I am an economic layman, but I want to know more. I recently started reading Murray Rothbard's "What Has Government Done to Our Money?". I am about 50 pages in and there are two things that are confusing me. 1) In arguing that money must arise out of a free market process as opposed to government edict, he states that "For embedded in the demand for money is knowledge of the money-prices of the immediate past; in contrast to directly-used consumers’ or producers’ goods, money must have preexisting prices on which to ground a demand". I'm confused as to what he is saying here. 2) He argues that although changes the in money supply confer no societal benefits, "movement in the price of money causes by changes in the demand for money yields a positive social benefit". I understand why a change in the money supply confers no societal benefits, but he loses me when he says that changes in money demand does. Can someone clarify?
1) In arguing that money must arise out of a free market process as opposed to government edict, he states that "For embedded in the demand for money is knowledge of the money-prices of the immediate past; in contrast to directly-used consumers’ or producers’ goods, money must have preexisting prices on which to ground a demand". I'm confused as to what he is saying here.
Murray Rothbard is re-stating and paraphrasing Mises's regression theorem (first introduced in The Theory of Money and Credit, but re-stated and defended in Human Action, pp. 405–408), which argues that in order for money to be valued as a medium of exchange it has to enjoy prices denominated in that currency of the immediate past, otherwise there is no reason why that commodity will be valued as a medium of exchange. Does this lead to a regressus in infinitum? No, argues Mises, because you can trace the exchange value of that commodity to the first day it became demanded as a medium of exchange and realize that it only became a medium of exchange on account of its demand for industrial use.
To clarify Mises's argument, I think it's best to envision the rise of a new medium of exchange as a gradual process — take gold as the commodity in question. Gold has a number of industrial applications, and so at some point in human history gold began to be exchanged with other goods in barter, establishing exchange ratios between gold and these other goods. Gold probably became relatively proliferate and slowly, gradually began to be demanded to be exchanged in the future against other goods, gradually establishing exchange ratios with other goods. Through the establishment of these exchange ratios it became possible for gold to become a medium of exchange — or a widely used form of currency. But, its usability as a widely accepted medium of exchange depends entirely on the existence of prices of the immediate past, since without these prices there's no way anybody would know how much to demand in order to use for future exchanges. The process of forming a new medium of exchange would happen anew.
2) He argues that although changes the in money supply confer no societal benefits, "movement in the price of money causes by changes in the demand for money yields a positive social benefit". I understand why a change in the money supply confers no societal benefits, but he loses me when he says that changes in money demand does. Can someone clarify?
He gives his rationale in the same paragraph. Assume that there's 3,000m.u. (money units) in circulation, and suddenly there is an increase in demand for money by 500m.u., reducing the amount of m.u. in circulation 2,500m.u. It's a very simplistic example, but it allows us to see that prices will have to conform to the reduced amount of money in circulation. What occurs is a fall in prices, and thus an increase in the purchasing power of each m.u.
1. If you want apples now, you don't care what their price is or used to be. You want them because you are hungry. Of course, if they are too expensive you won't buy them, but the ultimate reason you want them is because you are hungry, not because they cost a dollar a pound, or whatever.
But if you want money, want it enough to work for it, you will want to know what it can buy for you [=its purchasing power]. If you will be paid in Estonian currency at the rate of 10 Estonians an hour, you won't work until you know what that money can buy you. Because maybe all it will buy is a pack of gum, and you don't want to work an hour for a pack of gum. So you have no demand for the money unless you know it's value [=purchasing power].
So if a govt issues new paper currency, you won't want to use it unless you know how much it is worth. So that nobody will want it, because nobody knows how much it is worth.
But if it issues new gold coins, you know how much gold is worth, because gold is bought and sold all the time, and has a clear market value. So you will accept the gold coins, because you know what they are worth.
2. He later says what the benefit is: for it satisfies a public desire for either a higher or lower proportion of cash balances to [do] the work done by cash.
Meaning if people want to save a lot of money under their matress, how will there be enough money to to do all the buying and selling of everyday life? And the answer is that money will increase its purchasing power and thus there will be enough to get things done.
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It's easy to refute an argument if you first misrepresent it. William Keizer
thanks to both of you who answered! Regarding #1, I understand how government edict of a currency is bad because, at first, there is no established market value. However, does not this problem go away over time? I know what my dollars can buy for me now.
MDay1985:thanks to both of you who answered! Regarding #1, I understand how government edict of a currency is bad because, at first, there is no established market value. However, does not this problem go away over time? I know what my dollars can buy for me now.
Yes, you know what your dollars buy now, so that part isn't a problem. Rothbard and Mises were simply starting from the beginning, explaining that money is a commodity that evolves out of a free market process, and that cannot be centrally planned.
The problem with our dollars now is that they no longer represent a claim on the natural resource commodity that they once did...meaning, the only reason people accepted the use of dollars and knew what each dollar was worth is because it represented a certain amount of gold or silver...two commodities that already had an established value in terms of other goods. But now that our dollars are not redeemable for any amount of gold or silver at all, they can be printed out of thin air at virtually no cost. And this is, of course, inflation of the currency, which Rothbard covers as the main problem.
So to recap, money can only come into existence out of a free market process...meaning it has to start out as a commodity that has some sort of utility value, and then gradually as it begins to be priced in terms of other goods, it can begin to be used as a medium of exchange, i.e. a commodity not consumed, but simply used to facilitate an exchange. And what happened over time was that gold and silver became the most preferred commidity to use in this way because of the qualities it possessed that made it an ideal money. (See the video below). However, eventually, people found it easier to use pieces of paper (certificates) that represented the gold, instead of having to carry the physical gold around with them all the time. The paper just represented the gold. This meant there had to be real money involved in exchanges. However, now, the gold backing has been completely removed. We still know what dollars are worth in terms of other goods, simply out of habit. But the problem comes in because now that there is no need for anything real to back up the dollars in existence, they can simply be printed out of thin air at will.
And of course, this is known as "inflation"...which is really just thieving transfer of wealth.