A Critical Review of Ludwig Von Mises's Theory of Money and Credit III/VII
This refers to the policy that aims to increase the objective exchange-value of money also called "Restrictionism". The idea is to not increase the money supply when demand increases or not increasing it by as much as demand, as a way of increasing the value of money.
The proposal of this is to stop further increases in Money supply and wait out the effects on the value of money as demand outweighs supply.
He argues tht inflationism only existed because of the "inflated fiscal motives" of the government.
Inflationism is the cheapest and easiest remedy for a low state of public finances, whereas Restrictionism or Deflationism, demands "positive sacrifices from the national exchequer when it is carried out". As it will involve withdrawal of notes from circulation or at the least, forbids the issue of new notes at a time when demand for money is increasing.
This Mises points explains why Restrictionism has not been able to compete with Inflationism. As much s this is true there are also other causes as well.
For one, attempts to raise the objective exchange-value of money isn't done uniformly by all states but in isolation by a handful of states at any point in time. And this leads to a modification of international trade as exportation becomes more difficult in the country with the stronger money, and importation easier.
Furthermore, creditors gain at the expense of debtors, taxation becomes more burdensome. As a result, restrictionistic ideas have never been met with adequate sympathy.
On the note on creditors, in an inflationary policy environment, the loss of the creditor can be somewhat if not fully compensated for. However the debtor can't have a compensationary mechanism except of course you make interest rate negative.
Invariability of the Objective Exchange-value of Money as the Aim of Monetary Policy:
Deflationism which does the value of money goes contrary to the interest of the "many" which in itself makes in improbable to hold in the long-run. Inflationism on the other hand goes contrary to the interest of only a few, and so seems desirable.
Their goal, Mises' says "can be more easily and more satisfactorily reached in other ways, while their execution meets with quite insuperable difficulties."
So both the augmentation and the dimunition of the objective exchange-value of money has to be rejected, making the "ideal" money, that which has an invariable exchange-value "so far as the monetary influences in its value are concerned" —that is a money whse value isn't dependent or altered by monetary influences.
To a layman, the idea of a stable money is one without variations from the Monetary or commodity side of things. This Mises says is impossible to achieve without a regulating body in principle, but then the difficulties in measurement of these variations in the objective exchange-value of money is almost impossible and marred with difficulties.
Mises however argues strongly agisnt the involvement of the state in the determination of the objective exchange-value of money. Recommending Metallic Money for the freedom it has from state control.
Though Metallic money is also marred by fluctuations in the conditions and production of the metal and variations in industrial demand for it. However the effects moderate and "deserve preference over one subject to State intervention" as the latter would be subjected to a much higher degree of fluctuation.
Limitations of Monetary Policy:
Mises draws conclusions stating that the State doesn't govern the market, though it may have considerably influence, but it is just one of many parties. And all attempts to transform exchange ratios between economic goods would only be possible through instruments of the market. So it can never foresee any future result of a present intervention.
As such it cannot bring about the desired result to the degree that it wishes. Because the means through which it does that (demand and supply), is only done through subjective valuations.
Subjective Valuations are true but the rejection of the objective element to pricing is a big flaw in Mises' theory and hence the reason for his underplaying of State money and policies associated with it, in favor of metallic money.
Mises assumes that the moderation in metallic money's valuation would be such that there would never be a time when demand outweighs supply leading to an increased objective exchange-value of money. This was proven wrong in the late 1920s where monetary contraction forced price declines and stifled output growth leading to a recession caught in a liquidity trap.
So the state may not be able to foresee changes, but history serves as a guide and monetary policy applied to moderation (data dependent) might have its flaws, but remains the most effective system.
Monetary Policy of Etatism:
Etatism refers to the doctrine of the omnipotence of the State and as a policy in an attempt to regulate "all mundane affairs by authoritative commandment and prohibition"
It doesn't aim to transform all ownership of means of production to into state ownership but the biggest Industries. In certain areas like agriculture and small scale businesses, private property is to continue.
There is no room, he says, for independent enterprise, and prices are to be regulated authoritatively —as opposed to the market forces.
In this system, there is no speculation, or room for innovation except decreed by the State who directs and supervises everything.
Every word of the Etatist is contradicted however by doctrines of sociology and economics, and this Mises says is the reason why Etatists endeavored to prove that these sciences do not exists, are that social affairs in their opinion should be asked by law. And that there is no sphere in which State Intervention is not omnipotent.
Etatists and Money;
For a long time Etatists (referring to the German Historical School of Economics, led by Gustav von Schomller) shrank from an explicit application of their principles to the theory of money. The war economy was the highlight of the Etatists views on monetary policy. However in spite of its "ill-success" at the time, Etatistic ideas still prevailed in monetary policy doctrine.
He went on to give an examination of Etatistic ideas on Monetary Policy.
For Etatists the more powerful a state is the better it's money. As money is a function of the state as opposed to being just another economic good. However history has shown that "the monetary standard of Victors' can prove to be very bad".
Example is in France in the late 16th century where despite the victories of the revolutionary army, the metal premium rose continually until the value of its Money touched zero in 1796. The victorious state has carried Inflationism to its extreme.
The relative wealth of a country also doesn't have any bearing on the value of its money.
A notion I agree with as monetary systems successes depends on market acceptance which is inadvertently affected or dependent on their views on the stability of the objective exchange-value of money.
The Regulation of Prices by Authoritarian Decree:
This is the most popular and oldest instrument of estatic monetarism. As estatists view high prices, not as a reduction in the objective exchange-value of money, but "a consequence of reprehensible activity in the part of "bulls" and 'profiteers'.
Whilst this may be true in certain conditions, it doesn't hold for the most part in trading activity for entrepreneurs place a premium on turnover and sales. Hoarding or speculation however is only but a natural consequence of the expectations of changing market conditions.
The official fixing of prices, which is intended to establish wage generally below the level that they would attain in a free market is impracticable"
You can control prices but not the willingness to sell at those prices, so subjecting prices of individual Commodities to restrictions creates disturbances that then invariably leads to a rebalancing of Exchange-ratios.
A systemic driven towards price control is also inevitably driven towards elimination of the ownership of private property, as eventually the entire production and consumption determinant becomes the State.
"Economic organization is based upon division of labor and private property in the means of production can function so long as pice determination in the market is free"
Balance of Payments Theory as Basis for Currency Policy:
Mises attacks the view that money moves freely from a country where metallic money is used, abroad. Under a purely metallic monetary system, the metals which perform the function of money will be distributed according to the intensity demand for each State's money.
An undesired efflux of money can therefore can only be as a result of State intervention, so all the state needs to do to preserve the monetary system, is refrain from such interventions. This is the one stance of the classical economists and their immediate successors that Mises agrees with.
When countries substitute credit or Fiat money for metallic money, the rate of exchange between each Fiat currencies according to Gresham's Law is determined by the Balance of Payments.
The Balance of trade theory neglects the fact that prices moves trade and not currency he says.
Neither exportation nor importation can occur if there were no price differences. So the price level determine balance of payments and ultimately exchange rates.
[For price level to be different, productivity or quantity must be as well for every single product on the international markets. So productivity and resources endowments drive trade and by extension balaance of payments, through price differentials for the cost of production and availability of the commodity if it's a natural resources. This I think is a deeper view into price and BOP determinants.]
If a country wishes to import more, they must export more of goods, raw, and unfinished or export shares bonds and other financial securities. Thus, it follows from this that imports are paid for by exports (in the present or future) and nor by money. Money merely is an instrument by which this exchange takes place.
Part3 Money and Banking:
The Business of Banking:
The Business of Banking falls into two distinct categories that are inextricably linked. Credit negotiations of deposited fund, and granting of credit through the issue of fiduciary media. This connexion of both functions is founded on the "peculiar nature of the business of banking".
However, these two activities (of borrowing from savers and lending to borrowers) must be kept strictly apart in economic theory. This he says is essential for understanding their nature and functions.
There are other functions of banking like the functions of exchanging money, and asset management functions —activities not peculiar to Banks, and have no "inherent connexion with banking proper".
The connexion he described as lose and superficial and has no significance with the banking influence on the objective exchange-value of money. (Like currency and trade,, it could facilitate it, but not determine what the exchange values would be.
Banks as Negotiators of Credit:
Banks essentially lend to others by virtue of borrowing from others. The difference between the rates paid to them and that which they pay to savers becomes their profit (less expenses). Banking then becomes a negotiation between "granters of credit and greatness of credit".
"Imprudent granting of credit is bound to prove just as ruinous to a bank as to any other merchant.' The existence of this credit risks is the reason why the business of banking is needed and I dare say essential in the first place. And from the acceptance of this risk rhat banks derive their orofits or losses.
As far as monetary theory is concern "the function of the banks as Negotiators of credit is of significance only so far as it is able to influence the issue of fiduciary media".
Banks as Issuers of Fiduciary Media:
An exchange can happen such that both parties could fulfill their contractual obligations at the same time or at different times. The second one constitutes a credit transaction. Now, credit transactions fall into two groups; Commodity Credit and Circulation Credit.
Commodity Credit: The refers to those that impose a sacrifice on the party that is first to fulfill their obligations, and the party who doesn't have fulfill their own part until a later date.
"In their respective valuations, both parties take into account of the advantages and disadvantages that arise from the bargain immediately, and disadvantages that arise from the difference between the times at which they have to fulfill the bargain. The exchange ratio embodied in the contract contains an expression of the value of the time in the opinions of the individuals concerned".
Implications of the above quote by Mises somewhat makes a case for money being a store of value but more so as explained below, that valuation of credit or goods and services is not purely objective.
An Interplay Between Subjective and Objective Valuation:
The objective element to valuation here is the implication that there's a measurable, external standard (or factors) against which value can be assessed.
Here, the value of deferring goods or money (in the form of commodity or circulation credit), measured objectively. But this is just one side to the story, there's also a subjective valuation aspect –is it worth it to me?.
Subjective Valuation here is determined by personal preferences (how much does the consumer need this credit?), expectations (what they hope to gain on terms of utility or returns from using this credit obtained), and the circumstances (market conditions).
So each party places their own premium or discount on the time ( the “value”), and a valuation is reached based on the bargaining strength and leverage of borrower (buyer) or lender (seller of credit). This bargaining process by which a price is reached can be formal or informal, direct or indirect and can often happen swiftly.
The same applied to goods and services for which these monies are deployed. The seller takes into account his own valuation (cost of goods and desired profit), as the buyer does take into account, expected utility or returns, opportunity cost, income constraint etc, into their respective valuation process
Though money is often more objective, God's and services are usually skewed to the consumer, above the floor beyond which it becomes unprofitable and undesirable for seller.
So the final price is dependent on the consumers valuation to a large extent and the floor price dependent on the producer or sellers valuation. This makes the valuation process both objective and subjective.
To say that value is purely subjective is to ignore the fact that there are overheads in production or assume that businesses just gamble on production without regard for public need, and also to assume that inability to pay is unwillingness to pay.
Circulation Credit; The second group is characterized by the fact that in them the gain of the party who receives before the pays is balanced by no sacrifice of the other party —the granter of credit. For the Bank, there is no reduction of satisfaction and the granting of credit bears no economic sacrifice.
It is this form of credit that Mises is concerned with as commodity credit has no effect of increasing quantity of money in the present. Only as one party has to sacrifice current receipt of his own part if the deal for a future date.
This is true however, commodity credit increases the volume of goods sold in the present by offering the buyer and opportunity to pay in the future. The existence of commodity credit is proof that there is indeed desire to consume future income with or without banks.
He explains this in the next section where he illustrated how circulation credit emantes.
Deposits as origin of Circulation Credit:
Deposits are the basis on which notes are issued and accounts opened that could be drawn up on by cheques."
However if credit means exchange of a present good for a future good then it is hardly possible to include the transaction above as a credit transactions since he can draw on it anytime.
However the business of banking where these deposits which are payable on demand are issued as credit to another has led to the mistaken opinion of bank deposits being defined as credit transactions.
And it is with this kind of money where notes are insured and accounts opened not covered by money that Mises is concerned. For the value and volume of money is affected by no other credit transactions than that if the isiers of fiduciary media (banks).
Other credit transactions can be performed by individuals who do not specialize in such transactions, however the issue of credit through a fiduciary media is "only possible on the part if the undertaking which conducts credit transactions as a.matter of regular business".
This means commodity credit can be issued by anyone in possession of that commodity, but circulation credit is a specific undertaking done by specialized institutions –banks.
As a rule deposits are distinguished into two groups, current accounts (or demand deposits) which can be withdrawn without any prior notice and carries no interest and then, then"investment deposits" which bear interest and are repayable on notice in advance.
The larger the sums brought in as investment deposits the greater the probability that the sms paid in on any particular day will balance those whose payment will be demanded.
In my view, the separation of the sacrifice on the lending institution from the transaction, and transfer of that to investment account customers makes banking a more sophisticated form of credit transactions which inadvertently speeds up the changes in the objective exchange-value of money, as opposed to commodity credit. So bank credit are indeed credit transactions done in behalf of depositors.
A person who accepts and holds notes, grants no credit as he exchanges no present good for future goods.
The evolution of Fiduciary Media:
These are claims to payments of a given sum on demand. These are issued by banks to other borrowers or the banks themselves could use monies entrusted to them directly.
Fiduciary media springs from two different roots; (i) deposit banks and, (ii) governments int he form or notes and current accounts and Treasury notes. From an economic standpoint, Mises' treats the bank-notes and current accounts as the same, and only different in commercial usage and legal criteria.
Clearing Houses v Fiduciary Media:
Mises
differentiates between credit system under clearing houses and credit issued by
banks.
Under clearing systems, two parties enter into a contract where based on an
agreement and no money changes hands only the difference is settled. An illustration
of how clearing houses work;
B needs $110 but has $100, he now issues the $90 to A who needs it, for $100 in
the future, now he can effectively give C $100 + the IOU worth $10 to make up
the difference.
Unlike Banking, no new money is issued, and transactions are based on real
money with less cash needed upfront. This reduces the money supply relative to
reserve banking and is less inflationary.
It is also limiting in that not all seekrs of credit would find willing
issuers, as not all wealthy folks are financially literate enough or skilled to
appreciate the advantages of this form of credit. There's also the issue of
trust, as Banks are liable for any losses on depositor funds.
Furthermore, some credit need geared towards capital investments are long term and could need more than one creditor to finance the project. Clearing houses are as limiting as they are less inflationary.
Though clearing houses between territories (or countries) took longer time, the international settlement by clearing houses "transcursed political boundaries and created for itself a world-embracing organization in the international bill and cheque system".
The validity of fiduciary media, at the time remained nationally limited. As there were no monetary substitutes or fiduciary media generally accepted at the time Mises' wrote the article
However things are not the same today, and fiduciary systems have grown a fairly effective network for international trade settlement.
Fiduciary Media and the Demand for Money:
Clearing house systems reduces the demand for money in the broader sense as "part of its exchanges made with the help of money can be carried through without the actual physical circulation of money or money substitutes".
However a tendency for the reduction in the objective exchange-value of money arises. The development of fiduciary media also has the same effects. However it wasn't left to market forces, as intervention took place with the objective of "furthering the expediting process."
Shifting from Commodity to Fiat (and Credit) Money:
The classical school Adams and Ricardo were the first I suggest the use of notes as a a less costly means of payment, continuous use of metallic money would have diverted more resources to the exploration and production of these "monetary metals" leaving little for other commodities, and eventually stalling welfare.
The cost of producing Fiat is almost relatively negligible as less labor and capital is needed to produce distinctive notes that serve the same monetary purpose as previous metals –commodity money. Add tht to the zero direct cost of issuing extra money in the form of loans and you have an even larger circulation of money.
It follows then that the problem of diminishing the cost of the circulatory apparatus when Fiat or credit money is employed must be of an entirely different nature from what it is when commodity money is employed.
Commodity Money has physical constraints, and Fiat or credit money deals with institutional and technological efficiency issues. The latter is easily solvable and explains why credit and Fiat money grew in popularity.
Fluctuations in the demand for money:
These are largely guided by the same law, demand and supply as a "an extension of exchanges mediated by money increase the demand for money, and a decrease in indirect exchanges, a return to in natura decrease the demand for money.
Mises points that these variations are insignificant nowadays as increases in population, progress in division of labour and extensions of exchange increase the demand for money of the community. A decrease in population and retrogression of the exchange economy brings about contractions in it.
These are identified by Mises as the determinants of the big changes in the demand for money. So, unless there is a reduction in the size of the population, or a reversion to direct exchanges, the demand for money would always increase, but since this represents purchasing power of other goods and services, responding to "consumption" demand with an uncontrolled increase in supply to match demand inadvertently reduces the objective exchange-value of money.
However "production" demand for money if not met, stifles economic growth as individual businesses with growth potential do not always have the initial startup capital to fund their ventures.
It follows then that money supply should be allowed to adjust to the needs of the market, but skewed more to favor of production activity. For as far as human wants outweigh resources, there would always be a larger demand for money than supply of it. And any attempt to reduce this natural gap, would only result in higher inflation(a quicker fall in the objective exchange-value of money).
The elasticity of the System of Reciprocal Cancellation:
This refers to the idea that "present day organization of money, clearing , and credit system is said to have the tendency to balance out variations in the quantity of money and render them ineffective".
This means that the issuance of fiduciary media by banks doesn't increase the stock of money as it is balanced out by the supply of money (non-demand), by depositors.
However Mises argues that "before the soundness of this assertion can be tested, they must be brought out of the obscurity that is due to the confusion between the effects of the clearing system and those of the issue of Fiduciary Media". The two must be considered separately.
He then went on to state that, the "rigid maximum limit to the transactions that can be settled through the clearing system." As a communities demand for money cannot be forced below "a minimum which will be determined according to circumstances."
These limits do not exist in the same way in fiduciary media.
Elasticity of Credit Circulation based on Bills, especially Commodity Bills:
The doctrine of the elasticity of fiduciary media – their automatic adjustments to the needs of the market at any given time—"stands in the very center of banking theory". Mises intended to show tht this doesn't correspond with the facts, in the form in which it is generally understood.
Tooke, Fullarton and Wilson taught that it does not lie in the power of the banks to increase or diminish their note circulation. "The quantity of notes in circulation is settled by the demand within the community for media of payments". And not by individual reserves as in the clearing system.
They say that the quantity of the media of exchange should increase or decrease with the demand for it for payments. Expansion therefore is never the cause but the effect of fluctuations in business life.
This is a notion I agree with as it should be in principle, but the stock of money can and has been issued beyond the demand for it in certain occasions in central banks attempt to intervene in the markets. Fiduciary Media is therefore inelastic.
Mises argues that the Banking School's fundamental error in this is the failure to "understand the nature of the issue of Fiduciary media". He argues that since the issue of Fiduciary media is essentially an exchange of a present good for a future good, it is only possible to speak of limitations when the future good exchanged in the loan market is limited to a fixed amount.
The issuers of fiduciary media at able to induce an extension of the demand for it (loans) by reducing the rate of interest below the rate that would be established by market forces of real capital were lent, without the mediation of money.
This I see as a confusion because there are limitations to loans that could be issued by banks even if interest rates were zero or negative, under fractional reserve banking system. This essentially places a limitation in loans that can be issued by banks at any given time.
In differentiating between commodity credit and circulation credit, he points that "where there is a delay in payment of the purchase price, only those can sell who do not need money immediately". But this is not the case of bank credit he claims.
(Which is true but again, banks lend depositor (or investor) funds, and so the same principle applies as only those with excess cash reserves would put their monies up for the banks credit transactions.
Those under the commodity credit who want money immediately can only accept to make credit sales, "if they have the prospect of immediately able to turn into money the claims which the transaction yields them".
Other granters of credit can only place so many present goods (or money) at the disposal of the loan market, but for banks this is different,because they re able to procure additional present goods (or money) by the issie of fiduciary media.
Basically banks have a larger pool of funds than any one individual or legal entity can. But they aren't as Mises claimed "satisfy all request for credit that are made to them". There's a limit to which banks can lend.
Banks can increase or decades the demand for money by increasing or reducing loans granted. And so circulation or fiduciary media is not elastic since it automatically accommodates the demand for money to the stock of money".
So, the quantity of Fiduciary media circulation has no natural limits. Save for banking policy. Here Mises indirectly acknowledges the need for a "monetary policy" whilst criticizing the erroneous classical assumption of money neutrality (that is money stock increasing without a change in the objective exchange-value).
Commodity Credit v Circulation Credit:
Whilst the variation in money's objective exchange-value is lesser under commodity credit, it is also limiting if long-term projects that take years to yield returns, like pharma research, tech software development etc.
This limitation is what led to the emergence of circulation credit. Although it is possible to over extend credit and manipulate or over increase money supply under the Fiduciary system, it is...
Mises concludes that because circulation credit is inelastic and independent of market conditions, a "part of the increase in demand for money in the broader sense has been robbed of its influence on the purchasing power of money by the increase in the quantity of Fiduciary media."
Meaning that the increase in objective exchange value of money has been neutralized by the "inelastic" and unconstrained issuance of Fiduciary or circulatory credit.
So fiduciary credit artificially stabilizers prices, contrary to what the market demands for money suggests. Beinging about am inflationary effect on the deflation that was mean to occur from the initial increased money demand.
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