Mises on Money

II

THE OPTIMUM QUANTITY OF MONEY

How confident are you that you understand Mises's monetary theory so far? If this were a final exam in a college class on Mises's monetary theory, which answer would you select for the following question: The optimum quantity of money should be determined by. . . "?

If you selected E, as Walter Williams says, "Go to the head of the class."

In Part I, we have already explored some implications of Mises's definition of money: the most marketable commodity. If money is a commodity, then an analytical question arises: "Is money a consumption good or a production good?" That is, "Is money a form of capital?"

Part I, Chapter 5 of The Theory of Money and Credit discusses this issue: "Money as an Economic Good." Mises concluded that money is neither a consumption good nor a capital good. He argued that production and consumption are possible without money (p. 82). Money facilitates both production and consumption, but it is neither a production good nor a consumption good. Money is therefore a separate analytical category.

Mises singled out his teacher and co-founder of the Austrian School of economics, Eugen von Böhm-Bawerk, as having erred in designating money as a capital good; he viewed it as social capital (p. 83). Mises disagreed. "It is illegitimate to compare the part played by money in production with that played by ships and railways. Money is obviously not a 'commercial tool' in the same sense as account books, exchange lists, the Stock Exchange, or the credit system" (p. 83).

CHANGES IN THE MONEY SUPPLY

We now come to another crucial aspect of Mises's theory of money. Indeed, it is a uniquely distinguishing feature of his monetary theory, one that is not shared by other modern schools of economic thought. Because money is not capital, he concluded that an increase of the money supply confers no identifiable social value. If you fail to understand this point, you will not be able to understand the rest of Mises's theory of money. On this assessment of the value of money, his whole theory of money hinges.

What prevents us nevertheless from reckoning money among these "distribution goods" and so among production goods (and incidentally the same objection applies to its inclusion among consumption goods) is the following consideration. The loss of a consumption good or production good results in a loss of human satisfaction; it makes mankind poorer. The gain of such a good results in an improvement of the human economic position; it makes mankind richer. The same cannot be said of the loss or gain of money. Both changes in the available quantity of production goods or consumption goods and changes in the available quantity of money involve changes in values; but whereas the changes in the value of the production goods and consumption goods do not mitigate the loss or reduce the gain of satisfaction resulting from the changes in their quantity, the changes in the value of money are accommodated in such a way to the demand for it that, despite increases or decreases in its quantity, the economic position of mankind remains the same. An increase in the quantity of money can no more increase the welfare of the members of a community, than a diminution of it can decrease their welfare. Regarded from this point of view, those goods that are employed as money are indeed what Adam Smith called them, "dead stock, which . . . produces nothing" (p. 85).

This theory regarding the impact that changes in the money supply have on social value is the basis of everything that follows. Mises offered here a unique assessment of the demand for money. He implied here that an individual's demand for production goods or consumption goods, when met by increased production, confers an increase in social value or social welfare. Both the consumer and the producer are made better off by the exchange. Society is better off because at least two of its members are better off. What Mises inescapably was saying here is this: while an individual wants more money, and a producer of gold can make a profit by selling him more money (gold), society as a whole is not benefited by this voluntary exchange. This is why money is a separate analytical category in Mises's economic theory.

Let us take this conclusion even further. If a producer benefits society by increasing the production of a non-monetary good, later finding a buyer, then society is benefitted because there are at least two winners and no losers. (To say this, the economist logically must dismiss as socially irrelevant the negative assessments of envious people who resent anyone else's success.) Therefore, if a producer of gold and a buyer of gold both benefit from an exchange – which they do, or else they would not trade – yet society receives no social benefit, then the analyst has to conclude that some other members of society have been made, or will be made, worse off by the increase in the money supply. This analysis would also apply to decreases in the money supply.

There are two conceptually related issues here: (1) money as a separate analytical category, neither a consumption good nor a production good; (2) changes in the money supply as conveying neither an increase nor decrease in social value.

This leads us to a major question for all economic analysis: "What is social value?"

SUBJECTIVE UTILITY AND SOCIAL VALUE

Mises began his economic analysis with the presupposition that all economic value is subjective. He followed Menger on this point. But if all economic value is subjective, then it cannot be measured by any objective standard. He said this specifically: there is no measure of economic value. This is a major theme in Chapter 2 of The Theory of Money and Credit, and it remained a constant throughout his career. (In 1955, Hayek went so far as to write of Mises that "most peculiarities of his views which at first strike many readers as strange and unacceptable are due to the fact that in the consistent development of the subjectivist approach he has for a long time moved ahead of his contemporaries." The Counter-Revolution of Science, Part One, note 24.)

If there is no objective measure of an individual's subjective value, then there is no way to make comparisons of subjective utility among individuals. There is no way to add or subtract subjective utility. An individual can compare his own subjective utilities on his scale of economic values – first, second, third – but he cannot measure them. Even less plausible is any assertion that an outside observer can measure the subjective utilities of others.

The first economist to discuss this in detail was Lionel Robbins, a disciple of Mises who wrote the Introduction to the 1934 English edition of Theory of Money and Credit. In Chapter VI of his book, An Essay on the Nature and Significance of Economic Science (1932), Robbins discussed the problem of the epistemological impossibility of making interpersonal comparisons of subjective utilities.

By the time Human Action was published, Mises recognized the implications of Robbins's argument for any concept of social value. Mises modified his earlier statement regarding the effects on social value of changes in the supply of money. Once again, he discussed cash-induced changes in the purchasing power of money. He arrived at a different conclusion regarding social value.

http://www.mises.org/humanaction/chap17sec6.asp

Nothing can be said of aggregate social value, except this: it cannot be measured. This conclusion is consistent with the assumption of an exclusively subjective theory of economic value. An economist who is consistent in his application of subjective value theory cannot accept even the theoretical possibility of a scientific rationale for making interpersonal comparisons of subjective utility. With respect to aggregate social value – "total satisfaction or total happiness" – the subjectivist can logically say only this: no one on earth can measure it.

NO NEW MONEY IS REQUIRED

On the very next page of Human Action, Mises discussed the free market's use of whatever quantity of money is presently in presently circulation. "As the operation of the market tends to determine the final state of money's purchasing power at the height at which the supply of and the demand for money coincide, there can never be an excess or deficiency of money. Each individual and all individuals together always enjoy fully the advantages which they can derive from indirect exchange and the use of money, no matter whether the total quantity of money is great or small." The conclusion is obvious, and he makes it: "The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do" (p. 421).

I emphasize this because there are economic commentators and analysts who claim to represent Mises's position on monetary theory, but who are proponents of the expansion of money by the State or by the fractional reserve banking system. They argue that society can and does benefit from such an expansion of money. Make no mistake about this: anyone who argues that a change in the money supply conveys either net social benefits or net social costs has repudiated Mises's explicit statement to the contrary in his earlier writings, and has repudiated Mises's denial in his later writings regarding anyone's ability to make such a scientific judgment. He who defends, in the name of Mises, government or central bank policies that deliberately promote either monetary inflation or monetary deflation has two obligations: (1) to show why his recommended policy is really consistent with Mises's economic theory; (2) to suggest reasons that led Mises to make such a serious mistake about the implications of his own theory.

Mises was in favor of free markets. He did not recommend civil laws against voluntary exchange. Therefore, he did not oppose gold mining. He did not recommend that the State prohibit miners from adding to the quantity of money. But he readily acknowledged that any increase of the money supply from gold mining will inflict losses on some participants in the economy – participants who were not parties in the original transaction of selling new gold into the economy. In this sense, changes in the money cannot be neutral. There will inevitably be winners and losers.

Mises stressed the following fact in his theory of money: new money enters an economy at specific points, i.e., through specific voluntary exchanges. New money does not appear magically in equal percentages in all people's bank accounts or under their mattresses. Money spreads unevenly, and this process has varying effects on individuals, depending on whether they receive early or late access to the new money. This was one of Mises's original contributions to monetary theory, one that is ignored by all other schools of economic analysis.

This analysis of the uneven spread of new money applies to gold as well as to central bank money. It therefore applies to a legally unrestricted free market.

Let us, for instance, suppose that a new gold mine is opened in an isolated state. The supplementary quantity of gold that streams from it into commerce goes at first to the owners of the mine and then by turns to those who have dealings with them. If we schematically divide the whole community into four groups, the mine owners, the producers of luxury goods, the remaining producers, and the agriculturalists, the first two groups will be able to enjoy the benefits resulting from the reduction in the value of money the former of them to a greater extent than the latter. But even as soon as we reach the third group, the situation is altered. The profit obtained by this group as a result of the increased demands of the first two will already be offset to some extent by the rise in the prices of luxury goods which will have experienced the full effect of the depreciation by the time it begins to affect other goods. Finally for the fourth group, the whole process will result in nothing but loss. The farmers will have to pay dearer for all industrial products before they are compensated by the increased prices of agricultural products. It is true that when at last the prices of agricultural products do rise, the period of economic hardship for the farmers is over; but it will no longer be possible for them to secure profits that will compensate them for the losses they have suffered. That is to say, they will not be able to use their increased receipts to purchase commodities at prices corresponding to the old level of the value of money; for the increase of prices will already have gone through the whole community. Thus the losses suffered by the farmers at the time when they still sold their products at the old low prices but had to pay for the products of others at the new and higher prices remain uncompensated. It is these losses of the groups that are the last to be reached by the variation in the value of money which ultimately constitute the source of the profits made by the mine owners and the groups most closely connected with them (pp. 208-9).

http: //www.econlib.org/library/Mises/msT4.html

The later recipients of the new gold that has entered the economy face higher prices than would otherwise have prevailed, had the new gold not been mined and spent into circulation by mine owners. These late recipients were not parties to the early transactions, beginning with the mine owners, who sold the gold either for gold coins or money-certificates, and who then spent it. Nevertheless, these late recipients suffer losses.

Mises said specifically that the sources of the economic profits of the gold mine owner are the economic losses sustained by the late recipients of the new gold. "It is these losses of the groups that are the last to be reached by the variation in the value of money which ultimately constitute the source of the profits made by the mine owners and the groups most closely connected with them." This indicates a fundamental aspect of Mises's monetary theory that is rarely mentioned: the expansion or contraction of money is a zero-sum game. Mises did not use this terminology, but he used the zero-sum concept. Because the free market always maximizes the utility of the existing money supply, changes in the money supply inescapably have the characteristic features of a zero-sum game. Some individuals are made better off by an increase in the money supply; others are made worse off. The existing money is an example of a "fixed pie of social value." Adding to the money supply does not add to its value.

Economists argue that in a conventional economic exchange, both parties win. One person does not benefit at the expense of another unless there has been fraud. The "pie of social value" has grown because there are two winners. The conceptual problem begins with a fixed social pie.

Mises argued that the losses of the late-coming losers are the source of income for the early arrival winners. This inescapably identifies the monetary system as a zero-sum game. In Human Action, he included a section denying what he calls the Montaigne dogma: "the gain of one man is the damage of another; no man profits but at the loss of other" (p. 664). He then added: "Now the Montaigne dogma is true with regard to the effects of cash-induced changes in the purchasing power of money on deferred payments." He was being disingenuous here, which is not characteristic of his argumentation generally. The three words, "on deferred payments," appear to restrict the applicability of the Montaigne dogma in monetary affairs. Yet his entire theory of money rests on this dogma's complete applicability in the matter of increases and decreases in the money supply. The economic benefits obtained by the early users of new money, even gold, are made at the expense of those who gain access to it after it has altered the array of prices. (Although he never described the reverse scenario, deflation, he would have said that losses suffered by losers of credit-money that has disappeared through default must be the source of the economic gains for holders of coins or currency or credit money that did not perish in the deflation, who soon will face lower money prices because of the contraction of the money supply.)

Again, here is his theory, briefly stated. Money is neither a production good nor a consumption good. Thus, increases or decreases in the supply of money cannot scientifically be said to create or destroy wealth in general. These changes distribute wealth.

This raises a major epistemological issue. If the economist cannot logically say anything about net social utility because he cannot scientifically make interpersonal comparisons of subjective utilities, then he cannot identify a zero-sum game. Scientifically speaking, given the individualistic epistemology of subjective economic value theory, no one can say whether a game's redistribution of wealth among its participants has increased or decreased or failed to change net social value. Perhaps the loser really does not mind, and the winner is ecstatic, or vice versa. If we are strict subjectivists, we must refrain from using the idea of a zero-sum game. It is not that Montaigne was wrong about capitalism. It is that his dogma cannot apply to any exchange. We cannot legitimately make interpersonal comparisons of subjective utilities if we hold to an exclusively subjectivist value theory.

A subjective value theory economist can, however, legitimately deny another subjective value theory economist's assertion that a transaction is or is not part of a zero-sum game. He can also legitimately deny that someone who suggests a policy of either inflation or deflation has scientific grounds for justifying his recommendation in terms of any alleged benefits to society. In short, the power of exclusively subjective value theory is very great in undermining all policy recommendations that are based exclusively on subjective value theory. But, like an acid that eats everything, including every known container, it is a risky argument to invoke.

GOLD STANDARD VS. STATE-ISSUED MONEY

Mises's commitment to economic freedom led him to the conclusion that the State should not prohibit gold mining and silver mining, for these are voluntary activities. But he did argue for market-created monetary standards that are based on money metals. Why? Because the cost of mining is high, which will always limit the expansion of money. In the Preface to the 1934 English edition of Theory of Money and Credit, he wrote:

http://www.econlib.org/library/Mises/msT0.html#Foreword

It is obvious what Mises regarded as the supreme benefit of a gold standard: a metallic money standard hampers the State. In his chapter on "Monetary Policy," he wrote:

http: //www.econlib.org/library/Mises/msT5.html

He said it over and over: metallic money is superior to money issued by the State. Its value will fluctuate less than State-issued money, but it will fluctuate. A monetary system that cannot provide stable prices is the price men must pay for economic liberty, namely, freedom from the control of money by the State. With the State in control of money, society gets more fluctuations in value and less freedom.

Mises recognized the costs associated with gold mining. He discussed this in Part III, Chapter III, "Fiduciary Media and the Demand for Money." He said that capital and labor must be applied to mining. This reduces productivity in other areas of the economy. Also, precious metals that are used for money cannot be used to satisfy industrial or ornamental demand for these metals, further reducing welfare. He even said that, apart from successful voluntary ways to reduce demand for metallic money, "the welfare of the community would have been reduced" by the costs of mining (p. 299). Even the great Mises sometimes could not retain his commitment to subjective value theory, with its concomitant denial of community welfare.

Mises favored credit clearing-house systems (p. 297). They lower the demand for money, i.e., reduce the downward competitive pressure on money-denominated prices. A clearing house produces "the reciprocal cancellation of claims to money" (p. 283). For a fee, a bank clearing house offsets daily liabilities and assets that are created as a result of commerce. Business A owes business B ten ounces of gold. Business B owes business C ten ounces of gold. Business C owes business A ten ounces of gold. So, at the end of the day, the accounts are cleared, and no gold changes ownership if the three firms belong to the same clearing house. There can also be clearing houses for clearing houses. This arrangement is voluntary and not dependent on the expansion of money, either metallic or fiduciary. It therefore saves on capital and labor that would otherwise have been devoted to mining for the purpose of digging up money metals.

Why did Mises defend a money system based on money metals? First, because such a system reduces fluctuations in the value of money. Second, in order to get the State out of the money business. The State makes things worse.

The State's policy-makers are unable to foresee the results of their interventions in the money supply. They are blind. The free market is preferable to the State in the establishing of the optimum supply of money.

http: //www.econlib.org/library/Mises/msT5.html

First, Mises was convinced that the free market always maximizes the use of the existing money supply. No additional money is needed, even though each participant would like more money for himself. Second, he was convinced that mining costs establish limits to the expansion of money. This is an advantage, for all monetary inflation has unforeseeable effects on the distribution of wealth: winners and losers. If mine owners make a profit by producing metals, some of which will be used for money, then others in the economy suffer losses as a result of this increase in the money supply. A metallic money standard minimizes these losses. Conclusion: a metallic money standard is therefore preferable to any State-run system in which the State has the power to increase or decrease the money supply or set exchange rates for money. As he wrote in a chapter of his 1951 appendix, "The Principle of Sound Money,"

http: //www.econlib.org/library/Mises/msT9.html

Mises recognized the implications of a State-induced redistribution of wealth. The following comment came in his discussion of State-issued money. In Human Action, he wrote:

http://www.mises.org/humanaction/chap17sec10.asp

Mises always defended his economic analysis as value-free. Here, he acknowledged that monetary inflation by the State does redistribute wealth. It would be fraudulent, he says, for politicians to justify the issue of additional fiat money on the basis of the supposed increases in the public welfare. Why fraudulent? Because, for Mises (and for any fully consistent subjective value theorist), there is no such thing as measurable public welfare. It is impossible to add up benefits and losses in estimating total welfare because there is no objective measure of subjective utility. So, any State policy that rests on a claim of an increase in the public welfare is scientifically bogus and therefore fraudulent.

This is a radical epistemological position to defend. It means at least two things: (1) a subjective economist cannot scientifically recommend any policy on the basis of increased aggregate social welfare; (2) any appeal to a supposed increase in aggregate public welfare must rest on some version of a theory of objective economic value.

Mises nevertheless concluded, "But one could still consider them [cash-induced redistributions of wealth] as political measures suitable to promote the interests of some groups of people at the expense of others without further detriment." Here is a major point of contention between Rothbard and Mises. Rothbard regarded the State as morally evil because its effects always redistribute wealth by coercion. He had a moral objection to the State that Mises never voiced. Therefore, his objection to the State's fiat currency had a moral element. But he would have agreed with Mises on this point: it is fraudulent for politicians to justify an expansion of State-issued money on the basis of any supposed increase of public welfare.

MISES VS. GOVERNMENT MONETARY POLICY

Mises believed in free market-generated money. He believed that the civil government should not have any monetary policy, other than an absolutely fixed money supply. A civil government that is powerful enough to have a flexible, "scientific" monetary policy is too powerful, in Mises's opinion. As he wrote in his 1951 appendix essay, "The Return to Sound Money,"

http://www.econlib.org/library/Mises/msT9.html

In Human Action, Mises said that the government's task is to enforce contracts. Among these contracts are contracts for redeeming money-certificates for money metals on demand. He defined a money-certificate a receipt for a money metal that has 100% of the promised metal in reserve. He said that banks should not be favored by the government. They should not be allowed the right to break contracts, which is what a refusal to redeem money-certificates on demand is. "What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual to fulfill all obligations in full compliance with the terms of the contract" (p. 443).

A traditional gold standard is where the government issues pieces of paper that promise to the bearer full redemption in gold coins. Mises did not defend the traditional gold standard. His theory of money and credit denies the legitimacy of such a gold standard. Mises did not believe that civil governments should be in any way involved in the creation of money or the destruction of money. He defended free banking because he did not trust the government with sufficient authority to enforce 100% reserve banking.

He believed that a non-governmental national gold standard is no different in principle or operation from the international gold standard. There was no one-world government that enforced the international gold standard when he wrote Human Action or in the nineteenth century, when it was a major factor in world trade. In fact, the attempt by modern governments to regulate in any way an international gold standard is always a political ruse to undermine its anti-inflationary bias. "The international gold standard works without any action on the part of governments. It is effective real cooperation of all members of the world-embracing market community. . . . What governments call international monetary cooperation is concerted action for the sake of credit expansion" (p. 476). Conclusion: there is no need for a national government to enforce a national gold standard.

Economic logic does not end or begin at a political border. There are no economic laws linking individuals within borders that do not also apply to individuals across borders. To argue that there are different economic laws for different groups is utterly spurious. Mises called this dualism polylogism. He devoted an entire section of Human Action to its refutation (pp. 75-91). (I believe that the only term that was more contemptible than "polylogist" in Mises's vocabulary was "empiricist." But I could be wrong. Maybe "polylogist" was at the top.)

To argue that Mises recommended any monetary policy for governments is to argue that he simultaneously believed that (1) the international gold standard needs no joint government intervention; (2) nevertheless, for some unstated reason, domestic governments must develop and enforce specific monetary policies relating to gold, banks, and the issue of government claims to money. But Mises did not hold such a polylogist position. Mises left no wiggle room on this point: "Now, the gold standard is not a game, but a social institution. Its working does not depend on the preparedness of any people to observe arbitrary rules. It is controlled by the operation of inexorable economic law" (p. 462).

I remind you once again of the representative "conservative" policy recommendation that I mentioned in Part I.

This idea is a conservative's well-intentioned but totally anti-Misesian version of a comment by John Maynard Keynes, in his book, Essays in Persuasion (1931):

The Individualistic Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient – perhaps cannot survive – without one.

For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision. We can no longer afford to leave it in the category which the distinguishing characteristics are possessed in different degrees by the weather, the birth-rate, and the Constitution, – matters which are settled by natural causes, or are the resultant of the separate action of many individuals acting independently, or required a Revolution to change them.

Mises recommended no "scientific" government monetary policy whatsoever. He recommended private ownership, the State's enforcement of all contracts, and legal sanctions against private violence. As he wrote in his 1927 book, Liberalismus, "This is the function that the liberal doctrine assigns to the state: the protection of property, liberty, and peace" (Liberalism in the Classical Tradition [1985], p. 37). Providing money of stable purchasing power was not on the list. He took this extremely limited set of government policies and applied them to all of economics, including monetary theory.

CONCLUSION

Money is neither a production good nor a consumption good. Therefore, an increase or decrease of the money supply cannot be said to add to the social value of the economy. There is no way to measure social value.

Mises said that profits from mining are paid for by those participants in the economy who gain access to the newly mined money metal late in the process of exchange, after prices have risen. Those who gain early access are the beneficiaries.

He defended the metallic money standard because it reduces fluctuations in the value of money compared to State-issued money. The costs of mining are greater than the cost of printing money. This reduces the increase of money. For this reason, a precious metal-based monetary system is an advantage over a State-issued currency. He recommended private ownership and the State's enforcement of contracts. He did not offer any recommended monetary policy for the State, other than a freeze on its existing money supply.

Then what of the goal of stable prices? What of the goal of a truly neutral money, in which changes in the money supply hurt no one? These are the subjects of Part III.