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Marginal Utility of Gold and Dr. Fekete

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In addition to his rejection of the Misesean/Rothbardian critique of the Real Bills Doctrine, Dr. Antal Fekete has taken issue with Mises monetary theory. Don Lloyd has noted the following passage:

...According to Carl Menger, subsequent units of a commodity are valued less by the economizing individual than units acquired by him earlier. This is known as the Principle of Declining Marginal Utility. If we rank commodities according to the rate of that decline, then we shall find that the marginal utility of one of them declines more slowly than that of any other. The commodity with this property is none other than gold. In fact, the marginal utility of gold declines so slowly that it is practically constant. It follows that gold hoarding must be limited by something other than declining marginal utility so that demand for it may not become arbitrarily large, and gold coins may stay in circulation. The fact is that demand for gold is limited by the positive rate of interest channeling gold into monetary circulation, away from hoarding. This makes gold the corner-stone of both the theory money and the theory of interest.

Ludwig von Mises in Human Action denies that the marginal utility of gold is constant (second edition, p 404). His reasoning is that constant marginal utility would mean infinite demand which is contradictory. Elsewhere in the book (op. cit., p 205) Mises also denies that it is possible to construct a unit of value because two units of a homogeneous supply are necessarily valued differently, according to the Principle of Declining Marginal Utility. Yet gold has successfully furnished the unit of value for thousands of years to many a flourishing civilization, including our own, and when it was removed it had to be done by travesty, trickery, and police force. Mises failed to grasp the connection between gold and interest. Interest is obstruction to gold hoarding: but for the presence of interest gold hoarding would be unlimited, since gold's marginal utility is constant. It is interest that keeps gold hoarding within bounds. Interest is the opportunity cost of gold hoarding. By contrast, hoarding of a non-monetary commodity is kept within bounds by declining marginal utility....

Don wrote the following email in response to Dr. Fekete, which he has given permission to be posted here:

Dear Dr. Fekete,

When you say that gold has a constant marginal utility, or at other times when you say that gold has a slower rate of diminishing maginal utility than any other good, you are misapplying the concept of marginal utility and combining concepts that are logically separate. If, for simplicity, we ignore factors of production, then all economic goods must fall into one of two categories : i.e. either subjective use-valued goods, or exchange-valued goods, including money. Subjective use-valued goods derive their value from the satisfaction that their consumption is expected to directly provide to an individual. Exchange-valued goods derive their value indirectly from their potential to be exchanged for use-valued goods in the future. Diminishing marginal utility only directly applies to subjective use-valued goods. It means that the marginal satisfaction that results from the acquisition and use of incremental units of a good diminishes as the quantity possessed of a good increases.

If you have four apples, you may rank the satisfactions that can result from their consumption so that the first apple is simply eaten, the second apple is baked into a pie, the third apple is fed to a pig and the fourth apple is thrown at a passing freight train. The fourth apple has a marginal utility that is the satisfaction that you gain by throwing it at the freight train. Exchange-valued goods, including money, can be said to indirectly have a diminishing marginal utility that is potentially provided in the future by an exchange for or purchase of subjective use-valued goods for the satisfaction that they provide.

If the only goods that money can buy are apples, and the purchase can only happen today, then the indirect diminishing marginal utility of money is identical to the direct diminishing marginal utility of apples. On the other hand, if money can buy some other use-valued good, or apples on some future day, then that alternate purchase may result in a higher degree of satisfaction than the purchase of a fourth apple today. This possibility is what allows money, or any exchange-valued good to indirectly have a slower rate of diminishing marginal utility than any subjective use-valued good.

In general, since there are a lot of goods to chose among, and there is a lot of future for them to be purchased in, the indirect marginal utility of any exchange-valued good must diminish at a far slower rate than any individual use-valued good. This is true to the same extent whether we are talking about dollars, euros, gold or silver, or whatever. The differentiation between different exchange-valued goods has nothing to do with marginal utility. Rather it has to do with expectations about the future changes in supply and demand for all of the possible exchange-valued goods. It is an allocation and speculation issue including possible diversification.

Regards, Don Lloyd

In addition to Don's reasoning, I will add the following. To clarify what Mises meant, if the marginal utility of gold were "constant", then in an individual's preference ranking, any number of units of gold would appear ahead of the first unit of any other good, e.g.:

  1. first ounce of gold
  2. second ounce of gold
  3. third ounce of gold
  4. fourth ounce of gold
  5. fifth ounce of gold
  6. ......

If gold had constant marginal utility for an individual, then that person would never demand any other good, and they would exchange any goods that they had for more gold. There is a big difference between the MU declining slowly and not declining at all. Fekete's conclusion, that there must be some other factor than declining marginal utility, does not follow from his premise.


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