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Tag: Monetary Theory

Bitcoin—A New Kind of Money

In the last articles, we discussed what money is and why money was invented. We found that there are different kinds of money. So, what kind of money is Bitcoin?
Is it commodity money? Is it unbacked token money? Or is it something entirely new?

Austrian economists are divided in their assessment of Bitcoin, some see it as the best money ever, while others see it as worthless fraud. As can be visualized by the below tweet from the Swedish Mises Institute.

This goes back to the unfortunate and previously discussed errors/unclarities in Mises’s monetary theory. Which leads many to believe that the only way for sound money to emerge is by means of the regression theorem out of a valuable commodity.

While I agree that the regression theorem accurately describes, how a commodity can become money, it should not be seen as a law that ONLY through it can something become money. Especially since history clearly shows that ledger money is older than commodity money.

The reason for this error according to Argentarius is that most monetary theories only describe what money does and not what it is. He thus separates the concept of money, from the token that represents the money. To make the distinction a bit easier to see, I will call Argentarius’s concept of money “Meta-Money” from here on.

As I laid out in my article “The Evolution of Money”, the reason humans invented the various forms of money, was to represent the virtual Meta-Money. The concept of Meta-Money is brilliantly explained in “The Essence of Money”, I definitely recommend you to read the full book, still let me try to summarize it here:

Meta-Money is the virtual placeholder used when a trade cannot be made directly, but rather needs to be shifted in time, space or party.

A shift in time and place is easy to understand. You deliver 10 crates of beer to your friend’s house on Friday, and the friend pays you back in food and organizing the party at the beach on Saturday.

Meta-Money in this case is the virtual placeholder in your head that says, “I delivered beer, so I am owed food and party.”

Meta-Money is thus a virtual ledger that contains both debts and credits that result from a contract which is only partially fulfilled. One could say that Meta-Money represents the right to just compensation for a service delivered, but not yet paid for.

Tracking this Meta-Money is very difficult as soon as more than a few parties are involved. Especially, if the compensation does not come directly from the person you are trading with.

In the example with the party, this could look as follows:
You deliver 10-crates of beer to your friend’s house and every one of the other guests delivers some food, drink, or snack. The whole stash is then shared at the party. In this case, you deliver the beer to your friend, but the compensation comes not from your friend, but rather from everybody else who attends the party.

Now, how do you track this debt? What do you do, if you brought the beer, but some guests fail to bring the food they promised to bring?

This is the point where money tokens come into play.

The function of a money token is to represent the Meta-Money in a standardized, quantifiable way.

For our party, this could be done by simply issuing a set of vouchers. Everybody who brought his or her promised good, gets 10 vouchers and can thus take ten other food/drink items.

The problem with this approach for said party is obvious: Those who didn’t bring anything will have no fun at all. So, you need to give them a chance to compensate you and the other reliable party goers for your goods.

Conveniently, other monetary tokens already exist, so you can agree on one of the following options:

  1. People who brought nothing can use Euro/Dollar/Bitcoin to purchase vouchers that can then be redeemed for food.
  2. You skip the vouchers entirely and set a fixed fee everybody who brought nothing has to pay to get all-you-can-eat access to the buffet.

After the party, the currencies collected can be split equally between all those who brought food/drinks.

Now, what if people bring unequal amounts? You bring 10 crates of beer, somebody else just one. Another person brings an elaborate 3D modelled cake, vs. somebody else’s $1 store bought cake.

If everybody gets the same compensation, you will rightfully feel betrayed. For beers, this would be easy to resolve. If you brought 10 crates, you obviously get 10x as much, as the person who brought one. But how about the cakes? How many $1 cakes equal the labour-intensive 3D cake?

In the small-scale party situation, this conflict can be very difficult to resolve, since valuations are highly subjective. The creator of the 3D cake may feel it’s 1000x more valuable than the $1 cake, while the dollar cake bringer thinks it’s only 10x and others may call it at 100x.

In nationwide or global economies that use a common money token or currency, this conflict of subjective valuations is resolved by price discovery in the market.

If many people buy and sell goods, even though individual valuations differ, a market price emerges. Which means nothing more than that at the current supply, demand and cost levels, you will likely find a buyer for your goods at that price if you are a seller. And you will find a unit of the good to purchase at this price as a buyer.

The problem with these market prices is that they do not only depend on the demand, supply, and cost structures in the market, but also on the characteristics, of the money token used to express the prices.

In the case of the party, this can be easily seen. If every party goer gets 10 vouchers and there are 10 people at the party, every person can get 1% of the food and drinks.

If now suddenly 10 other persons come to the party and the reckless host just also hands everyone 10 vouchers, everybody suddenly can only get half of a percent of all food and drinks.

So one criterium to measure the accuracy of any money token or currency obviously is the total quantity of tokens. If people who have actually earned a token by a partially fulfilled contract, while other people get tokens without having rendered any service, the consequence is a redistribution from people who have delivered value, to people who have not.

But what is “accurate” money?

As we saw above in the cake example, value is subjective and prices need to be discovered via the market process. Market prices fluctuate over time, so at which point in time you look makes a big difference. So, what is the “just” price?

This may seem like an unresolvable riddle. After all, for the past 100 years, central banks have desperately tried to keep prices “stable” and failed miserably.

Luckily, Argentarius made a discovery that can help us get out of the dilemma. He observed that under a hard money (e.g. gold coins) where the overall supply of money tokens changes very slowly over time, the abstract “value” represented by one token remains extremely stable.

If historically, a pair of boots cost 1 gold coin, as long as the difficulty of making the shoes remained the same, the 1 gold coin price would stay the same for centuries.

Only if it gets significantly easier to produce the boots (automation) or significantly harder (natural disaster destroying leather supply), will the price change accordingly.

This may seem a very strange phenomenon, if you learned in school that price depends solely on supply and demand. The answer to the riddle is the velocity of money.

Unlike the vouchers in the party example, a gold coin does not get destroyed/devalued when it is used. So, 1 Gold coin can be used 100, 1000 or even a million times to buy one pair of boots. The velocity of money (i.e. how often the average coin is spent per year), thus, regulates the amount of Meta-Money represented by the tokens to a consistent level. One could say that the velocity of money automatically adjusts to offset fluctuations in the supply and demand for goods.

If you studied Keynesian economics, this probably will sound like an outrageous claim to you, even though it is not a claim at all, but rather an observation made by Argentarius.

Let me try to explain to you some of the factors that enable this kind of automatic price stability under hard money:

  1. People have an uncanny ability to remember prices of common commodities. Here in Germany, even over two decades into the reign of the Euro, you will still hear people refer to the old, relatively stable Mark prices.
    “What, this costs now €10? That’s 20 Marks, this used to cost only 5 Marks.”
    This price memory is one factor that makes market prices for commodities slow to change under hard money.
  2. Another factor is that, while the velocity of money changes, hard money means that the absolute number of tokens doesn’t change. And every transaction covered in the velocity of money is done by two parties agreeing on a price for a good or service.
    While the subjective valuation, and thus agreed price, may be above or below market price, the “loss” of one party in any given trade means an equal amount of “gain” for the other party. Overall, the net results cancel out and the “value” represented by each money token remains stable.

In a nutshell, this means that hard money does not require a central bank to keep prices stable. Market processes and human psychology automatically regulate the money velocity, so each money token represents a relatively stable purchasing power or “value”.

If a hard money market price goes down long-term, this is not deflation, but rather an indication that the production of a good has gotten easier. Vice versa, if there are sustained price increases it means that it has gotten harder to satisfy the demand, harder to produce the good in question.

If a currency supply expands, the equilibrium is broken and the market will need some time to reprice all the goods in terms of the new total supply of tokens. If the monetary supply is expanding faster than the market can balance itself, the consequence is that the “value” represented, transferred and stored in each money token will be distorted.

The goods and services preferred by the ones closest to the source of tokens will get up first and higher than the goods and services preferred by those furthest from the source. This is known as the Cantillion Effect.

This mechanism is also the reason, why central banks were able to create outrageous amounts of money tokens over the past decades and yet, consumer prices remained relatively low.

The newly created money was parked in assets by the first receivers (banks and large corporations) and did not circulate. Thus, only asset prices exploded, and money velocity was artificially suppressed.

In a nutshell, this is the reason, hard money requires a stable supply to represent Meta-Money accurately:
According to Argentarius, if the supply of a money token is stable (in the ideal case, exactly constant), then that token will represent a constant “value” across the economy that uses that token. And this “value” will stay stable over time and space so that you can use the token as a universal coupon. A coupon that will give you the “just” compensation you are due for services rendered and goods delivered, no matter where, when or with whom you “redeem” it.

From Argentarius findings, it becomes clear that all the different kinds of money, be it Fiat paper money, Gold coins, Mesopotamian clay tablets or Bitcoin are only different money tokens, not different forms of Meta-Money.

The properties of a token only influence how accurately the token can represent the Meta-Money over time, space and party.

Ok, not so fast. Commodity moneys are a special case… While a Fiat money has no other value than the Meta-Money captured, commodities also have a non-monetary value.

This is a point that in my opinion has confused many economists. When you review commodity money, you need to carefully separate the uses and valuations.

If you receive a gold coin, melt it down and make electronic circuits, then you have not used it as money at all, but purely as a commodity. And your valuation of the coin will be based on how useful the commodity “gold” contained in it is to you.

If you receive a gold coin intending to spend it to get other goods, you value it according to the goods you hope to get for it and how valuable these are to you. In that case, it makes no difference (as long as the number of tokens in circulation doesn’t change) whether the coin is made of gold or paper. You value it based on the Meta-Money represented and use it purely as money, not as commodity.

When you use a commodity as money, the physical characteristics of the good do only indirectly influence the value of the money token, not directly as if consumed.

This happens in two ways:
Firstly, the commodity value of the token set’s upper and lower bounds to the amount of Meta-Money it can store.
If the commodity value of gold should get higher than its monetary value (negative monetary premium) than people will stop using it as money token and consume it instead.
If the production cost falls and availability of the commodity gets higher, then the value of the money tokens must fall because people will simply produce more tokens until equilibrium is restored.
Since a scarce good like gold can store much more Meta-Money than its value as commodity, the standard case for any commodity money is a positive and rather large monetary premium. Meaning that the use value is negligibly small compared to the monetary value.

This leads to misallocation of resources, since the monetary use forces commodity consumers to pay a significantly higher price than the “normal” market price of the commodity.
For this reason, among others, usually commodities like gold, silver, or seashells become money, since they are not a vital part of the economy. Times when food, real estate or other basic necessity gain a significant monetary premium are typically desperate times, accompanied by social unrest.

The second way the physical properties of a commodity influence its value as a money token is their usability. How scarce, how divisible, how durable, etc. is a good, determines how well it can be used as money.

Eggs are terrible monetary tokens, they are too readily available, not divisible and spoil fast.
Gold is a very good monetary token because it is scarce, lasts forever and is relatively easily divisible.
Still, gold is far from perfect. It is too valuable given its density, which is why historically small purchases were done in Silver, which is not quite as scarce as gold and almost as durable.
Furthermore, Gold is quite hard to ship globally and easily stolen, which makes it awful to carry for daily groceries or use in international trade.

A significant downside of all commodities is that the difficulty of production changes with time. Problematic are especially big technological breakthroughs that can make a formerly scarce token abundant and thus worthless (see Rai Stones, Cowrie Shells).

NOTE: Gold is not safe from this fate either, asteroid mining is probably just a few decades away and earth is not fully explored yet.

In comparison to commodities, Fiat, debt-based and ledger currencies have the advantage that the total supply is not dependent on any natural/industrial process, but in theory can be set to a fixed amount.

The problem with that however is that until Bitcoin came along, you always had to trust somebody to keep the ledger honest and not expand the amount of money tokens.
So far, every human organization in charge of the money supply has miserably failed in keeping the money honest and limited in the long run. Thus, Fiat currencies were almost always bad stores of value and extremely inaccurate in representing Meta-Money.

The best theoretical money would be a hypothetical god-money. A token, created by an incorruptible deity who ensures that a fixed number of tokens exist and smites anybody who dares try to forge new tokens.

Bitcoin is as close to god-money, as one can get, without having a trustable deity to control the money.

The great differentiator in Bitcoin is the difficulty adjustment. No matter, how efficient miners get or if countries ban mining. Every 2016 blocks, difficulty is adjusted based on the time between blocks in the last period, to keep the time at an average of 10 minutes per block.

This, combined with the overall incentive structure Bitcoin provides, makes it almost impossible to change the schedule of Bitcoin issuance or expand the total supply.

Bitcoin is an unprecedented, wholly new kind of money which has both the advantages of commodity money and Fiat money, without the individual downsides and many never before seen upsides.

This all makes Bitcoin the most accurate money token ever invented, maybe even the best token possible.

The more Bitcoin grows in usage, the more monetary premium it will absorb from commodities and other forms of money. Until hopefully in the future, we will have the whole Meta-Money of the global (or perhaps interplanetary) economy accurately represented by Bitcoin.

We will discuss this future and its implications in one of the upcoming articles. If you don’t want to miss any new articles, please subscribe to my newsletter below.

United States of Bitcoin—How the US can save their empire

In my previous articles, I discussed how China is trying to bring down the Euro-Dollar system and how this may lead to the fall of the US empire.

Today, I invite you on a journey into a hypothetical scenario explaining how the USA can utilize Bitcoin to escape this fate.

Imagine that right now, the United States treasury is secretly putting Bitcoin on their balance sheet. In a few months, they will announce that they managed to acquire 5 Million BTC.
Soon after a law is passed, recognizing Bitcoin as legal tender and guaranteeing a fixed one-to-one peg of Dollar to Satoshi (One Bitcoin is 100,000,000 Satoshi or Sats for short).

This immediately sparks panic on the international money markets. Many creditors want to quickly have their debt paid off, before the Dollar inevitably loses value. The United States government offers every claimant that they will pay USD debts in coins with a million, a billion, or even a trillion denominations.

Some take the coins, many take the Sats.

Since the USA are still the biggest military power and the Dollar is still the world reserve currency, other nations face a tough choice. Should they keep their Dollar reserves and trade in USD? Or should they switch?

US adversaries that have over proportionally large holdings of gold or silver will switch to various gold and bi-metallic currencies. Most notably China and Russia.
Countries low in gold reserves will choose Bitcoin.

By this bold action, the United States would effectively get rid of their debt and at the same time establish the hardest currency imaginable as the world reserve asset.

Granted, this scenario is not very likely for many reasons. The US might already be too weak, the corruption in Washington too big and economic understanding too close to zero.

But let’s roll with it for now, to see where it could lead.

The United States effectively defaulted on their debt in 1971. Due to their enormous military might, no country dared challenge them to pay back the debt, and everybody accepted the worthless paper Dollars.

Unfortunately, the “exorbitant privilege” turned out to be an exorbitant curse eventually.

Every transaction ultimately gets settled in goods and services.

So, while the worthless paper Dollars lead to a massive influx of cheap goods into the States, creating the illusion of a privilege, the international circulation couldn’t contain all these Dollars forever.

It’s all nice and fun, having USD on your balance sheet, while the economy is hot and growing fast. When the music stops, however, no investor with more than two brain cells wants to be the one holding unbacked paper or even worse, unbacked ones and zeros in a computer, which can be deleted at any time.

How fast this can happen, could recently be seen, when Russian central bank assets were frozen.

This moment, in the Ukraine-Russia conflict, essentially marked the second default of the US. The US of A admitted that their Dollars are just empty promises that they never intended to actually fulfil when the going gets tough.

A wider occurrence of such freezes is just a matter of time. The reason for this is simply that the US have run out of assets.

For years, the Chinese and other nations have been expecting the music to stop and started exchanging their USD reserves for physical gold and other hard assets, like US companies and real estate.

Essentially, the price for cheap goods, paid for with unbacked FED dollars, was the capital stock of the United States.

The more exorbitant the valuations of US stocks and real estate got, the less powerful the United States became. This problem was exasperated by the fact that so much cheap money leads to malinvestment, corruption and a rotting of the capital stock.

Thus, the US military (the only thing actually backing the USD) got more and more expensive, while its combat power declined.
The military industrial price inflation, is probably the worst inflation for a Fiat nation imaginable because it chips away at the very foundations of the system.

So, for every clear eyed witness, it’s obvious that the US military hegemony is very close to falling apart and being replaced by the Chinese empire.

From my perspective, the US have only three options how to continue:

  1. Yield to China → very undesirable
  2. Break the East militarily → WWIII, likely nuclear, extremely undesirable
  3. Rebuild their economic power → only possible with monetary reform

If history is any guide, the only viable option for the United States would be a monetary reform. Historically, this would be done by a fractional reserve gold peg, which was used in Weimar (albeit much too late) and ended the hyperinflation within one week.

The US do not have this option.

Remember, Nixon only suspended the gold standard. If the States wanted to return to a gold peg, at any level apart from the old ratio, they would essentially declare that they are not a trustable debtor.
Of course, you may say that implicitly that was already what Nixon did, but stating it explicitly, especially in a time of weakness, like the current geopolitical situation, this would likely result in WWIII, just like option 2.

The only other real alternative is Bitcoin.

If the US government had read Argentarius and thus understood money, it would be obvious, why Bitcoin is the one weapon that can overthrow China.
(Or overthrow the US, if China should be the first mover.)

In monetary history, there was seldom a second best. The hardest currency always drains the monetary premium from alternatives. The only reason that gold and silver bi-metallic standards existed is the limited practicality of gold for very small transactions.
If you tried to compete with a silver standard versus a gold or bimetallic standard, this would cost you dearly, as medieval China learned the hard way.

Bitcoin is for many reasons a better monetary token than gold. The most important advantages are the hard-coded, transparent supply, as well as it’s decentralized nature. Furthermore, Bitcoin can be transferred globally at almost zero cost (more on why Bitcoin is the ultimate currency, in my next article).

If no unforeseen calamity happens to wipe out Bitcoin, the 99% likely scenario for this century is that gold and silver will lose their monetary premium to BTC.
A trend, US adoption, would greatly accelerate.

Assuming that China has little to no Bitcoin reserves, an outsized US stack could easily tip the global power scales in favour of the Stars and Stripes banner.

Not only would such a bold move into a Bitcoin standard, essentially wipe out all the Chinese dollar reserves, it would also reverse the “exorbitant curse” dynamics of the Euro-Dollar system.
The world would still need to trade in the USA currency, be it Bitcoin backed USD or Bitcoin directly, but suddenly, they would find themselves in a situation, where there is more purchasing power in the US than current economic power.

This first mover advantage would allow the US to interest rate free finance the rebuilding of their broken economy and infrastructure.
Furthermore, it would likely topple the already cracking Chinese real estate market, leading to a monetary crisis in China.

In a nutshell, this means that a surprise Bitcoin standard has the best risk/reward profile, of all available options, from a United Stated perspective.

So, even though I am not a big fan of the US empire, I think the best chance to keep our freedom is if they win the currency war. Otherwise, a Bitcoin standard might be preceded by decades or even centuries of CCP style social credit dictatorship.

What are your thoughts?

The Evolution of Money

How was money invented? Why do we need currencies? What is the best money?

In a previous article, I explained the differences in monetary theory between Mises (Austrian School) and Argentarius.
Recent discussions between me and proponents of Mises’s theory have shown me that there are several points that are not entirely clear. So today I would like to dive a bit deeper and show on practical examples, how and why money evolved and what good money is.
Furthermore, I will try to show exactly at which points the two theories diverge and where I see the problems with Mises’s explanation.

Throughout all our examples, we will use the four Persons A, B, C and D. You can see the goods they start out with, in the below picture.
The transaction we want to resolve is that Person B wishes to buy a pair of shoes from Person A.

Example 1

The First Example will be simple. Person A and B do a direct barter trade. So, A and B simply draft a contract. Since C and D are not involved in this trade, we will omit their balance sheets for now.

NOTE: Historically these types of trade were done verbally, so the contracts and balance sheets in Examples 1, 2 and 2a are only for visualization. Practically, they would usually be in memory only.

Once the contract is signed, the goods are exchanged. Once both have delivered, the debts from the contract are erased and the trade is done.

Example 2

In the next example, we increase difficulty. Person A now doesn’t want eggs, but rather grain, which only Person C can provide.
To facilitate this trade, Person A negotiates a three party barter contract.

To fulfil the contract, first A and B need to exchange goods, and then A and C exchange goods.

As you can see, arranging a three party barter trade is already rather difficult, and if not all goods are available at the same time, the Person facilitating the trade must take quite some risk, since they need to trust their partners and give them credit.

This method of trading gets impractical quickly once more than three parties are involved.

Example 2a

So, if Person A is not willing to set up a three-party contract, the other option for B is to acquire the goods A wants in a separate trade.

To reduce the risk of giving credit, the three parties meet at one place and goods are exchanged directly.

While this is a safer way to trade, it’s even less practical to arrange, the more parties and different types of goods are involved.

Example 3

To resolve this issue, humanity invented the balance sheet and the debt transfer.
Archaeologist have found clay tablets, showing such trades were done as much as 5000 years ago.

Let’s have a look how such a clay tablet trade works:

This is much more practical, but since clay tablets are not too easily edited, another trick needed to be invented.

Example 4

Instead of rewriting clay tablets to represent who owes who, we will now simply use a Coupon redeemable in grain, signed by Person C as medium of exchange.

To spice things up a little, we will assume now that A doesn’t want to redeem the grain coupon, but they rather want Gold, which is available from D who in turn wants grain.

Such a coupon system is already the beginning of a commodity money, slowly turning into a currency.

The main evolutionary step from coupons/commodities functioning as money to currency, is the market process by which a commodity—like gold—becomes so widely accepted that everybody accepts the commodity as payment, even without any intention to directly exchange it for a good they actually need.

Example 5

If we do the same exchange of goods like in Example 4, but with Gold as widely accepted medium of exchange, it will look like this:

As you can see, this is a way easier way to trade that does not require any balance sheets or tracking of debts.
With this system, it is also possible to have the commodity money—Gold—change hands thousands, even millions of times, before the commodity actually reaches somebody who wants the Gold as a commodity itself and not for the monetary function.

Up to this point, the theories of Argentarius and Mises agree. The differences begin, once there is a standard medium of exchange.

Mises would now argue that you can simply write the transaction from Example 1 as follows:

Argentarius however would argue we would still need to take the full chain into account as shown in Example 5. If this example was rewritten to just show Person A’s and B’s direct trades, it would look like this:

This way of looking at things may look like nitpicking to you, but it is crucial, once inflation and changing production methods come into play.
If you use the Mises style analysis in times of high inflation, you will be selling yourself poor.

As Argentarius records, during the Weimar inflation days, business owners accounted by simply adding a profit margin to their costs.
While this is quite a common practice and not necessarily harmful in times of low inflation, as soon as inflation becomes faster than your business cycle, it will lead to the “selling poor” effect.

What this effect means can be seen in the chart below. The grey line represents the material costs, which after 1 year of no inflation start to inflate at 10% per month.

The orange line is a merchant who has a 3-month production cycle and calculates his prices based on 30% margin on cost.

The yellow line is a merchant who calculates his prices after production by what he expects to be the next month material cost.

As you can see, at such high inflation rates, the orange merchant rapidly falls into the “selling poor” zone, where despite a 30% profit on paper, his stock dwindles, and he has to go out of business.

Of course, it is not always possible to accurately predict inflation and such high inflation rates are rare.

Nevertheless, this example highlights the differences between Mises and Argentarius.

Mises operates under the framework of Praxeology. While this is a great tool to evaluate economic processes, like any model it makes simplifications.
These simplifications are necessary to have any chance at analysis of complex systems.
In edge cases, such simplifications can lead to erroneous results, which is why you always need to stay aware of these assumptions.

As Rothbard explained, Praxeology, unlike Psychology, does only concern itself with how people act, not with why they act as they do.

This can be a problem, when it comes to analysing contractual relationships. A contract is nothing more than a declaration of what two parties want.
So, when judging the quality of a contract, it’s important to check whether all parties received the result desired from the contract.

Unfortunately, humans are not always fully aware of their intentions, so contracts can be written in a way that looks acceptable to all parties, but in fact turns out to have been contrary to the intent of the parties.

This can be clearly seen in the above example.

The merchant, who calculates 30% profit on cost, does so, not because he wanted to have the money, but because he wanted to restock, pay his bills and maybe save or invest a little.

Basically, he wanted to do a multi party barter trade. He intended not to have any money token or currency, but rather to exchange finished goods, for raw materials, factories, machine depreciation, etc.

He only used money as a placeholder, due to convenience. Since the money worked for a while, the merchant fell into the trap where he forgot that the money was not the good he actually desired and thus sold himself poor.

Money tokens were invented to facilitate multi party barter trades. Their function is just a placeholder. Thus, the best money token is the one that most accurately transports a barter “value” over time, space and party.

In the next article, we will discuss what this means for the engineering of sound money.

Monetary Theory—Argentarius vs. Mises

What is money? Many economists have tried to define this omnipresent tool of human trade. Few have come close to a comprehensive analysis. The two men who in my opinion did the best job so far were Ludwig von Mises and Alfred Lansburgh (better known under his pen name “Argentarius”).

Mises as one of the most famous representatives of the Austrian School is of course more well known than Lansburgh, but while I greatly admire the man, this time I need to side with Argentarius.

The two theories are rather close and not entirely incompatible, but a few key differences exist, and I think they are due to Argentarius seeing what Mises overlooked. Let me explain…

While Mises traces money back to the value of the underlying commodity (Regression theorem), Argentarius adds another layer to the analysis. He does not dispute the history, how commodities became monetary tokens, he rather claims that the concept of money is entirely separable from the underlying commodity and much older.

While I cannot lay out in a few lines, what Lansburgh explained in an entire series of books, let me try to rephrase how he claims money evolved.

Why are money tokens even necessary?

Whenever you trade with other people or render them services, one side will inevitably need to grant the other side credit at some point. Few goods can be exchanged one to one at the spot.
If you pay for a pair of shoes with eggs, for example. It will neither be practical nor helpful, if you deliver the payment of a thousand eggs at once in exchange for the shoes.

Rather, you will make a deal with the shoemaker, where either you deliver 1000 eggs first, in household quantities, over say a year (i.e., you give the shoemaker credit) or you get the shoes first and then pay off the debt with eggs over time (the shoemaker gives you credit).

In ancient human history, such debts were either remembered by people or chalked down. We know that as much as 5000 years ago, people would use clay tablets to record ledgers of such commodity debt contracts, e.g., in Mesopotamia.

This debt is what Argentarius calls “money”. Or more precisely, the debt that results from a contract that has been partially fulfilled. Looking at archaeological findings, it seems that Argentarius is indeed correct, and these ledger-based debts go back further than commodity money.

Of course, we need to note here, that what we colloquially call “money” is different from Lansburgh’s definition. In day to day life, we usually equate the money tokens or currency with “money”.
So, when we compare the different theories, we need to keep in mind that Argentarius calls the virtual debt “money” and the physical currencies “money tokens”.

Why and how did humans even switch from a virtual, ledger-based debt “money” to token money?

The answer lies in the growth of civilization. While, a debt denominated in individual goods and services and recorded in virtual or physical ledgers, may work for a city or even a state, the bigger and wider trade networks become, the less practical it becomes—especially for small transactions.

Just imagine either a harbour innkeeper having to know all his customers and remember their tabs, or a central national clay-tablet database recording every beer drunk in the nation and not yet paid for.

Thus, tradesmen started to seek for a standardized medium of account, similar like kings standardized length measurements to multiples of their foot. The problem with value is that it is subjective, however.
As Mises correctly points out, all humans rank their possessions hierarchically, but cannot quantify them because there is no SI unit for “value”.

Your kid is hopefully more valuable to you than a donkey you own, but if you had to put a numerical value on either, you wouldn’t be able to. Unless, of course, you compare it to a good or service you need right now that is of equal or greater value to you.

If there is a famine, you will probably first sell your donkey for grain because the grain is more valuable to you than the donkey. And the grain and donkey are both less valuable than your kid, so you don’t even consider selling the kid at first.
If the famine continues, however, you may come to a point, where you start to think about how much food you could get—for you, your wife and your four eldest children—if you sell the fifth and youngest kid.

I know, this example may sound cruel to us today, but it was a tough choice people often faced historically and even in Central Europe as recent as 150 years ago children were still occasionally sold to feed families.

So, how exactly do we calculate values, prices, debts in a standardized way then?

How many money tokens equal one child, and how many money tokens equal one loaf of bread? If we want to express values comparably, we need to develop a solution to this, we need to find a common denominator.

This is especially important for an economy, since something as valuable as a child, is worth more than a single merchant can supply in useful goods. If we wish to trade extremely high-value goods, for relatively low-value ones, we need a standardized way to express value and debt, so we can defer a transaction in party.

What do I mean by that?

In our example, even if the grain merchant offers you 5 tons of corn for your child, this will not help you feed your family. You are unable to transport and store 5 tons of grain, and you will need other goods, like drinkable water, basic shelter etc. that the corn trader cannot deliver.

A good money token thus needs to allow not only for the monetary functions of the historical ledger-based money (transferring a transaction in time and place), but also to transfer a transaction in party, i.e., a way to collect debts from another person than the one you are directly trading with.

One way this has been achieved is that traders of staple commodities, like grain, would give out coupons redeemable for their good instead of the good itself.

In our example, this means that instead of 5 tons of grain, the father receives 5000 coupons redeemable for 1 kg of grain each.
With these coupons, the father can then pay the shoemaker for new shoes, the well owner for some drinking water etc. This works because all of these merchants also need grain.

While this coupon money, solves the problem of transferring a transaction in party to some extent, it still does not solve the issue of a universal medium of exchange. Only people needing grain and trusting the merchant issuing the coupons will accept the coupons as payment.
(Of course, some will also just trade the coupons, but for brevities’ sake, we will exclude this from our analysis here.)

Furthermore, the validity of such coupons will be limited geographically. A merchant 500 miles away, is not likely to take a coupon he can only redeem by travelling to a far away city and redeem with a merchant, he does not personally know.

Thus, the market found a solution in money tokens which had some market value independent of the exchange value guaranteed by some central entity. Historically, precious stones, cowrie shells and metals like Gold and Silver were chosen. Why and how specific goods were favoured over others, is explained brilliantly by Mises, so I won’t go into it here.

Once a money token or commodity money gets dominant in a region, either by market choice or by government decree, it finally evolves further into a “medium of exchange”. This means nothing more than that the money token (e.g., a gold mark or paper mark) is universally accepted as a placeholder in transactions and every good or service over time establishes a “market price”, denominated with the token.

The market price of a good or service, is the closest approximation one can objectively make to the subjective concept of “value”. This does not mean that every person values the same good or service at this market price, but rather that on average the marginal utility of both sellers and buyers of the commodity meet at this price, under current conditions.

So with the “market price” a medium of exchange finally allows us to express the “value” of things in a standardized, quantifiable manner and transfer transactions in time, space and party.

In a nutshell, this means that whatever good or service you are trying to exchange for whatever other good or service, you can just use the dominant money token instead.

The implication of this being that instead of having your employer pay you for your work in shelter, food, clothing, etc. You can receive your salary in the money token and then exchange the token for the desired goods at any merchant.

Up to this point, Mises and Argentarius largely agree, even though they place their emphasis on different aspects of the process.

Let us recap:
Argentarius traces the history of money back to “contractual debt”, tracked mentally or on clay tablets, which then became coupon money and then commodity money and then by choice or decree a medium of exchange.
Mises, on the other hand, traces the evolution of commodity money, by a free market process. Defining this type of money token as “money” if it is used as “universally employed medium of exchange”.

Both economists agree that a monetary token dominant in a given market/country becomes a universal medium of exchange. They disagree in the core definition of money.

To Argentarius, “money” is an abstract concept. A placeholder for a debt in an open transaction. Money gets born when somebody renders someone else a service and has not yet received the compensation. As soon as the transaction is completed, i.e., the debt is paid, the virtual money disappears. A money token in this context is used only to represent and quantify the abstract money.
The implication of this is that any given transaction is only finalized, once both parties have received the actual goods and services desired by the transacting individuals.

So, in the case of the shoemaker, it does not change the transaction, whether the shoes are paid for in eggs or whether the eggs are sold for a money token and then the shoes bought for such a token. The transaction is only finalized once the shoemaker in turn has exchanged the money token for eggs.

Mises, on the other hand, attests the monetary token a marginal utility of its own, reflected in the market prices of all goods and the monetary premium the token has over the commodity it consists of.

Here I see the flaw in Mises’s argument.

If a monetary token is accepted as payment for its own sake—as a commodity—and not to be re-traded for something else, then in this case it has not acted as “money” at all, but as common barter.

When a money token is used as a placeholder in a transaction—to transfer a transaction in party—it is not valued by the parties for its commodity value, but exclusively on its monetary premium.

This monetary premium arises not by the market pricing of the underlying commodity, but rather by the act of capturing the market price of the desired goods.

We do not use a money token because we want to own it, and we don’t price it for its own sake, rather we use the money token because we want to buy something that our trade partner cannot deliver, and we expect the token to have the same “value” as the good we desire.

So, why is the view of Mises—namely that a transaction is finished once a money token has been handed over for a commodity—problematic and factually incorrect?

To see this, we need to study an extreme example:
Let’s say two people, called Alice and Bob, want to do a barter trade. Alice exchanges a Picasso painting for a serial-number-one sports car of Bob’s.

The Picasso is delivered to Bob, but Bob’s wife hates it and immediately trades it for a van Gogh. The sports car is put on a lorry and shipped to Alice.
Unfortunately, the truck has an accident and the car is damaged beyond repair.

Now Bob is in a difficult situation. He does not have the one of a kind commodity he owes, and he also doesn’t have the one of a kind commodity he received, for the transaction to be reversed.
Naturally, Bob offers Alice the van Gogh painting, since to his family it had the same value as the Picasso. Unfortunately, Alice hates van Gogh as patently as Bob’s wife hates Picasso.

How does Bob pay his debt?

The common way to resolve such a dispute is to involve a mediator, often a court. Given that the two parties are unable to agree on a fair substitute for the car, the judge will need to get an appraiser who determines the “value” of the lost vehicle.

According to Mises’s school of thought, this price should be denominated in the dominant medium of exchange of the area, while Argentarius would call for the money token dominant or decreed for the area.

If the two parties come from regions which have different media of exchange, the customary thing to do would be to use Alice’s medium of exchange, for she is the one who is the creditor.

If I explained this case well, you, dear reader, will have probably come to the conclusion that in most cases the two schools of thought will arrive at the same monetary token and valuation in this case.

Yet, the two cases could not be more, different. The problem I see is both of a philosophical and practical nature.

Let us start with the philosophical problem:
Under Mises’s doctrine, a free market process should be completely voluntary. Since he furthermore attests a marginal utility to the monetary token itself, the only way to view a court’s decision as “just” is, to ask Alice whether the marginal utility of the money token is equal or greater than the marginal utility of the lost car. If Alice does not value the possession of the money token itself, the marginal utility of the token is zero and Alice has, in fact, been robbed by the court.

If Alice, however, attributes a value to the money token solely based on the expected resale value, this means that she does not really attribute any marginal utility to the token itself, but rather values the token based on the marginal utility of what she expects it to buy her.

So in the first case, a “just” solution is impossible. In the second case… well, in the second case Argentarius was right all along.

Now, philosophical and moral implications aside. What are the practical issues with Mises’s theory?

To understand the significance, we need to first call to our attention, why economic theories are important.
Over the past few centuries humanity’s standard of living has been rising steadily, thanks in large parts to the advancements of science. If you have a better understanding of how the world works, you can create better products to enable you to satisfy your basic needs easier and to also address higher order needs, otherwise unsatisfied.

In economics, one of the most important pieces of understanding required, is how scarce goods can be best allocated. The best process discovered for this so far is the “free market”. The free market according to Hayek is so good at this because the market price effectively is an aggregate of the knowledge and information possessed by the market participants. With billions of people participating in a free market, it seems obvious, why this process must be better informed than any group of central planers.

But what if market participants are missing a piece of information or collectively share a piece of wrong information?

The inevitable consequence is a misallocation of goods and services. Sub par products will win out over better products, and many innovations will never come to fruition.

This is particularly devastating to humanity, if the error lies in the very tool itself used to express market prices, namely the monetary tokens.

With Mises’s theory of money, you can understand what a “good” token is only to the extent at which it is accepted by market participants as a commodity.
Failing to see the function of a monetary token to quantify and standardize the underlying abstract concept of “money”, it is likely that suboptimal tokens are chosen by market participants and that better tokens only emerge by accident or not at all.

The key difference in the two theories thus is that Argentarius requires a “good” token to be stable in “value” from the time a contract is made to the time it is finalized, which in this case is not the moment the token is handed over, but rather the moment the token itself is redeemed.

Let us look at an example of where the fatal consequences of Mises’s theory become visible, namely the Weimar Hyperinflation.

As early as the year 1921 Lansburgh saw that the majority of people in Germany were confusing monetary tokens with “money”. They bought and sold goods using money, thinking the transaction was finalized when they handed over the Mark bill and overlooked that in reality their intention was not to have a Mark bill, but to spend it.

The consequence of this error was what Argentarius calls “selling themselves poor”. Shopkeepers and industrialists priced their products in Marks, based on the current market value of the Mark, instead of on the expected market value of the Mark when they needed to restock.

Thus, shops often found out only after they had sold their whole inventory that the Mark had fallen so much in value that they couldn’t afford filling up their shelves and had to go out of business.

Enough for today.

Thank you, dear reader, that you stayed with me for this long. In one of the following issues, I plan to go deeper into what a “good” money token is and why the Euro-Dollar system is currently going into hyperinflation.