Study Guide to the Theory of Money and Credit

Chapter Outline

1.   Money in the Socialist Community

If a socialist society completely abolishes all property rights and distributes scarce goods and services according to a central plan, then there is no scope for even direct exchange (let alone indirect exchange) and therefore no room for money.

However, some socialist visionaries concede that even in their ideal society, people would retain ownership rights in personal consumption goods such as cigarettes, apples, loaves of bread, sweaters, and so forth. In this case, people would naturally engage in mutually beneficial trades, and ultimately would foster the development of money.

2.   Money Cranks

Throughout the ages, reformers have blamed money for social ills. (The love of money is famously declared to be the root of all evil.) The hostility to gold and silver is particularly intense. Yet these reformers never explain their full vision of a world without money, for if they attempted such a description, the problems with their schemes would be obvious.

Other critics do not call for the abolition of money per se, but merely for an “elastic credit system,” which expands or contracts the money supply according to the community’s “need for currency.” According to this particular group of money cranks, the current money and banking system imposes an artificial scarcity by restricting credit and charging higher interest rates than necessary.

Technical Notes

•   Some socialists viewed money itself as a “dirty” product of the market economy, and believed that in a pure socialist society, there would be no need for it. However, as Mises explains, some of the more sophisticated theorists imagined that the workers in a socialist community would have property rights in consumption goods (and perhaps personal tools of the trade for skilled artisans etc.). However, what cannot be allowed in a socialist community—lest it become a system of capitalism—is private ownership in the large-scale means of production, such as farmland, factories, railroads, etc.

•   Mises concedes that a socialist community that retained private ownership in personal consumption goods, could foster the emergence of genuine money. However, Mises is not here referring to the “labor certificates” envisioned by some socialist theorists. For example, we could imagine that socialist factory and farm managers hand out one certificate for every labor hour (of suitable quality) that each worker performs. Then, once the “crop” of output goods has been “harvested” from all the various factories and farms—including not just bottles of milk but also television sets and basketballs—the socialist leaders determine what fraction of the crop each certificate entitles the bearer to, based on the size of the harvest and the total number of certificates that were issued. Although many casual observers think that this is basically what money is—a claim on the “real output” of society—such a view is very superficial. Actual money (as opposed to a money substitute) is not a claim on anything; it is its own good, but of course it is valued because of its expected purchasing power. If a fire destroys half of the crop, then the labor certificates will necessarily entitle their holders to one-half as much. But with one unit of money, it is not necessarily true that its exchange value in the market would drop by exactly one-half, and in any event the processes governing its purchasing power are completely different from those governing the “redemption power” of a labor certificate in a socialist community.

•   When dealing with the last category of “money cranks” on page 94, Mises explains that the mainstream economists of his day could not effectively refute those who claimed that a massive expansion of the money supply—in order to drive the interest rate down to zero—would bring about material abundance. Although most economists and practical businessmen shied away from such extreme proposals, they were merely the logical extension of the prevailing economic doctrines concerning money and banking. It would take Mises’s own work, in particular his development of the circulation credit theory of the trade cycle, to adequately explode this variety of monetary crankishness.

New Terminology

Circulation credit theory of the trade cycle: The theory developed by Mises (in the present book) explaining the boom phase of the business cycle as due to the artificial expansion of bank credit, made possible by fiduciary media. The bust is then inevitable, as capital goods are malinvested during the boom.

Money cranks: Very naïve writers who believe that scarcity is an artificial institutional constraint, and that prosperity requires only a sufficient willingness to create more money and/or issue more bank credit.

Study Questions

1.   What two trends cause the emergence of indirect exchange to become inevitable? (p. 91)

2.   Would the isolated household use money? Why or why not? (p. 91)

3.   Do all socialists propose the complete abolition of money? (p. 91)

4.   If the amount of “real output”—number of apples, TVs, heart surgeries, etc.—were to fall in half, would the purchasing power of money necessarily fall in half? (p. 92)

5.   Does Mises endorse the banking theories of Tooke and Fullarton? (p. 94)