Theory of Money and Fiduciary Media

7

Gary North

The Regression Theory as Conjectural History

Menger on the Origin of Money

Carl Menger’s last published work during his lifetime was an 1892 essay, “On the Origins of Money.” He introduced it by pointing out how odd it was in his era that the precious metals, gold and silver, were universally used as money. That coins should circulate widely seemed strange to investigators in his day.

But that every economic unit in a nation should be ready to exchange his goods for little metal disks apparently useless as such, or for documents representing the latter, is a procedure so opposed to the ordinary course of things, that we cannot well wonder if even a distinguished thinker like Savigny finds it downright “mysterious.”1

One explanation of the origin of money is that the civil government declared precious metals coins as money. Sovereignty is therefore the source of money’s acceptance and therefore its value.

To assume that certain commodities, the precious metals in particular, had been exalted into the medium of exchange by general convention or law, in the interest of commonweal, solved the difficulty, and solved it apparently the more easily and naturally inasmuch as the shape of the coins seemed to be a token of state regulation. Such in fact is the opinion of Plato, Aristotle, and the Roman jurists, closely followed by the mediaeval writers. Even the more modern developments in the theory of money have not in substance got beyond this standpoint.2

No Historical Documentation

Menger rejected this hypothesis. He offered this explanation for his rejection: there are no historical records of such a transition from local value to widespread value by means of fiat dictate.

An event of such high and universal significance and of notoriety so inevitable, as the establishment by law or convention of a universal medium of exchange, would certainly have been retained in the memory of man, the more certainly inasmuch as it would have had to be performed in a great number of places. Yet no historical monument gives us trustworthy tidings of any transactions either conferring distinct recognition on media of exchange already in use, or referring to their adoption by peoples of comparatively recent culture, much less testifying to an initiation of the earliest ages of economic civilization in the use of money.3

His rejection of a historical explanation was based on the absence of primary source evidence. There should be records in some archive of such a transition, given the widespread use of precious metal coins. He called such a theory of money created by state decree unhistorical: “. . . the presupposition is unhistorical.”

Nor do even the theorists above mentioned honestly face the problem that is to be solved, to wit, the explaining how it has come to pass that certain commodities (the precious metals at certain stages of culture) should be promoted amongst the mass of all other commodities, and accepted as the generally acknowledged media of exchange. It is a question concerning not only the origin but also the nature of money and its position in relation to all other commodities.4

When an explanation for the origin of any private practice or institutional arrangement is based on historical events that lack any substantiating historical evidence, we could call this thesis conjectural or hypothetical. It is an explanation of the way things must have occurred. It seems logical that this was the way that they did occur. So, they must have occurred this way.

The Most Marketable Commodity

Menger came to a conclusion regarding the function of money. Money metals were adopted because they were subject to widespread demand. This made them eminently saleable.

The theory of money necessarily presupposes a theory of the saleableness of goods. If we grasp this, we shall be able to understand how the almost unlimited saleableness of money is only a special case,—presenting only a difference of degree—of a generic phenomenon of economic life—namely, the difference in the saleableness of commodities in general.5

Two decades later, Ludwig von Mises defined money as the most marketable commodity.

The greater the marketability of the goods first acquired in indirect exchange, the greater would be the prospect of being able to reach the ultimate objective without further maneuvering. Thus there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.6

This was a recapitulation of Menger’s argument. Menger had written,

Hence it is also clear that nothing may have been so favourable to the genesis of a medium of exchange as the acceptance, on the part of the most discerning and capable economic subjects, for their own economic gain, and over a considerable period of time, of eminently saleable goods in preference to all others. In this way practice and a habit have certainly contributed not a little to cause goods, which were most saleable at any time, to be accepted not only by many, but finally by all, economic subjects in exchange for their less saleable goods; and not only so, but to be accepted from the first with the intention of exchanging them away again.7

In Part 8, Menger offered an explanation that served as an alternative to the conjectural history of the origin of money as the product of state decree. Precious metals came into use as money because of their uses as ornaments. He devoted a total of one sentence to this explanation.

There is no centre of population, which has not in the very beginnings of civilization come keenly to desire and eagerly to covet the precious metals, in primitive times for their utility and peculiar beauty as in themselves ornamental, subsequently as the choices materials for plastic and architectural decoration, and especially for ornaments and vessels of every kind.8

At this point, we expect some historical documentation. There is none. This creates a tactical problem. A defender of the fiat dictate theory of money’s origin can invoke the same argument against Menger as he had invoked against the critic’s ideological peers. Each side declares that the origin of money was rooted in a particular institutional arrangement. What seems reasonable to one commentator does not seem reasonable to the other.

Economic Value: Forward and Backward

Mises offered a more detailed treatment of the transition from commodity-for-use to commodity-for-exchange. He began Chapter II of Part Two of Theory of Money and Credit with a consideration of this problem.

Mises argued for subjective economic value. This process of subjective imputation of economic value applies to all factors in the economy. Money is no exception. Then what accounts for the use of any commodity as money? Two things: expectations of future exchange value and historical memories of past economic value. People impute value to scarce assets in the present because they believe that others will impute value to these similar assets in the future. But, in making these forecasts, they look to the past. Has a particular commodity maintained its objective exchange value? If so, buy it. It will function as money. But this raises a theoretical problem. Why did a commodity gain value in exchange yesterday? It does no good to appeal it its value the day before yesterday. That would lead to infinite regression. “It’s turtles all the way down.” Mises understood this.

To trace back the value that money has to-day to that which it had yesterday, the value that it had yesterday to that which it had the day before, and so on, is to raise the question of what determined the value of money in the first place. Consideration of the origin of the use of money and of the particular components of its value that depend on its monetary function suggest an obvious answer to this question. The first value of money was clearly the value which the goods used as money possessed (thanks to their suitability for satisfying human wants in other ways) at the moment when they were first used as common media of exchange. When individuals began to acquire objects, not for consumption, but to be used as media of exchange, they valued them according to the objective exchange-value with which the market already credited them by reason of their “industrial” usefulness, and only as an additional consideration on account of the possibility of using them as media of exchange.9

He spoke of “an obvious answer.” But the answer which he provided was not based on a detailed study of historical sources in a wide range of societies. Yet it also lacked the quality of certainty which Mises referred to in Human Action as “apodictic certainty,” meaning a category of human action.10 As he wrote, “Apodictic certainty is only within the orbit of the deductive system of aprioristic theory. The most that can be attained with regard to reality is probability.”11 So, with respect to the transition from value-in-use to value-in-exchange, the most that we can say is that this transition was probable.

The historian asks, “How probable?” When he asks this, given the non-mathematical training of most historians, he really does not mean statistically probable. Neither did Mises ask such a thing of records from the distant past, with the accumulated data governed by some algorithm. The historian means something like this. “Do we have sufficient documentary evidence to judge the nature of this transition in a representative sample of widely dispersed societies?” If money is as universal as Menger asserted, then there should be some trace of the supposed pattern of the transition from barter to money.

Yet, because of the nature of the transition, there will not be such documentation. While the archeological records of ancient mercantile civilizations are heavily weighted by tablets relating to commerce, these documents came from societies that had highly developed monetary arrangements. This is why the records are so extensive. The mind-numbing similarity of these tablets within a collection leads translators to cease translating after about 10 percent of the documents are translated.12 What the historian wants is a collection of records of trade before money, with records of gold and silver as ornaments. This would mean barter. Then, at some point, records would show more transactions using gold and silver as tools of exchange. That would require sustained continuity of record-keeping and record-preservation. To find documentary evidence on transition from metal as ornamental to metal as money would be a remarkable discovery. To find such records in a dozen societies in several time periods and locations would be historically unprecedented.

Conjectural History in Action

So, my conclusion is that Menger and Mises resorted to conjectural history. Conjectural history operates in the unexplored nether region between historical documentation and apodictic certainty, between Heraclitus’s flowing stream and Parmenides’s logical order. It is more like common sense than anything else. The problem, as always, is that common sense is not all that common.

Some critics have rejected such exercises in common sense as just-so stories: fantastic explanations of origins. Others have substituted their own conjectural histories. We find this in rival stories concerning the origin of civil government. Thomas Hobbes, John Locke, and Jean-Jacques Rousseau all offered conjectural histories of the social contract. They all offered a version of how men must have gotten together once upon a time before there was writing to make documentary records. Men agreed to surrender sovereignty to the state. There is no documentary record of such a meeting. So, each of these scholars felt free to describe the event. The classic statement of all time regarding conjectural history is Rousseau’s, which he wrote early in Chapter 1 of his Discourse on the Origin and the Foundation of the Inequality Among Mankind (1754). “Let us begin therefore, by laying aside facts, for they do not affect the question.” The statement has generated its share of ridicule. But the paragraph that preceded it is insightful.

The philosophers, who have examined the foundations of society, have, every one of them, perceived the necessity of tracing it back to a state of nature, but not one of them has ever arrived there. Some of them have not scrupled to attribute to man in that state the ideas of justice and injustice, without troubling their heads to prove, that he really must have had such ideas, or even that such ideas were useful to him: others have spoken of the natural right of every man to keep what belongs to him, without letting us know what they meant by the word belong; others, without further ceremony ascribing to the strongest an authority over the weakest, have immediately struck out government, without thinking of the time requisite for men to form any notion of the things signified by the words authority and government. All of them, in fine, constantly harping on wants, avidity, oppression, desires and pride, have transferred to the state of nature ideas picked up in the bosom of society.13

It is not that Menger and Mises laid aside the facts. It is that there were no facts to lay aside. The explanation which they gave for the rise of the money economy is reasonable, in the sense that it is difficult for an Austrian School economist to reject. He does not believe that a fiat declaration by a political sovereign would have been capable of changing the self-interested behavior of individuals in a barter-based economy. Such a declaration would not have persuaded large numbers of people to substitute metals of ornamental value for goods valued in exchange for their immediate use. An expensive bar of metal is neither a tool nor a consumption good. It is safer to store up other goods to be used to exchange later. Salt could work. Arrowheads could work. But not bars of shiny metal. The Austrian School economist looks to the free market for creative solutions to widespread problems. But, for economists and non-economists who are prepared to accept the word of a political sovereign as both creative and authoritative, the story of the origin of money in the declaration of a monarch sounds plausible.

History vs. Development

Robert Nisbet, in his book Social Change and History (1969), presented a detailed study of two approaches to studying the past. The one approach, which he called the historian’s past, involves a study of dates, personalities, and events. The other approach takes a broader perspective. He called this developmentalism or evolutionism. In such an outlook, he wrote,

the emphasis is not upon the past as conceived as a genealogy of happenings and persons, but upon more or less timeless sequences of emergent changes. If event is the key to the historiographic perspective, change is the key concept in the developmental perspective. Time in the very broad sense matters, of course, but the developmentalist, whether social or biological, is far more interested in arriving at correct before-and-after relationships in his changes and types than in the probably futile search for dates as to when exactly a certain change occurred.14

Given this analysis, Menger and Mises were more developmentalists than historians when they discussed the origin of money. Their joint attempt to explain the origin of money in terms of individual human action, governed by subjective value, has the characteristic features of developmentalism. They did not search for documents in a dozen archives or museums relating to the use of gold and silver in ornaments, determining when and under what circumstances the transition to money occurred. They offered a theory of how it could have happened, and more than this, how it must have happened, given the goal of individuals to improve their circumstances. Yet they stopped short of identifying their account as inherent in human action in the way that higher prices reduce the quantity demanded. So, in a peculiar development, which we can in fact date historically, Menger and Mises invoked a form of developmentalism in order to explain individual action. The origin of money must have happened this way every time.

Conclusion

The Menger-Mises regression theorem is not historical. It is developmental. It is an example of conjectural history. It seems more consistent with known human behavior than the theory of state-created money. But I speak as someone persuaded of most of the categories of Austrian School economics, especially in monetary affairs.

I have devoted more time and space to Greenback monetary theory than any living Austrian School economist.15 The Greenbackers are persuaded that fiat money is a category of human action. They regard money as inherently statist. In contrast, I see no way that sovereigns declared money into existence: i.e., speaking something into existence. The state is not God. But I find it odd that I would accept as a substitute a conjectural theory of the origin of money. It would be nice to have some case studies.

Mises did not approve the use of historical examples to prove economic theory, but unless he regarded the origin of money as an inescapable historical corollary of the timeless axioms of human action, which he never asserted for his regression theory, then I find myself knee-deep in developmentalism. This is not where I planned to be when I first read The Theory of Money and Credit in 1963.

Gary North holds a Ph.D in history from the University of California, Riverside and is the editor of GaryNorth.com.

• 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.