extent and at what date a definite amount of inflation or deflation (an increase or a reduction in the quantity of money and credit) will increase or reduce the prices of various commodities and services.

3. Apart from other deficiencies, the proposals for stabilization are faulty because they are based on the idea of money’s neutrality. They all suggest methods to undo changes in the purchasing power of money that have already had their effects. If there has been an inflation, they wish to deflate to the same extent and vice versa. They do not realize that by this procedure, they do not undo the social consequences of monetary changes (that is, the shift of income and wealth from some groups to others), but simply add to them the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposite direction.

D. The Case Against Flexible Foreign Exchange Parities

If the purchasing power of an individual country’s domestic currency changes, while the other countries’ currencies do not change at all or not to the same extent, foreign trade is affected. As a rule, foreign exchange rates are adjusted at an early stage of the inflationary or deflationary process to the new state of the domestic money supply, even while the prices of some commodities and services still lag behind and are not fully adjusted for a time. As long as the inflationary or deflationary changes have not exhausted all their effects on the structure of prices, the comparatively low or high state of some prices results — in the case of inflation — in encouraging exports and discouraging imports. From the viewpoint of mercantilist fallacies, a fall of the domestic monetary unit’s purchasing power is, therefore, considered as a very fortunate occurrence.

What really happens is this: The country exports more than it did before, and it gets, as compensation for these increased exports, a smaller amount of foreign products. Exports are, as it were, subsidized and imports penalized to the burden of the natives. The inflation is, by and large, tantamount to a tax imposed upon the domestic consumers in order to cheapen the consumption of domestic products by foreigners.

Nowadays, currency devaluation is mostly advocated as a remedy against the rigidity of wage rates. People are afraid of fighting openly the inappropriate policies of labor unions. They resort to an indirect attack. They hope that currency devaluation will, notwithstanding the rise of domestic commodity prices, not raise money wage rates and thus reduce real wage rates. Lord Keynes believes that “a gradual and automatic lowering or real wages as a result of rising prices” would not be “strongly resisted” by labor. He does not see that wage rates are rigid only on the downside, not on the upside, too.

E. The Case for the Gold Standard

The gold standard is not perfect. No human institution is.

The main argument in favor of the gold standard is that it renders the formation of the monetary unit’s purchasing power independent of arbitrary action on the part of governments, political parties, and pressure groups. It places a check upon inflationary policies, and is the only standard which can possibly become an international, a world standard.