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from merchants selling amounts of A. This specific demand will cease only when no further profits can be reaped on account of price discrepancies between prices expressed in terms of each of these two currencies. The market rate is maintained by the fact that there is no longer an advantage for anybody in paying a higher price for foreign exchange. Buying either of A against B or of B against A at a higher price (expressed in the first case in terms of B and in the second in terms of A) than the market price would not bring specific profits. Arbitrage operations tend to cease at this price. This is the process that the purchasing-power-parity theory of foreign exchange describes.

The policy pretentiously called foreign-exchange control tries to counteract the operation of the purchasing-power-parity principle and fails lamentably. Confiscating foreign exchange against an indemnity below its market price is tantamount to an export duty. It tends to lower exports and thus the amount of foreign exchange that the government can seize. On the other hand, selling foreign exchange below its market price is tantamount to subsidizing imports and thereby to increasing the demand for foreign exchange. The illusive standard and its main tool, foreign-exchange control, result in a state of affairs which is—rather inappropriately—called shortage of foreign exchange.

Scarcity is the essential feature of an economic good. Goods which are not scarce in relation to the demand for them are not economic goods but free goods. Human action is not concerned with them, and economics does not deal with them. No prices are paid for such free goods and nothing can be obtained in exchange for them. To establish the fact that gold or dollars are in short supply is to pronounce a truism.

The state of affairs which those talking of a scarcity of dollars want to describe is this: At the fictitious parity, arbitrarily fixed by the government and enforced by the whole governmental apparatus of oppression and compulsion, demand for dollars exceeds the supply of dollars offered for sale. This is the inescapable consequence of every attempt on the part of a government or other agency to enforce a maximum price below the height at which the unhampered market would have determined the market price.

The Ruritanians would like to consume more foreign goods than they can buy by exporting Ruritanian products. It is a rather clumsy way of describing this situation to declare that the Ruritanians suffer from a shortage of foreign exchange. Their plight is brought about by the fact that they are not producing more and better things either for domestic or for foreign consumption. If the dollar buys at the free market 100 Ruritanian rurs and the government fixes a fictitious parity of 50 rurs and tries to enforce it by foreign-exchange control, things become worse. Ruritanian exports drop and the demand for foreign goods increases.

Of course, the Ruritanian government will then resort to various measures allegedly devised to "improve" the balance of payments. But no matter what is tried, the "scarcity" of dollars does not disappear.

Foreign-exchange control is today primarily a device for the virtual expropriation of foreign investments. It has destroyed the international capital and money market. It is the main instrument of policies aiming at the elimination of imports and thereby at the economic isolation of the various countries. It is thus one of the most important factors in the decline of Western civilization. Future historians will have to deal with it circumstantially. In referring to the actual monetary problems of our day it is enough to stress the point that it is an abortive policy.

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[1] For the reasons that led to the establishment of such foreign-exchange equalization accounts, see Human Action, pp. 458-59.

Chapter 23. The Return to Sound Money

1. Monetary Policy and the Present Trend Towards All-Around Planning. 2. The Integral Gold Standard. 3. Currency Reform in Ruritania. 4. The United States' Return to a Sound Currency.