A Critical Review of Mises's Theory of Money and Credit by Ludwig Von Mises I /VII
By Chinedu Okoye
Money as a Price Index:
In typical Austrian fashion, Mises argues that Money isn't a measure of price or value because the valuation is subjective and so cannot be measured. So objective exchange-value is impossible.
However, objective value is indeed measurable as prices is a function of costs and mark-ups on the part of the seller or producer and a function of income, and preference scaling on the part of the consumer. When both meet they bargain based on their respective subjective valuations and meet at a price, but there is a level below which the producer wouldn't go.
The base price (agreed price) sets a precedence and highlights what other consumers might be willing to pay and overtime the various series of bargaining based on subjective valuations sets a price level. And because this price is quoted in terms of money, money becomes a measure of price and value, derived from bargaining at indirect exchanges.
To say that prices are dependent only on the consumers subjective valuation —going by Mises— is to ignore the cost implications and going concern of the business/seller.
The various kinds of Money:
The properties of money according to Ludwig isn't unique to money. However the peculiarity lies in the extraordinary frequency of completing transactions. The introduction other forms of money (money substitutes; Bank deposits, bank notes), into the scientific terminology of economics is most undesirable.
This is because they are valued independently and "reckoned nt directly to the sums of money to which they refer" and that there are other "special factors that help determine exchange-value. This certain classes of money should be contrasted from money.
The problem with this line of thought is that, even though these instruments aren't money, they differ only in relative liquidity, for a cash exchange transfers money without the involvement or need for a bank. That is granted, but because they facilitate indirect transactions just like money, and because —as Ludwig concedes– anyone who accepts money would most likely accept these money substitutes, they are indeed money as they cannot ethically be issued without being backed by a stipulated sum of money available on demand, and transferable.
So money and money substitutes should be included in the theory of money and defined as such for they only differ in liquidity and not necessarily value or acceptability. An increase in money supply is reflected in the markets through money and money substitutes.
Commodity Money, Fiat Money and Credit Money:
It is a mistake Mises points, to deal economic problems “according to legal criteria" "economics must construct it's own terminology from other objects that are not money".
"A piece of paper that is specially characterised as money by the imprint of some authority is in no way different from another piece of paper that has received a similar imprint from an unauthorized person". By this he meant that the only difference between both is the institution that regulates the manufacture.
So all the law can do is regulate the issue of money and “it is beyond the power of the state to ensure in addition that they actually become money". This money can only be created by the usage of those who take part in commercial transactions.”
So there are now two kinds of money, commodity money, where a commodity acts as a consumption good and medium of exchange, and then Fiat money-those that comprise of legal qualifications.
Then there is a third category: Credit money. The sort of money that "constitutes a claim against any physical or legal person." But these claims aren't payable on demand or absolutely secure, for if they were "there would be no difference between their value and that of the sum of money to which they refer". They can also not be subjected to independent valuation.
The three forms of money can be defined as follows:
Commodity Money - money that comprises of an actual commodity employed as a medium of exchange; Fiat Money - which derives its qualification from the stamp it bears and not the material which carries the stamp; and Credit money, money that fall due at some point in the future, which is used as a medium of exchange.
Mises's Critique of Nominalistic Monetary Theories:
Mises argues that the "nominalistic monetary theories of the present day are characterised by their inability to contribute a single word to the chief problem of monetary theory" which he stated as: the task of explaining the exchange ratios between money and other economic goods. For their authors he said, "the economic problem of value and prices simply do not exist".
This isn't entirely true for value is expressed (subjectively and objectively) in price. For just as the price of commodity A in terms of commodity B is subject to changes in supply, such is the price of goods and services in Fiat Money subject to changes in money supply.
The monetary theorists he referred to simply relied on the very subjective valuation (from which objective valuation is derived) reflected in prices. So if money supply increases, so does demand, money being commodity A in the illustration above falls in comparison to commodity B (general goods and services). This reduction in exchange value leads to an increase in price for the desired goods and services.
But contrary to his argument that they do not inquire how "exchange values between money and their economic goods are established", the quantity theory of money actually takes into account how changes in supply and demand for money affects the exchange-value (price) of money with regards goods and services.
Thus, the exchange ratios between money and other economic goods, does indeed appear to be a self evident matter, to which the proportion is the only unknown factor.
As to question if "what is a unit of value", I'd have my Austrians understand that that could not possibly be accurately defined. As it refers to the worth of general economic goods and services for which there is a wide range, whose prices (exchange-value), involves a series of subjective and objective valuation processes.
On Regulation Of Purchasing Power:
“At all times, and among all peoples the principal coin (Gold), have been tendered and accepted, not by tale without consideration of their quality and quantity, but by specific degrees of weight and fineness.”
He then asserts that "fiscal considerations have led to the promulgation of a theory that attributes to the minting authority the right to regulate the purchasing power of the coinage it thinks fit." As governments have "tried to fix the weight and content of the coins as they wished".
However "commercial practice has always insisted that what has to be considered in valuing coins [money] is not their face value but their value as a metal".
[This is true as far as the Gold standard lasted. Now the value somewhat depends on the demand and supply of the local currency in the foreign exchange market.]
[Because these monies represent and/or are backed by goods and services (industrial and consumption goods included), and real and financial assets, not much has changed, but the rate of change in money's exchange value (prices) for goods and services.]
In other words, inflation, a consequence of an increased supply of fiat money relative to real output. This ultimately points to a problem of price stability and not valuation. Though fiscal authorities can attempt to regulate —or stabilize—purchasing power, it is beyond their power to do so, and the market always reacts to artificial indiscriminate changes in money supply.
Commercial Practice Still Resorts to "Real" (the equivalent of Metallic) Valuations:
Commercial practice still resorts to "real" valuations, not in the sense of a metallic value, but in terms of its perceived exchange-value for desired goods and services. So it is an abstract form of "bonitas intrinseca" that is considered in repayment of debts and in price valuations, by way of interest and inflation rate adjustments.
The debasement of money today (coinage as Mises referred to it), is still unable to force "commercial practice to attribute the same value to newly printed notes that invariably increase the money supply (as did the debasement of coinage at the time). As the value of money still falls in proportion to available goods and services, with increased supply (or coinage). Below I digress by providing logical evidence of an Objective component is presented together on why Credit Money should be included in the Theory of Money.
An Evidence of an Objective Component to Pricing and why Credit money should be included in the Theory of Money:
If the price of a good/service solely depends on the individuals (buyers) subjective valuation, it would be impossible to successfully forecast commodity price movements absent an objective element to pricing. For it would be akin to reading the minds of millions of individuals in advance.
However, with the appreciation of an objective element to valuation, it becomes possible to forecast "exchange-values" by an extensive study and observation of elements that affect it inform future prices. If an entity can forecast a shortage in supply relative to demand, you have an arbitrary opportunity to stack up said commodity today, at current values. This is possible with both commodity, Fiat and credit money.
The possibility of forecasting future prices and the existence of a bottom line, below which the seller will be unwilling to exchange his goods for any if the acceptable forms of money (be it commodity, Fiat or credit), is a clear evidence of the country existence of an objective element to valuation. In the same vein, the fact that all forms of money are capable of facilitating indirect exchanges, mean that commodity, Fiat and credit money deserve a place in the theories of money that includes them.
Where Subjective Valuation Applies in Absolution:
Afurrher rebuff to the ideas that subjective valuation is absolute is that it is only absolute, with regards (opportunity) cost determination. So an individual can decide that the minimum asking price surpasses his utility expected from that product and in that case opts to buy something else worth that amount (in price or in volume).
He can decide in that moment to forego that good/service for another in the present (where he makes an alternative immediate indirect expenditure) or int the future (where he decides to save). He can’t however decide the monetary value beyond an extent.
Money and The State:
Here Mises addresses the role of the State in the monetary system.
Mises on The States Position in the Market:
“The Position of the State in the market; differs in no way from that of any other parties to commercial transactions as "the state exchange Commodities and Money on terms governed by the law of price".
It excises it's sovereign rights Mises by subjecting society to levy compulsory contributions (where the state derives its revenue — which enables it to participate in the market– from, but in all other aspects, like everyone else it adapts to the commercial organization of society.
[This assertion however untrue —as states have other sources of income, like SOEs, and Resource Revenue —also means that there is a limit to which government participation and in markets can increase sales (and real output by extension), id the government revenue/income is restricted to taxes.]
He states further that the state, by its ability to tax and spend or "command resources outside the market", is the biggest disruptive element in the market. Mises further argues that as a result, it will be a mistake to imagine that similar regulations would have led to the desired result.
According to Mises, government intervention only succeeds in a socialist state. Insinuating that economies are either fully capitalist or fully socialist —this is not the case as we have always had mixed economies. However history has shown that extreme socialism leads to gross inefficiencies as extreme capitalism leads to larger inequality. So either in its extreme is bound to fail.
[Also the State is in no way just another market participant, for without it's existence or participation in the markets, there would be little incentive for the market to produce certain goods/services at prices which demand would be forthcoming. But the State can be disruptive as it increases on size beyond necessary leading to gross inefficiencies.]
He goes further to rightly that "to ascribe the concept of money as a creature of law state is clearly untenable" and that "to ascribe the state powers of dictating laws of exchange is to ignore the fundamental principles of a money using society"
[Whilst this is true, as money has always existed, the unique function of money as a general medium of exchange and facilitator of indirect transactions, is a creature of the state. But its appeal led to its acceptance and integration into commercial organization for the very reason that it was backed and issued by the state —flexibility.]
[The only difference between Fiat and commodity money is that Fiat (or state) money supply can be altered indiscriminately, but it is not without consequences as in doing so, it's exchange value falls and prices rise, hence, in reality, the real value of money in circulation (in terms of the purchasing power), can barely be altered, in the long-run.]
[The state can only regulate (not dictate) exchanges in the short-term. And states can never really be ascribed the powers of dictating exchanges. , the market would only respond accordingly.]
Influence of State on Monetary Systems: The Evolution of the Influence of the State on Monetary Systems
"State activity in the monetary sphere was originally restricted to the manufacture of coins", however the influence of the state gradually extended beyond just controller, legislator and judge.
The state, he reiterated can only supply money but cannot force it's acceptance into commercial practice. However he conceded that the states influence on commercial usage has increased because of the states importance as an economic agent has also increased.
But the states influence on monetary systems is limited in real terms, as the state is still not able to increase (long-run) real money supply indiscriminately as money's value drops with increased artificial supply. Taxes and government spending could stabilize, support or disrupt markets depending on the extent to which the government tries to stretch it's short-term powers.
So to a large extent the function of the State is still limited to the manufacture and distribution of money. It is the attempt to stretch it's powers beyond the aforementioned in pursuit of short-term growth that caused disruption in the markets, not merely its involvement or existence.
Money as an Economic Good:
Economic goods are characterized in two broad forms; consumption goods and production goods. Money according to Mises is neither a consumption or production good. But he says that "if we regard the two-fold division of money as exhaustive, we shall have to rest content to putting money in one group or the other". This is the position of economists who put money as a production good.
Knies howevr made room —unlike Roscher– for a third classification of goods "a media of exchange".
Transportation as a Production Good:
Mises also brilliantly talked about situation of goods and asserting that production isn't just the process of converting natural resources to finished goods, as location matters. Getting it to the final consumer also plays a role. Water in the desert is different from water in front of a spring, even though their chemical components are identical.
This brings a further classification into play for consumption goods; first and second order goods. The former refers to goods that are already were they will be consumed, the latter can be transmitted to the former's status of first order good, by a combination of a complimentary good transportation.
So except for pleasure trips, means of transportation are considered (rightly) by Mises as production goods because it "satisfies human needs indirectly".
Money not a Production Good:
Mises rejection of money as a production good is rooted in his isolated or closed economy example where he stated in Part 1 (of the Book in Review: Theory of Money and Credit): "there is no need for money either in the isolated household, or in a socialized community".
This will hold only if production happened in isolation (as in the example he gave) and absent the need for an exchange of other production goods. For as long as there is need for indirect exchanges to procure production goods and services (equipment , land, raw materials and labor) it becomes impossible to make anything without a media of exchange which is essentially what money is.
Money therefore in this view becomes as much a production good as capital equipment.
The rationale behind Mises' Classification lies behind the idea that a loss of consumption or production goods results in a loss of human satisfaction. From this thinking, changes in the values of money is accommodated in such a way that it doesn't affect the economic position of mankind.
[These implies that changes in money supply does not affect real output and so leaves welfare relatively unchanged. This is a strong point, however it doesn't take into account the tradeability of money.]
[Money just like land or equipment can be rented, (borrowed) and a cost (interest), and without it is impossible to undertake the many indirect transactions that are necessary for the production process to commence in the real-world.]
[In furtherance to his contradiction on money not being a production good, he argued that no part of the total result of production is entirely dependent on money, but then goes on to concede that "the use of money, may be one of the fundamental principles on which economic order is based".]
[The above is a direct concession of the indispensable nature of money. However the view on Money not being a production goods builds from the treatment of money as just a medium of exchange and not a store of value as posited by Mises in the earlier chapters. As all forms of money are indeed a store of value and can be traded, just like any commodity or capital good]
[If as Mises says, "production goods derive their value from their part in production", then money obtained to secure such transactions should be regarded as a production good. As; A physical, tradeable store of value which is fundamental to acquiring input in the production process is indeed a production good.]
Mises' example of isolated households fails to represent the complexity of real-world economic systems, where indirect exchanges are essential to production.
Money as Part of Private Capital:
The conclusion that money is not a production good, Mises says, would "help us to answer the question on whether money is capital or not." This question he says "provides a check upon the answer to a further problem concerning the relations between the equilibrium rate of interest and the money rate of interest."
The first grave difficulty, in "any investigation into the relation between money and capital, arises from differences in opinions that exists about the definition of the concept of capital"
Mises avoided arriving at a conclusion but aimed only to "shed some light".
He starts off by classifying capital in two forms as per Bohm-Bawerk's classification: private capital and social or productive capital. Mises' begins his investigation with an inquiry into "the connexion between private capital and money."
Bohm-Barwerk definition of private capital: An aggregate of the "products that serve as a means to the acquisition of goods." This he states explicitly, has never been questioned. As "the development of scientific capital starts from the notion of an interest bearing sum of money". And the "gradual evolution of the concept of capital, has meant the same time, an increasing understanding of the functions of money as capital".
But the earlier explanations of money on loan bears interest couldn't satisfy scientific requirements". As money is "barren" acceding to science.
[As much as this is true, money as a token in which the exchange value of scientific products can be measured, as per my earlier assertions, would indeed satisfy any requirement of private capital. As money put to work can produce output worth more than the exchange value of the various production goods purchased to make that item.]
In Mises’s own words “Money is an acquisitive instrument only when exchanged for some other economic good." And in that respect money can be compared with those consumption goods that form part of private capital only to the point that these goods are not consumed by their owners themselves, but used for acquisition of other goods by means of exchange.
So money is no more acquisitive capital in that sense, than these consumption goods are, as "the real acquisitive capital becomes the goods for which money (or the consumption goods) are exchanged. By this theory, idle non-interest bearing balances are not part of private capital until they are exchanged for other goods.
This may be case for money lying in under the mattress, but not for money in the bank bearing interest —all things equal, bankers always have the incentive to lend money’s borrowed (deposits) to earn income from their primary business. As it is inconceivable to think that money lent by the saver which the bank lends to a borrower, who intends to exchange it for other economic goods, doesn't constitute qualify 'capital'.
Money not Social Capital:
Drawing from Bohm-Bawerk again social capital was defined as "the aggregate of the products intended for employment in further production". An acceptance of this view means a rejection of Money as private or social capital.
This will mean that money in the bank accounts above aren't indeed capital, even though a portion of those balances are intended to be lent out for productive purposes –productive here being defined as interest bearing purposes.
[The rejection of Money as a productive good is to assert that there is no link between the money market and production. For money satisfies the conditions of what initially constitutes private capital.]
The Enemies of Money:
"As division of labor and differentiation of wants are extended, indirect exchange becomes inevitable “the evolution of indirect exchanges then leads to the employment of a few or even one particular commodity as a media of exchange. However when there is no exchange of any sort (eg the isolated household) the media of exchange is unknown.
A decrease of the value of real social income (that is the purchasing power of money) doesn't necessarily involve or bear any direct relations to the decrease in size of income. And it might happen that the decrease in value of money results in a proportionate decrease in the purchasing power of money, but this is not a necessary condition.
If we then suppose that a system of exchange can happen in a socialist system and not merely the exchange of labor certificates but the exchange of consumption goods, between individuals then "we may conceive of a place for the function of money even within the framework of such societies".
The Money would not be so frequently employed within the framework as if it were based on private ownership of the means of production, but it's use will be governed by the same fundamental principles."
He argues based on this considerations that dictate the use of money, that "so long as a scheme completely excluded free-exchange of goods and services (just like the case of the isolated household), then it "follows logically that it has no need for money".
He follows; "so far as any sort of exchange at all is allowed, it seems that indirect exchanges achieved by means of a common medium of exchange must be permitted also".
[This is a notion I agree with totally. Not in the sense that there would be indeed no use for money, but that the use for money would be in itself determined by the need for the isolated economy.]
Superficial critiques of the capitalist economic system are in the habit of directing their attacks principally against money. They are willing to permit the continuance of private ownership of the means of production and consequently, given the present stage of division of labour, of free exchange of goods also; and yet they want this exchange to be achieved without any medium, or at least without a common medium, or money."
They disregard the use of money as "harmful" and hope to overcome all social evils by eliminating it." This doctrine he explained was derived from notions that have always been extraordinarily popular in lay circles during the period when money usage was becoming increasingly popular.
They couldn't simply contend with the realities of a free exchanges, nor understand he it could be made equitable. (My opinion). As Mises put it; "all the processes of economic life appear in a monetary guide; and those who do not see beneath the surface of things are only aware of the monetary phenomena and remain unconscious of the deeper relationships".
The socialists (the ‘enemies’ of money in this context) regarded money as the cause of theft and murder, deceptions, and betrayals when these issues have always occured. However the accumulation of wealth in other forms made it more difficult to steal it dwindle one of their goods, absent a universal and efficient medium of exchange as portable as money.
[This would also mean that money is indeed a store of value since it can be substituted and must be used to acquire these other economic goods in which wealth can be stored.]
"It is not so clear whether it is thought that the return to a direct exchange by itself will be able to overcome all the disadvantages of the use of money, or whether it is thought that reforms would be necessary as well." They felt no obligation to follow their ideas to a final conclusion.
The "enemies of money" he says, take their argument from the then "prevailing theory of banking" and "propose to cut all human ills by means of an elastic credit system, automatically adapted to the need for currency".
If this is meant that money supply should follow the whims of the society, then it is automatically flawed, for an indiscriminate increase in the supply of money, absent restrictions does nothing to improve equality or the state of affairs that constitute the "evils of money". Theft would still go on, but money loses value rapidly.
This is proven in today's world where reserve Central banks have taken to measures like QE to adapt the supply of money to prevailing market demand. It also does nothing in the long-run to affect real output, but can affect shorterm capital investments, via issuance of credit money which could affect long-run productivity. But that is only if money supply is measured and not indiscriminately increased artificially to chase some faux socialist motive.
The Theory of the Value of Money:
This chapter in part 2 of the book (Theory of Money and Credit), is dedicated to the valuation of money. He begins by the discussing the subjective and objective value of money, identifying the "Central element in the economic problem of money" as the objective exchange-value of money– otherwise known as it's purchasing power.
However subjective value is not less important in the theory of money. The subjective estimates of individuals as in other economic goods is derived from attaching to it a good or complex of goods. Thus, this subjective valuation is conditioned by its objective value.
[This notion I have argued applies to both money and general economic goods. However Mises states that the subjective value of money and it's objective value coincide and both derived from the objective exchange value for money has no utility other than obtaining other economic goods in exchange.]
[This is not entirely accurate in my view as commodity money (the earliest form of money) derived it's exchange-value from objective properties bestowed on it by nature. It didn't matter whether a generally acceptable medium of exchange (say commodity A) was valuable to you, it's value comes from the objective qualities —if these goods were exchangeable with actually desirable goods, which sometimes could coincide with subjective valuations.]
[The mere fact that these commodity monies can be held for the sole purpose of exchange and it’s readily acceptance by the market places reinforces the argument against Mises’s assertions that money is not a store of value]
[The commodity –acting as money–would only be exchangeable, if it is deemed to have a superior or unique quality that makes it generally acceptable in indirect exchanges.
This usually builds from its industrial value. So, they are held as stored value, because they were generally acceptable and readily exchanged with desired goods.]
[From this it holds that; the value of economic goods including money, is an intersection between subjective and objective valuation. Money cannot have an objective and subjective valuation and the goods it purchases or is exchanged for is valued subjectively.]
The task of dealing with the value of money is then in no way different from the task of dealing with the value of commodities that act as money, save for the fact that these commodities can actually be consumed. As the "objective exchange-value of goods is their objective significance in exchange".
However Mises maintains that, the exchange ratios established between different goods in commercial transactions are determined by a collective influence of subjective valuations.
So, money has an objective valuation, but prices have a subjective valuation or is so derived. If this hold them the exchange ratios of money and commodities are objectively and subjectively determined, as market conditions can cause the value of money or the price of goods and services in money to change. These conditions are sometimes unanticipated, and in that case won't take the consumers subjective valuation into account.
Whilst each good (as Mises pointed), may not arrive at the market with a specific or definite Quantity of value, certain goods do have a baseline value below which the seller or producer would be unable to part with it. So value in exchange plays a leading role in some markets, owing to costs of factors of production.
However Mises argues that the concept of 'price and exchange-value are by no means identical. Then goes on to assert that "the objective-value of a good lies in its ability to command a certain quantity of other goods in exchange".
The contradiction here is that this makes it's price the quantity of that other good.
This is exactly what the objective value of money depends on, so price and objective value are indeed identical, for the price of money is the quantity of goods and services you can obtain with it.
Problems involved in the Theory of the Value of Money:
Here Mises argues that: *The Theory of the value of money must account for the fundamental difference between the principles that govern the value of money and those which govern the value of commodities."
[Both are in my opinion a reflection of each other. And are governed by the same underlying principles —supply and demand.]
However he makes a point where he stated that "In the theory of the value of commodities, it is not necessary at first, to pay attention to the objective exchange-value." So, price determination for commodities are first expressed in the subjective values. Whilst objective exchange value is the basis for price determination of money.
[This, once again takes away the objective element to price determination of commodities. For it is a reflection of the objective exchange-value of money. Prices of goods determine the value of money.]
[By maintaining the subjective valuation of commodities, Mises, — in true Austrian and Menger fashion—assumes that the cost of production is not important in pricing and producers invariably depend on the buyers valuation before fixing a price on their goods.]
According to Mises, “It is not the use-value but the exchange-value that appears to govern modern economic order", however the perceived use-value is what informs exchange-value, after cost considerations have been accounted for.
The Barter System Explanation: Apples and Oranges
If I farm oranges and trade them for Apples with an Apple farmer, and I pay my workers out of my orange output, any increase in wages per worker, without a proportional increase in output would reduce the amount of oranges I bring to the market to exchange for apples.
This reduced supply could influence the exchange-ratios and hence the exchange-value of my oranges in terms of apples.
The use-value of apples can remain the same whilst the exchange-value changes because production costs changes (perhaps there’s a shortage in Orange farming segment of the agriculture labor force).
The use-value informs the exchange value in that you still need oranges as the apple seller of a particular quantity, however with supply low, the exchange value increases ,—you give more apples per unit of orange to acquire the same quantity you desire. This makes exchange values a derivation of both cost of production (the objective element) and prevailing market demand (an index of subjective valuations).
In the case of money, the objective exchange-value cannot be referred back to any sort of use-value independent of the existence of this objective exchange-value". This is true, for money in itself cannot be consumed and it's value is derived in the exchange for another economic good.
Mises, having already established that money’s value originate from the use-value —in procuring consumption goods—it follows that money has a consumption feature in that though it can’t be eaten, one can’t eat without it.
Money's Use-value in early and modern monetary systems:
Commodity money ceases to circulate in the hands of the final buyer who consumed it, so there were, in the early stages of money, "commodities which served as money, whose natural qualities precluded their employment as money for more than a short time".
In more modern times, he said, Fiat, and credit money or even Commodities of which large quantities remains in circulation are spent not directly consumed, have no use except as a media of exchange.
So in this he resorted to removing the industrial qualities of money from the determining factors of the value of money.
In eliminating the determinants of the value of money that arise from its possible industrial use, he points that "the value of commodity money is of importance for monetary theory, only in so far as it depends on the peculiar economic position economic position of money, on its functions as a common medium of exchange" .
Changes in the material value therefore only makes it less suitable for performing its functions as money. So, for commodity money (that largely remained in circulation), the value of the chosen medium of money, in monetary theory has to take the value as a given until proven otherwise. The value of the commodity and the money of the commodity changes uniformly.
But this is not the case for Fiat and Credit money. For Fiat, the substance that bears the impression is insignificant to its value determination, and so must have a higher exchange-value than it's counterparts made of the same material —other paper products–as long as the participators in commerce continue to employ it as a medium of exchange.
For credit money, the claims used as money have a different exchange-value as other similar claims of the same kind not used as money. As the former is always higher than the latter. An example can be given with a bank demand deposit and a fixed deposit at the same bank.
Both are credit money to the bank, but the demand deposit is valued higher today, as it can be used as money (for payments), however the fixed deposit has to be liquidated first.
For Commodities like gold, it's monetary value gives it more importance in that it can be exchanged for other commodities.
He concludes with saying that " the task of the theory of the value of money is to expound the laws which regulate the determination of the objective exchange-value of money." and not it's "business to concern itself with the determination of the value of the material from which the commodity money is made."
However a confusing statement is made that contradicts his subjective valuation theory of other economic goods, "there is nothing to be said about the subjective use value of money that differs in anyway from the subjective value of other economic goods."
Therein lies another contradiction for if the value of money is derived from its objective exchange value, and "there is nothing to be said about the subjective use-value of money that differs in anyway from the subjective use of other economic goods", then the subjective value of these other economic goods are to some extent determined by objective elements.
The Determinants of the Objective Exchange-value or Purchasing Power of Money:
The dependence of the Subjective Valuation of Money on the Existence of Objective Exchange-value:
Price according to Mises Value Theory, is a result of market interactions between commodities and price-goods.
Goods are valued by individuals, he reiterates, according to their subjective use-values (my stance on this is clear by now that there is an objective element to valuation). Their exchange ratios he says, is determined within that range where supply and demand are in exact quantitative Equilibrium. Supply and demand being in exact quantitative equilibrium, means that prices are determined at a point where the market clears and there is neither surplus nor deficit.
The price of money, he follows is determined in a not too dissimilar fashion, but the subjective valuations coincides with its objective exchange-value. This is basically the anticipated use-value of things that be bought with it. Thus, "the subjective use-value of money must be measured by the marginal utility of the goods for which the money can be exchanged".
This is another notion that confirms my earlier assertions and contradicts Mises' functions of money, as money is indeed a store of value and an economic good. For if it's utility is derived from the utility of goods it can purchase them it is a medium that not only acts as a means of exchange but a store of value and a substitute to economic goods –on basis of liquidity preference.
He went further to state that;
"Once an exchange-ratio between money and commodities has been established in the market, it continues to exert an influence beyond the period during which it is maintained; it provides the basis for further valuation of money."
Hence prices today sets precedence for future prices depending on market conditions, so a baseline price is set, below which it would only go should market conditions change. And these conditions are both subjective and objective in nature. Money prices today being linked with money prices tomorrow, gives credence to this view, and highlights contradictions in Mises' Value Theory.
The starting point for Money Valuation based on Objective Exchange-value:
Mises posits that, “money's objective exchange-value must always be linked with its pre-existing market exchange-ratio with other economic goods. So a commodity cannot be used as money, unless prior to that it already "possesses an objective exchange-value based on some other use".
This link, he argues is necessary for Fiat and credit money as well. As he paints a possible case in which “coins that once circulated as commodity-money are transferred into Fiat money by cessation of free coinage, with no obligation of conversion being de jure or de facto assumed by anybody, and nobody having any grounds for hoping that such an obligation ever would be assumed by anybody".
This would constitute the starting point of valuation based on objective exchange-value and not it's subjective use-value.
A Historically Continuous Component in Money's Objective Exchange-value:
Mises acknowledged that there is a "historically-continuous component is contained in the objective exchange-value of money."
The past value of money is taken over by the present and the present passes into the future. This would form a contest between the determination of the exchange-value of money and that if the exchange-value of other economic goods. And all preexisting exchange ratios are irrelevant to the reciprocal exchange-ratios of other economic goods.
This means the past exchange-ratios is not a guarantee of future exchange ratios. What costs $1 today may cost $1.20 tomorrow. However, there is some continuity to the "real" exchange-ratios between goods.
This is true even as he alludes that price changes slowly overtime as subjective valuations of individuals also changes slowly.
He ads that "If prices changed erratically, then "the conception of objective exchange-value would not have attained the significance that it is actually accorded both by consumer and producer". Alterations to Money's Exchange Ratio:
Pointing out possible artificial price distortions, Mises notes that "It is not disputed that there are institutional forces in operation which opposed changes in prices" that would otherwise have occurred by changes in subjective valuations.
As changes in prices can be postponed even though market conditions require it to. In this sense he says it is quite permissible to speak of the inertia of prices.
As a result of the above, there is no causal connection between yesterday's price and today's price, due to alterations (caused by institutions) in the exchange-ratios of goods.
[There is no argument against this "fundamental" notion for the markets and goods it applies to.]
The Applicability of Marginal-Utility Theory to Money:
Here Mises addresses the subjective valuation theory of money absent it's objective exchange-value. He argued that the search for the determinations of the objective exchange-value of money will always lead to a valuation of the chosen money based on its other functions.
[This means that money first drive it’s value, not as an exchange media, but as an element with other uses of the chosen money.]
This valuation process and method, he says "prepares the way for developing a complete theory of the value of money on the basis of the subjective value theory and it's peculiar doctrine of marginal utility."
[The conclusion here is that, a subjective valuation of money has not to do with its function as a medium of exchange, and all to do with its other properties and functions. Cannot be further from the reality of (commodity or fiat) monetary valuation which is unequivocally based on the acceptance as an exchange media and it’s purchasing power. Again subjective valuation of money of any kind is absolute within the confines of opportunity cost.
Minsky identifies two theories of money acknowledged for their attempt to deal with the problem of the value of money as;
(i). The objective Value theories, which succeeded in introducing a formally unexceptionable theory of money into the systems which deduces the value of money from its cost of production. A theory which was abandoned for fundamental weakness. For one it was unable to deal with the issue of Fiat and Credit Money.
(ii). Davazanti's Quantity Theory: The other similarly "complete" theory was that of Davazanti’s Quantity Theory. Here all things that are able to satisfy human wants are conventionally equated with all the monetary metal".
Davazanti was the first who attempted to provide a theory to explain variations in exchange ratios and the origins of this variation. Based on the subjective and dynamic nature of value. All other Quantity Theories he said, merely sort to apply the laws of supply and demand to the theory of the value of money.
[This I find a misconstrued statement as the value of money is indeed affected by the laws of supply and demand as is the exchange-ratios between money and other economic goods. For money's value increases with a relative increase in output, and decreases with an increase in money supply relative to output.]
[Menger and others at the time had not attempted to solve the fundamental problem of the value of money, that is the determinants of the objective exchange-value of money. However later Quantity Theories did justice in that regard.]
[This is also not too dissimilar —save for it’s mechanistic form— from Davazanti’s theoretical attempt. He asserted that the choice of gold or commodity) money is built from its industrial use (or metal content), however the value of money comes not from the then metal content but from its accept and social trust.
[Also, preceding marginalists in thinking, he recognized that monetary value is not purely intrinsic. So money doesn’t have to have an intrinsic or use-value to function as an exchange media, so as it is widely accepted]
[A further contrast to the critique of the quantity theory applying laws of demand and supply to the quantity of money that makes the QTM is that Davazanti also states that ‘the exchange-ratio between money and goods, could be traced to changes in demand and supply of said goods and services and of money itself.’]
The Quantity Theory:
When the determinants of exchange-ratios between economic goods were first inquired into, attention was early devoted to" the available quantity of a good in relation to another. So the price of that good increases with a decreased supply.
This is yet another self-contradictory statement by Mises. For if prices are affected by market conditions, the subjective valuation of a consumer wont matter if the good becomes scarce, he would pay more for it than he is willing to, as long as he can afford and his need for it hasn't totally diminished. It is not important that it increases, it just has to be high enough in his scale of preference, and fall within his means.
The core doctrines of the quantity theory consists in the proposition that supply of money and demand for it both affect its value". This, be says, sufficiently describes one cause of price changes. But "inadequate for dealing with the problem exhaustively" Mises' points. Cause by itself it doesn't constitute a theory.
The doctrine of supply and demand, the cost of production theory and the subjective theory of value Mises' says have had to provide the foundations for Quantity Theory of Money.
From this he expressed a connexion between us the value of money and the variations in the relations between the demand for money and the supply if it. A core truth in theory he elucidates, from a historical perspective.
Beyond this proposition he states that the quantity theory can provide us with nothing. As it failed to explain the mechanisms of variations in the value of money.
The expositors then didn't touch upon this question and all others he says, employ inadequate principles for dealing with it. But "observation teaches us that certain relations of the kind suggested between the available stock of money and the need for money, infact do exist. And quite right so seen as money is required for different types of transactions., and is the medium in which price which denotes subjective and objective value is referenced in.
Again, money is a price index and a store of value, and a medium of exchange (it's fundamental core) it's price varies just like any other economic good. The problem of deducing this relationship (between the available stock of money and the need for money) from fundamental laws of value he detected would later be treated by Cambridge economists and further developed by Keynes in his QTM. This is explained in detail in the next section.
A View on Keynes' QTM as Expansive and more Realistic:
The classical QTM assumes that there is a proportional relationship between money and price. This held key assumptions Mises wasn't comfortable with —that prices adjust proportionately to changes in money supply. It also assumes that people's behavior in response to changes in money supply, stays the same. Which Mises explains isn't the case and responses infact can change. This plays a balancing role in determining price levels.
Keynes would further expound in this idea by highlighting that output is not fixed and neither is velocity of money —or the rate of circulation, so short run changes in money supply can have real effects, through changes in aggregate demand. So whilst prices my respond to changes in money supply, the reaction isn't an exactly proportionate one. And velocity of money isn't constant in that people have various motives for holding or demanding cash, the pinnacle of his liquidity preference theory.
The Stock of Money and the Demand for Money:
On the stock of and demand formoney, Mises argues that the demand for money is subjectively determined. Stating that: "The intensity with which supply and demand are expressed, and consequently the level of the exchange-ratio at which both coincide, depends on the subjective valuations of individuals." This means that the value attached to money depends on the value individuals attach to its exchange-value with other economic goods. This the level at which supply and demand for money changes affect prices, is subjectively determined.
This is true but the natural order of things is that money Supply increases in relation to overall output (other economic goods), invariably leads to a lower exchange-ratio —or higher nominal prices. The demand for money, isn't solely dependent on subjective factors, though lower priced credit money (lower interest rates on loans), increases the (credit) money supply— inducing investment demand —which then chases other economic goods in higher volumes, leading to a decline in it's exchange-value (inflation).
The way and manner in which credit money is priced isn't subjective as interest rates are standardized and quoted independently of the borrowers valuation. So, the demand for money is both subjective and objectively determined.
Mises dismisses the idea of a demand for money, by stating tautological fashion that "the demand for money of an economic community is nothing but the sum of demands for money of the individual economic agents composing it."
The admission of a "sum of demands" translates to the fact that there is indeed an aggregated level of demand at every point in time when summed up. [I believe that it was his inability to think up a measure for this aggregated figure that led to this convoluted take.]
How "objective factors affect the matter only as motivations of the individual" but not capable of exerting a "direct influence upon the actual amount of his demand for money" is barely explainable. For with increased money supply these objective factors would give way to an increase in price (a reduction in money's exchange-value).
Problems with the Older Theories:
The older theories failed to arrive at this conclusion —that demand for money is non-existent and deroved from the individual demand subjectively —he said. For they started at an "erroneous conception of the social demand for money".
[This seems to be the main disconnect between both theories but even though, the classical errors doesn't erode the existence of a social demand for money, they just didn't relate it to the supply of it assuming that the supply of money stays constant, with every "change" changing prices in an exact proportion, such that money becomes neutral –it isn't.]
[Though the proportion is not always exact or the change always immediate, an increase in money supply relative to output will reduce its objective exchange-value, in the same manner as the apples and oranges examples I gave earlier.]
[For if as Mises stated, an individual might be willing to settle at a lower money-price in exchange if a commodity/good he possesses due to his need for money, then in that bargain the demand outweighed supply (or willingness to participate with as much cash), and so the price of that good in money decreases as the exchange value for money increased.
This is an interplay of subjective value of money of the buyer, and that of the good it's to be exchanged with the seller. Resulting in a change in price from a higher desire for the seller to hold cash relative to the buyers desire to hold or consume that commodity. There in also lies objective elements to the transaction if you switch their motives in reverse. The only thing wrong with the classical theory is their assumptions of exact proportionality in their theory of money.]
The consequences of an Increase in the Quantity of Money while the Demand for Money Remains Unchanged or does not Increase to the same Extent:
A variation in the objective exchange-value of money can arise when "a force is exerted in one direction that is not cancelled by a counteracting force in the opposite direction".
He argues that it is likely that these forces counterbalance each other if the causes are merely accidental and personal. And that only were disturbances occur in the community that the ratio existing between the stock of money and the demand for it is altered.
Such disturbances he said cannot have an effect "except by altering subjective valuations of a large number of individuals" if not "simultaneously and in the same degree, at least in the same direction". Such that there is some resultant effect on the objective exchange-value of money.
An increase he says, in the stock of money either through production or importation of the commodity that is used as money or new issuances of Fiat or credit money, always increases the stock of money. But this new money, need not be accompanied by an increase in the quantity of goods available to the quantity (output). An increase in the stock of money always means a diminishing marginal utility to a unit of money. This he says influences their behaviors in the market as they are able to demand for goods they desire more strongly. And also willing and able to offer more monetary units for the same quantity of goods.
The rise in prices would "by no means be restricted to the market for those goods that are desired by those who originally have the new money at their disposal." There's a ripple effect basically as those who bright these goods to the market would also have more income at their disposal, and would he able to demand more intensively goods that they want, which will also increase in prices. This eventually reaches all commodities to greater or lesser extents.
Those who hold the mechanical version of the Quantity Theory will be more inclined to believe that the increase in prices would be uniform. That is the earlier Quantity Theories. Mises debunks this with the logic that since the increased quantity of money first reaches the hands of a few, it is the goods that these few decide to purchase that initially experiences this increase. Though a certain degree of adjustment would take place it is not going to be in unison.
The establishment of a Price Level Building from Mises' Theory:
Now this establishes a common thought that having been expounded by Keynes, led to the concept of calculating price level changes — Consumer Price Index. Since it's been established that increases in money supply leads to increases in prices but to varying non-linear degrees. Let's assume that every individual is one the same level wealth wise and so has an equal amount of money units. You then double the monies they have, by giving them an extra $ for each unit of money they have.
This increases the demand for economic goods but to varying degrees. As if they are more marketable commodities that function as money then there are more marketable consumption goods. It then follows that the goods preferred the most tend to increase in price to higher degrees, but every other food follows in the same direction to varying degrees. So the increase in price of each and every economic good — from either an increased money supply or reduced output, would affect consumers differently,and the more in-demand a good is the higher it's price
In the real world scenario where this money supply increases is not even and neither is their wealth, price increases will affect individuals in the community differently. Some may be able to afford the same amount of goods they usually demand in the market, some would be able to afford less and some more.
So indeed there is no way to calculate the effect of a price increase for whatever cause on the society at large. Except of course you device a means to capture price level changes for all economic goods. This wasn't entirely possible in Mises' time. But as business transactions and operations became more sophisticated, there became a way to calculate a reference for orice level changes by monitoring changes in prices of the most in-demand or marketable goods. A "Consumer Price Index" (CPI).
This CPI forms a reliable gauge for price level changes not in the sense of uniformity, but for a guide as to the pace at which prices of these goods are changing. And just as well, it moves in the same direction for all economic goods traded within the period. Whilst Austrians may disagree with the logic of CPI, it is only but a matter of misunderstanding of what it is supposed to represent. And in any case they leave the question unanswered, by rejecting it, absent any alternative solution or metric, which monetary policy can be guided by.
Assuming that prices rose with the stock of money is tonassume that if every individual was given double of their income, it will invariably leads to each of them valuing their income as a halve (ie what it was before). Doubling the quantity of money doesn't lead to a halving of the objective exchange-value of money.
Arguments against the Crtiscms of The
Quantity Theory:
The objection to Mises' critique of the quantity theory that an additional quantity of money can be hoarded was indeed a valid objection to his critique "a sharp weapon" as he phrased it. He would state that he addresses this in the the third part of the book.
Going on to state the arguments;
Hoarders according to Fullarton, absorb the superfluous quantity of money and prevent it from flowing into circulation.
[This isn't entirely correct because of the medium through which this money supply increase happens. In today's economy the quantity of money can be increased by either enacting open market operations (bond purchases) or reducing rates.]
[Either of the two is done with bans acting as a conduit. So unless banks intentionally refuse to lend, or borrowers decided to borrow at a cost (interest) and then save, the cash hoarding theory does not hold.]
It also "neglects to indicate the way in which variations in the demand for money set in motion the mechanism of the hoards". That is to say unlike the Keynes' QTM, they do not account for the ways in which demand for money could lead to hoarding.
Furthermore Mises points that from an economic point of view, no such thing as money lying idle exists. This is true in that even the most liquid form of cash and are in some way part of someone's cash reserve, which would sooner or later eventually be transferred.
It also follows that individual cash reserves are maintained by replenishment and not hoarding.
He also points that besides objective factors "subjective" factors also exist in that help determine the individuals demand for money.
This I see as the broad definitions described by Keynes' (speculative, transactionary and precautionary).
For he goes on to say that;
"the uncertainty of the future makes it seem advisable to hold a larger or smaller part of ones possession in a form that will facilitate a change from me way of using wealth to another, or transition from the ownership of one good to that of another, in order to preserve the opportunity of being able without difficulty to satisfy urgent demands that may possibly arise in the future."
Holding possession in a form that would facilitate a change of using wealth in one form to another qualifies as speculative demand for money, and preserving the opportunity to satisfy urgent demands that may possibly arise in the future are definable as precautionary reasons.
Speculative and precautionary demands for money becomes complementary motives driving the decision to hold the most liquid asset (money). But in no way means it translates to hoarding, as these monies would be spent one way or the other.
Transactionary demand in the short-term drives prices of goods and services. As they are used immediately in exchange in the market.
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