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Ludwig von Mises and the Nature of Money

As a true disciple of Carl Menger, Ludwig von Mises began the presentation of his theory of money with an analysis of the nature of money itself. He then went on to deal with the determination of money’s purchasing power and with the impact of what he called Umlaufsmittel (fiduciary media) on the monetary system.

In dealing with the nature of money, Mises relied heavily on the work of Carl Menger. The founder of the Austrian School had shown that money is not to be defined by the physical characteristics of whatever good is used as money; rather, money is characterized by the fact that the good under consideration is (1) a commodity that is (2) used in indirect exchanges, and (3) bought and sold primarily for the purpose of such indirect exchanges.

Menger also stressed that money emerges spontaneously on the market as a response to the lack of the double coincidence of wants. Indirect exchanges are resorted to, for example, by the chair maker seeking to buy a dozen eggs from the farmer who already has enough chairs, or by the painter trying to purchase a glass of beer from the brewer who does not care for art. They first exchange their products into highly marketable commodities, such as salt, wheat, or silver coins, in order to exchange these “media of exchange” against eggs and beer in a subsequent deal. The significance of this fact was that a monetary system could come into being without a prior social contract and without government fiat.1

Mises added to and refined this analysis of the nature of money in four ways.

First, he took issue with the idea that the functions of money—being a means of exchange, a store of value, a means of payment, a means of deferred payments, a numéraire (measure of value)—were of equal importance. Mises argued that a commodity could play the role of numéraire only because it was used as a means of exchange; and, similarly, a commodity was held as a store of value precisely because it was marketable. Thus there was a hierarchical order of the functions of money: the means of exchange was primordial, being a necessary condition for the others.

Second, Mises developed a comprehensive typology of monetary objects—that is, in Mengerian language, of all the things generally accepted as media of exchange. On the most fundamental level, he distinguished several types of “money in the narrower sense” from several types of “money surrogates” or substitutes. Money in the narrower sense is a good in its own right. In contrast, money substitutes were legal titles to money in the narrower sense. They were typically issued by banks and were redeemable in real money at the counters of the issuing bank (see diagram on the previous page).


In establishing this fundamental distinction between money and money titles, he applied crucial insights of Böhm-Bawerk’s pioneering work on the economics of legal entities. He stressed: “Claims are not goods; they are means of obtaining disposal over goods. This determines their whole nature and economic significance.”2  As his exposition in later parts of the book would show, these distinctions have great importance, both for the integration of monetary theory within the framework of Menger’s theory of value and prices, and for the analysis of the role of banking within the monetary system. At the heart of his theory of banking is a comparative analysis of the economic significance of two very different types of money substitutes. Mises observed that money substitutes could be either covered by a corresponding amount of money, in which case they were “money certificates,” or they could lack such coverage, in which case they were fiduciary media—Umlaufsmittel. Mises devotes the entire last third of his book to an analysis of the economic consequences of the use of Umlaufsmittel.3

Third, Mises refuted the idea that money prices are a measure of value. Here he relied on the work of the Czech economist Franz Cuhel who some years earlier, in his Zur Lehre von den Bedürfnissen (On the Theory of Needs), had clarified several fundamental issues of the new Mengerian price theory.4  Cuhel was a champion of the psychological theory of marginal utility (Gossen-Jevons-Wieser), but several of his contributions to the theory of value and utility proved useful despite that fact.

Cuhel refuted Böhm-Bawerk and Wieser’s quantitative claims about marginal utility, which referred to homogeneous units of a supply of goods, where each individual unit provides the same utility. According to Böhm-Bawerk, the utilities derived from the use of several units could be added, to the point that the utility, say, of consuming fifteen plums equals exactly fifteen times the utility of consuming one plum. But Cuhel objected that this contradicted the basic idea of the law of diminishing marginal utility, namely, that the satisfaction derived from the consumption of each additional unit of the good is lower than the utility derived from the consumption of the previous unit.5

Cuhel also made a devastating case against interpersonal comparisons of satisfactions. The benefits derived from the consumption of two different goods could be compared only indirectly, and only in one narrow case, namely, in the case of individual decision-making at one point of time. From the fact that an individual chooses to enjoy satisfaction A rather than B, one can infer that A yields more satisfaction to this person than B does, because at the time of the choice both A and B were present and competed directly with one another.6  Hence, the observed choices of individuals provide evidence about the relative size of enjoyment. But this is the only type of evidence available because it is fundamentally impossible to perceive the comparative satisfactions of other people.7  One can only have direct knowledge of the utilities that the satisfaction of various needs has for oneself. Other people’s utilities have to be inferred, indirectly, from their actual decision-making.

It follows that there is no such thing as value calculation or even value measurement. Even money does not have a constant value, and is therefore unable to provide the basis for a value calculus. Moreover, since money prices are the result of individual valuation processes, they are individual historical events, always determined by the particular circumstances in which they emerge. Contrary to what Walras’s system of equations suggests, there are no constant relationships between money prices of different times and places.

It was therefore out of the question to follow Irving Fisher in his attempt to establish a quantitative law—such as in physics— of the relationship between the quantity of money and money prices (the price level). Mises placed great emphasis on this crucial implication of value theory for the methodology of economics:

Because there are no constant relations in the field of human action, the equations of mathematical catallactics cannot be made to serve practical problems in the same way the equations of mechanics solve problems through the use of data and constants that have been ascertained empirically.

In my book on money I did not say one controversial word against the mathematical school. I presented the correct doctrine and refrained from attacking the method of mathematicians. In fact, I even resisted the temptation to dissect the empty term “velocity.” I refuted mathematical economics by proving that the quantity of money and the purchasing power of the monetary unit are not inversely proportional. This proof demonstrated that the only constant relationship which was believed to exist between “economic quantities” is a variable determined by the data of each individual case. It thus exploded the equations of exchange of Irving Fisher and Gustav Cassel.8

Mises’s criticism of the mechanical version of the quantity theory had an impact well beyond the theory of money. For this version of the quantity theory represented a larger agenda: a quantitative view of social science in general. Mises showed that there are no quantitative constants linking human actions to repercussions in the social realm. An increased demand for apples would in all cases lead to higher apple prices than would otherwise have existed, but there is no law that tells us that a 10 percent increase of the apple demand will cause, say, an 8 percent or a 14 percent increase of apple prices. Actual quantities will always depend on the particular circumstances of each individual case.

Fourth, and finally, Mises dealt more explicitly than Menger with the claims of the monetary statists or “chartalists.” Whereas Menger had argued that money could emerge spontaneously on the market, the statist scholars asserted that money was a creation of the state.

Debate on this topic can be traced back to the times of Plato and Aristotle. It ran all through the Middle Ages and was only settled, for a short while, by the classical economists, who had argued along Mengerian lines. But at the end of the nineteenth century the statists struck back. Cernuschi in France, Neupauer in Austria, and Lexis in Germany reasserted the view that money is what the state declares to be such.9  But the most famous champion of this view was Georg Knapp—the same Knapp who had pioneered the studies on Germanic rule as a liberating force for East-European peasants.

In his Staatliche Theorie des Geldes (State Theory of Money), Knapp argued that money was a creation of the legal order and that the theory of money therefore had to be studied as a branch of legal history.10  According to Knapp, money came into being through government proclamation. The state says that this or that is money, and it suddenly becomes a token for some corresponding amount of real goods. The essence of money was therefore to be a government-proclaimed token (charta in Latin) that could be used as a legally valid means of payment.11

Knapp’s views were not well received at first,12  but did find early support from prominent bankers13  and eventually won many converts to the state theory of money. His chartalist theory did, after all, perfectly complement the statist convictions already prevalent among German economic professors. As Mises later observed:

The statist school of German economics has probably reached its high point in Georg Friedrich Knapp’s State Theory of Money. It is not per se remarkable that this theory has been formulated; after all, its tenets have been championed for centuries in the writings of canonists, jurists, romantics, and certain socialists. What was remarkable was rather the success of the book.14

Knapp’s fundamental error was in failing to see that government orders can only be relevant in the context of presently existing contracts involving deferred payments. Ex post, governments can determine what should be counted as “money” and, hence, what should be counted as payment. But it does not have the power to impose on market participants the future use of any means of exchange:

Business usage alone can transform a commodity into a common medium of exchange. It is not the state, but the common practice of all those who have dealings in the market, that creates money. 15

Excerpted from Mises: Last Knight of Liberalism
  • 1Although Menger delivered a painstaking analysis of the process of the emergence of money (a process that was in his view the best illustration of the emergence of social institutions) he was not the first economist to point out that money does not come into being by social contract. Among Menger’s predecessors were John Law (1705), Ferdinando Galliani (1751), Étienne de Condillac (1776), Adam Smith (1776), Antonio Genovesi (1788), Jean-Baptiste Say (1802), and Richard Whately (1832). On the emergence of this approach in the eighteenth century see Arthur E. Monroe, Monetary Theory before Adam Smith (New York: Augustus M. Kelley, [1923] 1966).
  • 2Mises, Theory of Money and Credit, p. 65; also Mises quoted Böhm-Bawerk’s Rechte und Verhältnisse vom güterwirthschaftlichen Standpunkte, pp. 120ff.
  • 3Regrettably, this comparative focus of his analysis was lost in the English translation of the title of the book: Theory of Money and Credit. The term Umlaufsmittel, which literally translates into “means of circulation,” was rendered in the English text as “fiduciary media.” Consequently the title of the book should have been Theory of Money and Fiduciary Media, but the publisher decided that the unusual terminology would irritate readers and thus opted for the smoother but toothless Theory of Money and Credit, failing to honor the fact that even in the original German version the expression was unusual. Mises was hostile to innovations in language that were not justified by the analysis of hitherto neglected phenomena. But the difference between money certificates on the one hand, and Umlaufsmittel on the other was such a neglected phenomenon, to the point that established scientific terminology even lacked the means for expressing this difference. Mises thus introduced the expression Umlaufsmittel for this purpose and even used it in the title of his book to highlight its importance.
  • 4See Franz Cuhel, Zur Lehre von den Bedürfnissen. Theoretische Untersuchungen über das Grenzgebiet von Ökonomik und Psychologie (Innsbruck: Wagner, 1907).
  • 5See ibid., pp. 190f. Böhm-Bawerk had made this claim in a long essay on the theory of value, his first statement on value theory. See Böhm-Bawerk, “Grundzüge der Theorie des wirtschaftlichen Güterwertes,” Jahrbücher für Nationalökonomie und Statistik n.s. 13 (1886): 48. It was this passage that met with criticism in Cuhel and Mises. Mises said many years later that, in distinct contrast to corresponding passages in Böhm-Bawerk’s Positive Theory of Capital (New York: G.E. Stechert, 1930), the statement in Grundzüge “was incompatible with the whole tenor of Böhm’s theory” (Mises to A.E. Foerster, letter dated March 2, 1965; Grove City Archive: Böhm-Bawerk file). ​This letter raises a certain problem because Mises here said that Böhm-Bawerk eventually realized his error and expressed the correct formulation in a later edition of Capital and Interest (South Holland, Ill.: Libertarian Press, 1959, vol. 2, bk. 3, part A, chap. 3, p. 148). But in the second edition of Theorie des Geldes und der Umlaufsmittel, 2nd ed. (Munich and Leipzig: Duncker & Humblot, 1924, p. 13), Mises said Böhm-Bawerk had not said anything new on this matter
  • 6See Cuhel, Zur Lehre von den Bedürfnissen, pp. 178f
  • 7See ibid., p. 210. Cuhel called subjective utilities by the unusual name of “Egenzen.” In an analogous case, Vilfredo Pareto called subjective utility “ophélimité.”
  • 8Mises, Notes and Recollections, p. 58.
  • 9See Henri Cernuschi, Nomisma; or, “Legal Tender” (New York: Appleton & Co., 1877); Josef von Neupauer, Die Schäden und Gefahren der Valutaregulierung für die Volkswirtschaft und die Kriegsbereitschaft (Vienna: Lesk & Schwidernoch, 1892); Wilhelm Lexis, “Papiergeld,” Handwörterbuch der Staatswissenschaften (Jena: Gustav Fischer, 1893; 2nd ed., 1901, 3rd ed., 1910). Mises mentions Neupauer’s book in Mises, “Die wirtschaftspolitischen Motive der österreichischen Valutaregulierung,” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung 16 (1907): 578.
  • 10See Georg F. Knapp, Staatliche Theorie des Geldes, 2nd ed. (Munich & Leipzig: Duncker & Humblot, 1918), p. 1.
  • 11See ibid., p. 31. Knapp thought he had to create an entirely new vocabulary to adequately deal with the theory of money and among many other innovations came up with the expression “chartal.”
  • 12In particular Andreas Voigt, one of the leaders of the small but growing cadre of anti-Schmoller economists, gave Knapp an unfavorable review. See Andres Voigt, “Die staatliche Theorie des Geldes,” Zeitschrift für die gesamte Staatswissenschaft 62 (1906): 317–40. 
  • 13See L. Calligaris, “Staatliche Theorie des Geldes,” Münchener Allgemeine Zeitung (February 1, 1906); idem, “Staatliche Theorie des Geldes,” Österreichische Rundschau 7, no. 80 (May 10, 1906); F. Bendixen, Das Wesen des Geldes (Leipzig: Duncker & Humblot, 1908), p. 3; idem, “Fünf Jahre Geldtheorie,” Bank-Archiv 10, no. 10 (1911): 145ff.; W. Lexis, “Eine neue Geldtheorie,” Archiv für Sozialwissenschaften und Sozialpolitik 5 (1906): 557–74; idem, “Die Knappsche Geldtheorie,” Jahrbücher für Nationalökonomie und Statistik, 3rd series, 32 (1906): 534–45.
  • 14Ludwig von Mises, Staat, Nation und Wirtschaft (Vienna: Manz, 1919), p. 5, n. 3. Mises referred to Anderson’s verdict that Knapp’s book “has had wide influence on German thinking on money. It is typical of the tendency in German thought to make the State the center of everything.” Benjamin M. Anderson, The Value of Money (New York: Macmillan, 1917), p. 433. He also quoted Carl Menger’s exasperated comment on the success of the State Theory of Money: “It is the logical development of Prussian police science. What are we to think of a nation whose elite, after two hundred years of economics, admire such nonsense, which is not even new, as highest revelation?” Mises, Erinnerungen, p. 20; Notes and Recollections, p. 35.
  • 15Mises, Theory of Money and Credit, p. 93.
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