Questions on Mises XIII and XIV: All or Nothing?
Jason Kuznicki on Jan 30th 2007
At the opening of chapter 18 of The Theory of Money and Credit, Mises writes:
Admittedly, the question does arise: Are there any persons whose capacity to pay is so completely certain as to be quite beyond all doubt? And it may be pointed out that more than one bank, whose solvency nobody had dared to call in question even the day before, has collapsed ignominiously; and that so long as the remembrance of events of this sort has not entirely vanished from human memory, it must evoke at least a small difference between the valuation of money and that of claims to money payable at any time, even if, as far as human foresight goes, these latter are to be regarded as completely sound.
It is undeniable that such questions reveal a possible source of a certain lack of confidence in notes and checks, which would necessarily result in money substitutes having a lower value than money. But, on the other hand, there are reasons which might cause individuals to value money substitutes more highly than money, even if demands for the conversion of money into money substitutes were not always satisfied immediately.
Fair enough; I can see both sides of this. But….
…then later we read:
The view has sometimes been expressed that if an issuing body wishes to secure equivalence between its fiduciary media and the money to which they refer, it should take precautions so as to be able to redeem those fiduciary media that are returned to it through lack of confidence on the part of the holders. It is impossible to subscribe to this view; for it completely fails to recognize the significance and object of a conversion fund. It cannot be the function of a conversion fund to enable the issuing body to redeem its fiduciary media when its counters are besieged by holders who have lost confidence in them. Confidence in the capacity of circulation of fiduciary media is not an individual phenomenon; either it is shared by everybody or it does not exist at all.
This is interesting on several fronts. First, it is a disavowal of the view that fractional reserve banking is necessarily a bad thing. (It’s trivially easy to see how, from a libertarian view, compulsory, government-run fractional reserve banking is necessarily a bad thing. But for the moment this is beside the point.)
Second, Mises argues that, as a practical matter, the “conversion fund” (that is, the bank’s reserve of commodity money) need only extend to cover those cases where holders of the bank’s fiduciary media find themselves obliged to trade with individuals who will recognize a commodity money, but not the fiduciary media in question. This would happen on the fringes of an exchanging community that accepts the fiduciary medium — or on those rare occasions when the community rejects the medium (for which see Question XIV, below).
Here, Then, is Question XIII: Wouldn’t this system, if allowed to function indefinitely, lead by an invisible hand process to the general adoption of one kind of fiduciary medium worldwide — that is, a world bank? And if this world bank had a truly universal fiduciary medium at its disposal, then — according to Mises — couldn’t it do away with its fractional reserve entirely? If the reserve exists only to satisfy the demand for exchanges outside the fiduciary medium, and if the medium is recognized by all, then we can just be done with commodity money. (Or perhaps: We cannot help but lose our commodity money in the end, no matter how ideologically dear it may be to us.)
The conveniences of trading within the global fiduciary system, and without the need for commodity money, would seem to ensure that lesser fiduciary systems would all either fail or be consentingly absorbed into the greater one. The inconveniences of commodity money (weight, storage costs, industrial uses for which there will always be a demand) would seem to ensure that the world fiduciary medium is preferable to it as well.
And here is Question XIV: Which one is it, Dr. Mises? Do we discount the inability to pay, and reckon fiduciary media as being worth some fraction of their face value, based on our relative confidence in the issuer’s ability to pay? Or, as you say in the second quote, is it rather the case that “[c]onfidence in the capacity of circulation of fiduciary media is not an individual phenomenon; either it is shared by everybody or it does not exist at all”?
The passage that follows throws no light on this question, either:
Fiduciary media can fulfill their function only on the condition that they are fully equivalent to the sums of money to which they refer. They cease to be equivalent to these sums of money as soon as confidence in the issuer is shaken even if only among a part of the community. The yokel who presents his note for redemption in order to convince himself of the bank’s capacity to pay, which nobody else doubts, is only a comic figure that the bank has no need to fear. It need not make any special arrangements or take any special precautions on his account. But any bank that issues fiduciary media is forced to suspend payments if everybody begins to present notes for redemption or to withdraw deposits. Any such bank is powerless against a panic; no system and no policy can help it then. This follows necessarily from the very nature of fiduciary media, which imposes upon those who issue them the obligation to pay a sum of money which they cannot command.”
Again, which one is it? True, we need not fear the isolated yokel. But if a small group loses confidence? Or a larger group? Or everyone? It seems that a discounting system would arise precisely to address these issues, and to attempt to estimate the future worth of any given fiduciary medium. Yet which of the following actually causes a run on a bank?
–a yokel. (We present this one only for the sake of completeness.)
–”a part of the community.” (With influence? Or without? What if our community has a lot of yokels?)
–”Everybody.” (Taking into account the fact that “everybody” may well be influenced by a part of the community. Or by yokels. Or not at all.)
I would guess that, these choices touching on psychological considerations, it is beyond the ability of economists to plumb the question much further. But as I have said in the past, the further I read into The Theory of Money and Credit, the less confident I am of asking the right questions, let alone of finding the right answers. I now invite the few intrepid readers who have stayed with me to offer their thoughts.
Filed in The Boardroom
Question VIII: I think I’ve noted before that I disagree with the premise that the “invisible hand” leads to a singular currency, so, instead of beating my dead horse further, I’ll just note that even today, not all transactions in the U.S. occur via currency.
Question IX: I think you’ve found an exceptional example of an inconsistency in his thought process. The first time I read the quote, I said “he didn’t say that, did he?”, but certainly he did - Mises jumped ship on subjective value. And lest you think I’m overstating the case, look at this quote from the same chapter:
“Capital and labor would have been diverted from other branches of production to the production of the monetary metal. This would undoubtedly have meant increased returns to certain individual undertakings; but the welfare of the community would have suffered.”
In essence, Mises is arguing that individual preferences in the disposition of capital are objectively wrong in this instance! But I would say he’s wrong, in that he 1) has left his theoretical underpinning (subjective value) behind, and 2)doesn’t trust the market enough.
First, not all gold (or any other precious metal) is used as currency - mostly, these precious metals are used for decorative purposes. If monetary gold became so valuable that it was worth it for people to convert their jewelry into currency, that would represent one ceiling on the price of gold.
Second, as gold value increased, it would start to lose functionality for low value transactions, which, in turn, would create a demand for an alternate currency. If gold became prohibitively valuable, this alternate currency would likely start to supplant gold as money, thereby decreasing the demand for gold money, which obviously would start eroding the value of gold.
Finally, drifting over into ethics, because as you note, this discussion is starting to drift into the hazy boundry between economics and psychology, I’d say that allowing someone who risked their own labor and capital to reap the reward of an increase in the supply of gold money (which wouldn’t necessarily be the end result of gold mining operations, see point 1 above) to the point where the demand was worth it (IOW, the price exceeds the cost) rather than allowing some banker, whether central or not, to reap the reward of printing new money at minimal cost and nearly zero risk, is the more ethical procedure.
Question XIII: In agreement with quasibill, I see no “invisible hand” process (that is, arising from the free market) tending to reduce the issuers of fiduciary media to one. On the contrary, such a development would surely shake the customers’ confidence, by creating a “single point of failure” - they must see that if the single issuer fails, the whole monetary system collapses. But there is a more fundamental objection. Fiduciary media are by definition derivative: they are fiduciary media precisely because they can at once be exchanged for what we may call the primary money. It follows that if the primary money loses its monetary character, the fiduciary media derived from it lose that character also (assuming, of course, that they have not lost it already). Thus if (or should I say “when”?) physical dollar bills become worthless, bank accounts in dollars will also be worthless. In contrast to Mr. Kuznicki, I say: We will never get rid of commodity money, no matter how much we would theoretically profit by doing so.
Matt,
Mises thought that there would be a tendency toward only one issuer of fiduciary media because it is at the fringes of the system that people will try to redeem their fiduciary media — and thus it is profitable to try to make those fringes as few as possible. The end result of this trend is a world bank of some sort (though certainly not the World Bank of the present day, which is in no sense relevant to the question).
The trend may perhaps be countered by other trends, but the “single point of failure” concern on the part of consumers seems doubtful to me. After all, there was one point of failure to the worldwide gold standard, yet people readily adopted it, too.
As to whether we will ever get rid of commodity money, we already have, at least in the technical sense: U.S. currency is almost entirely valueless as anything other than currency, and thus it is not a commodity money. Nor can it be exchanged for commodity money — there is not even the fraction of commodity money on reserve that would render the dollar a fiduciary medium. It is a fiat money, and the result of a fiduciary medium having had all of its backing removed. (One may of course issue fiduciary media denominated in fiat money, but this does not change the status of the money itself.)