Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

A Critique of Monetarist and Keynesian Theories 531“equation of exchange” is simply an ideogram which ratherawkwardly represents the relationship between growth in themoney supply and a decline in the purchasing power ofmoney. The origin of this “formula” is a simple tautology whichexpresses that the total amount of money spent on transactionsconducted in the economic system during a certain time periodmust be identical to the quantity of money received on the sametransactions during the same period (MV=Σpt). Howevermonetarists then take a leap in the dark when they assume theother side of the equation can be represented as PT, where T isan absurd “aggregate” which calls for adding up heterogeneousopponents. This is due to the fact that the great majority of the theory’sdefenders have accepted the mechanistic equation of exchange which,at best, merely represents a tautology: that the income and expenditureinvolved in all transactions must be equal. Furthermore they attempt tosupply a comprehensive explanation of economic phenomena byadding up the prices of goods and services exchanged in different timeperiods and assuming the value of the monetary unit is determined by,among other factors, the “velocity” of circulation of money. They fail torealize that the value of money originates with humans’ subjectivedesire to maintain certain cash balances, and to focus exclusively onaggregate concepts and averages like the velocity of money conveys theimpression that money only fulfils its function when transactions arecarried out, and not when it remains “idle” in the form of cash balancesheld by economic agents. Nonetheless economic agents’ demand formoney comprises both the cash balances they retain at all times, as wellas the additional amounts they demand when they make a transaction.Thus money performs its function in both cases and always has anowner; in other words, it is included in the cash balance of an economicagent, regardless of whether the agent plans to increase or decrease thebalance at any point in the future. According to Mises, another crucialdefect of the equation of exchange is that it conceals the effects variationsin the quantity of money have on relative prices and the fact thatnew money reaches the economic system at very specific points, distortingthe productive structure and favoring certain economic agents,to the detriment of the rest. Ludwig von Mises, “The Position of MoneyAmong Economic Goods,” first printed in Die Wirtschaftstheorie derGegenwart, Hans Mayer, ed. (Vienna: Julius Springer, 1932), vol. 2. Thisarticle has been translated into English by Albert H. Zlabinger and publishedin the book, Money, Method, and the Market Process: Essays by Ludwigvon Mises, Richard M. Ebeling, ed. (Dordrecht, Holland: Kluwer AcademicPublishers, 1990), pp. 55ff.