Mises's Revolutionary Theory of Money
[Excerpted from Theory of Money and Fiduciary Media edited by Jörg Guido Hülsmann, which celebrates the centennial of the great work by Ludwig von Mises, known in English-speaking countries as The Theory of Money and Credit.]
The Early Evolution of Mises’s Monetary Theory
The publication of Ludwig von Mises’s Theorie des Geldes und der Umlaufsmittel in 1912 marks a turning point in the history of economics, and of the Austrian School in particular. Mises integrated the theory of money within the framework of the theory of subjective value pioneered by Carl Menger. Based on this foundation he revisited all the great monetary debates of his time and of the preceding century, and weighed in these debates with original and penetrating arguments, each of which he articulated at its proper place within the edifice of an encompassing monetary treatise.
He also made an astounding number of other major contributions, so-to-say in passing. Most notably he developed the general theory of subjective value itself by stressing that value was rooted in choice. He developed a subjectivist typology of money starting from which he delivered a systematic theory of the causes and consequences of money prices. He applied that theory to international relations, thus becoming a pioneer of international monetary economics. He analyzed the pricing process in unorganized markets. He delivered in-depth refutations of the mechanical quantity theory of money, of mechanical price theories, of the index-number method, of Currency School theory, and of Banking School theory. Last but not least, he developed a theory of economic crises, stressing that monetary expansion is likely to entail inter-temporal disequilibria of the structure of production. Side by side with these major contributions, Mises fleshed out various other noteworthy themes. For example, he highlighted particular features of economics as compared to neighboring disciplines such as law or history; and he made several important observations on monopoly theory, on economic calculation, and on the consequences and limitations of government interventionism.
Mises’s monetary thought would remain the backbone of his entire economic theory. Eventually he would articulate it within the larger context of a general theory of human action, but the main theses remained unaltered. The first publication of his treatise in 1912 presented more than a full-fledged theory of money prices. It opened virtually all other major threads of his later work as well, with the notable exception of epistemology. While Mises changed his mind on a certain number of issues (see Gertchev 2004) his theory of money features a remarkable continuity throughout the four decades stretching from the first to the last edition of his treatise. The purpose of the following pages is to highlight the logical structure of his treatise and its chief contributions, as well as the most notable changes made to the second German edition of 1924 and the English edition of 1934.
The Logical Structure of His Treatise
In Theorie des Geldes und der Umlaufsmittel, Mises extended and developed Carl Menger’s (1871, 1892) general approach to economic analysis and the theory of money in particular. Menger had shown that the market prices of economic goods were caused by the subjective marginal value of these goods. However, he had neglected the special case of monetary prices, and well-known critics such as Carl Helfferich and Knut Wicksell had argued that it was impossible indeed to apply the new subjective-value theory to the monetary economy. Mises stepped in to fill this gap with the publication of his Habilitation thesis.
Following in Menger’s footsteps, he set out to explain the causes and consequences of money prices. But he did not simply apply the Mengerian concepts to a special case that hitherto had been neglected. In the first part of the book, he completely revised Menger’s framework itself to lay the foundations for a new theory of money. Most notably, Mises revised the general theory of subjective value and developed a new typology of monetary objects in line with the subjectivist approach. He also stressed the methodological importance of that approach. All economic phenomena had to be traced back to individual decision-making, lest the analysis be vitiated and lead to wrong conclusions. Let us highlight these contributions in some more detail.
New Foundations for the Theory of Money and Banking
Mises stressed that a correct causal analysis of market prices requires tracing the explanation back to individual human behavior. Again and again, at crucial junctures of his argument, he emphasized that aggregate considerations lead into error, and that a correct causal analysis of the pricing process must start from individual choices. For example, discussing one of Helfferich’s contentions, Mises stated:
The error in this argument is to be found in its regarding the utility of money from the point of view of the community instead of from that of the individual. . . . All consideration of the value of money must obviously presuppose a state of society in which exchange takes place and must take as its starting point individuals acting as independent economic agents within such a society, that is to say, individuals engaged in valuing things. 
Mises did not just apply the theory of subjective value that he had received from Menger and Böhm-Bawerk. Rather, he purged that theory from all elements of cardinal value, respectively cardinal utility, and stressed the ordinal nature of subjective value, which springs from human choices. 
Moreover, right from the first edition of his book, Mises repeatedly emphasizes that human action takes place in a context of uncertainty (see for example, A6, A117, A162, A182) and points out that the very existence of money is premised on this fact. Indeed, people want “to hold a sum of money in reserve against unforeseen and indefinite expenditure. (A349, C338). Most importantly, human choice respectively, subjective value is itself one source of uncertainty. The relative impact of any cause of an exchange ratio is mediated through the individual value judgements. Quantitative factors therefore never have a constant impact on market prices. For example, the apple price might remain constant even in the presence of changes in the apple stock and the money stock, if the value judgements of buyers and sellers offset these changes. Similarly, the apple price might change even though both the apple stock and the money stock remain constant. In Mises’s words:
. . . in monetary theory, as in every other branch of economic investigation, it will never be possible to determine the quantitative importance of the separate factors. Examination of the influence exerted by the separate determinants of prices will never reach the stage of being able to undertake numerical imputation among the different factors. All determinants of prices have their effect only through the medium of the subjective estimates of individuals; and the extent to which any given factor influences these subjective estimates can never be predicted.
In short, there are no constant relationships between market prices (A216, A471). This entails the related impossibility to measure any variations of the purchasing power of money (PPM). The causal analysis of economic theory traces the change in the exchange ratio between any two goods—money included—back to the demand for and supply of the two goods, and from there to their subjective values. But this theoretical analysis can never establish how much of the observed change was due to which cause. It can never make a quantitative determination. Hence, the demand for money and the impossibility to measure the purchasing power of money both have their origin in the pervasive fact of uncertainty.
Mises therefore questioned the usefulness of quantitative methods in economic analysis. He eventually acknowledged that index numbers can “perform useful workaday services for the politician” if they are based on “points of time that lie close to one another.” But he always rejected outright the possibility to demonstrate any contention about causes and consequences with statistical or other quantitative methods. 
The subjectivist approach which Mises had adopted from Menger led him straight to a new classification of monetary goods. In order to explain money prices as resulting from individual choices, it is necessary to consider how individuals evaluate the different monetary economic goods when they exchange them against non-monetary economic goods. Mises stressed that, while this evaluation process has certain general features, there are also categorical differences in the evaluation of different types of money. These differences do not stem from the physical characteristics of the goods, but from man-made differences rooted in legislation, contracts, and business practice.
Mises’s classification of money relies on the fundamental distinction between money—respectively money proper—and money substitutes. This economic distinction must not be confused with the physical characteristics of the respective monetary objects. A paper note can be a money substitute, but it can also be fiat money, depending on whether it is redeemable into some other economic good that serves as money. Gold coins or silver coins are not per se money proper, but can also be money substitutes if redeemable into some other economic good that serves as money. Token coins are not a separate form of money, but are a metallic form of money substitutes.
As far as money proper is concerned, Mises distinguished three forms: commodity money (including precious metals), fiat money, and credit money (see A43–48). In all three cases, the monetary object is evaluated in its own right. It is wrong, therefore, to interpret money in general as a claim or as an “assignment” to some other good. While some monetary goods are indeed claims, money itself is not by its very nature a claim. It can be used to bid for other goods in market exchanges. But, unlike a claim, money proper cannot be redeemed into other goods. 
Yet there are monetary objects that are truly claims on something else—namely, on money proper respectively money in the narrow sense—and which can therefore be evaluated as though they were money. They are “money substitutes.” Regarding such money substitutes, he stressed the difference between fully covered substitutes, which he called “money certificates,” and substitutes without any coverage, which he called “fiduciary media.”
The upshot of these distinctions is that fiduciary media feature a number of very particular causes and consequences. Most notably, while the production of money proper or of money certificates is costly and therefore constrained within fairly narrow limits, fiduciary media are essentially costless to produce and can therefore in principle be produced in unlimited amounts. Their production is constrained in practice only because of accidental circumstances such as a lacking coordination among banks or legal interference. Most importantly, the creation of fiduciary media tends to bring about economic crises, whereas no such consequence results from an increase of the supply of money proper or of money certificates. To highlight these very particular features of fiduciary media was a central achievement of Mises’s book. This was also reflected in its title, which in a literal translation reads Theory of Money and Fiduciary Media.
In the second part of his book, Mises set out to analyze the causes and consequences of the “value of money” in general. He did so by presupposing hypothetically that all money substitutes were fully covered by money. In other words, he assumed there would be no fiduciary media at all. In the third part, he would drop this assumption and turn to study the particular features of “fiduciary media and their relationship to money.” He pointed out (A145, A206, B407) that this procedure had already been the methodological approach of the Currency School, which based its reasoning on the hypothesis of a “purely metallic currency” in comparison to which it had analyzed the impact of banknotes.
 “Writing my Nationalökonomie afforded me the opportunity to think through my theory of money and credit yet again and present it in a new form. . . . Thus did I carry out the plan I had conceived thirty-five years earlier; I combined the theory of indirect exchange with the theory of direct exchange into a unified system of human action.” Mises (2009, pp. 94f.)
 However, the most important facts which eventually would become the starting points for his methodological and epistemological reflections were already highlighted in the Theorie des Geldes und der Umlaufsmittel in 1912. See below, pp. 4f.
 To our knowledge, no scholar has so far traced the evolution of Mises’s economic thought back to the first edition, which was never translated into English. This also concerns most notably Pallas (2005) and Hülsmann (2007).
 All references to page numbers of the first edition of 1912 are preceded by the letter “A”. Similarly, references to page numbers of the second edition of 1924 are preceded by the letter “B” and the letter “C” refers to the widely used American edition of 1981, which is identical with the English edition of 1934, except for the spelling and the additional fourth part added to the 1953 American edition.
 A130f., C144. See also A6, A142, A155, A159.
 “Every economic transaction presupposes a comparison of values. But the necessity for such a comparison, as well as the possibility of it, is due only to the circumstance that the person concerned has to choose between several commodities” (A15, C51f.). See also A119, A130, A178, A234, A354, A373. We have discussed Mises’s contribution to the theory of value in some detail in Hülsmann (2003) and Hülsmann (2007).
 C218. The original text: “Wie in jedem anderen Zweige der nationalökonomischen Forschung wird es nämlich auch auf dem Gebiet der Geldtheorie niemals möglich sein, zur Bestimmung der quantitativen Bedeutung der einzelnen Faktoren zu gelangen. Die Prüfung der Einwirkung der einzelnen Preisbestimmungsgründe wird niemals dahin kommen, die zahlenmäßige Zurechnung an die verschiedenen Faktoren vorzunehmen. Alle Preisbestimmungsgründe wirken nur durch das Medium der subjektiven Wertschätzungen der Individuen; wie stark ein bestimmtes Moment die subjektiven Werturteile beeinflußt, kann aber niemals vorausgesagt werden” (A217, B173).
 C222, B177. The section where he makes this concession to the practical utility of index numbers has been added to the second edition of the book.
 See A171, A216, A276, A405, A474.
 Thus Mises deals with one of the major shortcomings of the conceptions of the Currency School. See below.
 He calls money also “money in the narrow sense.” Most economists today call it “base money.” Notice that Mises argued that the essential function of money is to serve as a generally accepted medium of exchange. All other functions are consecutive functions. They are derived from this primary one (A10–12). Mises endorsed Knies classification of money as a good sui generis, that is, as distinct from consumers’ goods and from capital goods. The reason is, again, that these three types of goods are subject to different laws of valuation and pricing (A79).
 Mises argued most notably that the fatal error of the Currency School, which otherwise had sound conceptions that he endorsed in his book, was to regard banknotes as some form of money, whereas it considered demand deposits as pure credit instruments and not as a form of money. This was in Mises’s eyes a distinction without a difference and it led to the practical failure of Peel’s Act. We will deal with this issue in more detail below.
 During WWI, Mises refuted the assignment theory in a 1916 journal article “on the classification of monetary theories.” This paper would then be incorporated into the 1924 edition of his Theorie des Geldes und der Umlaufsmittel (chapter 9 of the second part; see B242–63) and remained as an appendix in the 1953 edition (see C503–24).
 See North (1993, p. 159).
 They are not different in all respects. For example, increasing the supply of fiduciary tends to entail an increase of the price level, just as it would be in the case of an increased supply of money proper or of money certificates.
 Unfortunately, the English rendering as Theory of Money and Credit obscured this central theme. We will address the problems of this translation below.