Dr. Harper is a member of the staff of the Foundation for Economic Education.
In the market we find persons trading the fruits of their special abilities with one another. Each does whatever economic task he can do best. He creates a surplus beyond his own needs. He then trades this with others who are in a similar position of surplus, having things he wants. So by trading rather than by working harder, both sides of the exchange greatly increase the satisfaction of their wants. Human differences can in this way be made to yield a more bounteous living for every participant. That was the theme of the previous article in this series.
Yet there is another important aspect of trading to be considered, too. It involves an aid to trade, without which our high and rising wages would not be possible.
Two men living in an isolated society of their own will find the trading of their specialties easy to arrange and to carry out. All they need do is meet and arrive at the terms of the trade, and then make the physical transfer of the goods. The magnet of mutual benefit draws them together for a deal.
From being a simple matter in this society of only two persons, the process of direct trading of goods for goods becomes increasingly difficult, if not impossible, when the number increases to three, then four, and eventually to two billion persons.
Let me illustrate. I enjoy tea. Yet I know not a single person who produces any. And even if I did know someone, perhaps he would not want what I have for sale. Most likely he has no appetite whatever for words from my pen, for instance. So the two of us cannot trade our products directly. The difference between what we produce and what each wants causes a sort of friction that precludes a trade. So our offerings will not move in trade until an alternative outlet—perhaps involving a sort of lubricant to remove this friction—can be found.
Now suppose a third party who has sugar for sale wants to buy some of my written words. And suppose the tea producer wants sugar. Now we have a sort of lubricant that will let all three products move in trade. The sugar man trades me his sugar for my words; then I trade the sugar with the tea producer for his tea. Everybody thus obtains what he wants, whereas previously we had been unable to do so.
Money Enters Trade
If the third man had entered the market with money instead of with sugar, the trade would have been even easier to arrange. With money acceptable to all, the man with the money could have traded with either of us initially, whichever was the most convenient for any reason. He could have bought my words; then, with the money, I could have bought the tea. Or he could have first bought the tea; then he and I could have traded tea for words.
This, in essence, is the function of money. It serves as a lubricant in exchange—a medium of exchange. Persons who do not want it for itself alone will accept it as an intermediate step to getting what they want in the trading process. Serving in a sense like a lubricant in a motor, money facilitates the movement Sf other things in exchange without itself being consumed or ever wanted for consumption. Money does not serve as the end product in the satisfaction of human wants—except perhaps for the miser who may hoard some and gloat over its possession as one would prize a picture or an antique. In which case, the miser holds some of it as a commodity rather than as money per se, and to that extent it is no longer money.
In the earlier illustration where the sugar man entered trade, the sugar itself served temporarily as money and thereafter reverted to a commodity. It came to rest with the tea man for purposes of being consumed. This illustrates how it is possible for a “money commodity” to serve either one or the other of these two functions, at different times and places.
Had I for any reason doubted that the sugar would be acceptable to someone who had tea for sale, the sugar could not have served to lubricate the trade. It was necessary for me to accept its acceptability by others whose products I wanted, else I would have refused it in trade for purposes of money. So for anything to be accepted and to serve as money, the decision is not restricted to the desire for it by only one person. It is unlike strawberries which one person may prize whether any other person likes them or not. For anything to serve as money, it must enjoy a multiple acceptance; otherwise it cannot perform the task of money. And the wider its acceptance, the better it will serve as a lubricant for trade.
A Great Invention
Money is perhaps the greatest economic invention of all time. It lubricates the vast economic mechanism of trade which could not operate without it. It allows a deal to be made between persons unknown to each other, because of distance or some other reason.
By using money, the two persons don’t need to find each other directly. Instead, every producer puts his goods and services into a vast stream of trade, getting money in return. Then he puts the money back into the market to get what he really wants.
The producer does not know—nor does he care, really—to whom his product goes for consumption. Neither does he know nor care who produced the item he consumes or uses. It is all done behind the curtain of money exchanges in a trading economy. The only person who need be contacted is the one person at the point of trading contact. And even this can be quite impersonal. Witness, for instance, the unknown sources of all the things in a department store, or in a mail order catalog.
That is why money is such a great invention. That is why it serves so efficiently as a lubricant for exchanging the specialties of production all over the world, between widely separated persons in remote locations. The Yukon fur draped over the shoulders of a Park Avenue lady, or a mahogany table in the home of a wheat farmer in some remote part of Canada, can be explained only as an accomplishment made possible by money.
A great advantage of money, so far as wage earners are concerned, is that it is a device that reduces all alternative offerings of employment to one common denominator of expression—the money wages of the various job offerings. Comparison is then much easier than if the pay offer were in one case a certain number of bushels of wheat, in another some shoes, and the like.
The more people accept one money the world over, the better that money will lubricate trade. Ideally there would be but one money enjoying universal acceptance. Then all trade could pass through one medium. And in this way, goods and services produced in abundance as specialties all over the world could, so far as money is concerned, enjoy the widest possible access to those who want them.
All sorts of things have served as money in exchange—such as cattle, shells, silver, gold, copper, aluminum, paper. In Europe during World War II, nylon hose and cigarettes became important as money.
But it is not relevant to this discussion to wonder why different things have served as money. It is sufficient to note that separate and competing monies will continue until and unless the “ideal money” is found; until and unless something gains enough common acceptance and understanding so that nobody can adulterate its use and destroy its usefulness as money; until and unless neither politician nor any other person can gain the power to tamper with money for his personal gain.
Adulterating the Lubricant
For purposes of our present problem, we shall only observe that we operate with an imperfect money system. We do not now have an ideal money, nor are we even threatened with this blessing for the foreseeable future. And so it is important to note the effect on wages of an imperfect lubricant of exchange, which we now have.
When you accept money in trade, you are proceeding on faith in it as a sort of implied contract. The implied contract is this: When you trade something for money as an intermediate step to getting what you eventually want in exchange, you are operating on the assumption that the money will serve your intent rather than thwart it.
Let us say, for instance, that you accept money as an intermediate step between your bushel of wheat and the two bushels of corn you want. You might have traded direct, but you preferred to use money as a go-between. So you sell the wheat for two dollars in money; then you buy the corn for one dollar a bushel, or two dollars for the two bushels. While the money was in your possession, it was your expectation that nothing would be done to money to alter its worth in terms of the wheat or the corn. So far as the money is concerned, you expect it to retain worth in exchange equivalent to one bushel of wheat or two bushels of corn. That is the nature of the contract implied in one’s use of money as money. Your use of it is not for the purpose of speculating in the worth of money per se.
Yet the worth of a unit of our present money is subject to constant change. Under inflation it becomes worth less—prices rise unless there are offsetting influences to be ignored here.
In the illustration, if there is inflation the two dollars you received for your wheat would lose some of its worth while you held the money, and would then buy less than the full two bushels of corn that you had presumed to be its worth under the implied contract. You still have the two dollars, of course, but as a result of inflation the corn has risen above one dollar a bushel. Through no overt act of your own, you lose some of the worth of your property. So would everyone else who was then holding money or money claims.
Who would gain, if all these persons lose? The gains go to the diluters of the money—a counterfeiter, perhaps, or the government, either by a direct act of its own or by a grant of permit to someone. They gain by getting some money without producing anything in the usual sense; by getting something for nothing while the sufferers lose some worth of their money and money claims. Then as a consequence of inflation, various other persons gain or lose through effects that alter the essence of all sorts of contractual deals.
Inflation and Wages
Inflation affects wage earners directly in two principal ways: First, since the wage earner gets essentially all his income as a money income, his money then loses worth. His pay will lose worth while he keeps it as money or in the form of some money equivalent. Even while he holds his pay check it loses worth, though this is an insignificant amount of loss for those who spend their pay quickly. Only in a panic stage of inflation, like that of Germany in 1923 or of China in the mid-forties, can it be much of a factor while one holds a pay check for a day or two. In China, for instance, when money was said to lose half its worth every two weeks, the loss would be a few per cent by one who held his pay check one day.
Second, it affects the worth of his pension funds, his life insurance, his bonds, and other such forms of savings that are money contracts. Their loss of worth can be extremely serious, both in degree and in timing. It can become serious in degree because of the cumulative effect of continuing inflation. If a dollar loses 10 per cent of its worth each year as compared with the previous year, there will remain only twelve cents of its worth at the end of twenty years.
But more important than either of these, in a sense, is the illusion of welfare that inflation creates. This can lead to serious consequences. Whenever a person is less well off than he thinks he is, he is likely to be headed for considerable trouble.
For instance, a wage of eight dollars an hour, after the twenty years of inflation at the rate of 10 per cent each year, is no better than a dollar an hour without the inflation. If one is fooled by this and raises his level of living from one to eight, or to four, or even to a 1.01, he will be living beyond his means.
Inflation also seriously affects such things as wage contracts extending into the future. Insofar as inflation alters the implied contract assumed by those who hold money—namely, that it will continue of equal worth—its violation also becomes reflected in every monetary contract like a wage contract. As the worth of money is reduced by inflation, the burden of a contracted wage rate is also reduced. This violates, in a sense, the implication in the contract when it was negotiated. To protect against this, some wage contracts are being designed to include an increase to take care of assumed inflation. Inflation thus becomes a legally vested interest in contract form, throwing the weight of sentiment on the side of continuing the inflation. Can inflation ever be stopped that way?
The Clipped Dollars
Over a period of years, money wages in the United States have risen for two reasons—(1) increased production, in which wages have shared, and (2) inflation. The first adds buying power. But the second is an illusory gain because inflation merely adds more dollars of less buying power. And the extent of the inflation illusion has been great.
Suppose, for instance, that a man now due to retire at age 65 began work when he was 20. And suppose, to simplify our problem, he had never advanced in skills beyond swimming with the tide of the over-all increase in productivity, so that his wage went with the average for all private employment during the period. His money wage per hour now would be more than seven times what it was in 1910. Had there been no inflation, however, his wage would presumably have risen to a little less than three times what it was in 1910, not seven times.
Or if we compare his present wage with that of a quarter century ago, it is now two and one-half times as high as it was then. Considerably more than half of this rise has been an illusory wage increase of inflation, reducing the worth of the dollar.
So for nearly half a century now, inflation has put more dollars into the pay check than have come from increased productivity. Inflation is not real dollars in the sense of buying power, like the ones arising from increased productivity. They seem nice to have, and they look exactly like the other dollars. But these added dollars really buy nothing, as against having avoided inflation with its addition of worthless dollars that go into the pay check.
Inflation, then, does not raise real wages. It only creates the illusion of rising wages.
Though somewhat beyond the scope of this article, it should be observed that the government controls money. It is therefore government which inflates the money, or allows it to be inflated under controls such as the monetary standard, the reserve requirements, and interest rates. And so, in this sense, government must be held responsible for creating the illusory wage rate which accompanies inflation.
My final point is to suggest the disaster that would come upon us if, through inflation and deflation, the efficiency of the lubricant for exchange should be retarded, or the money system destroyed. What if violent changes should turn money from a lubricant into an object of speculation? For when persons hoard money in anticipation that it will gain worth, or avoid it because of anticipation that it will lose worth, this miraculous lubricant cannot do its work. Then catastrophe would be upon our highly geared economy. Then the usual progress which causes real wages to rise could no longer operate, until and unless a new lubricant were found and installed.
We are interested here in why wages rise, in a real sense rather than in an illusory sense. It behooves all of us who want continued progress, therefore, to become greatly concerned about this threat of inflation. This means searching out the underlying cause of why governments either want to inflate money or feel impelled to do so; then correcting the cause. 
Of all the contrivances for cheating the laboring classes of mankind, none has been more effective than that which deludes them with paper money.
Read the next part of this series here