3. Böhm-Bawerk’s Influence on Mises’s Typology of Money

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Malavika Nair

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Böhm-Bawerk’s Influence on Mises’s Typology of Money

Introduction

This year marks the hundredth anniversary of the publication of Mises’s (1981) book The Theory of Money and Credit. While monetary and financial instruments have evolved and grown in multifarious ways since it was first published, the theoretical concepts and analysis in the book still provide us with tremendous explanatory power over the real world today. This fact in no small way attests to the greatness of the book. This chapter aims at providing a deeper understanding of the background for Mises’s typology or classification of money. Mises develops his typology of money in the early chapters of the book and uses it consistently throughout the entirety of its analysis. In particular, this chapter is concerned with Mises’s distinction between money and money substitutes. This distinction is crucial since it allows Mises to further distinguish between money certificates (fully backed money substitutes) and fiduciary media (unbacked money substitutes), concepts that lie at the heart of his theory of the business cycle.

This chapter is divided into two sections. The first part of the chapter summarizes a recent debate regarding the nature of token coins and their classification between Selgin (2009) and Nair (2011). A close reading of Mises’s distinction between money and money substitutes helps clarify issues raised by Selgin (2009) regarding the keeping of full reserves against token coins, thus highlighting the continuing relevance of Mises’s typology for doing economic history. The second half of the chapter delves into the connection between Mises’s typology and Böhm-Bawerk’s work on the distinction between goods and claims to goods. While Mises cites Böhm-Bawerk’s work on rights and claims while setting up his own distinction between money and money substitutes, he does not elaborate upon the connection. The aim in this chapter is to fill in that link between Böhm-Bawerk’s own theorizing and Mises’s classification.

Mises’s Typology of Money and the Study of Economic History

Selgin (2009) puts forth a challenge to those who support 100 percent reserve banking by questioning the practicality of the same reserve requirements as applied to small change. Historical evidence from the private coinage episodes in eighteenth century England shows that as a result of coin shortages, mine owners and private minters started producing their own small denomination coins to pay as wages to workers. Selgin (2009) opines that requiring a rule of 100 percent reserves would have proved to be too costly for the private producers and hence burdensome for the economy. The producers of these small or “token coins” bore the cost of minting the coins as well as guaranteed redemption on demand for standard money to the holders of these coins. Thus, to Selgin (2009), these coins represent market issued fiduciary media, and requiring a 100 percent reserve rule against these tokens would be cumbersome for the minters and producers and hence would slow down growth in the economy.

For not only would the producers have to bear the cost of production and minting but also keep an equivalent amount of standard money always at hand (100 percent reserved), hence making it impractically costly for entrepreneurs to venture into the coin production business. The need for keeping reserves at all arises from the fact that private minters made these coins “redeemable” or “payable on demand” in the standard money of the realm.

Selgin (2009) explains his reasoning with this example:

Suppose that the cost of one dollar’s worth of custom-made token coins, including that of their constituent metal, is 50 cents. Under the 100 percent rule, not only must the retailer bear this cost, but he (or his redemption agent) must keep on hand gold reserves equal to the full nominal value of any tokens placed into circulation. Finally, the retailer must pay any fees charged for keeping his gold under safe storage. Even if, following White (reference suppressed) we suppose that the latter fees are as modest as that charged by modern gold storage services, that is, one percent per annum, it will cost our retailer $1.51 to place just one-dollars’ worth of tokens into circulation for one year.

Hence, Selgin (2009) interprets the private coins as fiduciary media or partially backed money substitutes. Since it was too costly for any producer to keep 100 percent reserve backing against them, the only way they could actually circulate was if they were partially backed. In interpreting the small coins as fiduciary media, Selgin is also indirectly interpreting them as money substitutes. For according to Mises’s typology of money, only money substitutes (redeemable claims to money) can be either fully backed (money certificates) or partially backed (fiduciary media), money itself cannot be interpreted as being fully or partially backed. This subtle point proves to be crucial for the argument in Nair (2011).

Nair (2011) argues against Selgin’s (2009) particular interpretation of the events. Using the careful theoretical distinction that Mises provides of money and money substitutes, Nair (2011) argues for the small coins to be seen as money proper rather than money substitutes. The important distinguishing factor for Mises is that redeemable claims to money that are valued by holders only for being claims and for no other purpose deserve to be included in the category of money substitutes. Mises (1980, p. 65) writes:

Claims are not goods; they are means of obtaining disposal over goods. This determines their whole nature and economic significance. They themselves are not valued directly, but indirectly; their value is derived from that of the economic goods to which they refer. Two elements are involved in the valuation of a claim: first, the value of the goods to whose possession it gives a right; and, second, the greater or less probability that possession of the goods in question will actually be obtained. Furthermore, if the claim is to come into force only after a period of time, then consideration of this circumstance will constitute a third factor in its valuation.

Hence, Mises states that any other factor present in addition to a claim being valued as a claim must lead us to not classify it as a money substitute. Only those claims that are pure claims to money can thus be money substitutes.

Using this distinction, Nair (2011) uses Selgin’s (2008) historical work on the private coinage episodes to show that there is indeed evidence that points to the coins being valued for reasons other than their redeemability. In particular, evidence shows that workers valued the coins for their metallic content as well as for the redemption guarantees that they held. Thus, Nair (2011) reinterprets the private small coins as money proper, commodity money that was stamped with a buy-back guarantee (redemption pledge). Seen in this light, the question of needing to keep 100 percent reserves does not arise, since the goods in question are money proper not money substitutes. If the redemption pledges are buy-back guarantees, the level of “reserves” that the issuer must keep becomes a purely entrepreneurial decision, one that depends upon his expectation of future redemption demand. One example of a piece of evidence provided by Nair (2011) is presented below. It refers to a case in which workers refused to accept “lightweight” coins from their master Wilkinson, hence indicating that workers actually did value the metal content of the coins. Selgin (2008, p. 54) writes:

Instead, he originally assigned his coins, which bore no express denomination, a value of one penny despite the fact that they only weighed half as much as Druid pennies. . . . Wilkinson’s workers and tradesmen where his works were located refused to accept the great ironmaster’s tokens at the rate he assigned to them, forcing him to cry them down, as it were, to half their originally intended value. Considered as half pennies, the Willeys were as good as their Druid counterparts, and only at this rating did they first gain widespread acceptance. Wilkinson had inadvertently discovered an important difference between commercial and regal coins: that while the royal mint could take advantage of its copper coins’ limited legal tender status to make them as light as it wished, commercial coins could be lightened only subject to the public’s approval, without which they could not circulate.

Mises was thus extremely careful when setting up the distinction between money and money substitutes. For if it were true that any good that bore a redemption pledge for an equivalent amount of money could be classified as a money substitute, it would lead us to the seemingly absurd conclusion of having to put goods like cars, milk bottles, and televisions in that category. For all these goods and many others come with a promise to exchange an equal amount of money (typically the purchase price) at any time if the customer is unhappy with the product. However, using Mises’s careful distinction, since goods like cars and milk bottles serve ends of their holders independent of the fact that they bear redemption guarantees, leads us to classify them as regular goods that have an added benefit of a buy-back guarantee. The same analysis applies to a money good, just as it is possible for a producer to offer a buy-back guarantee on a car, so it is possible to do the same for a metal coin. The next section turns to the analysis of the connection between Böhm-Bawerk’s work on claims and legal rights and Mises’s distinction between money and money substitutes.

Böhm-Bawerk’s Distinction Between Claims and Goods

Mises cites Böhm-Bawerk’s (1962) essay titled “Whether legal rights and relationships are economic goods?” in his exposition laying out the differences between money and money substitutes. Specifically, the citation appears in the following passage Mises (1980, p. 52):

Claims are not goods; they are means of obtaining disposal over goods. This determines their whole nature and economic significance. They themselves are not valued directly, but indirectly; their value is derived from that of the economic goods to which they refer.

The relevant phrase “claims are not goods” refers to Mises’s characterization of money substitutes as pure claims to money, deriving their entire significance and value from the underlying money asset. Hence, they are not to be understood as a separate class of goods, in anyway embodying distinct goods-value to their holder other than the value he attaches to the actual money itself. This short phrase forms the entire subject of Böhm-Bawerk’s essay. In the essay, Böhm-Bawerk lays out the problem as he sees it of regarding claims as distinct goods and then provides theoretical reasons for why it should not be so. The rest of this chapter lays out his argument while focusing on its most relevant aspects.

Böhm-Bawerk begins by analyzing a question present in the works of Henry Dunning Macleod and John Law. The question goes as follows: If A lends to B a sum of money for three months, in return for which B issues a claim (an IOU) to A stating that A will once again hold the money in three months’ time, has total wealth in the economy doubled as a result of the loan? Writers such as Henry Dunning Macleod and John Law put forth theories claiming that such increases in the amount of credit actually do have the effect of veritably doubling the total wealth in the economy through a doubling of goods. Since B now has in his possession the sum of money while A has a claim that is worth the amount of money loaned, effectively society is now twice as rich. This account of the matter is wholly unsatisfactory to Böhm-Bawerk however, he writes:

It will doubtless be generally accepted today that the basic principle of that view is in error. It is all too patent that it involves an erroneous duplication in that it posits as a good not only the object which is conveyed on credit but also the right or legal claim which arises from the transaction. . . . In spite of the complete self-assurance with which Macleod’s doctrine was advanced, it encountered virtually universal and unanimous rejection.

Böhm-Bawerk sees the problem stemming from unresolved issues within the theory of goods. The problem, as he sees it, lies in the premise of accepting claims of all sorts as legitimate economic goods. For once they are accepted as legitimate economic goods; Macleod’s conclusions about the doubling of wealth as a result of a credit transaction follows naturally. Hence, Böhm-Bawerk turns his attention to the theory of goods.

He provides a brief survey of the development of the theory of goods by highlighting the major periods, culminating in Menger’s exposition of what constitutes economic goods. The theory of goods first included only tangible or material goods and only then slowly came to incorporate immaterial goods such as services. Adam Smith’s distinction between “productive” and “unproductive” labor was seen to imply the importance of material or tangible goods as genuine goods to the exclusion of all intangible services. It was J.B Say who extended the category of wealth or “richesse” to include services provided by physicians, lawyers, actors and the like whose product though not tangible in the physical sense still fulfilled important purposes. Hence, economists came to accept both physical tangible goods as well as intangible services under the rubric of economic goods. It is at this point that Böhm-Bawerk believes economists went too far so as to include also intangible objects such as claims and legal rights as goods.

Using Menger’s conditions for the requirements of qualifying as a genuine good, Böhm-Bawerk next stresses the subjective valuation of concerned individuals as crucial for economic significance. Things and services possess value and hence achieve goods status only if they can be used as means to fulfill certain subjective ends for valuing actors. In other words, it is the “renditions of service” provided by tangible and intangible objects that elevates them to true goods status. Hence, it becomes clear how a physical house as well as the services of a doctor both deserve the status of genuine economic goods. Renditions of service however, are not the only crucial factor for Menger. Other conditions are that the thing or service in question must be objectively adapted or able to fulfill a certain end, man must recognize and be aware of such an adaptability, he must also possess the knowledge and skill necessary in order to utilize its capability and last but not least he must have power of disposal over the thing in order for it to be classified as a good. To understand why the last of these conditions is important, Böhm-Bawerk provides the example of how gold mines on the moon or exceedingly attractive building lots on undiscovered islands are not economic goods since no man has the power of disposal over them. To these conditions, Böhm-Bawerk adds another condition of his own, that a good can be a good to a valuing person only if all of Menger’s preconditions are present at the same time. Even one of the foregoing conditions being absent must disqualify a thing from being classified as an economic good.

Armed with the pre-requisites of goods character, Böhm-Bawerk turns his attention to claims and legal titles to goods. Since claims or even legal titles do not by themselves provide power of disposal over actual goods, but only promises of future power of disposal, they cannot be awarded genuine goods status by themselves. For example, an IOU issued by a borrower is a claim to a future payment and does not afford its holder any power of disposal over the actual money borrowed in the present. That power of disposal lies for the time being with the borrower himself. Hence the money or loan signifies economic goods character for the borrower while it does not do so for the lender. Similarly, a claim or legal title to a house, by itself, does not provide its holder with any power of disposal or ability to satisfy his subjective ends the way the actual house can. Hence legal titles are not to be regarded as distinct goods, independent from the physical house that is the real subject of individuals’ ends. In this regard Böhm-Bawerk (1962, p. 59) writes:

A legally based power of disposal alone without the natural, physical power would be inadequate because factual objective enjoyment of a good cannot be derived from that good without the natural physical control over it. Not until they are combined do legal and physical control constitute that fully assured power of disposal which is demanded by our economic interests and which, as we have already seen, bestows on the useful things in question their goods-character and makes them for us genuine goods.

Hence, to Böhm-Bawerk, credit transactions do not double the wealth of any society and the claims or IOUs ought not to be regarded as independent sources of wealth.

Yet, Böhm-Bowerk is acutely aware of the fact that in practice and accounting, one does in fact list claims, IOUs, loans, and legal titles to things under the assets category or as wealth. Hence, even though such items are not independent goods in the economic sense of the term, they do end up in the computation of wealth for society and its members. This does not present a special problem however; just merely a peculiarity stemming from the fact that man’s computation of wealth is always future oriented and hence includes those goods that are not yet within his power of disposal. Thus, even though claims to goods enter into the computation of wealth, they do not embody distinct economic goods nature. Once again Böhm-Bawerk (1962, p. 89) provides a powerful example which illustrates his point:

There are two colonists, A and B, both devoid of wealth, but both industrious and able bodied; they live at a point remote from the rest of their community. A, in consideration of a service done him by B, promises B a sum of money “when his ship comes in.” Now this promise has a sound basis in the economic soundness of the debtor; it could as justifiably be accounted by B a part of B’s wealth as could the bond of a solvent government or private individual by a European, a man-of-independent-means living on the income from his securities. And thus in that small colonists’ “circle” an amount of wealth will have come into existence where there is a complete absence of any factual supply of goods. In this manner, by the method of anticipation of the future, goods and values are taken up into a computation of wealth before they have even begun to exist.

This brings Böhm-Bawerk to put forth a new terminology that is helpful in overcoming this seeming difficulty. He distinguishes between the materials of wealth and forms of wealth. Materials of wealth are the genuine economic goods that possess within themselves the power to satisfy subjective ends. Forms of wealth on the other hand are embodied in rights and relationships to genuine economic goods, including payment claims and IOUs, that do not provide power of disposal by themselves over genuine goods, yet are included in the computation of wealth owing to practical considerations. Hence, forms of wealth do not deserve independent goods status; they are merely forms or embodiments of the underlying economic good and to award them such status would result in double counting.

To conclude, the following analogy he provides of material objects and their shadows superbly highlights the differences between materials of wealth versus forms of wealth (1962, p. 115):

In a sense, rights are shadows—the juridical shadows which real corporeal goods cast upon the image of our wealth. For where there is no corporeal object to which a right pertains, there can be no right. The more substantial and the more distinct these shadows are (and they can be so only because the corporeal thing that casts the shadow stands, substantial and distinct, in close proximity) the more indubitably are they recognizable as shadows. The more vague, the more indistinct and the more unrecognizable the corporeal thing is which casts the shadow, the weaker, the more nebulous the shadow consequently is, the more easily is it possible for us to fail to recognize it as a shadow, and the easier it is to consider the shadow to be an independent entity.

Conclusion

Mises appears to have advanced Böhm-Bawerk’s theory of claims and goods. By differentiating between money and money substitutes, Mises applies Böhm-Bawerk’s reasoning to claims that are redeemable at any time, not just claims that are coming due sometime in the future. Money substitutes are hence defined as “absolutely secure and immediately convertible claims to money.” Böhm-Bawerk only deals with claims or IOUs issued as a result of explicit loans, claims that may be redeemed for money only at a fixed date in the future. As a result of this, the value of the claim may differ from the underlying money loaned. This is not so in the case of money substitutes. The value of a money substitute (bank note or checking deposit) must always be equal to the actual money to which it lays claim, as a direct result of instant redeemability. Hence, through Böhm-Bawerk’s reasoning, money substitutes do not represent goods independent of the underlying money asset and the issuing of money substitutes does not increase the wealth of a society.

Even so, Mises is aware that money is a unique good and that an instantly redeemable claim to money is theoretically capable of performing all the functions of money itself. If people trust the issuer of a bank note or checking deposit well enough, it is possible they utilize the money substitute in multiple exchanges without ever thinking of redeeming it for money proper. In this regard he writes (1980, p. 50):

A claim to money may be transferred over and over again in an indefinite number of indirect exchanges without the person by whom it is payable ever being called upon to settle it. This is obviously not true as far as other economic goods are concerned, for these are always destined for ultimate consumption.

Yet, he sticks steadfastly to Böhm-Bawerk’s thinking in this matter and steers clear of the temptation to include money substitutes in the category of money itself. A claim to money cannot have any value to its issuer if the promise of redemption does not stand good. Herein lays the crux of the matter. Hence, even though money substitutes are capable of performing all the functions of money, they are not to be seen as independent goods that provide value to their holders for any reason other than being redeemable in real money.

It is apt to conclude with the following passage from Mises (1980, p. 53) where he defends his strategy and leaves it ultimately to the readers to judge whether it is the right one.

It may be pointed out, for instance, that the significance of perfectly secure and liquid claims to money is quite different from that of claims to other economic goods; that whereas a claim on a commodity must sooner or later be liquidated, this is not necessarily true of claims to money. Such claims may pass from hand to hand for indefinite periods and so take the place of money without any attempt being made to liquidate them. It may be pointed out that those who require money will be quite satisfied with such claims as these, and that those who wish to spend money will find that these claims answer their purpose just as well; and that consequently the supply of money-substitutes must be reckoned in with that of money, and the demand for them with the demand for money. It may further be pointed out that whereas it is impossible to satisfy an increase in the demand, say, for bread by issuing more bread-tickets without adding to the actual supply of bread itself, it is perfectly possible to satisfy an increased demand for money by just such a process as this. It may be argued, in brief, that money substitutes have certain peculiarities of which account is best taken by including them in the concept of money. Without wishing to question the weight of such arguments as these, we shall on grounds of convenience prefer to adopt the narrower formulation of the concept of money, supplementing it with a separate concept of money-substitutes. Whether this is the most advisable course to pursue, whether perhaps some other procedure might not lead to a better understanding of our subject-matter, must be left to the judgement of the reader. To the author it appears that the way chosen is the only way in which the difficult problems of the theory of money can be solved.

References

Böhm-Bawerk, Eugen von. 1962. Whether Legal Rights and Relationships are Economic Goods. Grove City, Penn.: Libertarian Press.

Nair, Malavika. 2011. “Money or Money Substitutes: Implications of Selgin’s Small Change Challenge.” Quarterly Journal of Austrian Economics 14, no. 2.

Mises, Ludwig von. 1981. The Theory of Money and Credit. Indianapolis, Ind.: Liberty Fund.

Selgin, George. 2009. “100 Percent reserve Money: The Small Change Challenge.” Quarterly Journal of Austrian Economics 12, no. 1: 3–16.

Selgin, George. 2008. Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage, 1775–1821. Ann Arbor: University of Michigan Press.

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Malavika Nair is an assistant professor of economics at the College of Charleston.