Mises and His First-Best Option

     

The Theory of Money and Credit reinvigorated the two central assertions of classical economics, that: (1) the wealth of nations depends on nonmonetary factors; and (2) it cannot be increased by stimulating the production of money through political interference. But the mainstream of 20th-century economics did not follow Mises. It followed Irving Fisher and John Maynard Keynes. This is precisely why it is still important and inspiring to read Mises today. Lawrence White is right on target in praising The Theory of Money and Credit as an “intellectual treasure chest” that is “worth reading more than once.” He draws our attention to Mises’s regression theorem and to his favorable assessment of the role of competition among banks of issue. We shall follow him onto these grounds, with some more emphasis on free banking.

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Mises developed the regression theorem based on the work of Friedrich von Wieser (Wieser 1929; Hülsmann 2007), who himself could rely on the 19th-century German literature (see Gabriel 2012). Contrary to Wieser, Mises argued in terms of demand and supply, and he later emphasized that the demand for money was not just derived from the subjective value of nonmonetary goods, but from the subjective value of the cash balances themselves.

From an epistemological point of view, the regression theorem does not seem to be an element of Misesian praxeology. It does not concern an a priori causal relation (see Hülsmann 2006, North 2012). The subjective value of money depends on the expected future purchasing power of money (PPM), but these expectations are not necessarily based on the prior PPM (see Hülsmann 1996, pp.168–71). Moreover, as the case of Bitcoin shows, the subjective value of a medium of exchange need not be based on its expected future PPM at all.

On the question whether Bitcoin initially had a nonmonetary value, I therefore think that Robert Murphy (2013) has a better case than Lawrence White. By contrast, White correctly points out the difficulty of the quantitative determination of the initial Bitcoin value. He offers an initial-whim explanation. This is plausible. Indeed, whimsies are implied in the ideological nature of Bitcoin’s nonmonetary value component.

This ideological component is essential not only for Bitcoin’s initial value, but also for its survival. All media of exchange need a nonmonetary value component. Otherwise their future purchasing power is indeterminate, and they would be driven out of the market when that future purchasing power is – for whatever reason – widely expected to decline (Hülsmann 1996, pp. 263ff). The nonmonetary component of precious metals is well known. The nonmonetary component of fiat monies is the threat of violence (Kusnetzov 1997). The value of U.S. dollars ultimately derives from the fact, known to all users, that U.S. citizens will be coerced into accepting dollars as legal tender for all debts public and private. This provides a rock bottom to the value of U.S. dollars. What is the rock bottom of Bitcoin? Presently it is antistatist ideology. If ever the ideology vanishes, something else will have to take its place. At present, it is not clear what that could be.

Contrary to mainstream monetary thought, Mises insists that changes in the supply of and demand for money do not benefit the economy as a whole. This central idea runs through his monetary thought from beginning to end.

In the third part of The Theory of Money and Credit, he refutes one by one the claims purporting to show that the creation of fiduciary media by fractional-reserve banks could be beneficial from an overall point of view. Mises showed that credit granted in the form of fiduciary media was not “true credit”; that the issue of fiduciary media was not “elastic” in the sense that it accommodated changes in the demand for money at a constant price level; and that the issue of fiduciary media was in principle unlimited. It was also in that third part of his book that he presented his new crisis theory. The point was that not only are fractional-reserve banks useless from an overall point of view, but they are also in fact harmful to the economy. In conclusion he adopted the policy recommendation of the Currency School (see Hülsmann 2000, Hülsmann 2012, Salerno 2012), arguing that any further creation of fiduciary media should be outlawed.

Starting with the second edition, Mises began to highlight the beneficial role that competition might play in limiting the issue of fiduciary media. I thoroughly disagree with Lawrence White that this was Mises’s first-best policy, whereas the outlawing of additional fiduciary media was just a second-best option. It is exactly the other way round. Mises thought the outlawing of additional fiduciary media was the straightforward solution. But the government did not wish to go that way because it had an interest in perpetuating the practice of artificial money creation. It wished to control the banking system in order to channel funds into the public purse, and it imposed central banks upon the market to facilitate the extension of fiduciary media. Compared to that policy, Mises preferred not to regulate fractional-reserve banks at all.

But even this stance was not categorical. After all, fractional-reserve banks have an interest in agreeing on uniform policies to facilitate credit expansion. They do not need governments and central banks in this regard (see Mises 1912, p. 426; 1953, p. 397). The long-run implication is patent: “The quantity of fiduciary media in circulation has no natural limits. If for any reason it is desired that it should be limited, then it must be limited by some sort of deliberate human intervention – that is by banking policy” (1912, p. 360; 1980, p. 346). Mises therefore qualified his endorsement of free banking, admonishing his readers not to conflate it with an endorsement of fractional-reserve banking. The prudent approach was to continue watching the banking industry and act accordingly: “If it should prove easier now for the credit-issuing banks to extend their circulation, then failure to adopt measures for limiting the issue of fiduciary media will involve the greatest danger to the stability of economic life” (Mises 1924, p. 410; 1980, p. 439).

Therefore, in spite of his favorable reconsideration of free banking, Mises still maintained the general conclusion of the first edition, in which he advocated the legal interdiction of any further issues of fiduciary media.