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Question about the regression theorem

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Koen Swinkels posted on Sat, Oct 11 2008 4:21 AM

Mises uses the regression theorem to explain why money could only have emerged out of an invisible hand process and not through a government decision for example. But why is the latter impossible per se? If the government hands out banknotes to people and tells them to use that as payment from now on, then as Mises rightly puts it the whole system of exchange rates needs to get established and this is very difficult, but is it impossible, especially when we take in the longer run?

 

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It is impossible. If government gave people such notes, it would either enforce their usage or not. In first case people would not use them. Lets imagine someone gave you paper with an inscription on it "This is one hundred prazdno". How could you possibly use prazdno to pay for anything? Only if goverment exchanged its prazdno for something else, another money, gold, wheat etc. you could use it. But it is exactly what Mises pointed out, there must be reference to any other value since such papers have got no value of their own. In case of enforced usage of prazdno as the only monetary media in some country, its economy would fail immediately, it would be reduced to barter or (more probably) people would overthrow their government and return to old monetary standard.

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Okay, then I think I am just missing somethng: if government forces people to use those notes as payment and outlaws all other forms of payment, and if i for example get 1000 'prazdno' then if I want to buy something I will decide how I want to spend that 1000 prazdno, 20 for food, 100 for a car, etc. And other people will do the same. wouldn't exchange rates emerge out of this process? There now is a scarce good, called the prazdno and we can exchange that good for other goods (and no other exchanges incl. barter are allowed)

 

I know that the good, the prazdno is not valued for its own sake and nobody would use it if they had a choice, and people might be quite angry because of it, but suppose they had no power to overthrow the government: why would exchange rates not emerge out of this process? the good is scarce, people know they can use it to buy stuff with it (and this may be begging the question) and so they will use it based on how much they value the things they can buy with it. The severe problem of exchange rates that will have to emerge out of this are clear, but are they wholly different from those that would be there if for example people lost their memory of exchange rates of the past? 

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That's true, under such conditions prazdnou would eventually become general mean of payment. But those conditions are far from materializing any time any place.

First, people would try to use something else. No government would be able to stop them, they never did. Enforcing agency would have to be all-seeing and all-knowing to do so. It would have to employ many agents. How would they be paid? How would be taxes collected? Process of transition towards new monetary standard based on prazdno would without doubt destroy any goverment. During the turmoil production and markets would virtually stop. No goverment is able to manage revolt of its employees and citizens in the same time. Not even old money would solve it, I mean not even paying wages of  bureaucrats and soldiers in old standard to keep their mouth shut. They are not independent, they must cooperate with the rest of the society at least somehow, they must pay for their food, clothing, shelter. They could do this in old money thus preventing the transition process. Otherwise old money would almost instantly loose its value too. Simply, there is no way to enforce prazdno upon society.

All this would happen if government allocated prazdno without any regard to dollar cash holdings of each person (helicopter money). But if it did, then it would set exchange ratio between prazdno and dollars, establish link to "yesterday" dollar in "today" prazdno. This has happened many times (for example old and new franc) without great disturbance.

 

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that's a good point yeah, that the allocation of the new currency will be based on the earlier dollar, or that it is completely cut off  from the earlier dollar in which case the above might happen.

actually, for my question, I think, the only thing that matters is whether a government could create a new money when there was none before (but it's already hard to think of a situation in which there is a government but no extensive division of labor (because there is no money))

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The only way a government could create money, IMO, would be to demand payment of taxes in a given commodity, making that commodity widely desired. But this, again, is consistent with Mises's regression theorem. Anything else would lead to pure chaos.

-Jon

Freedom of markets is positively correlated with the degree of evolution in any society...

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