The Quality of Money

What is the purpose of money? Where does it come from? Inequality generates trade and specialisation creates the need for money .  A good money is widely marketable and must function as a genuine store of value, thus paper money should be consigned to the board game Monopoly.

Inequality Leads To Trade

In a state of subsistence farming money need not exist,  since a family, for example the Robinsons, might produce all the requirements for survival (food, shelter, clothing, water etc) and so have no reason to trade; however as soon as they come into contact with another family, the Andersons, group trade is possible and thus money could arise. Yet, why would anyone bother trading with another group in the first place? Mises cites three reasons:

  1. The natural inequality of man regarding their abilities to perform a task.
  2. The geographically unequal distribution of natural resources.
  3. Certain tasks require more than the labour of one man.[1]

 

Contrary to contemporary belief, Mises argues that the foundational glue for trade and also for society is inequality. If everyone had exactly the same abilities as each other in the absence of reason 3, no-one could be made better off by trading with the other party. Consequently, the only way one could benefit from another in an egalitarian utopia would be to steal his property and possibly kill him to prevent retaliation. In effect, inequality is a cause of peace: it allows man to have mutually beneficial interactions with others. Reason 3, Mises rightly contends, would only lead to transitory trade since after, for example, building a large bridge, there would be no further purpose for trade.

Thus, trade for Robinsons makes sense since it can improve their perceived standard of living – they could trade ten onions in exchange for twenty carrots from the Andersons which demonstrates, ex ante (before the trade), that they value twenty carrots more highly than ten onions, and also that the Andersons value ten onions more than twenty carrots. Ex post (after the trade) one or both of them could realise that they had made an error: the Andersons could turn out to be allergic to onions and the Robinsons could have underestimated their own carrot yield; however, they initially both believed that trade would make them better off which is certainly not the case with involuntary action – if I steal your car you’re still stuck in Bridgewater service station.

Trade creates an alternative to subsistence farming – specialised farming: no longer will the Robinsons have to grow everything for their own consumption but they can focus on those areas in which they have a comparative advantage and trade the rest for other goods.[2] Based on the reasonable postulate that the more you practice a particular operation the better you become, it is clear that specialisation will increase physical productivity and thus standards of living. An interesting by-product of specialisation is that marginal innate abilities become widely pronounced – today, an individual with slightly superior  innate athletic ability is selected for meticulous training improving his athletic ability far beyond  the average man; similarly, an individual with above average logical and numerical skill will be trained in engineering. This explains why, despite the marginal average differences,  the roles of men and women become more pronounced as society develops – far from being arbitrary social constructions, they are logical outworkings of mutually beneficial specialisations.

The Genesis of Money

How can a highly specialised society evolve from a simple barter economy? Imagine a sportsman trying to buy engineering services for the construction of his house. Unless the engineer is a massive fan of his it is highly unlikely he will accept payment in the form of watching him run around the office – this is the problem of the double coincidence of wants: in barter you must find someone  who wants direct use of the good you’re selling, and he must want direct use of the good you’re selling. This is more likely in agrarian economies than today’s economy since there are far fewer goods on offer – a direct exchange of cheese and wine is much more likely than the direct exchange of engineering and spectator sport services. Yet, it is still quite plausible that the winemaker does not want your Blue Stilton, instead he wants bread. In this case the cheesemaker has two options: reduce the production of cheese and devote those resources to grape cultivation, or find someone who sells a product that the winemaker wants but who also wants Blue Stilton. The first option will clearly be a waste of his resources and reduce his overall income (he won’t produce wine for many years beginning from scratch), so he will likely take the second option and seek out the cheese loving baker. The cheesemaker will then trade the cheese for the bread and then use the bread as a medium of exchange to facilitate the purchase of the much loved vintage wine. The cheesemaker only values the bread, in this case, solely for its exchange value, not its use value – thus how valuable a product is as a medium of exchange depends to what extent it is demanded by others. Crucially, however, before an object is used as a medium of exchange it must first have direct use value otherwise it could never function as a medium of exchange to begin with.[3] Thus, when fellow villagers notice the relatively higher living standards of the cheesemaker they will imitate him in using media of exchange. Ultimately, we will reach a point at which there are goods which are almost universally accepted in payment, the general medium of exchange: money.

Why Cows are a Bad Money

Historically, a myriad of different goods have been used as money from cows in Africa to shells in China. Yet, in the most developed economies the precious metals of copper, silver and gold have come to the fore, but why? Firstly, they are divisible – chopping a cow in half is unlikely to remain worth half a full cow in value whereas half a silver ingot is likely to be half the value of a whole ingot. Secondly, cows die – saving up your cows for a new Mercedes could end up being a Sisyphean task, [4] whereas gold continues to be, well, gold. Thirdly, cows are rather difficult to transport – walking a cow to the corner shop is significantly more burdensome than dropping a few coppers in your back pocket. Fourthly, not everyone wants cows, they’re smelly and very, very stupid whereas for whatever reason people for millennia like shiny objects for finery and embellishment, so far more people will accept metals as payment thus they are a much better money than cows.

Money Must Store Value Over Time

So far, even the most aggressive inflationist, such as the Bank of England’s Chief Economist Andy Haldane[5], would agree with the above characteristics of a good money – divisibility, durability, portability and wide marketability.  Nevertheless, following Adam Smith, they’d argue that (semi-)precious metals would be better used in industrial production or jewellery rather than in coinage since money is a mere token. Yet, what constitutes a waste of resources? Since money arises to service an individual’s needs it is from their perspective, and their perspective alone, which determines whether a money is a good money.

To return to the cheesemaker, he used the bread as a medium of exchange to purchase the wine. Now the bread must have remained fresh in the time between the initial exchange of the cheese for the bread and the final, bread for wine exchange. Thus the bread must have maintained its value in that time period otherwise it could not have functioned as a medium of exchange.[6] For exchanges which will take place in the relatively distant future, such as saving for the Mercedes, the function as a store of value becomes even more important. Further, the successful investments by firms is contingent upon predictable changes in prices – if they fluctuate wildly, it could lead to widespread error and/or a significant reduction in investments due to vastly increased uncertainty.

Price Stability is a Fiction

But isn’t the store of value of money represented by the government’s inflation target of 2%? Well firstly, 2% depletion of the value of money is hardly storing value.[7]  Secondly,  the inflation rate is an average and is of little interest to the individual.  All the individual cares about is whether the prices of the goods he (and his friends and family) purchases are increasing or decreasing in price relative to his pound coin. The anorexic computer nerd who lives in his parents’ basement would have found that his purchasing power had rocketed over the past twenty years as the price of technology products has dropped like Jimmy Saville’s popularity whereas the relatively normal person has seen the purchasing power of his pound collapse in that time period -the purchasing power of a pound is therefore different for different people since it depends what goods you in fact purchase. Further, why should the purchasing power of a pound remain constant? When you are selling pizza you are essentially buying pounds so why shouldn’t a pizza’s purchasing power (how many pounds you can buy with a pizza) remain constant as well? All prices and thus the purchasing power of all goods are in constant flux so why single out a particular good to have a perfectly stable purchasing power?

There is however, some commonality between the nerd and the average man in that both would prefer that their money increased in value over time, since it is an asset, but not so dramatically that it impeded its use as a medium of exchange. This last aspect explains why gold, silver and copper came to the fore historically as money: they were limited in supply so that the growth in the money supply  would marginally lag behind the increase in the demand for money so their purchasing power increased over time– they were high quality monies, each satisfying different values of transactions.[8] Also the fact that all three are used for non-monetary uses is far from a waste of resources – the fact gold, silver and copper have non-monetary uses provides insurance for the holder that if, for whatever reason, the value as a medium of exchange collapses it still has some value and so retains in part its function as a store of value.

Paper Money is Monopoly Money

These insights clearly condemn paper fiat (government enforced) currency as worse than toilet paper. The theoretically infinite supply which can be increased at will by the central bank through operations such as quantitative easing (buying government bonds with newly created money) obliterates the function of money as a store of value and demonstrates that paper currency is clearly of seriously poor quality. Focusing on the money supply, as the Monetarists do, to achieve some statistical equilibrium completely ignores the purpose and origin of money itself – the supply only matters to the extent that it increases or decreases the quality of money which must be viewed through the lens not of the supercomputer but the eye of the human actor. Through this eye we see the monetary history of the 20th century as a continual abasing of money from the collapse of the classical gold standard to Nixon closing the Gold Window in 1971. Given the extreme importance of money to the functioning of a highly specialised society it isn’t surprising that this incredibly poor money which is first issued by legally privileged central banks leads to vast income inequality and a financial system which enriches the elites.[9]

Gold Money is Quality Money

In conclusion, a quality money is one which best satisfies individuals’ preferences since it is only individual action which brings money into existence. The major preferences for a money are universal acceptance for exchanges and a mildly increasing purchasing power over time. Thus a high quality money will be divisible, portable, durable, widely marketable and crucially limited in supply since this helps to maintain money’s function as a store of value. Whenever the discussion of a good money arises the discussion needs to be framed within the context of the origin of money and thus the perspective of the individual actor – do not be entranced by the smoke and mirrors of “monetary policy’s” importance for the “economy”. Finally, high quality money is crucial to the proper functioning of a specialised economy so any reforms of the present economic system must first and foremost be focused on returning to high quality, voluntarily chosen money.

Notes

[1]    Mises, Ludwig von. Human Action 1st Edition (Auburn, Alabama – Ludwig von Mises Institute) 1998 P157-158

[2]    This is even true for those families and individuals who are absolutely less productive at all forms of production than others. See my Brexit and Free Trade article for elaboration.

[3]    This is Mises Regression Theorem. Mises, Ludwig von. Human Action  P405-413

[4]    “In Greek Mythology… Sisyphus… was the king of Ephyra (now known as Corinth). He was punished for his self-aggrandizing craftiness and deceitfulness by being forced to roll an immense boulder up a hill, only to watch it come back to hit him, repeating this action for eternity.” https://en.wikipedia.org/wiki/Sisyphusaccessed 15/05/17

[5]   Haldane recently suggested the abolition of physical cash so the central bank could effectively inflate the money   supply to even more dizzying heights than is presently possible.

[6]  Rist, Charles..History of Monetary and Credit Theory: From John Law to the  Present Day 1966 cited by Bagus,   Phillipp. The Quality of Money. The Quarterly Journal of Austrian Economics 12, No. 4. 2009 P22–45

[7]    The 2% target is based around the erroneous notion of sticky prices – that prices “should” change to a particular level to maintain monetary equilibrium. The problem is that this implies that if the sticker price of a good (or the wages for labour) doesn’t change then this is evidence of sticky prices.  Suppose demand for a product falls, should you immediately change the price? This depends on a myriad of factors from your expectation of changes in future demand to anticipating some firms leaving the market. The key point is that it is almost always possible for a firm to change the price if it deems it the correct course of action. The fact that changing prices isn’t costless is irrelevant. Now it is true that you could make an error by not changing your prices but the costs of changing prices does not imply systematic error. The only situations in which you could have legitimate sticky prices are literal government price controls where it would be illegal to change your price and a welfare state which prevents nominal wages falling to the market clearing level if the income on benefits is at, or close to, what would be the market clearing wage.

[8]    An increase in the demand for commodity money would stimulate mining and thus supply. One of the main reasons for the increase in demand for money over time would be greater physical productivity since as Jean-Baptiste Say explains, supply constitutes demand; so an increase in the supply of goods increases the demand for money.

[9]    For an overarching explanation of the present system see: Hoppe, Hans-Hermann Banking, Nation States, and International Politics: A Sociological Reconstruction of the Present Economic Order . Review of Austrian Economics, Vol.4 P55-87 1990


By Swithun Dobson
Source: The Ludwig von Mises Centre

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