Blogs & Articles: Confidence and money 🔗 3 years ago

A rather widespread idea about money is that we all accept it because it is an implicit social agreement, a shared belief or a “collective hallucination” in the sense we somehow have confidence that others will accept it. Popular authors like Yuval Noah Harari have helped to spread this idea in his book Sapiens.

I must clarify that I am not referring to confidence on money that is in turn a contract with a third party, because in those cases it is evident that we need to trust a specific obligor complying with the contract. This type of confidence in the fulfillment of a more or less specific obligation¹ is not what I want to refer to in this post, but rather to “confidence” understood as an expectation that the thing that we use as money will be widely and voluntarily accepted by others at a value equal or very close to which we acquired it just because we expect others to do it, and those others expect others to do it and so forth.

Fortunately, Carl Menger enlightens us on the matter in his book Money, making it clear that this supposed “confidence” would be equally applicable to any other good that we want to sell, and therefore it is a totally useless concept to distinguish money from any other economic good:

“What is overlooked here is that this is no peculiarity of money. The merchant, the speculator, etc. also acquire the goods that they subsequently offer for sale only in ‘confidence’ that they will be able to sell them again, and — as to the critical point here! — it is a matter of complete indifference to them whether the eventual buyers of the goods intend to consume them or sell them, in their turn. The same is true for money, which we acquire (regularly, but not without exception!) just as the merchant does with his goods: only with a view to its exchange value, i.e. to dispose of it again.” (Money, 1909, p. 92–93)

When an inventor tries to place a totally new product on the market that does not have any use value to him, for example prescription glasses, or when an intermediary buys a ton of concrete to later resell it and that does not have any consumption value for him, in any of these two cases we would be at exactly the same position of having “confidence” that the good will have a certain exchange value. And as Menger points out, the seller cares very little if the next buyer acquires it to later consume or resell it, as long as he values ​​it enough for at least one of those two purposes.

Moreover, one of the reasons money emerges is precisely to overcome the lack of confidence with other individuals². Indeed, we use money because its intrinsic qualities make it so useful for its intended purpose that even our enemies are willing to accept it without significant discount.

There are some goods that, because they are durable, divisible, fungible, difficult to counterfeit, have a limited supply, etc, are more demanded to pass from hand to hand indefinitely than for their consumption or use value (if they had any!). And what Menger explains above is extensible to this type of goods which we may call “pure commodities”. In other words, this reasoning does not only apply to money (commonly accepted), but also to other economic goods that are reasonable good means of exchange but not good enough to be commonly accepted. And that they may never be, staying in the category of plain means of indirect exchange (not generally accepted) for different reasons such as too much volatility or any other property that may limit their saleability (liquidity).

The value of economic goods that are subject to interpersonal relationships, such as commodities and network goods, like a telephone, are obviously dependent on the valuation of other individuals. Money is included in that kind of goods, nothing special.

It is also well known that any network good is more useful as it is more widely used or demanded. Again, nothing special of money despite being true that the network effect in the case of a medium of exchange reinforces liquidity. But as Menger points out, custom or the influence of government measures increase acceptance and therefore saleability, but they build on the saleability of the good due to its qualities (transportable, divisible, difficult to falsify, limited supply, etc). The network effect is therefore an added consequence that may endow greater value liquidity, but not a cause that originates value.

This effect can serve an established currency as a defense against a challenging currency if the latter does not have significantly superior qualities over the incumbent, since the cost of changing from one to another may be greater than the improvement provided by the challenger, and therefore not worth bothering to change. However, I believe that some economists like George Selgin overestimate the network effect as a defensive barrier and they misinterpret Menger by putting it ahead of the properties that make an economic good more saleable. It is worth noting that in chapter V of his book On the Origins of Money, Menger cited up to 18 traits of saleability, from which only one refers to demand (i.e. network effect).

Applying this reasoning of the network effect within an alleged battle between Bitcoin and the dollar, and I say “alleged” because I personally believe that there is no such battle since everything indicates that they satisfy different needs, Bitcoin matches the dollar in many aspects and also improves it in several others.

However, I don’t believe that the weakness of Bitcoin in such an alleged battle is the dollar’s network effect, but most likely one of its best known properties: The fixed supply. Although it is theoretically an excellent property for a long-term store of value, it may not be that excellent to dynamically achieve a balance between supply and demand that endows value stability, and therefore liquidity, in the short and medium term, which is a necessary treat for a good to be demanded as money, even if that stability develops within a clear downtrend. We can observe this in currencies with moderately high inflation, such as the spanish peseta or the italian lira at their time, which, far from being rejected, continued to be widely demanded locally for short holding periods because despite inflation, they were still reasonably stable in the short term. The erosion of value due to inflation for short periods of time was perfectly tolerable, such as the 4 or 5 days that pass from your payday until you pay your mortgage bill.

An argument against saleability is that, in general, we as individuals do not make thoughtful analysis of a good’s saleability to decide if we want it as money or not, but instead we simply look at the evolution of its price or purchasing power. And this is true. But the evolution of the purchasing power of money is the information that comprises the market’s assessment of its saleability, and in the absence of problems, it is way more practical and easy to just look at the price. But when price desestabilizes and we foresee problems, it is when we look for other alternatives, and then we analyze in detail the properties and risks of the alternative goods that we acquire, whether they are money or not, to escape inflation, illiquidity or uncertainty.

As a theoretical sidenote, this passage from Menger about confidence exposes Mises Regression Theorem as unnecessary, as it demonstrates that the exchange value of money is not explained differently than that of any other commodity, and that the commodity-value of a good derives exclusively from its saleability properties. For totally new commodities that are held for sale by their inventors or early buyers, it is particularly frequent that they end up failing and having no final use value nor exchange value, but yet their owners held them for sale for some time, therefore they had exchange value for them, at least until they realized the failure. A totally new commodity can have expected use value and exchange value (prescription glasses) or only expected exchange value (Bitcoin), and in both cases the bargaining process in order to discover their price would be essentially the same. And because they are totally new it is just not possible to trace back any prior use value, and it is not needed because under Menger’s theory, exchange value exists on its own merits and it is not dependent on use value. It makes no sense to trace back money to a commodity because money is always a commodity. It is, indeed, the quintessential commodity:

“money is vested with the character of a commodity permanently, the other goods only temporarily” (Money, 1909, p. 37)

In conclusion, it is not necessary to look for any special reasoning or ad-hoc theories to explain the value of money. The subjective theory of value applicable to any economic good is sufficient. Intrinsic qualities are what determine utility and therefore value, which in the case of money the relevant properties to fulfill the need of exchange are those that condition saleability.

[1] This is clear for redeemable currencies, but it also applies to today’s fiat currencies because their issuers (the Government, the Central Bank or the Banking System) are obliged to accept them to cancel debts (banks) or to cancel taxes (government).

[2] h/t to Pablo Neira for pointing this out so I could improve this post thanks to his feedback on the original article.

This is a free translation from an article originally published at Instituto Juan de Mariana