This is still not the whole story. A cumulative rise or fall in prices may in turn alter the relationship between aggregate demand and aggregate supply, thereby creating new macroeconomic conditions for further developments. Note that a rise in the general price level, or inflation, is equivalent to a depreciation of the value of money, while a fall in the general price level, or deflation, is equivalent to an appreciation of the value of money. It is from this point on that the purely speculative nature of money-holding begins to play a decisive role.

When aggregate demand is set and maintained above aggregate supply, the general price level starts to rise. As long as this is regarded as temporary, there is little change in people’s attitudes to their money holding. As inflation persists, however, some people may begin to expect inflation to continue. Once a majority of people come to expect that many others do, the spell is broken. People start to lose confidence in the value of money and try to reduce their money holdings by buying commodities. This tends to stimulate aggregate demand and speeds up the pace of inflation. Fearing a further acceleration of inflation, people stampede to unload their money holdings by snatching up any commodity available. Inflation accelerates even more, confirming consumers’ fears. The economy now enters into the hyperinflation phase, triggering a full-scale flight from money. Eventually, nobody is willing to accept money as money anymore, and it is reduced to an insignificant sheet of paper or a useless disc of metal, and the economy collapses, reverting to the most primitive system of barter exchanges. What we have seen is a bust of money as money. ¹

Conversely, when aggregate demand is maintained below aggregate supply, the general price level start to fall, and once a significant number of people start to anticipate that other people expect deflation to continue, they may come to desire money, itself no more than a medium of exchange for commodities, more than the commodities themselves. This tends to dampen aggregate demand and causes further deflation, meaning that the value of money rises still more relative to commodities in general. This in turn makes people even more inclined to hold on to their money. In the end, the economy falls into a depression, in which nobody wants to buy anything. This is a bubble of money as money.

Of course, as long as a certain form of outside money (mostly bills and coins issued by central banks and governments) is being used for economic payments, cumulative inflation will have the effect of reducing its real value and may work to narrow the gap between aggregate demand and aggregate supply, either by discouraging directly the demand for consumption goods (the so-called Pigou effect) or indirectly the demand for investment goods through the tightening of financial markets (the so-called Keynes effect). However, we now know that the effects of rising prices on the private debt/credit structure in financial markets have far stronger opposite effects. So long as they are not anticipated in advance, rising prices have the effect of transferring real purchasing power from the holders of private financial debts to their issuers, by relieving the real indebtedness of the latter. Since debtors are likely to have a higher propensity to spend out of their wealth than creditors, this redistributional effect of private debts is sufficient to exert a destabilizing effect. Moreover, the relief of the indebtedness of private debtors effected by rising prices may encourage them to deepen their indebtedness further by issuing more debt or by replacing their short-term debts in maturity with long-term debts. This injects new liquidity into financial markets and encourages both consumption and investment spending still more. This may be called “the debt-inflation process.”

The same argument applies equally well (indeed, more strongly) to the case of a cumulative fall in prices. Indeed, Irving Fisher, having lost both his academic reputation and financial wealth in the Great Depression whose occurrence he had denied publicly and speculated against privately, came to the view that the process of debt deflation (the reverse of debt inflation), was the chief cause of the Great Depression. His post-Depression view was elaborated further by Hyman P. Minsky. ² Besides, in what Wicksell called the “pure credit economy,” where all payments are effected by means of bookkeeping transfers through the private banking system, there is no room for a stabilizer to work. ³

Wicksell's theory was an emancipation from the spell of the “invisible hand”—or at least, a first step away from it. In contrast to an equilibrium between the demand and supply of an individual commodity, an equilibrium between aggregate demand and aggregate supply has no self-regulating tendency in itself; any deviation from it will trigger a disequilibrium process that drives the general price level cumulatively away from a state of equilibrium. What is more, the purely speculative nature of money-holding makes matters worse by widening the disequilibrium between aggregate demand and aggregate supply and throwing the economy into hyperinflation or depression. Not only is the “invisible hand” not working—it is causing the instability of the capitalist economy. The world of Adam Smith has been turned upside down.

We human beings stumbled upon money in the dim and distant past. It was the cause of the original move toward greater efficiency in economic activity, removing the inconvenience of barter trade and freeing economic exchanges from restrictions of time, space, and individuals. Without money, the grand economic structure of global capitalism could not stand. But at the same time, it is money that makes it possible for depressions and hyperinflation to occur. This is the fundamental trade-off between efficiency and stability under a capitalist system.

¹ Wicksell was well aware of this possibility. He wrote: “We may go further. The upward movement of prices will in some measure ‘create its own draught’. When prices have been rising steadily for some time, entrepreneurs will begin to reckon on the basis not merely of the prices already attained, but of a further rise in prices. The effect on supply and demand is clearly the same as that of a corresponding easing of credit.” ( Ibid ., p. 96.)

² Irving Fisher, Booms and Depressions: Some First Principles , Adelphi, 1932; -------, “The Debt-deflation Theory of Great Depressions,” Econometrica , 1(3), 1933, pp. 337-57; Hyman P. Minsky, Can “It” Happen Again? – Essays on Instability and Finance , M. E. Sharpe: New York, 1982; -----, Stabilizing an Unstable Economy , New Haven: Yale University Press, 1984, reprinted by McGraw Hill: New York, 2008.

³ Interest and Prices ; pp.70-71.