Theory of Money and Fiduciary Media

2

Amadeus Gabriel

Why was the Reception of the First Edition of Mises’s Theory of Money and Credit so Lukewarm?

1. Introduction

The German monetary theorists of the nineteenth century are virtually unknown in English-speaking countries. And yet, their influence on the work of great economists like Carl Menger, Joseph Schumpeter, or Alfred Marshall cannot be denied.1 This is also true of their influence on Ludwig von Mises. This paper addresses the question if—and in what way—the German monetary theorists were the forerunners of Mises’s first edition of Theory of Money and Credit. Likewise, this paper will not only focus on their influence, but also on the similarities and differences of their theoretical approaches regarding monetary theory. This evaluation will shed light on why the response to his treatise was so lukewarm in the German-speaking world. In the late 1920s, looking back on the reactions to the first edition of 1912, Mises wrote:

Sixteen years ago when I presented the circulation credit theory of the crisis in the first German edition of my book on The Theory of Money and Credit (1912), I encountered ignorance and stubborn rejection everywhere, especially in Germany. (Mises 2006, p. 54)

In his memoirs (1978), Mises dedicates a whole chapter to Theory of Money and Credit and states that “as could be expected, my book was rejected summarily by the journals of the German social sciences” (Mises 1978, p. 61). In his book, he had bluntly stated that he did not appreciate the work of most of his German colleagues. That was certainly not conducive to a warm reception by German academia at the time.2

Neither the lukewarm reception of Theory of Money and Credit nor Mises’s view of the value of German monetary theory are justified. The leading German monetary theorists of the ninteenth century were Carl Knies, Karl Heinrich Rau, Wilhem Roscher, and Adolph Wagner,3 and all made significant contributions to monetary theory. The works of the economists who came next, Menger, Schumpeter, and Marshall, were heavily influenced by these earlier theorists,4 as was Mises himself (Mises 1912, p. 441). So to say that Menger single-handedly revolutionized the way in which monetary theory is examined, as Mises does, may not be appropriate (Mises 1912, p. 408).

In this paper, I analyze the theoretical similarities and differences in Mises’s work concerning such topics as the nature of money, the value of money, the quantity of money, the redistribution effects of money productions, banks of issue and the consequences of uncovered paper money, and the necessity for a central bank. The similarities help us to understand why Mises’s assessment of German banking theories is partly unjust.5 The differences shed light on the question as to why the first edition of his treatise on monetary theory was rejected by German academia. Many of these ideas were welcomed, when they were first put forward by older German economists of the nineteenth century.

Most German economists of the older generation did not explain the nature of money by the existence of conventional agreements. They were aware of the establishment of money as a natural fruit of indirect exchange and its role as a common medium of exchange. Likewise, Mises’s famous regression theorem can be found similarly expressed in the writings of these economists. The dynamics of fiduciary media and its dangers were not unfamiliar to the older German theorists either. Mises’s approach to state intervention in the banking system and his skepticism about its effectiveness were totally shared by the younger Adolph Wagner.6

The main theoretical difference between Mises and the older generation of German economists is the treatment of the socially optimum amount of money. Whereas German economists propose an approach, where the velocity is the main explanatory variable, Mises claims that every amount of money is optimal for the needs of society. When the Theory of Money and Credit was first published most German economists were in favor of central banking. Mises was skeptical about central banking and its function, only becoming a full-fledged advocate of free banking with the publication of the second edition. Considering the favorable light in which central banking was esteemed by the political environment and advocated in policy, the rejection of the first edition can be understood and maybe expected. Things changed after World War I. The former scientific authorities in monetary theory rapidly lost their reputation when the implementation of their policies led to disastrous developments in Germany. Not surprisingly, the second edition had a more favorable reception.

The paper is structured as follows. We first analyze the literature pertaining to the nature of money (Section 2), and then deal accordingly with the determination of the value of money (Section 3); the optimal quantity of money (Section 4); the redistributive effects of money production (Section 5); the consequences of uncovered paper money (Section 6); as well as the necessity of a central bank (Section 7). We present our conclusions in the final Section 8.

2. The Nature of Money

One of the great insights of Austrian monetary theory is that money had to be a commodity in the first place and not just some sort of numeric value. Mises points out in several places that a commodity can never become money just because the state decides to attribute a value to it. Money is the fruit of indirect exchange (Mises 1912, p. 45). The spontaneous emergence of money becomes necessary as the division of labor increases and wants become more refined (Mises 1912, p. 5). Individuals only choose indirect exchange when the goods they can acquire are more marketable than those which they surrender.

The most marketable commodities will become common media of exchange and their position is strengthened as their relative marketability increases in comparison to other commodities (Mises 1912, p. 6). The main function of money is its universal use as a general medium of exchange (Mises 1912, p. 7). The secondary functions of money can mostly be neglected and deduced from its function as medium of exchange. As Mises says:

The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. (Mises 1981, p. 46f.)7

As mentioned earlier, goods can only become a common media of exchange through their use by those who take part in commercial transactions (Mises 1912, p. 59). For this purpose, it would not be appropriate to attribute the function of money—money being always an economic good—to a certificate which constitutes only a claim.

One might say that Mises’s statements on the nature of money are simply the integration of Menger’s ideas formulated in his famous essay on the origins of money, thereby reflecting Menger’s influence on Mises. Menger’s paper was written in 1892. In his treatise, Menger denounces Roscher as being among the economists who believe that the medium of exchange has been established by general convention or law and points out, referring to the convention claim, that “even the more modern developments in the theory of money have not in substance got beyond this standpoint.” (Menger 1892, sec. II) I will show that not all German economists of this time can be put into this category and the statement is an oversimplification. Many arguments of nineteenth-century German monetary theorists can be found within Menger’s work on money.

As a consequence, Mises was perhaps not influenced directly by these German economists, but rather indirectly by Menger’s work. German theorists before him had also recognized the spontaneous emergence of money. Knies points out that money is the natural fruit of indirect exchange, but at the same time refuses to recognize the need of conventions in order to establish money.

As Knies puts it:

The use of money is not the result of one special agreement between human beings and not the consequence of a law by the state. It actually originates everywhere as a natural fruit of exchange. (Knies 1873, p. 107)8

Hence, if an object has been chosen as the new general medium of exchange, it is not due to some arbitrary judgment. Rather, it is the flexible and durable commodity which is highly demanded for its properties. It naturally becomes the most marketable commodity and serves to set the standard of value of the other commodities (Knies 1873, p. 108). Money, in the sense that some “economic” value is estimated or measured, has to be a commodity of great value (Knies 1873, p. 114). Knies’s stance on the concept of objective exchange value does not really differ from Mises’s,9 but this aspect will be analyzed more precisely in the next section. But how did the other German economists define money?

Roscher’s definition of money differs from that of Knies. Roscher believed that money needs the approval of the state, as a medium of payment, in order to bring a commodity as money to perfection (Roscher 1854, p. 222).10 The development of money circulation goes hand in hand with that of personal freedom (Roscher 1854, p. 227). Only commodities with a generally accepted value have become money (Roscher 1854, p. 229).

Rau assumes that direct exchange is rare and after the introduction of money, indirect exchange divides a single transaction into two separate parts. These two parts consist of acquiring a desired good through the use of a more marketable good, in other words, by purchasing and selling the more marketable good (Rau 1868, p. 317). He describes the spontaneous emergence of money by the following procedure:

One must therefore assume that a generally popular and sought after commodity was even more frequently accepted by persons who did not want to use it themselves; in this way it obtained gradually the nature of money and the utility emanating stepwise from this kind of use was recognized more clearly. (Rau 1868, p. 317)11

Knies emphasizes that money by itself is not one function. Rather, it is the function of an economic commodity that is used for some special purpose (Knies 1873, p. 163). Claims cannot be qualified as money (Knies 1873, p. 164). Money must be a real commodity and not only a numeric value (Knies 1873, p. 182).

Furthermore, Knies attributes to money the role of a local transmitter of value through time and space (Knies 1873, p. 223). Mises criticizes this approach and claims that this function can also be traced back to its very existence as a common media of exchange (Mises 1912, p. 11).

The concept of hoarding can also be found in the work of Knies.12 Hoarding is an artificial problem (Knies 1873, p. 211) because money can never lie idle. Mises and Knies share this viewpoint and emphasize that all money addresses itself to the service of a monetary function (Knies 1876, p. 284; Mises 1912, p. 61).

The famous threefold division into means of production, objects of consumption, and media of exchange by Mises has actually its origins in Knies’s writings (Knies 1873, p. 20). Mises regrets that Knies’s arguments on this were sloppy and thus attracted hardly any attention (Mises 1912, p. 70). Mises develops this point and the threefold division becomes part of his monetary analysis.

3. Value of Money

German economists of the nineteenth century generally do not believe that conventions or the like are necessary for the establishment of money. The similarities in the approaches of Mises and the these German economists go even further.

Roscher and Rau derive the exchange value of commodity money from its natural scarcity and aesthetic properties (Rau 1868, p. 340; Roscher 1854, p. 235). The use value of the employed commodity determines its exchange value. The original use value of the non-monetary employment gets less important as the commodity becomes the common media of exchange (Roscher 1854, p. 239). Roscher uses the concept of supply and demand for money to determine its value (Roscher 1854, p. 241). Rau emphasizes that the good, which is now used as money, had to have a generally accepted value in the past, a value derived from its market value when it was still a commodity (Rau 1868, p. 317).

Similarly, Knies argues that the objective exchange value of money, which already existed due to its past use as a precious metal, obviously determines its objective exchange value as a medium of exchange (Knies 1873, p. 141). Wagner concurs (Wagner 1857, p. 37).

These observations by Knies, Wagner, and Rau are especially interesting in light of Mises’s explanation for the value of money, also known as the regression theorem. The regression theorem states that one traces back the objective exchange value of money only to that point where it ceases to be the value of money and becomes merely the value of a commodity (Mises 1912, p. 128). Mises’s approach was an extension of Wieser’s (1903) who argued that one has to go back in time to when money was still a commodity in order to understand the circularity problem of the value of money, which had been pointed out by Helfferich.

Most of the components of the regression theorem13 can be found in the writings of Knies and Rau and are simply a refinement of existing ideas.

Knies and Wagner assert that a new demand for the service of precious metals is added to its previous demand for its services as jewelry, etc., as soon as it becomes the common medium of exchange. The two demands together determine the price for its use as money, as well as its use for other services (Knies 1873, p. 141; Wagner 1857, p. 38).

Mises points out that the value of money is determined by both its industrial employment and its monetary employment. However, it is impossible to say to which extent the value of money is influenced by one or the other (Mises 1912, p. 105).14

The notion of subjective valuations is not explicitly used by Knies, but he observes that the objective exchange value is determined by individuals who take part in commercial transactions. As a consequence, a governmental decree as such is insufficient to ascribe an objective exchange value to a commodity. As Knies puts it:

Can a governmental authority, even if it were the most violent and the most persistent, attribute an exchange value to an object, which has no exchange value at all for the human beings that take part in the commercial life? (Knies 1873, p. 189)15

Knies adds the following remark a little further on in his text:

The government authority could declare just as well that a mountain is twice as high as it is in reality or that two pounds are actually six pounds. (Knies 1873, p. 189)16

Knies denounces that the law considers the value of money as being invariable and constant, whereas in fact no economic good has a stable value (Knies 1873, p. 318).17 Mises clearly sympathizes with this point of view and insists that money can never be stable but “for the law, invariability of the value of money is not a fiction, but a fact” (Mises 1981, p. 227).18 This is an important insight.

4. Quantity of Money

German monetary theorists agree that velocity is the most important explanatory variable for determining the money supply.19 Roscher asserts that the optimal quantity of money cannot be determined either as a function of the population figures or as one of the national income (Roscher 1854, p. 242). The transition from a medieval barter economy to the commercial monetary system necessarily implies a need for a higher quantity of money. One taler that circulates ten times performs the same services as ten talers that circulate just once (Roscher 1854, p. 242).

Rau takes a similar stance. The more a piece of money circulates between participants in commercial transactions, the more goods and services can be bought and a smaller quantity of money is needed in order to fuel commerce (Rau 1868, p. 323). Rau actually formulates in a footnote an equation which corresponds to Irving Fisher’s identity of exchange which shows the concept of velocity and the quantity of money.20

Knies is less clear about the optimal quantity of money. He agrees with Rau and Roscher that a unit of money can render more services if its circulation increases. For example, a coin that changes hands three times does the same service as three coins that circulate just once (Knies 1873, p. 180). The general opinion is that the more the money circulates the less quantity is required and vice versa.

Wagner, as a follower of Tooke, describes the money supply as the effect of money demand and not as the cause of it (Wagner 1857, p. 122). If the money supply increases, it is a result of more commercial activity causing prices to rise and not the cause as is put forth by the Currency School (Wagner 1857, p. 127). For instance, if the price of wheat increases due to a bad harvest, then the money supply has to increase (Wagner 1857, p. 128).

The scenario portraying the German theorists as being the predecessors of the quantity theory is not very enlightening with regard to how the socially optimal quantity of money is determined. Generally speaking, concepts of the social need of money are pretty imprecise and elusive. None of these German economists is capable of expressing a clear opinion about the social demand of money within the framework of a national economy. Actually, they seem to avoid direct consideration of this, referring to “the demand of the medium of payment for the commerce” without specifying anything in a precise manner. One desperately seeks a definitive predication, such as can be found in the works of the early Austrian economists.21

These points of view can clearly be distinguished from those of Mises. Mises’s criticism of the quantity theory and, in particular, its concept of velocity is well known (Mises 1912, p. 142). The arguments of the quantity theorists are too mechanical and their assumption that modifications in the value of money must be proportionate to changes in the quantity of money is not in accordance with empirical facts (Mises 1912, p. 139).

Rather, Mises derives the basis of the demand for and stock of money in the whole community by observing that as long as there are no money substitutes in use, the social demand for money and the social stock of money are merely the respective sums of the individual demands and stocks (Mises 1912, p. 145). Later in his text he further specifies the case when money substitutes are issued:

It is thus obvious that a community’s demand for money in the broader sense cannot be the sum of the demands of individuals of money and money substitutes, because the money that serves as a cover for them as the banks and elsewhere is to count the same amount twice over. (Mises 1981, p. 156)22

With regard to the socially optimal quantity of the money, Mises’s statements are articulated in a forthright way. As Mises writes:

In the first place, it must be pointed out that the levels of the total stock of money and of the value of the money unit are matters of complete indifference as far as the utility obtained from the use of the money is concerned. Society is in enjoyment of the maximum utility obtainable from the use of money. Half of the money at disposal of the community would yield the same utility as the whole stock, even if the variation in the value of the monetary unit was not proportioned to the variation in the stock of money. (Mises 1981, p. 165)23

This clear opinion, however, was put forward with some reservations.24 For instance, he states that the need of money depends on the degree of modernization of a society, the season, and other magnitudes (Mises 1912, pp. 341–70). Similarly, he claims that there can be a lack of fiduciary media (Mises 1912, e.g., pp. 345, 350) which suggests that not every quantity of money is sufficient for the economy. This sort of explanation can already be found in the works of Roscher and Rau as I mentioned before.

5. Redistribution Effects of the Production of Money

It may be appropriate here to briefly outline the principle of money redistribution: The new money that enters the market affects the dynamic adjustment process. Richard Cantillon25 recognized that the demand schedules of those initially affected by the monetary disturbance change before the demands of those who receive additional money balances only as the effects of the monetary change spread through the economy. This phenomenon results in a redistribution of income and wealth in favor of those who are close to the source of money production and at the expense of those who are among the final links of the redistribution chain.

Actually, one of the most important points of Mises’s critique of the production of credit money is the redistribution effect of this procedure. He states that the new money always increases the quantity of money as it is disposed of by individual agents (Mises 1912, p. 150) and the increase in the quantity of money does not mean an increase of income for all individuals (Mises 1912, p. 152). Even if the increase of money was the same for every person, this would not necessarily mean a uniform price increase since the structure of demand is affected during every process of money production (Mises 1912, pp. 153–54).

Knies points out that the economy is dynamic and the prediction of the modifications of economic situations is generally impossible (Knies 1876, p. 135). He contradicts himself when he emphasizes that changes in prices due to the modifications of the quantity of money are only temporary and are likely to be adjusted by those who are involved in the commercial transactions (Knies 1876, pp. 321, 326).

Rau shows that entrepreneurial profits increase as a result of the increase in the money supply. Consequently, there are incentives to expand production, and this in turn dampens the price increase. Rau observes that those higher entrepreneurial profits go in hand with “the affliction of other social classes” (Rau 1868, p. 330). The higher commercial activity (due to the new money) is only for the public good as long as it provides the basis for an increase in production. Otherwise, those who sell goods receive advantages as a result of the additional expenditure of other citizens (Rau 1868, p. 375).

Mises’s approach is similar. Money production per se cannot improve the welfare of the people except for the case of a production increase (Mises 1912, p. 235). Rau is less restrictive and states that an increase of the quantity of money always has a positive impact in the beginning of the process. Nevertheless, Rau clearly observes the redistribution effects of money production:

. . . [C]onsequently the price of the different goods in commerce cannot increase in the same proportion, some earlier and stronger, others later and weaker; many maladjustments arise, several win, others namely the holders of big sums of money, the creditors, the employees lose considerably. (Rau 1868, p. 378)26

As does Mises, Knies denounces governmental measures which aim at improving the situation of debtors at the expense of the creditors (Knies 1873, p. 250). He points out the absurdity that we are still surrounded by “the delusion as if the creditor were a rich, otiose senior citizen and that it would be necessary to relieve the burden of the poor, living in bitter misery, by hook or by crook” (Knies 1873, p. 250). Wagner, too, was perfectly aware of the redistribution effects of fiat money. He observes that unredeemable bank notes are a means for first receivers to enrich themselves at the cost of the last receivers (Wagner 1857, p. 83).

Similar to Mises, Rau observes that an increase in the quantity of money by 1 or 2 percent can actually be a large sum, but the consequences would not be remarkable since the ones who take part in the commercial transactions do not perceive it to the same extent (Rau 1868, p. 329). This explains the unjust enrichment of those in charge of the issue of money at the expense of the people who don’t notice a modification of the quantity of money in the first place.

Knies explicitly mentions creditors as being the undeserved losers of “legal tender unredeemable paper money”27 and that this should be emphatically denounced (Knies 1873, p. 285).28 It is the creditor and not the debtor who bears the risk. Knies and Mises agree that this is also true in the case of bank notes where the holders, i.e., creditors of the bank, bear the risk of their credit. In this case the debtor, i.e., the bank, makes its profits by receiving the bank notes without paying interest (Knies 1873, p. 306; Mises 1912, p. 312). Without a doubt, these banks of issue benefit from the issue of notes (Knies 1876, p. 319).

Knies provides an explanation for the favoritism of the debtor at the expense of the creditor. Debtors benefit from better treatment since they are represented by the government (Knies 1873, p. 207); the largest debtor, though, is the state itself via the issue of governmental bonds that offer very favorable conditions to the creditors (Knies 1873, p. 143). If they ever get paid back, it is a long time coming (Knies 1876, p. 144).

6. Banks of Issue and the Consequences of Uncovered Paper Money

Knies is mistrustful of the banks of issue. The issuance of paper money must be legally restricted to guarantee the money at par. Compliance with regulations cannot be assured if it depends solely on individual attitudes and the short-sighted will of statesmen (Knies 1873, p. 279).

Similarly, Rau thinks that confidence in the government is an essential factor. Government attempts to avoid depreciation and to limit the losses for the receivers of money (Rau 1868, p. 379). He prefers redeemable paper money to unredeemable paper money since the issuance of an enormous quantity of fiat money is highly probable. Experience shows that the issuance of fiat money was always tempting and the consequences were always confusing for commerce (Rau 1868, p. 381). The lower the proportion of paper money is in comparison to the total quantity, the smaller is the danger of abuse (Rau 1868, p. 381).

As does Rau, Knies points out that it is much easier to refrain from a substantial issuance of paper money than to recover from it. The population always fears that the state benefits from its position and procures financial aid in the case of an emergency through the issue of notes (Knies 1873, p. 279). “The money supply is determined by the financial requirements of the government, rather than by the needs of the national economy” (Knies 1873, p. 208).

Knies cites a French incident from the first quarter of the eighteenth century to make his point. In this case, the “infinite fruitfulness of a paper press” (he uses this expression in an ironic way) and its consequences were clear, but in spite of everything, masses of supporters for this sort of procedure could still be found throughout that century (Knies 1876, p. 66). Knies describes the perpetual circulation of “depreciated paper money” as one of the worst plagues that could infest a national economy (Knies 1873, p. 281). The issuance of paper money is especially handy for the “weak, restricted, selfish and frivolous statesman” (Knies 1873, p. 274). He even develops a sort of business cycle29 which is likely to be caused by the issue of unredeemable paper money. As Knies puts it:

Suddenly one is exposed to the demoniacal rule of insuperable accidents, which one had once learned to perceive as a characteristic feature of “barbaric” economic conditions. Property and commerce become uncertain, even though the police and the courts continue their work as usual. Efforts made along time-tested paths, intense work in the pursuit of well-known objectives are paralyzed, and the floodgates are widely opened to the “adventurers.” Even the profits that result from calculated foresight are acquired only at the expense of others. No-one is grateful to the government for his undeserved profit, and everybody accuses it for his undeserved losses. Was it not one of the government’s most important missions to vouch for the soundness of money? But how often has this already been said! How much to the point, how congruently have the consequences of depreciated paper money been perceived! (Knies 1873, p. 282)30

Similarly, Knies analyzes the consequences of the overissue for the value of paper money:

The paper money that has become subject to price fluctuations has become a medium of exchange whose market value should be established anew by every acceptor, whereas the great bulk of the population is unable to carry out such examinations. (Knies 1873, p. 284)31

The existing problems of price fluctuations are augmented with the uncertainty about the value of future payments. This is not brought about by fluctuations of value and price measures, but by the value fluctuations of the imposed media of exchange whose amount is also measured in money (Knies 1873, p. 284). Thus, there is a tendency toward the reduction of objective exchange value as has been pointed out by Mises (Mises 1981, p. 331). As Mises writes:

If the fiduciary media are perfect substitutes for money and do all that money could do, if they add to the social stock of money in the broader sense, their issue must be accompanied by appropriate effects on the exchange ratio between money and other economic goods. (Mises 1981, p. 349)32

The effects of the uncovered notes also reach those who can deny the acceptance of all notes (Knies 1873, p. 311). Similarly, Mises describes it in the following way:

The fact that is peculiar to money alone is not that mature and secure claims to money are as highly valued in commerce as the sums of money to which they refer, but rather that such claims are complete substitutes for money, and, as such, are able to fulfill all the functions of money in those markets in which their essential characteristics of maturity and security are recognized. It is this circumstance that makes it possible to issue more of this sort of substitute than the issuer is always in a position to convert. And so the fiduciary medium comes into being in addition to the money. (Mises 1981, p. 300)33

In addition, Knies points out that by the use of claims, people forget about their real nature, i.e., claims for money which can be redeemed at the bank (Knies 1873, p. 304). Similar, Mises declares:

The immediately convertible note of a solvent bank is employable everywhere as fiduciary medium instead of money in commercial transactions, and nobody draws a distinction between the money and the notes which he holds as cash. (Mises 1981, p. 305)34

Governmental authorities have always used deposits to secure credits. Moreover, they accept the losses of the note holders if it helps to avoid the bankruptcy of the debtor (i.e., the national banks) (Knies 1873, p. 309). Knies denounces several times the idea of an interest free loan through the issuance of bank notes. This is a complete “abnormality” in the private loan sector (Knies 1873, p. 310). However, the bank of issue engages into this sort of business (Knies 1873, p. 311). That’s why Knies prefers the constrained note issuance to one without limits even if it is not the perfect solution (Knies 1873, p. 312).

Likewise, Knies is opposed to the issuance of unredeemable paper money in combination with credits. Any deals that involve sums of money whose value equivalence cannot be guaranteed are likely to entail arbitrary gambling and betting about losses and profits determine the outcome (Knies 1876, p. 142).

Wagner is of the opinion that credits cannot create money. Banks should always have enough reserves to redeem the notes (Wagner 1857, p. 73). The devaluation of money is made possible by the introduction of fiat money (Wagner 1857, p. 96) and that is why bank notes must be redeemable at any time (Wagner 1857, p. 97). However, the same applies for deposits as they feature the same characteristics as bank notes (Wagner 1857, pp. 163, 214). Under the banking system with voluntary reserve ratios, there are no problems for the banks to fulfill the redemption demands of their clients. Under the new system with required reserve ratios, banks go bankrupt (Wagner 1857, p. 220).

Wagner already anticipated to some extent Mises’s critique of the Currency School which failed to treat bank notes and deposits as a form of money (Mises 1912, pp. 43–48). Like Mises, Wagner claims that the physical characteristics of money is not important. Metallic and paper money are not really different in his opinion (Wagner 1857, p. 99).

Mises’s insight, that banks of issue can diminish the interest of the loan market, in the short run, via the issue of new money (Mises 1912, p. 358) had been observed by Rau in a similar manner:

Given that the supply of goods cannot be increased quickly enough during a substantial increase in the quantity of money, the prices must increase as a consequence and this is perceived as a difficulty to invest the new money in an advantageous way that arranges for the rate of interest to decrease during a certain period. (Rau 1868, p. 375)35

Rau believes that banks of issue should have the freedom to issue three to four times more notes than they keep as a reserve in order to increase the profits of the banks (Rau 1868, p. 384). However, he perceives the danger for banks if they grant loans in a less cautious manner than capitalists normally do, thus giving incentives to undertake risky projects.

I have demonstrated that the viewpoint of German economists about the banks of issue and the consequences of issuing uncovered paper money are similar to those of Mises. However, they do not necessarily share the same opinion about the necessity of a central bank.

7. The Necessity for a Central Bank

As one would expect, Knies asserts that the minting and issuing of money is the vocation of the state, i.e., its right and its duty (Knies 1873, p. 293). It is now even more important than in the past that the state guarantees the soundness of the national money, even if it is necessary to collect taxes to cover the expenditures (Knies 1873, p. 292). Knies is totally opposed to the idea of competing banks and compares it to the establishment of weights and measures. Knies writes:

Everybody concedes right away that it is unacceptable for sellers to enjoy the “liberty” of using different weights and measures, and that no buyer of a commodity should suffer harm due to the unreliability of weights and measures. Indeed, not everybody has the right to provide the weights and measures that shall be used in general commerce. Neither may private persons be entitled to provide those “weights and measures” of value, which shall be used in all spheres of the economic and legal life of a nation, in competition with the government. (Knies 1873, p. 294)36

Knies is a supporter of the Peel system and condemns the principle of free banking. However, Knies has a nuanced point of view. On the one hand, he is convinced that the state’s issue of uncovered paper money is unjust. On the other hand, the legal authorization for private banks to engage in this business is inappropriate and must be condemned (Knies 1873, p. 297). Similarly, the practically costless issuance of bank notes makes free banking impossible (Knies 1873, p. 313).

The common man does not distinguish between private paper money and state paper money. Private banks can issue (quasi-) legal tender notes with the aid of the state and everybody must accept them whether they want to or not (Knies 1873, p. 305). Moreover, Knies thinks that money is of public utility. He points out that “the issue of the notes which have actually come into use as money is not the task of the private industry that aims at entrepreneurial profits” (Knies 1873, p. 306).37

Knies’s feelings about currency competition in a bank note system are rather negative as well. He was in favor of uniform circulating notes that were used in the single states of Germany at the time when he wrote his book. His comment is quite harsh:

One cannot alter the diastrous heritage of the last years and decades, that is, the conduct of “banking policy” on the level of the individual states; the existing presumptuous note-proletariat has regular certificates of origin and of residence. (Knies 1873, p. 312)38

The most important opponent of Knies was Adolph Wagner. According to Wagner, the freedom of banks is the best guarantee for the good management of banks (Wagner 1857, p. 15). He underscores his argument by including statistics of the Scottish and English banking system. The issue of money was less reckless in Scotland,39 where competition of banks was allowed (Wagner 1857, pp. 21, 59, 60). As long as bank notes are redeemable, it is impossible to have an “inundation” of notes under a system of free banking (Wagner 1857, p. 144). Wagner denounces the required reserve ratio of one third, which entailed the unintended consequence that deposits were backed less than before40 (Wagner 1857, p. 172). Banks relied on the state to help out in the case of urgency. But “how can the state even know how many reserves a bank needs?” (Wagner 1857, p. 173). It is impossible to know a priori how many cash reserves are required and the competition among banks will sort it out (Wagner 1857, p. 214).

The legal imposition of a reserve rate is one of the worst state interventions, according to Wagner, as new banks are founded with lower reserves than required. This necessarily leads to a weaker banking system. In a framework of free banking, a bank would have to gain some reputation in order to hold lower reserves. Banks would only be founded where there is an actual need (Wagner 1857, p. 218). However, as pointed out by Smith (1990, p. 80), Wagner eventually became more and more prone to the influence of the German Historical School and ultimately stated that “all systems can be justified in the appropriate circumstances”41 (Smith 1990, p. 80). This “partial recantation” of free banking by one of its most strident supporters, Adolph Wagner, represented the end of opposition to the idea of central banking in Germany42 (Smith 1990, p. 81).

Mises’s view on free banking evolved and this evolution and development can be seen in the different editions of Theory of Money and Credit. Hülsmann gives a full account of these differences (Hülsmann 2012). In the first edition, he found several justifications for the existence of central banks. He favored a system of redeemable paper money as it allows to save on metal for other uses (Mises 1912, p. 150). As stated in the previous section, Mises believed in the increase of production through forced saving and the promotion of commercial banking. He also considered the possibility of a potential lack of fiduciary media. This implied more or less the need for a central bank.

He only evolves into a complete free banker in the second edition. In his opinion, etatism has been a failure (Mises 1981, p. 435) and the current arguments for central banking are unsound (Mises 1981, p. 437). He fears the establishment of uniform procedures on the part of all the credit-issuing banks throughout the world. Furthermore, monopolization of the banks-of-issue in the separate countries would facilitate the uniformity of the procedures. As the banks proceed uniformly, there tends to be a permanent increase of the circulation of fiduciary media, and consequently a fall of the objective exchange value of money (Mises 1981, p. 347). But are the problems of uniformity the only reasons for his support of free banking? Actually, Selgin provides a complementary explanation by pointing out that Mises’s support for free banking is based in part on his agreement with Cernuschi, who (along with Modeste) believed that freedom of note issue would automatically lead 100-percent reserve banking (which is contrary to what Knies advocated). In addition, Mises “believed that free banking will somehow lead to the suppression of fractionally-based inside monies” (Selgin 1988, pp. 62, 164).

8. Conclusion

This paper has compared Mises’s monetary treatise with those of the major German monetary theorists of the nineteenth century, namely Knies, Rau, Roscher, and Wagner. Essential points of Mises’s monetary theory can also be found in the writings of the German economists, in particular in that of Karl Knies.43 Even if direct influence cannot be proven in all of the cases, it seems plausible that many German ideas found their way into Mises’s work through Menger and Böhm-Bawerk.44

However, another purpose of this paper was to show the similarities and differences of the monetary theories of the leading German monetary economists of the nineteenth century compared to Mises’s Theory of Money and Credit in order to understand the lukewarm reception of his first edition.45 Thus, contrary to what is often supposed with regard to the tradition of the German economists, the nature of money is not explained by the existence of conventional agreements. German monetary theorists were aware of the establishment of money as a natural fruit of indirect exchange and its role as a common medium of exchange. Likewise, Mises’s regression theorem can be found similarly expressed in the writings of these economists. The dynamics of fiduciary media and its dangers were not unfamiliar to the German theorists either. Adolph Wagner was a champion of “Bankfreiheit” and promoted the idea of free banking which is similar to Mises’s approach to state intervention in the banking system, put forth in the second edition of Theory of Money and Credit.

What were the main differences? Mises claimed that any amount of money can serve the needs of society, thereby making a strong argument against state intervention. Free banking disappeared from the German academic scene with the gradual conversion of Adolph Wagner into a full historicist. However, Mises was not in favor of a full free banking system at that time in any case and was only partly skeptical of central banks. The rebuttal of the first edition has to be put into the context of the political environment which was supporting a strong central bank to control the economy, eventually leading to the German hyperinflation in 1923. Not surprisingly, the second edition which was published in 1924, had a much better reception. The German monetary theorists who rejected the first edition so thoroughly eventually disappeared from the forefront of monetary theory and Mises’s treatise of money lived to see a revival in his second edition.

References

Bodin, Jean. 1581. Les six livres de la République. Paris: Chez Jacques du Puys.

Böhm-Bawerk, Eugen von. 1998. Innsbrucker Vorlesungen über Nationalökonomie: Wiedergabe aufgrund zweier Mitschriften / Eugen von Böhm-Bawerk. Hrsg. von Shigeki Tomo. Marburg: Metropolis-Verl.

Cantillon, Richard. 1755. Essai sur le commerce. London: Chez Fletcher Gyles.

Greaves, Bettina. 1993. Mises: An Annotated Bibliography: A Comprehensive Listing of Books and Articles by and About Ludwig von Mises. Irvington-on-Hudson, N.Y.: Foundation for Economic Education.

Helfferich, Karl. 1903. Das Geld. 1st ed. Leipzig: C.L. Hirschfeld.

Hülsmann, Jörg Guido. 2007. Mises: The Last Knight of Liberalism. Auburn, Ala.: Ludwig von Mises Institute.

——. 2012. “The Early Evolution of Mises’s Monetary Thought.” In The Theory of Money and Fiduciary Media: Essays in Celebration of the Centennial. J.G. Hülsmann, ed. Auburn, Ala.: Ludwig von Mises Institute.

Knies, Carl. 1873. Geld und Credit. Darlegungen der Grundlehren von dem Gelde und des Credites. 1. Band. Das Geld. Berlin: Weidmannsche Buchhandlung.

——. 1876. Geld und Credit. Darlegungen der Grundlehren von dem Gelde und des Credites. 2. Band. Der Credit. Berlin: Weidmannsche Buchhandlung.

Law, John. 1720. Considérations sur le numéraire et le commerce. La Haye: Chez Jean Neaulme.

Menger, Carl. 1892. “On the Origins of Money.” Economic Journal 2: 239–55.

Mises, Ludwig. [1912] 2007. Theorie des Geldes und der Umlaufsmittel. 1st ed. Auburn, Ala.: Ludwig von Mises Institute.

——. 1966. Human Action: A Treatise on Economics. 3rd rev. ed. New York: Contemporary Books.

——. 1978. Notes and Reollections. Spring Mills, Penn.: Libertarian Press.

——. 1981. The Theory of Money and Credit. 5th ed. Indianapolis: Liberty Fund.

——. 2006. The Causes of the Economic Crisis: And Other Essays Before and After the Great Depression. Auburn, Ala.: Ludwig von Mises Institute.

Monroe, Arthur. [1923] 2001. Monetary Theory before Adam Smith. Ontario: Batoche Books.

Rau, Karl Heinrich. 1868. Lehrbuch der politischen Ökonomie. Grundsätze der Volkswirthschaftslehre. 8th ed. Leipzig and Heidelberg: Winter’sche Verlagshandlung.

Roscher, Wilhelm. 1854. Die Grundlagen der Nationalökonomie: ein Hand- und Lesebuch für Geschäftsmänner und Studierende. 6th ed. Stuttgart: Verlag der J. G. Cotta’schen Buchhandlung.

Schumpeter, Joseph. 1994. History of Economic Analysis. 12th ed. New York: Routledge.

Selgin, George. 1988. The Theory of Free Banking. Lanham, Maryland: Rowman & Littlefield Publishers.

Smith, Vera. 1990. The Rationale of Central Banking and the Free Banking Alternative. 2nd ed. Indianapolis: Liberty Press.

Streissler, Erich. 1989. The Influence of German Economics on the Work of Menger and Marshall. Duke University Program in Political Economy.

Wagner, Adolph. 1857. Beiträge zur Lehre von den Banken. Leipzig: Leopold Voss.

Wieser, Friedrich. 1903. “Der Geldwert und seine geschichtlichen Veränderungen. Antrittsvorlesung gehalten am 26. Oktober 1903 an der Wiener Universität.” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, pp. 43–63.

Amadeus Gabriel is a Ph.D. candidate at the University of Angers in France.

• 1The other three treatises are Socialism (Indianapolis: Liberty Fund, 1981), Human Action (Auburn, Ala.: Mises Institute, 1998), and Theory and History (Auburn, Ala.: Mises Institute, 1985). See the complete Mises bibliography at http://mises.org/misesbib.asp. For general biographical information on Mises see Murray Rothbard, Ludwig von Mises: Scholar, Creator, Hero (Auburn, Ala.: Mises Institute, 1988), Israel Kirzner, Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Books, 2001), and J.G. Hülsmann, Mises: The Last Knight of Liberalism (Auburn, Ala.: Mises Institute, 2007).
• 2Keynes had written a book review of Mises’s treatise, stating it “is the work of an acute and cultivated mind. But it is critical rather than constructive, dialectical and not original. The author avoids all the usual pitfalls, but he avoids them by pointing them out and turning back rather than by surmounting them.” (Economic Journal, September 1914, p. 417). Sixteen years later he stated that “in German, I can only clearly understand what I know already!—so that new ideas are apt to be veiled from me by the difficulties of language.” Keynes, A Treatise on Money (London: Macmillan, 1930), vol. I, p. 199, note 2.
• 3The 1953 edition (New Haven, Conn.: Yale University Press) included an additional fourth part on “monetary reconstruction” that Mises had written for this new edition. In that form the book was published again three more times: 1971 (Irvington-on-Hudson, N.Y.: Foundation for Economic Education; second print in 1978), 1981 (Indianapolis: Liberty Fund), and 2009 (Auburn, Ala.: Mises Institute).
• 4Several Spanish translations (La Teoría del Dinero y Del Crédito) have been made: one by Antonio Riaño, published in 1936 (Madrid: M. Aguilar), one by José Ma. Claramunda Bes (Barcelona: Ediciones Zeus, 1961), and one by Juan Marcos (Madrid: Union Editorial, 1997).
• 5The Japanese translation was made from the second German edition by Yoneo Azuma: Kahei oyobi Ryütüjshudan no Riron (Tokyo: Jitsugyo no Nipponsha, 1949) and re-published in 1980 (Tokyo: Nihon Hyöron-Sha).
• 6Translated by H.P. Yang (Taiwan: Taiwan Bank, Economic Research Department, 1969).
• 7The Russian translation, along with annotations, was made by G. Sapov who used both the American edition and the second German edition: Теория денег и кредита (Chelyabinsk: Sotsium, 2012).
• 8The French edition (La Théorie de la monnaie et du crédit) is incomplete and only available on the Internet (http://herve.dequengo.free.fr/Mises/Tmc/TMC_1_1.htm). A print edition is forthcoming along with a preface from Antoine Gentier (Paris: Editions de l’Institut Charles Coquelin).
• 9Brad Delong, “Paul Krugman Asks a Question: On the ‘Austrian’ Hatred of Fractional Reserve Banking, Paper Money, etc. Weblogging” (http://delong.typepad.com/sdj/2012/09/paul-krugman-asks-a-question-on-the-austrian-hatred-of-fractional-reserve-banking-paper-money-etc-weblogging.html#more; accessed on 3 October 2012, at 9h32 CET)
• 10On the shortcomings of the Batson translation, see chap. 1, below.
• 11He 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).
• 12Mises 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.
• 13During 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).
• 14See North (1993, p. 159).
• 15They 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.
• 16Unfortunately, the English rendering as Theory of Money and Credit obscured this central theme. We will address the problems of this translation below.
• 17See Menger (1968 [1909], pp. 73–75, 80–91. In the English edition the distinction between inner and outer exchange value was completely dropped. In a footnote (on p. C146) Batson explains: “Since this distinction has not been usual in English terminology, it has been omitted from the present version; and, in what follows, wherever ‘the objective exchange value of money’ is referred to, it is the innere exchange value that is meant unless the contrary is explicitly stated.”
• 18He repeatedly referred to Mathus’s Principles of Political Economy. See especially Menger (1968 [1909], p. 82).
• 19See Menger (1968 [1909], p. 75.
• 20In a passage where he explained that distinction (not translated into English), he stated (A132f., B104): “Both expressions are somewhat odd. But they have become accepted in science ever since Menger used them. Therefore they shall be used where appropriate in the following investigations.” (Beide Ausdrücke sind nicht gerade glücklich gewählt. Aber sie haben einmal in der Wissenschaft das Bürgerrecht erlangt, seit Menger sie verwendet hat; darum sollen sie auch in den folgenden Untersuchungen dort gebraucht werden, wo dies mit Nutzen geschehen kann.)
• 21B200, my emphasis JGH. The word “inner” lacks in the English edition, see C272. Similarly, see the definition of the term “inflationism” on A265 (deleted from the second edition). Mises was reluctant to use the term inflation at all, referring to the reservations expressed by Pigou. He thought scientific analysis could do without them. For a penetrating history of the common definitions of the terms inflation and deflation see Bryan (1997).
• 22A246, B200. Again, the English edition lacks the words “inner” (see C248). The translator, Batson, also tried to make a distinction between Geldwertpolitik, Geldpolitik, and Währungspolitik (see C247, footnote), whereas Mises used all three terms synonymously, as is common in the German-language literature. Similarly, Mises stated that monetary policy in that sense is the “complement” or “corollary” (Gegenstück) of policies designed to influence the prices of single commodities or groups of commodities. Batson translates Gegenstück out of context as “antithesis.”
• 23Amadeus Gabriel highlights the interesting fact that the core idea of the regression theorem can be traced back to the contemporary German literature. See Gabriel (2012) in the present volume, chapter 2.
• 24See A154f., B122f., C164.
• 25In a passage deleted as from the second edition (see A244f.), Mises discusses Irving Fisher’s attempt to empirically validate his contention about the relationship between real and nominal interest rates. Mises points out that Fisher succeeded only in those cases in which the inter-temporal exchange (the credit) involved several currencies; but not in those cases in which the credit was given and returned in terms of a commodity money.
• 26A78, C101f. See also A263, A402f.
• 27At one point he almost justified his repetitiveness, stating: “This was not recognized for a long time and to a large extent it is not recognized even nowadays” (A403, C379).
• 28The monetary interventionism recommended by mercantilist authors such as John Law was therefore not modern monetary policy in Mises’s sense. The mercantilists wished to increase the money stock, but they did not wish to diminish the PPM (even though they might have accepted this consequence as a collateral effect of their policies). See A263f.
• 29C250, A250, B203.
• 30He points out that the monetary history of Austria-Hungary in the nineteenth century was one of the most important cases of deflationist policies (A257).
• 31C264, A261, B217. At this point he quotes Bentham’s In Defence of Usury (1790).
• 32In the second edition, too, he characterizes a stable inner objective exchange value of money as a—yet unattainable—ideal of monetary policy (see B401).
• 33C269f., B222, A288. Notice that the English text falsely translates Sachgeld (commodity money) as metallic money.
• 34C270, B222, A290.
• 35AIV. The original text: “Manche ihrer Fehler sind von Tooke und Fullarton mit Recht getadelt worden. Aber das, was diese beiden an die Stelle der Currency-Theorie gesetzt haben, ist mit nichten eine brauchbare Theorie. Die Banking-Theorie enthält nicht nur Irrtümer, sie fehlt schon in ihrer Problemstellung.”
• 36A417, C390. Mises mentions the circumstance that explains this neglect: Currency School and Banking School agreed amongst themselves that there could be no such thing as costless credit. See A406f., C381.
• 37See A410, A412, A415–17, A428–30.
• 38This distinction is one of the central concepts to which Mises refers constantly through the entire book. See pp. A80, A145, A353, A358, A358, A419, A422, A429, A430f., A432, A435f., A445, A452.
• 39The only exception concerns commodity money. Here an increase in the demand for money tends to entail increases of the interest rate; but Mises contends that this fact is without practical significance. For a more recent re-interpretation of the significance of this fact see J.G. Hülsmann, “The Demand for Money and the Time Structure of Production,” Hülsmann and Kinsella, eds., Property, Freedom, and Society: Festschrift for Hans-Hermann Hoppe (Auburn, Ala.: Mises Institute, 2009); Dan Mahoney, “Free Banking and the Structure of Production: A Contrast of Competing Banking Systems,” Libertarian Papers 3, no. 14 (2011).
• 40A428f., B369f., C399.
• 41A430f. In the second edition, he modified the argument concerning the nature of the impossibility of artificially lengthening the period of production. He stated “and so, although it is in the last resort inadmissible and impracticable, a lengthening of the period of production promises for the time to be profitable” (C399; emphasis JGH). The original text of the second edition: “damit wird die Verlängerung der Produktionsperiode, obwohl in letzter Linie unzulässig und undurchführbar, zunächst scheinbar rentabel” (B371). The original text of the first edition reads: “damit wird die Verlängerung der Produktionsperiode, obwohl volkswirtschaftlich unzulässig und undurchführbar, privatwirtschaftlich zunächst rentabel” (A430). Thus whereas Mises argued at first that the artificial expansion of the money supply entailed a contradiction between overall possibilities and the individual assessment of those possibilities, he later argued that it temporarily entailed illusory profits. Clearly this new argument is problematic, because not all profits in the boom phase are illusory. The main motivation behind the change of argument seems to be Mises’s general quest, in the second edition, to get rid of all references to an overall or macroeconomic (volkswirtschaftlich) point of view, to emphasize methodological individualism, and to deny the existence of possible contradictions between individual interests and the common good. Thus we find in the new chapter on “the monetary policy of étatism” the following statement: “In this case, as in all others in which similar assertions are made, it is not true that there exists an opposition between the interests of the individual and the interests of the community” (B240, C290).
• 42The chapter title has subsequently been changed into “Pre-war policy problems relating to fiduciary media” (Probleme der Umlaufsmittelpolitik in der Zeit vor dem Kriege; English translation: “Problems of credit policy before the war”). The concluding fourth part of the first edition (A467–76) has subsequently been deleted respectively integrated into the final pages of the last chapter of part three.
• 43“It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown” (A472, B419, C448).
• 44A444, C411. See also A360, A420, and A425.
• 45“We know . . . that all credit-issuing banks endeavor to extend their circulation of fiduciary media as much as possible, and that the only obstacles in their way nowadays are legal prescriptions and business customs concerning the covering of notes and deposits, not any resistance on the part of the public” (A426, C397).