transferred from one person’s assets to another.
1
Unlike con-
sumer or capital goods, we cannot say that the more money in cir-
culation the better. In fact, since money only performs an
exchange function, we can assert with the Ricardians and with
Ludwig von Mises that
any
supply of money will be equally opti-
mal with any other.
2
In short,
it doesn’t matter
what
the money
supply may be; every M will be just as good as any other for per-
forming its cash balance exchange function.
Let us hark back to Figure 3.4. We saw that, with an M equal
to $100 billion, the price level adjusted itself to the height 0A.
What happens when $50 billion of new money is injected into the
economy? After all the adjustments are made, we find that prices
have risen (or PPM fallen) to 0B. In short,
although more con-
sumer goods or capital goods will increase the general standard of
living,
all
that an increase in M accomplishes is to dilute the pur-
chasing power of each dollar. One hundred fifty billion dollars is
no better at performing monetary functions than $100 billion. No
overall social benefit has been accomplished by increasing the
money supply by $50 billion; all that has happened is the dilution
of the purchasing power of each of the $100 billion. The increase
of the money supply was socially useless;
any M is as good at per-
forming monetary functions as any other.
3
To show why an increase in the money supply confers no
social benefits, let us picture to ourselves what I call the “Angel
The Supply of Money
45
1
A minor exception for small transactions is the eroding of coins after
lengthy use, although this can be guarded against by mixing small parts of
an alloy with gold.
2
See Ludwig von Mises,
The Theory of Money and Credit
(Indianapo-
lis:
Liberty Classics, 1981), p. 165 and passim.
3
Similarly, the fall in M depicted in Figure 3.4 also confers no overall
social benefit. All that happens is that each dollar now increases in purchas-
ing power to compensate for the smaller number of dollars. There is no
need to stress this point, however, since there are no social pressures agitat-
ing for
declines
in the supply of money.
Chapter Four.qxp 8/4/2008 11:38 AM Page 45
Gabriel” model.
4
The Angel Gabriel is a benevolent spirit who
wishes only the best for mankind, but unfortunately knows noth-
ing about economics. He hears mankind
constantly complaining
about a lack of money, so he decides to intervene and do some-
thing about it. And so overnight, while all of us are sleeping, the
Angel Gabriel descends and magically doubles everyone’s stock of
money. In the morning, when we all wake up,
we find that the
amount of money we had in our wallets, purses, safes, and bank
accounts has doubled.
What will be the reaction? Everyone knows it will be instant
hoopla and joyous bewilderment. Every person will consider that
he is now twice as well off, since his money stock has doubled. In
terms of our Figure 3.4, everyone’s cash balance, and therefore
total M, has doubled to $200 billion. Everyone rushes out to
spend their new surplus cash balances. But,
as they rush to spend
the money, all that happens is that demand curves for all goods
and services rise. Society is no better off than before, since real
resources, labor, capital, goods, natural resources, productivity,
have not changed at all. And so prices will, overall, approximately
double, and people will find that they are not really any better off
than they were before. Their
cash balances have doubled, but so
have prices, and so their purchasing power remains the same.
Because he knew no economics, the Angel Gabriel’s gift to
mankind has turned to ashes.
But let us note something important for our later analysis of
the real world processes of inflation and monetary expansion. It
is not true that
no one
is better off from the Angel Gabriel’s dou-
bling of the supply of money. Those lucky folks who rushed out
the next morning, just
as the stores were opening, managed to
spend their increased cash
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