From Mises Boot Camp

1. MONEY
Malavika Nair
Assistant Professor of Economics

2. What is Money?
• Money is neither a consumption good nor
production good- it is unique. Certain issues
need to be addressed while trying to apply
subjective theory of value to money.
• Money is what money does:
1. Medium of Exchange
2. Unit of Account
3. Store of Value

3. Why use money?
• Monetary or Indirect Exchange versus Barter
or Direct Exchange. Why introduce an extra
step into trading when you could directly
barter for what you really want to consume?
• Problem of the double coincidence of wants.
Example: Mr. Smith grows wheat and would
like to buy candles. Mr. Jones has candles but
doesn’t want wheat.

4. How does money emerge?
• Menger on the origins of money:
• Money emerges spontaneously out of market
process to overcome problems in barter
• Most saleable or marketable commodity will
have advantage to emerge as medium of
exchange
• Once established, pure monetary demand will
kick in further reinforcing use as money

5. • Implications of Menger’s theory:
• Government does not “create” or legislate
money into existence, peoples’ actions do.
• Explain the emergence of money completely
through individual actors’ decisions on the
margin, without recourse to omniscient
overarching power: simple, elegant yet
powerful.

6. Money through history
• Salt, Cattle, Shells, Tobacco, Beads, Cigarettes
• Metallic money: Copper, Silver, Gold
(Advantages: non-perishable, easily
standardized, portable, expensive to mine,
malleable and divisible)
• Banknotes, paper money and digital money

7. The Value of Money
• Subjective theory of value:
1. exchange goods for goods (use value)
2. exchange goods for money(exchange value)
• Problem of circularity: subjective value of
money depends on money prices of goods and
money prices of goods depend on subjective
value of money

8. Mises’ Regression Theorem
• Not a circular problem
• Subjective value of money (at time t) depends
on money prices of the immediate past ( at
time t – 1)
• Money prices of immediate past (t -1) depend
on subjective value of money at t – 2.
• Temporal sequence, not circular

9. • Implications of Mises’ Regression Theorem:
Keep pushing back the problem of subjective
value of money back to barter.
Subjective value of money initially emerges
out of use value in barter.
Ties back into Menger’s account of the origin
of money.

10. Role of Banks in money creation
• Money Substitutes: immediately redeemable
claims to money that can act as substitutes for
money
• Money is unique: claims to money are
technically capable of performing functions of
money, unlike other goods.
• Banks thus have role in creation of money:
through the issue of money substitutes

11. • Warehouse banking: goods or money
deposited for safe-keeping. Money substitutes
in the form of warehouse receipts. Money
redeemable at any time.
• Credit or loan banking: money lent to bank
that loans it out further and promises interest
return. Money redeemable only after fixed
period of time.

12. • Fractional Reserve Banking: can arise in two
ways
• Bank over-issues warehouse receipts thus
effectively creating fractional reserve of
money
• Bank lends redeemable checking account
balances either through issuing bank notes or
creating new checking accounts

13. • Fiduciary Media: Mises defines fiduciary
media as unbacked (by base or commodity
money) claims to money in circulation.
• Banks are thus intimately involved in the
money creation process through their power to
issue money substitutes
• Role in Business Cycle theory

14. Money and the State
• Commodity Money: Gold or Silver standard
(most of history)
• Fiat money (relatively recent, post 1971)
• Commodity standards place natural limits on
governments’ ability to influence money, pure
fiat money gives governments much more
discretion

15. • Kings controlled the mint: melt down metal and
stamp coins with royal seal
• Debasement: clip coins and make them lighter,
while face value remains the same thus increasing
king’s revenue
• As long as there is a free market for the metal, full
bodied coins become undervalued and disappear
out of circulation
• Gresham’s Law: Bad money drives out good
money

16. • Classical Gold Standard (1870-1914)
• Dollar defined as 1/20th of an ounce of gold
• Banks issue notes redeemable in gold
• Even in the presence of central banks, gold
standard causes outflow of gold reserves in
any country that over-issues notes, thus
checking against it. Price-specie flow
mechanism.

17. • Fiat Money and Central Banks
• No check on money creation other than threat of
high inflation
• Central Bankers more akin to Central Planners:
charged with checking inflation, maintaining
interest rates and full employment.
• Recent crisis led to unprecedented actions on
Fed’s part: “too big to fail”, bailing out insolvent
banks, propping up firms that should fail.