The myth of the “quantity of money and quantity of goods” is closely related to the legend that money has intrinsic value, as long as the state “correctly” invests it. This myth regularly surfaces in weighty discussions about inflation, deflation, crises, taxes, and about what else the state could do to improve things further.
Essentially, the thesis goes like this: “the quantity of money must correspond to the quantity of goods,” and in practice they usually draw the conclusion that “the quantity of money must grow alongside the quantity of goods.” This means that the central bank should print money, and most importantly—that there exists a truly infinite field of activity for politicians, experts, and journalists, because no one knows (and will never know, since it is impossible) exactly how to properly carry out this vital operation.
The fact that an explicit or implicit desire to regulate lies at the heart of all these discussions is indirectly confirmed by one simple circumstance. Surprisingly, another argument against commodity money lies on the surface—this is the growth in the number of people using this money. It actually matters for whether a certain item becomes money. It determines whether inconveniences arise with the divisibility of money. If for ordinary purchases you need to use vanishingly small quantities of the monetary commodity, then it simply becomes inconvenient. True, it is obvious that if you have a free market, and not some fly-by-night operation called a “central bank,” such an inconvenient commodity will eventually be replaced by a more convenient one, not to mention that IOUs and money substitutes (fractional coin) will be used. However, one way or another, this argument never surfaces, because it is understood that there is not much to regulate here.
The slogan “the quantity of money must correspond to the quantity of goods,” if you look at it closely, contains a whole bouquet of economic fallacies, and a whole book could be written based on it. In this column, I will point out only one circumstance that seems important to me.
Look here. In the thesis about money and goods, we are dealing with two static situations. In the first, the quantity of goods “corresponds” to the quantity of money, and everyone is happy. In the second, the quantity of goods has grown and there is “not enough” money. Closing our eyes to marginal utility, which clearly states that there is no demand for all goods (that is, the initial situation is simply incorrect), let me try to examine this case.
So, between two static states, something happened that for some reason increased the quantity of goods. The scheme does not provide an answer to the question of why this happened, and this is precisely (I will repeat—setting aside other numerous arguments) its error. In this scheme, goods are produced and consumed by themselves and for themselves, and the production of goods grows magically.
However, in reality, things are not at all the case. In reality, an entrepreneur, starting or developing a business, orients himself to existing prices. He will begin to work when he assumes that, in general, his price will be lower than existing ones for a good of equal quality. The reason that “the quantity of goods will increase” consists only in the confidence of entrepreneurs that people will give up consuming other goods in favor of either a lower price or a higher quality. That is, people will either maintain their preferences as a result of a price drop, or (in the case of a “new” good) people will have a greater choice, and depending on their current preferences, they will be able to exchange their money for a larger assortment of goods satisfying similar needs.
Moreover, for the simple case of a single good, it becomes clear that an increase in its quantity means, in general, a fall in its price. And this happens not due to mythical connections between the quantity of money and the quantity of goods, but for the simple reason that people satisfy their demand for this good and it becomes less needed than yesterday. They prefer to spend their money on other things they need more.
The scarcity of money and the inelasticity of its supply is precisely what allows this process to be demonstrated clearly to other market participants. A fall in demand and market saturation, as a rule, expresses itself through a fall in price and gives a signal to everyone else to look for other points of application of effort. This is one of the main mechanisms of the “invisible hand”—coordination of the actions of many people, occurring without prior agreement, a mechanism that has provided us all with the current prosperity.
Money that cannot reflect changes in supply and demand would never have arisen at all. There is no point in it. If the quantity of money were magically “tied” to the quantity of goods and grew together with it, people would not have used such money.
But how can that be, they will tell me, after all, there are more goods! Indeed, that is so. However, the scarcity of goods in the world in which we live, and consequently, the need to choose between them, does not disappear anywhere. Simply, as a result of entrepreneurial activity, goods become more accessible, their quality grows, and choice increases. Say, a thousand years ago, the average European was not very spoiled in terms of food consumption; for him, food most often consisted of just a few items. Now you can buy not just food, but choose among truly endless varieties of this very food. However, this happened not because people had more money, but because thanks to exchange, division of labor, capital, and other institutions and phenomena of the market, the quality of goods was improving all this time, and they were becoming increasingly accessible. This is especially visible in the example of high-tech industries, where improvements occur so quickly that even printing money cannot stop them. A new computer is cheaper than an old one. A new phone and a new car are also cheaper than old ones. In conclusion, I will offer what seems to me a clear analogy. To think that the quantity of money must correspond to the quantity of goods is the same as believing that the larger the supermarket you have entered, the more money you should have in your wallet.