Liberty Matters

Mises Was Lukewarm on Free Banking


I first read The Theory of Money and Credit in the spring of 1981. I ought to have been working on a master’s degree in resource economics at the University of Rhode Island. But I’d had my fill of Hotelling’s Rule and was itching to broaden my economic horizons.
Having read many general economics classics while I was an undergrad, I decided to start taking on works dealing with specific fields. Inflation was in the headlines, and monetary theory sounded challenging, so my plan was to start with it and then move on to easier stuff. That I’d read a couple dozen books before yanking The Theory of Money and Credit off the shelf turned out to be a lucky break: had I read it too soon, I’d certainly have found it dense, if not impenetrable. Instead, comparing it to everything I’d managed to glean from the other books, I never doubted that, despite its age, it towered over the rest. Indeed, though I’ve read hundreds of other books about money since, including some awfully good ones, none has had a greater influence upon my own thinking on the subject.
The Regression Theorem
Like Larry, I regard Mises’s treatment of the determination of money’s purchasing power, and the “regression theorem” that plays the central part in that treatment, as one of his book’s most important contributions. As Israel Kirzner makes clear in an excellent, though (so far as I’m aware) never-published, essay on the regression theorem, Mises’s approach was unique, not so much because of the particular explanation he offered of how agents come to form their expectations regarding an inconvertible money’s purchasing power, but because he realized that no theory of a fiat money’s equilibrium value could be considered complete unless it accounted for the people’s willingness to treat some particular paper medium, not as so many mere bits of paper, but as an economy’s generally accepted medium of exchange, to which a positive exchange value might reasonably be assigned.[1]Many other theorists—and Don Patinkin, most notoriously of all— simply failed to recognize the challenge posed by the presence of what we would today refer to as “multiple equilibrium solutions” to the value of a (potential) fiat money problem. One solution—the one taken for granted by Patinkin using the Walrasian “tâtonnement” approach—implies a positive equilibrium purchasing power.[2] The other is the one in which a would-be fiat “money” is not actually accepted as such, so that it commands no value at all. Patinkin assumes, in effect, that because agents might humor a Walrasian auctioneer by telling him that they would equip themselves with n units of some would-be paper “money” if each unit could buy q baskets of goods, and with n+x units if each could buy q-z baskets (and so on), those agents will in fact happily exchange valuable goods for the “money” in question at the determined equilibrium rate. To see the flaw in this approach, one has only to imagine the Walrasian polling being done using stage money. Evidently we need a theory that can account for the fact that one can buy things with actual fiat monies, but not with stage monies. Yet Patinkin didn’t see this, and neither do most of his readers, even today.
The regression theorem itself constitutes, as I’ve said, but one particular solution—a solution that might now be labeled “backward-looking” expectations-formation. Actual fiat monies are valuable, while stage monies aren’t, because the fact that the former have been valued historically makes the “Patinkin” equilibrium more salient, to backward-glancing agents, than the alternative, zero-value equilibrium. For a long time, as Larry points out, I also regarded this theorem as being the only practical solution. Consequently I saw in it the key, not only to the history of fiat money (and, in particular, to the “commodity money—redeemable money substitutes—fiat money” pattern of money’s historical development), but also to the successful launching of new official monies.[3]
Bitcoin’s success has, however, caused me to reconsider my previous understanding of the significance of the regression theorem; for that reason I think it only right that Larry should devote a substantial part of his retrospective to discussing a subject that some may think both esoteric in itself and at most tangential to the subject of Mises’s great work. Bitcoins aren’t even “money,” after all—not, at least, according to the standard definition, which holds that to be “money” a thing must be, not just an occasionally accepted, but a generally accepted, medium of exchange. But though Bitcoins aren’t money, their story challenges Mises’s theorem by suggesting that an otherwise valueless medium might become money despite not having a provenance linking it with some commodity progenitor.
Why, in that case, was anyone willing to be the first person to trade something having a well-established value, whether their labor or a pizza or some other good, for an as-yet useless medium? Here there was no question of a “friendly helix” of backward-looking expectations coming to the rescue. From a backward-looking perspective a Bitcoin was no better than a piece of stage money; the salient equilibrium, viewed from that angle, was the zero-value one, based on the prediction that nothing would change. Yet things did change, so that as of this writing a Bitcoin is worth about $1000. How was this possible?
In a post published at a couple months before Bob Murphy’s EconLib essay appeared,[4] I dubbed this question “the oyster problem”:
It is said[5] that the first person to eat an oyster had to have been exceedingly brave or exceedingly crazy or some of each. But that primordial mollusk eater had nothing on the first, equally anonymous person to receive bitcoins in exchange for valuable merchandise, in the hope of somehow fobbing them off in turn on others. The earlier pioneer might, after all, have simply taken his cue from a seagull or oyster-catcher. Unlike the rise of bitcoin’s network, that of various past money commodities like tobacco, cowries, and salt poses no puzzle: whoever first toyed with accepting such commodities for goods could count on the existence of persons who desired the commodities in question for their own sake, even if no one else was prepared to hazard their employment as exchange media…. The first person to accept bitcoins in exchange, in contrast, couldn’t hope to smoke them, make them into a nice bracelet, or sprinkle them on his food, in case he couldn’t trade them away: he (or she) could only hope that someone else would attempt a similar leap of faith, or face the consequences of trading some useful goods or service for so many units of digital dross.[6]
I went on to ask persons having intimate knowledge of Bitcoin transactions to submit their own explanations concerning how Bitcoin solved the oyster problem, and received a bunch of intriguing replies.[7] My own preferred theory invoked what I called “expressive exchange”—a counterpart to the “expressive voting” solution to the paradox of voting—a solution that treats voting as a source of direct satisfaction, like cheering on one’s favorite sports team while watching them on TV. The person who accepted Bitcoins for that first pizza did it, in other words, because he liked the ideas Bitcoin stood for, and wanted to root for them.
As I said, I liked the theory. But now I realize I wasn’t giving the Bitcoin team enough credit. Records show that a just a few persons took part in most early Bitcoin transfers, and especially in the larger-volume ones. My guess is that they all knew each other, and that those trades were more-or-less fictitious, with large values being traded and then traded back again, with the intent of enhancing the prominence of the positive-value equilibrium by drawing attention away from the much larger set of inactive Bitcoin markets. Bitcoin’s inventors, I’m now almost certain, were making conspicuous leaps onto their own bandwagon, so as to encourage others to do so, whether to express themselves or to profit by doing so. In short, a clever marketing strategy, including a little strategic sleight-of-hand, can substitute for history in putting a positive sign on the expected value of an otherwise useless potential exchange medium.
Mises, of course, can hardly be faulted for not having anticipated a possibility that has come as a surprise even to those of us who have watched it unfold. The Theory of Money and Credit does, however, suffer, in my humble opinion, from some serious shortcomings. One of them stems from Mises’s refusal to employ raw statistics, let alone econometrics of any sort, to bolster his claims regarding the merits or drawbacks of alternative monetary arrangements. Statistical measures of such things as money’s purchasing power are, admittedly, far from perfect. Nor would they serve any use if alternatives could be judged and compared on strictly a priori grounds. Generally, though, a priori reasoning alone will not allow one to conclude that monetary arrangement A performs better than arrangement B. In particular, it cannot tell us whether a managed fiat standard is likely to have a more stable purchasing power than a gold standard. Whether it does or doesn’t is an empirical matter, and as such it is one best settled by reference to the best available statistics, for such statistics, as crude as they may be, are at least better than mere assertions.
Alas, Mises’s disdain for statistics, and especially for statistics purporting to represent “price level” (or the inverse of what Mises’s called money’s “outer objective exchange value”), caused him to rely upon mere assertions in assessing the relative merits of gold and fiat money, and to do so even when available statistics would have supported his case. This was unfortunate, both because it rendered Mises’s particular policy recommendations less persuasive than they might otherwise have been, and because it almost certainly limited the overall appeal of The Theory of Money and Credit within a discipline that was becoming more-and-more statistically minded.[8]
Other significant shortcomings of The Theory of Money and Credit stem from Mises’s failure to rid himself of certain Currency School prejudices: although Mises, unlike many of his contemporaries, was never a doctrinaire exponent of either Banking or Currency School views, he did not succeed, in my view, in completely resisting some Currency School fallacies. In particular, he endorsed the Currency School view that, under a gold standard, a nation’s money stock ought to vary in strict accord with its monetary gold reserves, while blaming business cycles on deviations from this strict pattern. Mises sets out his opinion most clearly in Human Action:
Issuance of fiduciary media, no matter what its quantity may be, always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion.[9]
The same Currency School prejudice is, however, also implicit in the terminology employed in The Theory of Money and Credit, where Mises distinguishes between “commodity credit” and “circulation credit,” the first of which refers to credit based on actual savings.[10] It is not difficult to see how even such terminology, not to mention more explicit statements like that quoted above, have been understood by Rothbard and many others as embodying an implicit endorsement of 100-percent reserve “banking” as against any fractional alternatives, including free banking. At very least, it must be said (and here I’m afraid I disagree with Larry) that Mises’s defense of free banking was a lukewarm one, based on his (mistaken) belief that free banking would offer no scope for any substantial creation of fiduciary media.
[1] Israel Kirzner, “A Note on the Circularity ‘Bogey’ in the History of the Marginal Utility Theory of Money.” Ms., New York University, n.d.
[2] Don Patinkin, Money, Interest, and Prices, 2nd. ed. (New York: Harper & Row, 1965), pp. 115–16.
[3] George Selgin, “On Ensuring the Acceptability of a New Fiat Money,” Journal of Money, Credit, and Banking 26 (4) (November 1994), pp. 808–26, and idem.; “Adaptive Learning and the Transition to Fiat Money,” Economic Journal 113 (484) (January 2003), pp. 147–65.
[4] Robert P. Murphy, “The Economics of Bitcoin,” Library of Economics and Liberty, June 3, 2013.
[5] In fact the common statement misquotes Jonathan Swift, who observed, in dialogue 2 of his Polite Conversation, that “He was a bold man that first eat an oyster.”
[6] “Bitcoin,”, April 22, 2013,
[7] “A Challenge to the Bitcoin Community,”, May 2, 2013,
[8] See George Selgin, “Ludwig von Mises and the Case for Gold.” The Cato Journal 19(2) (Fall 1999), pp. 259–77.
[9] Ludwig von Mises, Human Action (Chicago: Regnery, 1949), p. 4439n.
[10] Theory of Money and Credit, part III, chap. 15, sections 10–12.