common denominator of all other prices, but that the money commodity

" "

The Austrian Theory of Money by Murray N. Rothbard

common denominator of all other prices, but that the money commodity

itself is still in a state of barter with all other goods and services. Thus, in

the pre-money state of barter, there is no unitary "price of eggs "; a unit of

eggs (say, one dozen) will have many different "prices": the "butter"

price in terms of pounds of butter, the "hat" price in terms of hats, the

"horse" price in terms of horses, and so on. Every good and service will

have an almost infinite array of prices in terms of every other good and

service. After one commodity, say gold, is chosen to be the medium for

all exchanges, every other good except gold will enjoy a unitary price, so

that we know that the price of eggs is one dollar a dozen; the price of a

hat is ten dollars, and so on. But while every good and service except

gold now has a single price in terms of money, money itself has a

virtually infinite array of individual prices in terms of every other good

and service. To put it another way, the price of any good is the same

thing as its purchasing power in terms of other goods and services.

Under barter, if the price of a dozen eggs is two pounds of butter, the

purchasing power of a dozen eggs is, interalia, two pounds of butter. The

purchasing power of a dozen eggs will also be one-tenth of a hat, and so

on. Conversely, the purchasing power of butter is its price in terms of

eggs; in this case the purchasing power of a pound of butter is a half-

dozen eggs. After the arrival of money, the purchasing power of a dozen

eggs is the same as its money price, in our example, one dollar. The

purchasing power of a pound of butter will be fifty cents, of a hat ten

dollars, and so forth.

What, then, is the purchasing power, or the price, of a dollar? It

will be a vast array of all the goods and services that can be purchased

for a dollar, that is, of all the goods and services in the economy. In our

example, we would say that the purchasing power of a dollar equals one

dozen eggs, or two pounds of butter, or one-tenth of a hat, and so on, for

the entire economy. 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. Since the array is

heterogeneous and specific, it cannot be summed up in some unitary

price-level figure.

The fallacy of the price-level concept is further shown by Mises's

analysis of precisely how prices rise (that is, the purchasing power of

becomes the appropriate concept for analyzing the uniquely

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The Austrian Theory of Money by Murray N. Rothbard

becomes the appropriate concept for analyzing the uniquely broad

monetary function of being held as stock for later sale. Mises was also

able to explain the dema nd for cash balances as the resultant of marginal

utilities on value scales that are strictly ordinal for each individual. In the

course of his analysis Mises built on the insight of his fellow Austrian

Franz Cuhel to develop a marginal utility that was strictly ordinal,

lexicographic, and purged of all traces of the error of assuming the

measurability of utilities.

The relative utilities of money units as against other goods

determine each person's demand for cash balances, that is, how much of

his income or wealth he will keep in cash balances as against how much

he will spend. Applying the law of diminishing (ordinal) marginal utility

of money and bearing in mind that money's "use" is to be held for future

exchange, Mises arrived implicitly at a falling demand curve for money

in relation to the purchasing power of the currency unit. The purchasing

power of the money unit, which Mises also termed the "objective

exchange-value" of money, was then determined, as in the usual supply-

and-demand analysis, by the intersection of the money stock and the

demand for cash balance schedule. We can see this visually by putting

the purchasing power of the money unit on the y-axis and the quantity of

money on the x-axis of the conventional two-dimensional diagram

corresponding to the price of any good and its quantity. Mises wrapped

up the analysis by pointing out that the total supply of money at any

given time is no more or less than the sum of the individual cash

balances at that time. No money in a society remains unowned by

someone and is therefore outside some individual's cash balances.

While, for purposes of convenience, Mises's analysis may be

expressed in the usual supply-and-demand diagram with the purchasing

power of the money unit serving as the price of mo ney, relying solely on

such a simplified diagram falsifies the theory. For, as Mises pointed out

in a brilliant analysis whose lessons have still not been absorbed in the

mainstream of economic theory, the purchasing power of the money unit

is not simply the inverse of the so-called price level of goods and

services. In describing the advantages of money as a general medium of

exchange and how such a general medium arose on the market, Mises

pointed out that the currency unit serves as unit of account and as a

The Austrian Theory of Money By Murray N. Rothbard

" "

[Reprinted from The Foundations of Modern Austrian Economics, Edwin Dolan, ed.

(Kansas City: Sheed Andrews and McMeel, 1976), pp. 160-84.; The Logic of Action

One: Method, Money, and the Austrian School (Cheltenham, UK: Edward Elgar, 1997),

pp. 297-320. The pagination on this edition corresponds to the Logic edition.]

The Austrian theory of money virtually begins and ends with Ludwig

von Mises's monumental Theory of Money and Credit, published in

1912.¹ Mises's fundamental accomplishment was to take the theory of

marginal utility, built up by Austrian economists and other marginalists

as the explanation for consumer demand and market price, and apply it

to the demand for and the value, or the price, of money. No longer did

the theory of money need to be separated from the general economic

theory of individual action and utility, of supply, demand, and price; no

longer did monetary theory have to suffer isolation in a context of

"velocities of circulation, " "price levels," and "equations of exchange."

In applying the analysis of supply and demand to money, Mises

used the Wicksteedian concept: supply is the total stock of a commodity

at any given time; and demand is the total market demand to gain and

hold cash balances, built up out of the marginal-utility rankings of units

of money on the value scales of individuals on the market. The

Wicksteedian concept is particularly appropriate to money for several

reasons: first, because the supply of money is either extremely durable in

relation to current production, as under the gold standard, or is

determined exogenously to the market by government authority; and,

second and most important, because money, uniquely among

commodities desired and demanded on the market, is acquired not to be

consumed, but to be held for later exchange. Demand-to-hold thereby

1 Ludwig von Mises, Theorie des Geldes und der Umlaufsmittel (1912); see the third

English edition, The Theory of Money and Credit (New Haven, Conn.: Yale University

Press, 1953).