Although often unintentional, one of the most fundamental errors that pervades mainstream economics instruction is to present economic categories independent of human action. This error is fundamental because, once committed, it pervades all aspects of the study of economics, making them unrealistic. For failure to treat economics appropriately as a social science, including human actions, interactions, subjective valuations, and choices, all kinds of economic categories lose their significance and become disconnected from the real world.
For example, a teacher could present textbook information about the definition of prices without explaining what a price is and how it is formed through property, subjective valuation, voluntary exchange, etc. Supply and demand graphs can be presented without articulating the underlying human choices that can be momentarily captured in such a graph. The critical role and function of the entrepreneur is likewise largely ignored in mainstream economics. This is also done chronically when it comes to money.
On the first day of a typical, introductory microeconomics class, if students are asked what they think economics is about, most of them will answer that it has to do with money, the stock market, and personal finances. Money is the most familiar aspect of economics to most people, but is probably one of the least understood. People are already used to living in a modern monetary economy and using money fiat currency regularly, and the typical mainstream definitions often help cement an understanding of money that simultaneously seems to inform while it actually obscures the reality about money.
When the mainstream Economics 101 course gets to money, either the teacher or the textbook usually informs the student that money is three things—a medium of exchange, a unit of account, and a store of value. This is not altogether untrue; in fact, there is a great deal of important truth in those functions of money. The main issue is that these functions are treated as ever-present, simultaneous, separable, independent, and unconnected with human action and a theoretical history of money. Thus, while the mainstream attempts to inform, it actually obscures.
The Basis: Medium of Exchange
Before a good can be considered money, it must first serve as a medium of exchange and become so through a market process of production, subjective value, and exchange. This necessarily also provides the basis for money to be a meaningful unit of account and a “store of value” (though the term is not fully appropriate). The Mengerian theory of money, refined by Mises and Rothbard, has been extrapolated more fully elsewhere; however, in brief, it posits that money emerges spontaneously from barter as market participants increasingly prefer more marketable goods as media of exchange, eventually producing a generally-accepted medium of exchange. These goods tended to have certain characteristics—scarcity, divisibility, portability, durability, recognizability, fungibility, high value per weight, etc.
Because of its function as a medium of exchange, money enables possibilities in an economy that would have previously been impossible or impracticable. Mises, however, argues that money is simply and solely a medium of exchange,
Money is a medium of exchange. It is the most marketable good which people acquire because they want to offer it in later acts of interpersonal exchange. Money is the thing which serves as the generally accepted and commonly used medium of exchange. This is its only function. All the other functions which people ascribe to money are merely particular aspects of its primary and sole function, that of a medium of exchange.
In fact, Mises describes, with some frustration, how many are unsatisfied with understanding the origin of money and that it is only a medium to facilitate the exchange of goods and services. He says that they are not satisfied “until they have enumerated half a dozen further ‘functions’” for money. On this, Mises writes further,
After Menger’s review of the question, further discussion of the connection between the secondary functions of money and its basic function should be unnecessary. Nevertheless, certain tendencies in recent literature on money make it appear advisable to briefly examine these secondary functions—some of them are coordinated with the basic function by many writers—and to show once more that all of them can be deduced from the function of money as a common medium of exchange.
Mises’s emphasis was that these other functions of money, beyond being a medium of exchange, were secondary to and dependent on money being a medium of exchange. For example, being a medium of exchange, money can also be used as a unit of account, a “store of value,” enable economic calculation, etc. All this can be deduced from its being a medium of exchange.
To be fair, most of us do not have the intellectual foresight of Mises, complete with the ability to logically deduce necessary consequences of money as a medium of exchange, so it is worth teasing out how a medium of exchange enables these secondary functions, and Mises arguably would have agreed since he often did just that. His point concerned overcomplicating money’s primary role as a medium of exchange such that the secondary functions of money might come to be mistakenly understood as primary, independent attributes of money. In other words, the primary function as a medium of exchange could easily become disconnected or even lost in the minds of people, fundamentally misunderstanding the nature and role of money. Arguably, this is exactly what has occurred with focusing on money as a unit of account and a store of value.
Unit of Account
“If we determine that a Dollar shall be our Unit, we must then say with precision what a Dollar is.” — Thomas Jefferson
Too often, money is treated as though it were simply an abstract unit of account—a common monetary unit in which prices, values, debts, and economic calculations are expressed and compared—but an abstract unit alone cannot perform this function. A unit of account must be a unit of something.
Imagine that a moneyless barter economy was told—either by an inventive individual, societal compact, or the political state—that they could start using “points” as a unit of account. From here on out, all exchange-ratios between goods and services could be denominated in “points,” which would allow meaningful comparisons of the exchange-ratios between goods and services.
The problem—if not immediately obvious—is that the “points” have no defined meaning or content. Therefore, “points” cannot act as a medium of exchange, possess purchasing power, transfer value through time, or provide a meaningful common denominator for economic calculation. Declaring that an apple is worth “two points” and a pair of shoes “one hundred points” does not explain what either price means or establish the exchange relationship between the goods. This is often how dollars are treated—just fiat accounting devices with no fixed definition.
The only way to ground such a unit of account without its having previously-acquired exchange value as a market-chosen medium of exchange is to externally establish what quantities of the unit correspond to what quantities of goods—that is, through some system of stipulated prices. This is what takes place in a game like Monopoly, where the “money” has meaning within the game because the rules provide a preestablished schedule of prices. This is how chartalism and Modern Monetary Theory (MMT) think of money within modern systems.
Both Mises and Rothbard argued forcefully that money cannot be an abstract unit of account independently of its role as a medium of exchange. In fact, they rarely used that terminology. When used, however, it was put in sequence and context. For example, Rothbard wrote,
Because gold is a commodity medium for all exchanges, it can serve as a unit of account for present, and expected future, prices. It is important to realize that money cannot be an abstract unit of account or claim, except insofar as it serves as a medium of exchange.
This is a crucial logical point. The unit of account function is derivative—it flows from and depends upon the medium of exchange function, and cannot exist without it. Money serves as a common denominator for prices precisely because it is the thing actually used in trade. If something ceased to circulate as a medium of exchange, it would quickly lose its usefulness as a unit of account as well. An abstract unit of account with no grounding in a real medium of exchange is therefore not just practically problematic but theoretically impossible as a starting point. Rothbard writes, “Money does not ‘measure’ prices or values; it is the common denominator for their expression. In short, prices are expressed in money; they are not measured by it.”
Rothbard also spoke of “bizarre schemes. . .for a separation of money as a unit of account from media of exchange. . .” Such a separation and such a view of money leads to all sorts of other errors. For example, chartalism and Modern Monetary Theory (MMT) basically assert that money is just a state-provided fiat-token that simply acts as an independent unit of account. As such, money is simply an accounting fiction and becomes a policy instrument of the state. The mainstream failure to understand the true nature of money, and the assumption that it is just a unit of account, favors inflationism by which central banks and governments can simply inflate and change the definition of the unit because it has no fixed meaning. As this process of inflationism becomes normal, terms like “dollar” and “pound” lose their defined meanings and the true nature of money becomes obscured further.
“Store of Value”: Expected Future Purchasing Power
The term “store of value” is itself subtly misleading. Value in economics is subjective and personal, relative to one’s ends and the scarce means available; it cannot be literally stored in a concrete good. Instead, it is more accurate and precise to speak of a good that has expected future purchasing power or exchange-value.
After clarifying, it becomes obvious that, logically, the possibility of using a good in exchange due to the expected current and future valuations of others regarding that good allows a medium of exchange to serve as a so-called “store of value.” While wisely not using this standard terminology, Mises did recognize this key secondary function of money,
[Money] is the most marketable good which people acquire because they want to offer it in later acts of interpersonal exchange. (emphasis added)
Therefore, Mises recognized that—as in all actions—there is an essential element of time involved. Mises insightfully pointed out that the future anticipation of the purchasing power of money was connected to its immediate past, as well as the current supply and demand for money in the present. He writes,
A medium of exchange without a past is unthinkable. Nothing can enter into the function of a medium of exchange which was not already previously an economic good and to which people assigned exchange value already before it was demanded as such a medium.
But the purchasing power handed down from the immediate past is modified by today’s demand for and supply of money. Human action is always providing for the future, be it sometimes only the future of the impending hour. He who buys, buys for future consumption and production. As far as he believes that the future will differ from the present and the past, he modifies his valuation and appraisement. This is no less true with regard to money than it is with regard to all vendible goods. In this sense we may say that today’s exchange value of money is an anticipation of tomorrow’s exchange value. The basis of all judgments concerning money is its purchasing power as it was in the immediate past.
There is a forward-looking, anticipatory element in every act of spending, holding, and accepting money in exchange. The reason money can function as a so-called “store of value” is—like the unit of account—because it is already a medium of exchange. Writes Mises,
The functions of money as a transmitter of value through time and space [i.e., a “store of value”] may also be directly traced back to its function as medium of exchange. Menger has pointed out that the special suitability of goods for hoarding, and their consequent widespread employment for this purpose, has been one of the most important causes of their increased marketability and therefore of their qualification as media of exchange. As soon as the practice of employing a certain economic good as a medium of exchange becomes general, people begin to store up this good in preference to others. . . . On the other hand, money still functions today as a means for transporting value through space [and time]. This function again is nothing but a matter of facilitating the exchange of goods. (emphasis added)
What exactly is the person anticipating when they accept a more marketable good in exchange for something? If they do not intend to consume it directly, they are anticipating that other people will also accept it later, either to consume or to use it again as a medium of exchange. The expectation is fundamentally about the good’s continued marketability and exchangeability, not value stored in a concrete good.
While the concepts of medium of exchange and store of value may overlap in time practically, they are not simultaneous in the order of causation. The medium of exchange function is logically and causally prior. The store of value function, properly understood, is therefore still derivative of the medium of exchange function—even when we fully acknowledge the anticipatory and forward-looking character of every monetary transaction.
