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Centenary of Mises's Theory of Money and Credit

This is the centenary year of Ludwig von Mises’s Theory of Money and Credit. The book was originally published in German, and not translated into English until 1934. That the translation continues to be in print from not one but two publishers is in my view more a testimony to the continuing significance of Mises generally rather than to the book specifically. Important books on money at around the same time by other economists have now been forgotten. (Only a few people interested in the history of monetary thought now know, for instance, of Frederick Lavington’s The English Capital Market.) Mises’s lesser works bask in the reflected glory of his two dazzling achievements, Socialism and Human Action.

My remarks are from a re-skimming of the book and a consultation of my old notes, not from a rereading of it. They accordingly touch on a few key themes rather than offering the lengthier treatment best left to someplace other than a blog.

At the time the book appeared, it made some steps forward in monetary economics. One was its stress on the subjective character of money, monetary exchange, and monetary prices. This is the lesson that has still not been fully enough absorbed into monetary theory; it is acknowledged intellectually but is not “in the bones” of  most monetary economists. Another step forward was the book’s emphasis on injection effects, known to some previous economists but not to enough of Mises’s contemporaries. Yet another was Mises’s understanding that what people often think of as differences in the purchasing power of a currency are really differences in the goods offered in different locations; in truth, the purchasing power of money tends to equalize across locations. Mises’s treatment of interest, though brief, linked Austrian and Wicksellian themes.

I am not as impressed as other Austrians are with Mises’s “regression theorem” to explain the value of money. It answers a puzzle, but one that could have remained unsolved without affecting the progress of other aspects of monetary theory. It also seems to me too backward looking, which was the basis of the criticism of it that according to the Austrians, fiat money was the “ghost of gold.”

Mises’s terminology is confusing. He should have called “fiduciary media” and “money substitutes” by the simpler term “credit.” They are IOUs having varying degrees of perceived trustworthiness and general acceptance. Unlike, say, gold in a gold standard system, they do not constitute final payment in transaction; that is, they are not used to settle clearing balances among financial institutions. They are a form of credit, backed (or not) by assets having various degrees of liquidity. The idea that “money substitutes” are money rather than credit seems to be at the origin of the misconceptions about the nature of banking that Austrian advocates of 100% reserve banking have.

It is highly misleading to say that any quantity of money can satisfy human needs as well as any other. Here Mises succumbs to what Schumpeter called the Ricardian Vice of  excessive abstraction. Once a particular quantity of money is in existence, it matters a great deal whether the quantity changes and how it changes.

Even granted that it is a theoretical work, The Theory of Money and Credit has too little to say about how different kinds of monetary institutions might influence monetary equilibrium. To the extent that Mises discusses institutions, it is those that were familiar a German-speaking reader of his time. He does not attempt a broader view across time or even across space. At the time he wrote, monetary systems ranged from “primitive money” in remote parts of Africa and the Pacific to the highly sophisticated arrangements of the major financial centers, and from free banking to currency boards to treasury issue of currency to central banking. There are only fleeting references to free banking (for instance, near the end of chapter 17, section 4).

And brother, is it long-winded. There have been many writers more lumbering than Mises, but the book is squarely in the German-language tradition of the big fat academic book. Mises, and we, are lucky that after he came to America he had Henry Hazlitt as an informal editor. Hazlitt was as pointed as Mises was ponderous.

If it seems that I judge The Theory of Money and Credit harshly, it is only because Mises did some work that was truly great, and The Theory of Money and Credit was merely good. "Good" is a status still sufficiently rare that the number of books on monetary theory that are its equal in terms of their contribution to the subject would not fill a bookcase.

  • Peter Surda

    There is a difference between money substitutes and credit. Money substitutes act as substitutes to money from economic point of view, whereas credit as such does not necessarily so.

    Almost all Austrians (for some reason, Selgin being an exception) acknowledge that the reason why money substitutes act as substitutes is due to them having lower transaction costs than the monetary base. The trustworthiness of the issuer is neither the defining nor a necessary factor of money substitutes, and in fact various mutual credit schemes and LETS which are irredeemable prove this.

    It follows that if monetary base has sufficiently low transaction costs, there would be no money substitutes, and there would be a clear separation between money and credit. Bitcoin shows that this is not only a hypothetical, but it might actually be possible that such a system could exist in reality.

    That credit acts as a part of the money supply is an empirical quirk, and leads to misleading conclusions. Mises was right and Bitcoin proves him so (same in the regression theorem).

    I actually address both of these (regression theorem, money supply) and also the microeconomically optimal quantity of money in a very-soon-to-be-published paper, if you promise not to disseminate it before I announce it officially, I can send it to you.

    Also re: "Even granted that it is a theoretical work, The Theory of Money and Credit has too little to say about how different kinds of monetary institutions might influence monetary equilibrium." actually it does. This is what he says:

    "If a country has a metallic standard, then the only measure of currency policy that it can carry out by itself is to go over to another kind of money. It is otherwise with credit money and fiat money. Here the state is able to influence the movement of the objective exchange value of money by increasing or decreasing its quantity"

    • Kurt Schuler

      As I said, credit is an IOU, and as such does not constitute final settlement of a debt. Money, or more precisely money in the narrow sense of the term, constitutes final settlement. Admittedly, there can be degrees of moneyness. Under an international gold standard, for instance, central bank base money constitutes final settlement within the national financial system but gold constitutes final settlement internationally. So-called money substitutes issued by the private sector, such as competitively issued bank notes, bills of exchange, etc., are under ordinary circumstances not substitutes in the sense that they constitute final settlement of a debt within the national monetary system. All they do is push settlement back a little, to the interbank clearing system that is out of public view. As for your quotation, it proves my point. I didn't claim that Mises had nothing to say; I said he had too little to say. The book is about 500 pages long, so a couple of sentences are just a drop in the bucket.

      • Peter Surda


        I disagree. Money substitutes do constitute a final settlement of debt. Salerno uses this criterion (in one of the chapters in "Money Sound and Unsound") as a distinctive criterion between money and non-money.

        For me, foreign cash is often less of a money than foreign demand deposit, because it has higher transaction costs (in the broader sense) The example I like to use is when I came back from Prague to Dublin last year, the exchange office refused my Czech crowns with the explanation that they don't take coins, only notes.

        My point about the quote was precisely that if you follow Mises, the idea of a "currency policy" (I believe he used to term to distinguish between adjusting the monetary base and money substitutes) runs counter to the concept of commodity money, so it is pointless to spend time on it.

        • Kurt Schuler

          Final settlement means that the instrument in question is not redeemed, or at least not ordinarily redeemed. (One can find some historical cases such as the bills of exchange that circulated hand to hand without frequent redemption in Lancashire in the early 1800s.) In free banking systems, bank notes, which I think qualify as money substitutes under Mises's definition if anything does, have been redeemed frequently–daily or more often–and in large volume. That the process is out of sight and out of mind to the public does not change the underlying reality. Mises speaks of money substitutes as being complete substitutes for money. But they are not complete substitutes, because unlike money in the narrow sense they do not constitute final settlement of debt, which is the key distinction between money in the narrow sense and credit.

          • Peter Surda

            Kurt, you might be right on that. I am not familiar with the practices of the 19th century on the redemption frequency of bank notes issued by commercial banks. However, nowadays, e.g. in Northern Ireland based on my personal experience, the notes issued by the Bank of Ireland are not normally redeemed (even though they are not legal tender), they circulate.

            Also, Mises wrote in ToMC that demand deposits are not money substitutes (I would need to lookup his exact justification), but in the meantime this has changed.

  • Mike Sproul

    Mises was a good monetary theorist like Ptolemy was a good astronomer. Just as Ptolemy thought that the sun orbited the earth, Mises believed that the value of money was determined by money demand and money supply, rather than by the assets backing that money.

    • Peter Surda

      Some complementary currencies (LETS, mutual credit, WIR, …) and Bitcoin disprove that the value of money is determined by backing. The mentioned types of complementary currencies are irredeemable, and Bitcoin is a pure network good.

      I remember that I defended you several years ago on the blog, saying that others should attempt to address your arguments instead of using ad hominems. While I still don't think that ad hominem is an appropriate response, I believe that the arguments you present have been refuted and you have not shown an effort to address them.

      • Peter Surda

        On a somewhat lighter note, last year I argued in one of the comments here:

        about Bitcoin that:

        "With a bit of exaggeration, I could say that it's backed by government's arrogance and greed :-)"

      • Mike Sproul


        There's bitcoin, with no assets backing it. Then there's the US dollar, which is listed on the Fed's balance sheet as the Fed's liability. Then there's the asset side of the Fed's balance sheet, with assets plainly labelled as "collateral held against Federal Reserve Notes".

        So, you observe that bitcoin is unbacked and conclude that the US dollar is unbacked.

        We have always recognized that things like gold, baseball cards, rare postage stamps, etc, have value because they are rare, at the same time that people, for whatever reason, desire them. This is what bitcoin has done. They created a curiosity that they make rare, and it becomes valuable. And just like gold, it can be used as money. Just like gold, its monetary usefulness can add to its value.

        Consider two explanations for the demand for bitcoin (1) its monetary usefulness (2) its value as a curiosity. If (1) is right, then any investment fund could short bitcoins. The hypothecated bitcoins issued in the process of shorting would also be usable as money, and therefore would reduce the monetary demand for bitcoins, thus reducing bitcoin's value. The investment fund would then profit from its short position. (In order for this to work, the hypothecated shares would have to promise either 1 bitcoin or an equivalent value of dollars. Otherwise, as the fund covered its short position, it would drive the bitcoin value back up.)

        If (2) is tight, then the shorting strategy I just described would not affect bitcoin's value. Since there are lots of funds out there that would love to profit from this shorting strategy, I conclude that explanation (2) is better than (1).

        • Peter Surda

          I did not say that US dollar is unbacked, but that your argument that the value of all monies is determined by assets backing the money is refuted by the existence of monies which do not have any assets backing them.

          Furthermore, merely by issuing an instrument for shorting Bitcoins, this instrument does not become usable as money, because it does not decrease transaction costs, unlike with gold or the types of fiat money we are used to.

          Also, there already are service providers that provide the ability to short sell Bitcoins. The largest one is currently in liquidation due to idiotic management, but the time when it was operating appears to have been accompanied by increased liquidity and stabilisation of the price.

          • Mike Sproul

            So do you think that the dollar is backed or not? My argument is, and has always been, that the modern-day dollar, euro, peso, yen, etc, is backed by the issuer's assets, and its value is determined by the assets and liabilities of its issuer.

            Any large financial institution is perfectly capable of issuing IOU's promising the delivery of one bitcoin on demand. These IOU's would be usable as money just like a checking account dollar (which is a promise to deliver one green paper dollar on demand) is usable as money.

          • Peter Surda


            I don't have a strong opinion regarding the backing of dollar (or any fiat money for that matter) either way. But I am somewhat sceptical, because I think that it requires that people trust that the redemption would actually be honoured, and this historically has not always been the case, so at least you'd have to admit that trust plays a role too. And liquidity of the backing assets.

            Regarding the IOUs, I agree with your assumptions, but you omit the most important one: transaction costs. Without the IOU being able to provide lower transaction costs than Bitcoin (which is very unlikely, in particular as long as states regulate banking and finance), then the IOU might have a market price of one Bitcoin and it would be theoretically possible to use it as a medium of exchange, but the market participants would not accept it as a full substitute to Bitcoin on account of transaction costs. On this important distinction Mises (ToMC):

            "The fact that is peculiar to money alone is not that mature and secure claims to money are as highly valued in commerce as the sums of money to which they refer, but rather that such claims are complete substitutes for money, and, as such, are able to fulfil all the functions of money in those markets in which their essential characteristics of maturity and security are recognized."

            I don't agree with Mises that this is particular to money (e.g. written and oral language also act as substitutes of each other), but he emphasises that the price alone is not a sufficient criterion.

            On the importance of transaction costs with respect to money substitutes, almost all the Austrians (apart from Selgin whose position is not entirely clear to me) appear to agree that they are a necessary condition. I found quotes from Schlichter, deSoto, Hoppe, White and Salerno confirming that. And I even found White in 1984 hypothesising that something with features like Bitcoin could exist:

            "Coinage reduces transaction costs compared to simple exchange, because of authentication and weighing. Bank liabilities also reduce transaction costs. But these are empirical factors, and not something inherent in all possible monetary systems."

          • Mike Sproul


            Redemption can be in gold, in bonds, in used furniture, or anything else of value. The Fed doesn't currently redeem in gold, but it does redeem in bonds and in loan repayments, and as long as that is the case then the value of the dollar can be maintained without gold redemption. If the Fed is ever unwound, then federal reserve notes are a first lien against the Fed's assets. This gives a significant positive probability that redemption would be honored.

            About transaction costs: If some institution started issuing IOU's promising 1 bitcoin on demand, and those IOU's were transferred electronically just like bitcoins, then of course transaction costs would be the same. There's also the fact that the quantity of bitcoins has an upper bound of 10 million, or something like that.

            As soon as some financial institution develops a system where you can transfer bitcoins by swiping a card, by paying a token hand-to-hand, etc, people will use those IOU's. Every issuer of those IOU's would then be in a short position in bitcoins, which would enable them to profit from the very bitcoin inflation that they caused.

          • Peter Surda


            regarding backing: I'm not necessarily disagreeing, I'm just saying that at least, the trustworthiness of the issuer and the liquidity of the assets need to be considered.

            regarding the transaction costs: they would not be the same. Even if we disregard the regulatory costs of financial instruments (KYC/AML/SEC …), there is also an inherent counterparty risk in financial instruments, the centralisation of property right policing, and the costs associated with the management of redemption. Bitcoin has no redemption costs as it's specie, and for the same reason it is not subject to counterparty risk. Bitcoin transactions are from a practical point of view irreversible, noone can freeze your account or deny you the ability to spend your money, and in general all kinds of features which nowadays require an issuer or a trustee can be implemented natively in a de-centralised form. Check out Mike Hearn's presentation:

            In a fully free anarchic system, Bitcoin would therefore most likely still have lower transaction costs that financial instruments denominated in Bitcoin, and in our current regulated world this gap is even higher.

  • Olav

    Mostly agree, but remember that the term that Mises used was "Umlaufsmitteln", which "Money substitutes" does not cover entirely. Umlaufsmitteln would mean credit that would be seen as good as money itself, such as bank liabilities, deposit notes, etc. or even IOUs of clearing houses.

    Could anyone by the way tell me how in a free banking system the use of money substitutes (;)) would be limited? Or do innovations such as IOUs of clearing houses, i.e., lower reserve needs due to more efficient clearing equal genuine savings? Is it therefore permittable that the banking system could increase loans? Why wouldn't this generate a business cycle?

    • Mike Sproul


      Under free banking, there is not need to limit money substitutes. The reason is that as a bank issues more money substitutes, it also gets an equal value of new assets in exchange, so backing rises in step with the issuance of money.

  • RobertThorpe

    > Mises’s terminology is confusing. He should have called "fiduciary media” and
    > “money substitutes” by the simpler term “credit.” They are IOUs having varying
    > degrees of perceived trustworthiness and general acceptance. Unlike, say, gold
    > in a gold standard system, they do not constitute final payment in transaction;
    > that is, they are not used to settle clearing balances among financial
    > institutions. They are a form of credit, backed (or not) by assets having
    > various degrees of liquidity. The idea that “money substitutes” are money
    > rather than credit seems to be at the origin of the misconceptions about the
    > nature of banking that Austrian advocates of 100% reserve banking have.

    The distinction Mises makes here is necessary. Not all bank liabilities circulate like demand deposits do, a great many are much more like bonds. For the UK you can read about the various categories that the BoE put things into in the Bankstats report. It shows that an important part of the financing of banks is formed by bond-like liabilities, just as an important amount is formed by demand deposits. During the past recession, for example, it's often happened that the total outstanding credit of UK banks has declined at the same time that the quantity of demand deposits has risen.

    What Mises means by "final payment" is that in normal trade people accept banknotes as payment and don't redeem them every time. A modern (or 18th century) Scotsman may have banknotes from a whole host of different banks in his wallet. These are regularly accepted as payment. It's true that in an FR deposit system the various banks exchange all liabilities for monetary base straight away (through a clearing house), and they'd do that in a free banking system too. But, that doesn't change the situation for banknotes. You could define "final payment" as what happens in a clearinghouse, but I think that's being obtuse.

    I don't think any of this causes people to argue for 100% reserves, though other things in ToMaC certainly do.

    > It is highly misleading to say that any quantity of money can satisfy human
    > needs as well as any other. Here Mises succumbs to what Schumpeter called
    > the Ricardian Vice of excessive abstraction. Once a particular quantity of
    > money is in existence, it matters a great deal whether the quantity changes
    > and how it changes.

    Mises is careful to describe what happens when the amount of money changes elsewhere in the book. When he says any amount will do he's talking in the sense of quasi-statics, not dynamics. The context makes it quite clear in my opinion.

    Although Mises doesn't talk much about free-banking (I expect he didn't know much about it historically), he does present clearly the idea that the money supply moves with the demand for money due to the flow of reserves/base. I know Poulett Scrope and a bunch of other Victorians had better theories about this, but AFAIK, the modern Free Banking movement first got the idea from ToMaC. I would have thought that this site would point to that part first.

  • Kurt, good post. I sometimes think that Mises borrowed Menger's excellent ideas on money and took step backwards. If Menger had proceeded beyond his microeconomic treatment of exchange, barter, and money to write about credit, I don't think he would have followed the same path as Mises. I never liked the regression theorem either, nor all the categories created by Mises (fiduciary, money substitutes, etc). He drew very arbitrary lines between various instruments. For instance, according to Mises a 3 month bill of exchange was a credit instrument, but if it was a 3 month site bill, ie. redeemable on demand, then it ceased to be credit. Odd. Anyways, I still recommend the book as a good learning tool.

  • Paul Marks

    Of course the "regression theorem" is implied by the work of Carl Menger.

    People do not treat fiat money as money simply because of legal tender laws and tax demands – they also do so by HABIT, but where does this habit come from?

    Because once these notes represented a real commodity – one that people valued. This habit can be broken by vast monetary expansion – but it persists till it is.

    As for "credit".

    This can mean various things.

    If I let you have a loaf of bread, on your promise that you will pay me tomorrow, I have let you have the bread "on credit" but I have NOT (and you have NOT) created money or a money substitute.

    What a banker (Central or private) does is to act as if their debt paper actually was money – i.e. to use the debt paper as a "money substitute". At least till the credit money bubble, the "boom", crashes down into the "bust" and "broad money" goes back down towards the "monetary base.

    Of course, under a fiat money system, governments can create more "monetary base" in order to save the banks (although not the economy) from the results of their own folly (I use the word "folly" as some people deny that the banking bubble is "fraud").

    Indeed Central Banks (such as the Federal Reserve) encourage banks (and other parts of the financial industry) to expand credit "money" far more than even the most insane banks would do on their own – the claim that Central Banking "restains" private banks is the exact opposite of the truth.

    The early 19th century "Currency School" (against the errors of the "Banking School") understood that credit-money expansion does NOT create real wealth – and that the banking credit bubble (the "boom") MUST collapse into a "bust" – against the false understanding of the "Banking School" that banks only expand credit-money to "serve the legitimate needs of trade".

    However, the Currency School concentrated on the issue of "Bank Notes" (hence such things as Sir Robert Peel's Act of 1844).

    In reality bankers have many other ways of creating "money" – hence the need (the unavoidable need) for the complex language that Ludwig Von Mises uses.

    "Why not just call it credit – I.O.Us?"

    Because bankers (and others) do not treat this various things as I.O.U.s – the treat them as if they were money, and even declare them "bank deposites" on which further lending can be "based" (totally divorsed from real savings) in a sort of insane inverted pyramid.

    Indeed bankers press for the treatment of these various instruments as I.O.Us to actually be made ILLEGAL.

    For example, the practice of "discounting" these financial instruments (if issued by the big New York Banks) was made ILLEGAL by the National Banking Acts of the 1860s.

    Government, even then, was standing behind the favoured banks and insisting that their instruments NOT be treated as "I.O.Us" but as "money" – for deposites and so on.

  • You overlook the fact that Mises' THEORY OF MONEY AND CREDIT introduced what has become known as the Austrian Business Cycle Theory, later elaborated by F.A. Hayek. (See Mises Wiki on ABCT) For that reason alone it stands out among books on monetary theory. When the economics profession in general catches up with Austrians on understanding what causes business-cycle booms and busts, it may become possible to bring an end to interventions by government in the market for money

  • Kurt Schuler

    I do not share your enthusiasm for the Austrian theory of the business cycle as it is usually conceived. It is a theory of circumstances under which cycles may sometimes arise, not a comprehensive theory of cycles and still less of business fluctuations. Austrians have at least as much to learn from the mainstream on the subject as the mainstream has to learn from the Austrians. As for your other point, yes, Mises's book was important in the development of Austrian business cycle theory and I should have mentioned it. To me, though, Hayek deserves pride of place because he was the one who elaborated the theory.

    • Peter Surda

      The mainstream ignores that credit acting as a part of the money supply is an empirical issue, so basing a theory on that is methodologically flawed.

      A system where only specie is money, without legally mandating it, is theoretically possible (and Bitcoin demonstrates how that could actually be implemented). That does not automatically mean that the gold standard proponents (i.e. 100% reservists) are correct and others are wrong, but it exposes this fundamental methodological flaw in the fractional reserve models, as it cannot account for such a situation. Also, as long as the theorists admit that transaction costs have a non-zero effect on the the decision whether to use a financial instrument as a medium of exchange (and I have yet to meet one that denies this, even Selgin whose position is not entirely clear to me, appears to admit that the relationship is not zero), then by definition the fractional reserve equilibrium model is flawed.

      On the other hand, the 100% reservists model is still compatible with such a system.

    • Paul Marks

      When asked what caused a bust the "mainstream" either waffle on about "animal spirits" or (like the late Milton Friedman) they point to the collapse of broad money – not understanding that this "broad money" (bank credit) was a bubble that created the boom-bust event in the first place.

      They are thus led to the folly of demanding the money supply (i.e. the bubble) be restored – by yet another monetary expansion (and the insanity proceeds).

    • Thank you, Mr. Schuler, I am flattered that you were kind enough to respond to my comment.

      Hayek elaborated, yes, but I feel it is more accurate to say that Mises was not merely important in its development, but was the first to discern its existence as an explanation for the economic phenomenon of booms and busts, as opposed to ordinary "business fluctuations," which I won't try to define either because it is too subjective.

  • Gonzalo R. Moya V.

    Regarding Mike Sproul's earlier post ("Mises was a good monetary theorist like Ptolemy was a good astronomer. Just as Ptolemy thought that the sun orbited the earth, Mises believed that the value of money was determined by money demand and money supply, rather than by the assets backing that money."), anything -and everything- that is exchanged both frequently and clearly enough to have a market of its own -e.g. money- has its price -i.e. purchasing power- ultimately determined by its supply and demand. The assets backing money -whether some specie or a combination of other currencies- indeed influence the value of money as they build confidence among its users, but that is finally incorporated among the factors that determine its demand, so the analogy of the earth and the sun does not apply here.

    • Gonzalo R. Moya V.

      A long time ago, it was also debated what determined the price of anything, if the cost it was incurred to produce it or the value that society gave it, but that is ultimately like debating whether the supply (production cost) or the demand (society's valuation) determine the price of something. The answer is obviously both (although with different degrees depending on the elasticities of each as anyone with a microeconomic background knows).

    • Gonzalo R. Moya V.

      Continuing to disagree with Mike Sproul, I quote fragments of another two of his posts: (1) "My argument is […] that the modern-day dollar […] is backed by the issuer's assets, and its value is determined by the assets and liabilities of its issuer." (2) "The Fed doesn't currently redeem in gold, but it does redeem in bonds and in loan repayments, and as long as that is the case then the value of the dollar can be maintained…"

      To further make my case, the price of any marketable bond -i.e. its interest rate- is also determined by its supply (the total amount of outstanding debt) and its demand, which also depends -among other factors- of the buyers' feeling of "trustworthiness" (as Peter Surda put it) in the issuer.

      In sum, although the price of a good sometimes may change its name (e.g. "purchasing power" for money and "interest rate" for a bond), as long as that good is exchanged in a market, its price will always (and without exception) depend on the supply-and-demand interactions.

      • Mike Sproul

        Supply and demand is a great model for real goods, really produced with a real production function and really consumed by buyers. But microeconomics textbooks don't speak of the supply and demand for financial securities; they speak of the supply and demand for apples and oranges. If some piece of paper promises 1 oz of silver anytime, then that piece of paper will sell for 1 oz. If it ever sold for 1.01 oz, then people would eagerly supply infinite quantities of them, while nobody would demand them. If that piece of paper traded in the market for .99 oz., then people would eagerly demand infinite quantities but nobody would supply them. The only reasonable way to draw the supply and demand curves for those pieces of paper is as flat lines, horizontal at 1 oz. But it wasn't supply and demand that determined that price of 1 oz. It was the 1 oz worth of backing that did it.

        When it comes to financial securities, it's assets and liabilities that matter, not supply and demand.

        • Gonzalo R. Moya V.

          Mr. Sproul, I see now where your confusion is: Your problem comes from wrongly identifying who constitutes the actual suppliers of financial securities. The current holders of a currency willing to exchange it (whether for a "real good" or some other currency) do not constitute its supply more than the current holders of a stock (or a bond) willing to sell it do. The actual (and only) supplier of a currency is its central bank the same way the actual (and only) supplier of a stock (or a bond) is the firm that issues it. If you correctly acknowledge the true (and only) suppliers of each market as such, you will find yourself able to draw the supply-and-demand graphs of financial securities differently than two "flat lines".

          • Mike Sproul

            The federal reserve is the supplier of federal reserve notes. Wells Fargo is the supplier of wells fargo checking account dollars. Amex is the supplier of Amex credit card dollars. In the 1800's, private banks were the suppliers of their own paper dollars. In every case, the dollars supplied are the liability of the issuer, and those dollars are backed by the issuer's assets.

  • Peter Surda

    I thought about it a bit. In defence of Mike Sproul's position, I suppose that if the redemption of the backing was functional from a practical point of view and the backing was sufficiently liquid, then undervaluation of money would open arbitrage opportunities which would lead to a new equilibrium, i.e. it would be self-correcting. So at least in the corner case, I guess I can agree with Mike. Whether these conditions though are applicable to real world is debatable, I'm quite sceptical about it, I don't think it applies to fiat money or fiduciary media as we know them. But at least theoretically, such a system is possible.

    • Mike Sproul

      Most of us have no trouble believing that the values of bonds, stocks, options, warrants, etc. are determined by the assets and liabilities of their issuers. But along comes the US dollar, and people somehow think that all the rules are off. They see that the Fed won't pay out gold for its dollars, and they conclude that the dollar is unbacked, even though the Fed plainly identifies the assets it holds as collateral against federal reserve notes, and even though the fed explicitly recognizes federal reserve notes as its liability. Once people make this mistake, they start asking how unbacked bits of paper can have value, and they come up with crazy answers like the regression theorem, overlapping generations models, tautologies like MV=Py, money supply and money demand, etc.

      Ancient astronomers started with a bad model that said that the sun orbited the earth. On top of this they piled bad idea after bad idea, until they had a tangled mess. Is there any better description of modern monetary theory?

      • Peter Surda

        The value of money is almost entirely (according to Mises, entirely) determined by its liquidity, not by its backing. The backing may (as explained above) determine the residual value in case liquidity evaporates. The market value of other goods is also influenced by liquidity, but to a lesser degree. For stocks, for example, I would say that EVA is a better indicator.

        Once again I point to Bitcoin which demonstrates that for a medium of exchange, liquidity, not backing, is of primary relevance. And Menger and Mises are the pioneers of the idea that liquidity increases demand, I see it as a precursor of the more general concept of the network effect. Bitcoin is an example of a pure network good (goods with zero residual value), similarly as languages, technological standards or, my favourite example, IP addresses. These all have value, and there is a high demand for them, but they are not backed by anything. They only have value because they are already demanded and switching cost are relatively high.

        In your model, you don't consider the possibility that irrespective of backing, the liquidity might evaporate for one reason or another, and then the good in question would stop being money. Even in the hypothetically best scenario, this decrease of liquidity would result in a redemption spiral, and the reserves would be depleted (i.e. everything would be redeemed).

        Last but not least, from a theoretical point of view, it is not completely incorrect that Sun orbits the Earth, it's just misleadingly inaccurate (saying that they both move on ellipses around a common barycentre would be more accurate). The main problem with the ptolemaic model isn't that it claims that the Sun orbits the Earth, but that it claims that the planets orbit the Earth.

        • Gonzalo R. Moya V.

          Completely agree with Mr. Surda (and Mises): (1) the liquidity of money has to do with its network effect (i.e. how easily you can get rid of it depends on how many people are willing to accept it). (2) money that becomes less liquid becomes less money as it loses one of its functions (i.e. medium of exchange). (3) liquidity is much more important than backing in all currencies ("fiat" or not), as reserves are merely precautionary and become relevant only in emergencies (i.e. runs or panics).
          Finally -and just to conclude my case- both factors (i.e. liquidity and backing)are included in the list of determinants of the demand for money, so that its analysis of purchasing-power fluctuation can still be done in a supply-and-demand graph.

        • Mike Sproul

          Bitcoin does not show up on the liability side of its issuer's balance sheet; its issuer holds no assets against it, and bitcoins are not issued via open-market purchases of bonds. The US dollar, on the other hand, shows up on the liability side of the fed's balance sheet; the fed does hold assets against it, and each new dollar is issued via open-market operations for a dollar's worth of new assets for the fed. The fact that bitcoins are unbacked does not show that the US dollar is unbacked. Bitcoins have value for the same reason that baseball cards have value: rareness and curiosity.

          If the dollar's liquidity evaporated, then people would return their dollars to the fed in exchange for a dollar's worth of bonds. Once all the bonds had been paid out, if there were still paper dollars wanting to be turned in, the fed could start buying them back for a dollar's worth of its gold. The fed's assets (reserves+bonds) are enough to buy back every dollar outstanding, so a loss of liquidity need not cause any drop in the dollar's value.

  • Mike Sproul: "Most of us have no trouble believing that the values of bonds, stocks, options, warrants, etc. are determined by the assets and liabilities of their issuers."

    Not me. I don't believe it. I spent some years as a professional, proprietary trader for a New York stock Exchange member firm. It was my observation that the values, meaning the prices at which the securities you mention were bought and sold, were only tangentially related to the assets and liabilities of their issuers. If what you find no trouble believing was true, prices would hardly fluctuate day to day, hour to hour, and minute to minute, as the prices of stocks and bonds invariably do, often in reaction to such nebulous and unmeasurable causes as rumors, true and false, about the health of a CEO, as the market for Apple shares moved up or down in response to reports and rumors pertaining to Steve Jobs' health.) Actually, market prices (current values) for such securities are often less affected by their issuer's current net-asset value than by what a consensus of buyers and sellers think net-asset value will be in the future. Finally, derivatives, such as options, at times have almost no relation whatsoever to net-asset values of the underlying issuer. Those mortgage-backed securities of the late financial crisis fame, which tumbled from par to zero in almost the blink of an eye, were valued before their fall at prices completely unrelated to the net-asset value of their issuers.

  • Mike Sproul: "If the dollar's liquidity evaporated, then people would return their dollars to the fed in exchange for a dollar's worth of bonds."

    How much is a dollar's worth of bonds? Is that a dollar's worth of bonds at par, or market value? What assets give the bonds their value? And where on the dollar or in the law does it say or imply that the bearer of a dollar has a call on any of the Fed's assets? The dollar's only value is based on your faith and the credit of the U.S. government, including the Federal Reserve. If the U.S.'s credit worsens, and if faith evaporates, the dollar will tank, and those who hold dollars wont be able to turn them in to the Fed for bonds or bread 'cause the Fed's window will be closed.

    • Mike Sproul

      So risky assets have uncertain value, and low-risk assets have stable value. That's no reason to reject the proposition that asset values determine liability values. Do you think all the world's accountants should just pack up and go home?

      The fed currently makes the dollar worth a certain fraction of a CPI basket by conducting open market operations at that set level. For example, a dollar might be worth 1/3 loaf of bread. So if all dollars are redeemed for bonds, the dollar will remain worth 1/3 loaf as the redemptions are carried out.

      Legally and in practice, bank notes are now, and have always been, a first and paramount lien against the assets of the issuing bank.

  • Paul Marks

    Government bonds are not real investments – the government does not take the money it borrows and use it to build factories or other productive things (and it would fail even if it tried to do that).

    The government just spends the money – and hands out IOUs in return.

    These IOUs are the "government bonds", "government securities" or whatever one wants to call them.

    They are as absurd as the government fiat Dollar notes themselves.

    And besides…..

    Today governments are the biggest, indirect, buyers of their own bonds. Their own debt.

    The Federal Reserve creates money (from nothing) and lends it out – the people who borrow money from the Fed, directly or indirectly (Shadow Banking) lend it back to the Treasury – at a higher rate of interest.

    That is one way that banks, and other such, make a profit – and real SAVERS do not come into the picture.

    The above is why it is vain to talk about the modern monetary (or fiscal) system as if it was rational.

    It does not make productive sense – it is not MEANT to make productive sense.

    The monetary system is a farce, the fiscal system is also a farce, and the financial services industry (which is dominated by monetary expansion and financing government deficits and other CONSUMPTION) is a farce also.

    All the above should be totally obvious – none of it is rocket science.

    Yet people persist in talking about the modern monetary and fiscal system (and about the banks and the rest of the financial services industry) as if it had meaning – as if it was not just a sick joke that is soon to collapse and pass away.

  • Mike, Risk has nothing to do with what you and I were discussing, which was your assertion, to wit: that "the values of bonds, stocks, options, warrants, etc. are determined by the assets and liabilities of their issuers." As you would know if you have studied economics, particularly
    Austrian economics, value (price) is subjective and is determined from minute to minute by what a willing buyer and seller agree to in an exchange. That alone is reason to reject your proposition, which doesn't hold water. I don't know what you are talking about when you bring accountants into the picture. Accountants do not determine the value of anything, neither assets nor liabilities.

    Mike, your second paragraph makes no sense at all. Where on earth did you get the notion that the Fed adjusts the value of the dollar to the CPI or a loaf of bread? Open-market operations have nothing whatsoever to do with the market for consumer goods and are not carried out to adjust the dollar's value to the price of bread or beer. Nor do open market operations, in which the Fed buys and sells Treasury securities to a group of selected, privileged investment banks, necessarily have any impact, directly or indirectly, on the price of bread.

    Legally and in practice, always and everywhere, its bank notes are worthless when the issuing bank tanks.

  • Paul Marks

    Ned you are wasting your time – and, sooner or later, if you persist you are likely to lose your temper (as I do).

    Think of a bar.

    You are a standing in your shirt – no jacket.

    And a man comes up to you and says "nice jacket you are wearing".

    And he then says "agree with my statement that you are wearing a nice jacket".

    The other man does not really see you wearing a jacket.

    Any more than a man who says that banks only lend out real savings really believes what he says. Or a man who says that the Federal Reserve has a lot of bread (or other goods) that it will hand out in return for its bits of paper (its fiat notes) really believes what he is saying either.

    What the man is really saying is "I want a fight".

    Not a debate – because he does not really believe what he is saying, and has carefully chosen a statement "say what I nice jacket you are wearing" (when you are not wearing a jacket) which you can not agree with, without being a coward.

    It is just an invitation to a fight – what men do to each other a lot.

    Although round here it is dressed up in "intellectual" or "academic" language.

    The advantage of the internet (as opposed to a bar) is that one can decline to fight, without being a coward (just by ignoring what is said).

    Of course if one turns one's back in a bar (in order to try and avoid a fight) it may be the last thing one does upon this Earth.

    But the internet is not like that.

  • Paul, I'm a pacifist. I trust God to keep me safe from all harm, and He never fails me. So I can turn my back, because He's got my back. Oh, yeah, and to help Him out, I stay out of bars unless I have a damn good reason to be there. Nevertheless, your warning is appreciated and I shall try to heed it.

  • Paul Marks

    Ned you are a wiser man, a much wiser man, that I am.

  • Thanks, Paul. If what you say is true, I'll just betcha that is is due to the all-but-certain fact that I am much older than you.

  • Paul Marks

    I would not bet too much gold (or silver or ….) on that.

    Besides – "you are as old as you feel".

    Which makes me about 93.

    Semipunch drunk – and with more friends gone on to the next world, than still in this one.

    Perhaps there will be one more fight (although I would be no use in it – being a waste of space).

    Even though that is exactly what Comrade Barack wants – to give him an excuse for a crackdown.

    Sometimes (whether it is in Ulster, Israel, the United States, or elsewhere) there is no real alternative to going straight into trap – even if one knows it is a trap.

    Still there is one thing the international left (and their allies) never remember.

    Economic law.

    They are wonderful chess players (whereas people like me can not really even remember how the little horse moves) – but economic law (objective reality) comes along and picks up the table the chess board is on, and hits them over the head with it.

    Of course the standard "the rich are to blame" line will be used to excuse any economic collapse.

    And the people are brainwashed (by the education system and the media – especially the entertainment media) to accept this line.

    But, oddly enough, the conditioning tends to breakdown sometimes.

    I do not know why.

  • Ah, so your an old coot too. Public-school indoctrination is probably responsible for the state of the media. The schools are the great statist training grounds.

    Speaking of Ulster, that's my ancestral homeland. My great grandparents left there in the 1880s. Took my grandson there for a visit over his Spring break in 1998 and again in 1999 during the Troubles. With Aer Lingus seriously discounting ares to Ireland in February, and with the "Celtic Tiger" just getting going in the Republic but not yet spoiling prices up North, it was cheaper to spend two weeks there than anywhere in the U.S. away from home. We arrived in Portadown on the same day a few hours after the center of town was blown up by an IRS bomb–no deaths though. ( The next year we visited the town of Omagh, six months after another IRS bomb blew up the center of that town, killing 29 adults and children and wounding 220. ( After visiting the memorial, we stayed the night at the Omagh youth hostel. There was only one other guest, a young man from Derry where we were headed in a few days. After he was sure we were Americans and not Irish Catholic-Republicans, he told us he was a member of the Apprentice Boys, a group of Derry Protestants known for their anti-Catholic position.

    I visited N.I. again last year, but only for a day in Belfast. Took my wife on a tour of the city. Belfast has noticeably deteriorated since 1998. Seems like N.I. didn't fully partake of the boom that made housing prices in the Irish Republic look like one big Las Vegas, but it probably got dragged down by the bust that followed in the south.

    Keep the faith, Ned

  • Paul Marks


    To be fair to this site (to George Selgin and co) I find it hard to believe they would have done what the government of the Republic of Ireland did.

    Signing a blank cheque (which was NOT required by Irish law) to cover any loss (any loss at all) by Anglo Irish Bank and the others.

    There was German pressure to do this – but the government of the Republic could have said "no – we are going to let these banks go bankrupt i.e. CLOSE THEIR DOORS".

    I believe that George Selgin and the others, once they had seen the numbers, would have come to that conculsion.

    What the Irish government did (signing the blank cheque) has doomed the Irish Republic – it is now just a slave of the E.U.

    And the recent budget is not "light at the end of the tunnel" (as the Economist magazine absurdly called it) – it is just yet higher taxes.

    The vast unemployment, the endless closed shops (over 40 shops IN A ROW closed on the main road into the capital Dublin).

    The very things that a "delfationary collapse" is supposed to cause – have HAPPENED ANYWAY.

    At least a "deflationary collapse" would not have bankrupted the government and made it a branch office of the E.U. – standing behind the banks has done just that (and NOT avoided the mass unemployment and general economic collapse).

    And next year (contrary to the international establishment) will be even worse.


    It has been dependent on British government subsidies for a long time. This "help" has undermined the place.

    And Britian is going down hill (for much the same reasons that the Republic of Ireland is).

    Still the Antrim Coast (although not the largest town on the Antrim Coast) is well worth visiting. Castles, the Giants Causeway, even a forest ("there are no forests in Ireland" – oh yes there are, if one knows where to look).

    I could pretend that I "see both sides" – after all my mother's name was "Power" (my grandfather's people were Waterford Catholics).

    However, my grandfather (although an Irish Catholic) was also British army – so it would be dishonest of me to pretend that I really see both sides of the argument.

    The IRA has never really been Catholic anyway (unless one counts Marxist "Liberation Theology" as Catholic – and I rather doubt the Pope would agree with that).

    Ulster will survive (somehow) – remember the people are "Rednecks", such people are tough, and a lot more intelligent than the university crowd think they are.

    For example at the battle of Somme (in the First World War) the British army order was that rifles were to be unloaded (the reasoning behind this was a masterpiece of "rationalist" insanity) – and the officers of the Ulster Division duely took the bullets from the rifles of the men, but then HANDED THEM BACK AGAIN (this did not violate the order you see). The Ulster Division also "charged" (i.e. ran forewards), as opposed to other British army units that walked slowly (in nice straight lines – officers to the front, as the British army always does, which means the officers get killed first which has the terrible result that no one is alive to order a retreat) – thus giving the Germans plenty of time to machine gun them.

    In the same offensive (in which 20 thousand British soldiers died on the first day) the Ulster Division found the dead body of someone who had been an enemy back home (the son of John Redmond – the leader of the Irish (Catholic) Nationalists, although the moderate faction). He had died fighting for a country he formally wanted to break with (there was no conscription in Ireland, there never has been, but vast numbers of Irish Catholics have always signed up in time of war anyway).

    They formed a wall of human bodies round the corpse and took it back – as the Germans shot them down.

    "It is stupid to die over a dead body" – perhaps it is.

    A strange people – they will fight to the death over a minor insult ("it is better to be dead than to be ashamed"), but they will give you their last crust of bread (even if it means they starve to death instead of you).

    And the Irish Republic?

    What is the point of being free of London – if one is ruled by the European Union instead?

    "Independence within the E.U." is a contradiction in terms.

    It is like saying "free banking – unless the banks get into trouble, then we must….."

  • I'll drink to that, Paul. Except like so many of us, I drank more than my share and am now forced (not literally) to let the others catch up.

    Poor Harps. As I recall they voted down and voted down again joining the EU, until the politicians wore 'em down and they finally passed the enabling referendum.

    In Ulster in '98, Ben and I visited the Giant's Causeway, but we missed the forests of the Glens because our time ran out.

    We went to the Republic in '04. By then prices had risen to the extent that even rural Ireland felt more like NYC or London for the prices.

    Spend a couple of days in Dublin in 2010 and saw the vacancies: one bank's shinny new premises on the S. bank of the Liffey a few blocks W. of the O'Connell Bridge–entirely empty and just beginning to show neglect. Locals we stayed with (Bray Head) were doing fine. Retired and living in a home with only the memory of a mortgage, they escaped the RE ride up and down. The wife's brother, a doctor, had recently purchased a beautiful coastal property in remote Donegal at a very favorable price, I was told.

    My father's family was from Armagh. I think I said my great grandparents left around 1890, but should have said grand parents. Dad's mother's name was Murphy, and she was Protestant! Probably a "souper," as my Derry sister-in-law suggests. (Converted during the Famine to get ahead in the soup lines. My father's ancestors were probably English or Scots who arrived in Ulster 800 to 1000 years earlier and became "more Irish than the Irish." She was dismayed when her son, dad, married an Irish-Catholic colleen whose parents were from Cork and Mayo. I grew up in an insular Catholic-Irish community and don't know but have no doubt that more than a few of my more rabid Irish friends provided financial support to the IRA through Sein Finn, thus helping to pay for those bombs. My sentiments are neither Republican nor Loyalist. I'd love to see Ulster, including all 9 of the original counties, secede and become an independent country. Nothing is impossible! Slainte.

  • Paul Marks

    Armagh was once considered (or so I am told) as alternative location for the H.Q. of the Catholic Church – far from the forces of Islam.

    However, then came the Viking age and peace in Ireland was over (Armagh itself was sacked more than once). Although, of couse, there were differences between the Church in Ireland and in Contenental Europe (date of Easter, clerical celebacy, and so on).

    Beware "false friends" (as is said in tranlating one language to another) – "loyalist" in American English means someone who supported the Crown in the Revolutionary War (many of whom ended up in Canada).

    However, in Irish English "loyalist" sepecifically means "supporter of the paramilitary organisations – or their political parties" the correct term for the mainstream Unionist parties is "Unionist".

    Calling a respectable shop keeper (or other such) a "loyalist" can get you a funny look (and rather more than that).

    By the way – on the other side….

    The respectable term is "Nationalist" and the terrorism linked term is "Republican" – nothing to do with American Republicans.

    Although (come to think of it) that could be funny.

    Someone going round a bar in Boston collecting money for the socialist IRA – and, if challenged, saying "I am just collecting for the Republican movement". I doubt there are many American Republicans in Boston.

    As for an independent Ulster.

    Well they could not do any worse than Dublin and London have done.

    And the Isle of Man (and Guernsey and Jersey and …..)rule themselves – so why not Ulster?

    I am great foe of not only the European Union – but of the whole "unification" thing.

    For example, I believe that the "unification" of Italy and Germany in the 19th century was a terrible mistake. Leading to higher taxes and (eventually) to world wars.

    I would love to see places like Barvaria become independent again.

    And, to bring things back to bank and money,……….

    The notes of the Bank of Ireland (another bit of Irish weirdness – it is not the Irish government, and it produces Pounds not Euros – even though its head office is in Dublin) are the most attractive I have seen.

    If there must be paper money – then at least it should be pretty. And privately designed and produced.