Part 2: The special nature of money, media of exchange, demand and supply and purchasing power

We have seen that money has historically been a commodity which, among other things, differed from other commodities in being demanded mainly as a medium of exchange, although it always had other uses. ¹ Economic goods are categorized in two different groups: Consumer goods and producer goods; the former satisfy human needs directly and the latter indirectly.


Apples, a dinner in a restaurant, a hair cut in a hairdresser, a videogame or a pair of shoes  are examples of consumer goods; a computer in an office,  a chainsaw in a carpenter’s workshop, iron ore or auto components are examples of producer goods. Consumer goods are the ultimate goal of production, the end of the “line” ,and producer goods (also known as capital goods) are all other economic goods that participate  in the production process. Does money belong to one group or the other? According to Mises ², money should form a category by itself as it can neither be consumed nor is it necessary for production . This may sound odd, but what matters for production are the physical real goods such as machines and intermediate goods and buildings that wear out and/or have to be replaced, not money. Thus we have three categories: Consumer goods, producer goods and media of exchange.

As a commodity, money has also its supply and demand, which in turn determine its “price” in the market. The price of goods is expressed in monetary units ³ such as a newspaper, 3$ a melon,  0.5$ a bread or 20000$ a car, but the “price” of money? The “price  of money “ is expressed in terms of these goods. The price of a dollar equals 1 newspaper,  1/3 of a melon, 1/20000 of a car, 2 breads and so on. Thus, Rothbard states that ‘the price of money is the “purchasing power” of the monetary unit” ⁴  and that “in short, the price, or purchasing power of the money unit will be an array of the quantities of alternative goods and services that can be purchased  for a dollar” ⁵  and people value and demand money because of this purchasing power. They don’t want money  for the sake of having it, they want the goods that money makes possible for them to obtain. So money as such is not an end, but a mean.  As said before, supply and demand determine its price: An increase in its supply (with a constant demand) lowers the price, an increase in its demand (with a constant supply) raises its price. We already know that the price of money is the purchasing power of the monetary unit, so if the price of money goes down, so does its purchasing power. And if the price of money goes down, the “money-prices” of all the other goods go up, although not uniformly. In other words, the purchasing power of the monetary unit has decreased, so you can “purchase” less goods with the same amount of money or you need more of it in order to buy the same amount of goods than before. Does it sound familiar? The prices of all the goods raise and they become more “expensive”, or the other way round, the monetary unit , the dollar for example, becomes “cheaper” (loses value) so you get less goods in return than before for the same amount of them. This is inflation , even though exposed in an oversimplified and incomplete way that may cause confusion. The topic will be handled in the next article.

Now we need to know what is actually the supply and the demand of money. The supply of money is simply its total stock in society at a specific period of time. In today’s monetary system of fiat currencies the stock of money is defined in complex aggregates such as M0, M1, M2 and M3, so to make things easier we will imagine that we have commodity money (gold). Citing Rothbard ‘the total stock, or supply, of money in society at any one time, is the total weight of the existing money-stuff. (…) Since money is gold, the total supply of money is the total weight of gold existing in society’ ⁶. Its stock depended on the production of the mines and on its use in industry (it is quasi indestructible, so wear and tear is limited), this is why, according to Rothbard, changes in total gold stock took place generally very slowly. An exception to this were the momentary “gold rushes” in California and South Africa in the XIX century, for example. It is evident that gold cannot be printed ⁷, unlike today’s paper money which is not mined, but printed. So it is easy to imagine that the stock of gold is fairly stable, but the stock of paper money isn’t, as it depends on who manages the printing presses and how: Greedy governments have ended up causing sever hyperinflations during the XX century by flooding the economy with notes.

What is the demand for money? We have advanced before that people demand money not to keep it idle, but in order exchange it for the goods and services they desire and that can be used directly. More specifically, Rothbard says that “money is not useful in itself but because it has a prior exchange value, because it has been and therefore presumably will be exchangeable in terms of other goods. In short, money is demanded because it has a pre-existing purchasing power; its demand not only is not independent of its existing price on the market but it is precisely due to its already having a price in terms of other goods and services” ⁸. So the demand for money is “total market demand to gain and hold cash balances”. How much of the individual income will one specific person keep in cash balances instead of spending it depends on its particular preferences and value scales. 

Now we can imagine that if someone has a demand for money that is 0, he won’t keep any single dollar of his income in cash balances, so he will spend every single dollar that falls into his hands automatically. If everyone acts that way, the demand for money of the whole economy will be 0 and, with a constant money supply or money stock, the price of money (remember, determined by its supply and demand) will fall to nothing and thus the money-prices of all the goods will raise to infinite. It may sound funny, but this is part of the explanation of hyperinflations. Governments increase the supply of money by printing more and more money in a massive way, the purchasing power of money goes down and therefore money-prices go up. After some time people expect that prices will continue to increase fast, (in other words, that the government measure was not so temporary) and they start to get rid of their cash balances, because the sooner they spend the money, the more they will be able to buy (as money-prices increase each day). In that case, the money demand is decreasing (people don’t want to hold cash balances) and the government is continuing to pump more money into the economy (money supply goes up). What is the result? Prices begin to rise more than the increase in the supply of money and the monetary system collapses in a sea of notes with thousands of zeros. 

Finally, Mises pointed out originally ⁹ that the stock of money, or money supply, at a given period of time equals the sum of all cash balances hold by individuals. In other words, every monetary unit has an owner and it is part of his or her cash balance; there is no money outside someone’s cash balance. Thus, money does not “circulate” like, e.g., blood in our circulatory system, it is actually transferred from one owner to other.

Quotations, references and comments:

¹ Prior to the end of the gold standard, the different currencies (dollar, pound, franc) were just defined in a specific weight of gold or silver. One unit of a currency was for example defined as 1/20 ounce or 1/15 ounce.

² Ludwig von Mises, La Teoría del Dinero y del Crédito, page 54. Published by Unión Editorial (1997). Any reference to this book will be based on the Spanish edition. Original title of 1912, Theorie des Geldes und der Umlaufsmittel. English edition of 1934, The theory of Money and Credit.

³ To simplify things, $ are chosen as the monetary unit, but you can put ounces of gold instead or imagine that theses dollars are redeemable.

⁴  Murray N. Rothbard, What has government done to out money, page 23. Published by Ludwig von Mises Institute, fifth edition.

⁵ Murray N. Rothbard, The Logic of Action One: Method, Money, and the Austrian School, page 299. Published by Edward Elgar Publishing Limited (1997).

⁶  Murray N. Rothbard, What has government done to out money, page 21. Published by Ludwig von Mises Institute, fifth edition.

⁷ Nevertheless, under the gold standard banks could make profit by  creating money substitutes (such as demand deposits redeemable in gold) above their gold reserves in the hope that these would not  return to the bank for redemption in large quantities. A 100% reserve gold standard has never existed.

⁸ Murray N. Rothbard, The Logic of Action One: Method, Money, and the Austrian School, page 305. Published by Edward Elgar Publishing Limited (1997).

⁹  Ludwig von Mises, La Teoría del Dinero y del Crédito, page 121. Published by Unión Editorial (1997). Any reference to this book will be based on the Spanish edition. Original title of 1912, Theorie des Geldes und der Umlaufsmittel. English edition of 1934, The theory of Money and Credit.