Mises's Theory of the Value of Money

Wieser had not gotten everything wrong. Explaining the present value of money by reference to its past value was a crucial breakthrough in monetary theory. Wieser's work inspired two young Vienna economists—Franz X. Weiss and Ludwig von Mises—to refine the raw idea and hammer out a new doctrine of the value of money.⁴⁷

The “regression theorem,” as Mises later called it, would become one of the pillars of his monetary thought, but first, let us consider two related problems of Wieser's version.

First, Wieser could not integrate the regression with the pricing process of the market. He had developed a pure value theory of the purchasing power of money: his general assumption was that the exchange ratios established between the various goods on the market were only a different expression of their value ratios.⁴⁸ But Mises thought this assumption entirely untenable. There was no such correspondence between value and price, even in a perfect Wieserian communism. Menger and Böhm-Bawerk had convincingly argued that while market prices did result from individual valuations, they were quantitatively unrelated to the value from which they emerged.

The second fundamental flaw in Wieser's argument was that he did not think of money as a good in its own right. Money was but a token of underlying real goods—a “veil” or “assignment” (Anweisung)—and thus had no independent impact on the pricing process. This assumption contradicted one of the main tenets of marginal-value theory. While all other market exchanges result from inverse valuations—with each trading partner preferring the commodity that he bought to the price that he paid—market exchanges in money were, in Wieser's theory, acts that acknowledged equality of value.⁴⁹ By paying a certain amount of money to take some commodity out of the “social warehouse,” one acknowledged it to be of equal value to the good one had sold before (“deposited in the social warehouse”) to obtain that sum of money.

Mises's great achievement in his Theory of Money and Credit was in liberating us from the veil-of-money myth. Money is a commodity by its very nature, not just by historical accident. By realizing this, Mises was in a position to integrate the theory of money into the general framework of marginal-value theory.

His integration would combine the commodity nature of money with Menger's theory of value and prices as refined by Böhm-Bawerk, and also Wieser's insight that the present value of money required a diachronic explanation. Mises could even rely on Menger's theory of cash holdings, which already contained in nuce the insight that money is itself an economic good and not just representative of other goods. But to combine these elements into one coherent theory required a radical break with time-honored pillars of monetary economics, in particular, with the classical tradition of presenting money as a mere veil. Mises was fully conscious that this was the key to his theory, which is why, in an introductory chapter of his book, he engaged in the somewhat tedious exercise of distinguishing various types of money proper (money in the narrower sense) from money substitutes. It was these substitutes in fact that were the sort of tokens or place holders that Wieser and the other champions of the assignment theory tacitly had in mind when they spoke of money. Mises's painstaking analysis demonstrated that mainstream theory had unduly generalized the features of money substitutes to money itself. While it is true that the value of a money substitute corresponds exactly to the value of the underlying real good (for example, 1 ounce of gold), the value of the gold money itself does not correspond to anything; rather it is determined by the same general law of diminishing marginal value that determines the values of all goods.

Mises almost succeeded in dumping the veil-of-money myth. At one place he still reverted to this fallacious doctrine. He claimed that the value of a marginal unit of money is equal to the value of the commodity that the unit is destined to buy. Here is the relevant passage:

The subjective value of money always depends on the subjective value of the other economic goods that can be obtained in exchange for it. Its subjective value is in fact a derived concept. If we wish to estimate the significance that a given sum of money has, in view of the known dependence upon it of a certain satisfaction, we can do this only on the assumption that the money possesses a given objective exchange value. The exchange value of money is the anticipated usevalue of the things that can be obtained with it.”⁵⁰

Whenever money is valued by anybody it is because he supposes it to have a certain purchasing power.⁵¹

His error is precisely the anticipated-usevalue sentence he quotes from Wieser. It is irreconcilable with his later statements in Nationalökonomie and Human Action, where he explains that the subjective value of a sum of money is the value of holding this quantity in one's cash balance.⁵² The same error seems to be behind his claim that the increase of money substitutes in the previous twenty years or so (up to 1911) had allowed for higher economic growth than would have been possible with the quantity of gold, which grew at a slower pace.^53,54

By the time he published his treatise Nationalökonomie (1940), he had removed these errors from his thinking.⁵⁵ But his earlier monograph on the theory of money was still being taken as his final word on the subject. Don Patinkin, the most influential monetary theorist of the post-1945 era, criticized Mises by referring precisely to the passage quoted above, in which the old veil-of-money notion shows through. Patinkin said that these views implied a circular explanation of the value of money.⁵⁶ He was correct in this criticism, but his overall point—that his predecessors had not come up with a coherent explanation of the value of money—ignored Mises's later work: Nationalökonomie and Human Action.