Hayek, Free Banking, and the Commodity Money Syndrome: Toward A Praxeological Theory of Credit and Money. Abstract

1 Hayek, Free Banking, and the Commodity Money Syndrome: Toward A Praxeological Theory of Credit and Money Abstract F. A. Hayek predicted that free ba...

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Hayek, Free Banking, and the Commodity Money Syn drome: Toward A Praxeological Theory of Credit and Money

Abstract

F. A. Hayek predicted that free banking would result in the emergence of a medium of exchange based on the right of a holder to exchange a unit of the medium for a fixed set of commodities. In this, he conforms to the norm among writers in Austrian macroeconomics of linking money tightly to commodities. A different approach was followed by some relatively obscure American writers, who claimed that macroeconomic thinking ought to be based on a theory of credit and fiduciary money. These writers developed a theory of the emergence of money that stood in opposition to Carl Menger's theory based on goods with different degrees of marketability. This paper reviews the Austrian theory and the credit theory of free banking. It defends the argument that a realistic Austrian theory of free banking under modern conditions should be based on a theory of credit. In such a theory, entrepreneurship would have free reign to invent contractual arrangements to support a credit money that yields a return to holders and users in one form or another. In addition, there would be innovation in the property system to reflect the demand for changes in contract law that are more amenable to entrepreneur-initiated developments in the credit system.

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Hayek, Free Banking, and the Commodity Money Syn drome: Toward A Praxeological Theory of Credit and Money

F. A. Hayek's last writings on money argued that the governments of the world should permit free enterprise in the supply of "private currencies," or free banking. I believe that a system is gradually emerging which, although different from Hayek expectations, nevertheless accomplishes the main goal he set for "denationalized" monies. He stated that the main advantage of free banking is that it would prevent governments from "protecting" the currencies they issue against the harmful consequences of their own measures, and therefore prevent them from further employing these harmful tools. They would become unable to conceal the depreciation of the money they issue, to prevent the an outflow of money, cap ital, and other resources as a result of making their home use unfavorab le, or to control prices...(Hayek 1978: 21)

The Asian financial crisis of the late 1990s shows that this advantage has largely been achieved. In the 1990s, several Asian governments had inflated their currencies and used the money to finance massive government projects and loans to business. Because of relatively liberal money capital markets, domestic and foreign holders of money capital were able to quickly withdraw their funds and they did so. The result was a sharp currency depreciation that revealed the "harmful consequences" of their fiscal and monetary policies. Of course, no modern state has adopted free banking. However, the leaders of each state have found that in order to participate fully in the global community of trading nations, it had

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to allow: (1) international competition in banking and (2) relatively free markets in foreign exchange. As a result, any holder of a national money who feared the consequences of government inflation could quickly buy foreign exchange. Because of the internationalization of banking, government central banks that want to attract capital and avoid capital flight are under strong pressure to take actions that will bring the international public to trust the currency they issue. In order to promote that trust, the central banks try to "demonstrate a capacity to regulate" their currency in a manner similar to that which would be forced upon them in a free banking system.(See ibid.: 117-118)1 One can agree with Hayek that there would be further trading benefits if all governments of the world completely abandoned the idea of controlling banking and the issue of currency.2 One looks forward to a day when this will happen. However, for the time being, a sober observer must conclude that the central banks of both the developed and developing nations of the world have strong incentives to maintain the international value of their currency. If the most severe monetary problems with which Hayek was concerned have already been solved, what is the point of reviewing his writings on money. The aim here is to examine his belief, along with the beliefs of most other Austrian economists, that a commodity or commodity-based currency would emerge under a free banking system. Hayek predicted the emergence of bank notes that are backed by a basket of raw materials.3 Yet the currencies that have emerged (the U.S. dollar, the Japanese yen, and the Euro, for example) are fiduciary currencies backed by nothing in particular.4 Given this fact, perhaps Hayek's prediction about

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the currency that would emerge as a result of free banking was wrong. It makes sense to ask whether this is so and, if it is, to try to find out where Hayek went wrong. The argument advanced in this paper is that in order to predict the type of currency that would emerge under free banking, one needs a richer theory of credit than Austrian economics has so far provided. I argue that Hayek's theory of money and credit, which was similar to that of Ludwig von Mises, was not sufficiently relevant to deal with the problem. Following Carl Menger, the Austrian economists have built their monetary theory on a foundation of commodities and commodity money. An alternative foundation, one that was developing in the United States at about the same time as Mises wrote his famous monetary treatise (1912), is credit. Such a theory was developed specifically by W. G. Langworthy Taylor. The Austrians, so far as I know have remained totally unaware of this development. 5 Austrian monetary theory has always been anchored by Menger's theory of the origin of commodity money. One might call this a "commodity money syndrome." Many Austrian writers either subconsciously assume that unless paper money is backed by commodities, it will ultimately fail. Others create elaborate justifications for a forced return to a commodity standard.6 To escape from this syndrome, it is helpful to know how fiduciary currency could emerge without the prior existence of commodity money. In order to show the importance of credit, Taylor produced such a theory. Part one of this paper presents the traditional Austrian approach to money, with special reference to Hayek. Part two discusses Taylor's theory of the credit system and shows how credit money, or fiduciary currency, can emerge without the presence of commodity money.7

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Part three explores the reason for the lack of an Austrian theory of the credit system. Then it sketches a praxeological theory of it. Part four ends the paper with a brief conclusion.

1. The Definition of and Approach to Money

Menger and Mises The major influences on the early development of Hayek's ideas on money seem to have been Menger (Menger 1981: Ch. 8) and Mises.(1935) These writers emphasized two characteristics of money: (1) its material character and (2) the impossibility of the state causing something that was not already money to become so. We focus on the first. Money, to Menger, was always a material commodity. He viewed its emergence as a gradual process through which self interested actions, aiming toward economizing on the costs of making exchanges, cause the item that is regarded by users as most marketable to emerge as money. Because the item that is most marketable may vary depending on the local conditions, different societies used different material items as the medium of exchange, or money.(Menger 1981: 262-271) Building on Menger, Mises developed an elaborate theory of money and credit that is perhaps best characterized by a term that Hayek later used an "inverted pyramid."(Hayek 1935: 99) Beginning with commodity money, he went on to show how banks can substitute claims to commodities (e.g., gold certificates) for the commodities themselves. He called these claims "money substitutes."(Mises 1935: 50) Today, we might call them representative money. Then,

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because banks provide what he calls "circulation credit" through their savings-deposit-lending activities (ibid.: 270), they can create a new kind of money based on this credit, which he called "credit money", or "fiduciary media."(ibid.: 61, 268) Fiduciary media is money based on circulating credit but which has the same appearance as the money substitutes. Indeed, it is because of this identical appearance that people accept it in exchange in the same say that they do money substitutes. The difference between a money substitute and the same denomination of credit money is entirely analytical. It is an invention of the economist. From the user's point of view there is no difference.8

The Early Hayek In Prices and Production, Hayek followed his mentors. I have already mentioned his use of the concept (i.e., the simile) of the inverted pyramid. He continues: The lowest part of the pyramid corresponds of course to the cash basis of the credit structure. The section immediately above to central bank credit in its various forms, the next part to the credits of commercial banks, and on these is built the total of business credits outside banks.(Hayek 1935: 99)

He goes on to write that a central bank could control the lowest two parts and possibly the third part. However, it could control the "uppermost section...only indirectly through a change in the magnitude of their basis, i.e., in the magnitude of bank credit." His point is that "the proportion between the different parts...is variable..."(ibid.) In other words, in the typical central banking monetary system, the proportion would not be under the control of a central bank. Yet, if a

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central bank wanted to "prevent the periodic misdirections of production caused by additional credit," it would have to compensate for the variations that occur in this proportion. And it is probably utopian to ex pect anything of that kind from central banks so long as gen eral opinion still believes that it is the duty of central banks to accommodate trade and to expand credit as the increasing demands of trade require.(ibid.)

This statement reflects his concern, in Prices and Production, with the idea that the government or central bank is able to achieve price stabilization and avoid misdirection of production. He aimed to show that there were numerous, different influence on prices. As a result, detailed knowledge and planning would be required to achieve these goals. So much knowledge would be required that it is unreasonable to expect that the government or central bank could succeed. Notice, however, his proviso: "so long as general opinion still believes that it is the duty of central banks to accommodate trade and to expand credit as the increasing demands of trade require." The implication is that if central banks do not accommodate trade and expand credit, the proportion may be controlled by the central bank. What I want to stress is that Hayek does not discuss an independent propensity, outside of the presumably regulated banking system, to create a new brand of fiduciary currency.

A Range of Money Objects Hayek's approach changed radically when, much later in life, he turned to the question of free banking. In a section on the definition of money (Hayek 1978: 51-54), he begins by noting the joint circulation of more than one currency in border towns and tourist areas. He goes on to say that because there are fluctuating relative values of currencies and because the

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currencies may be acceptable to different degrees and by different groups of people, the proper way to conceive of money is to recognize that there is "no clear distinction between money and non-money." What we find is rather a continuum in which objects of various degrees of liquidity, or with values which can fluctuate independently of each other, shade into each other in the degree to which they function as money.( ibid.: 52)

He notes that the simplification of making a clear distinction between money and nonmoney "is perhaps sometimes necessary but always dangerous and has led to many errors in economics."(ibid.: 53) To avoid these errors, he prefers to use the term "currencies," which includes "not only pieces of paper and other sorts of 'hand-to-hand money,' but also bank balances subject to cheque and other media of exchange that can be used for most of the purposes for which cheques are used." And he qualifies even this definition by repeating that there is no need to make a sharp distinction. "The reader will do best if he remains aware that we have to deal with a range of objects of varying degrees of acceptability which imperceptibly shade at the lower end into objects that are clearly not money."(ibid.: 54) It is worth noting that the later Hayek and Mises seem diametrically opposed on the issue of the analytical importance of retaining a clear distinction between money substitutes and fiduciary currency.9 This is probably due to Hayek's realization, due partly to his consideration of different national monies, that competing banks would offer different brands of money.

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What Kind of Money Would Emerge Under Free Banking? Hayek's answer was that it would be a form of money that was full bodied in terms of a mix of basic raw materials. "My expectation would be that, at least for large regions much exceeding present national territories, people would agree on a standard set of wholesale prices of commodities (a standard 'basket') to treat as the standard of value in which they would prefer to have their currencies kept constant."(Hayek 1978: 71-2) But he recognized a crucial problem. Would it be in fact possible and profitable for a banking institution to offer such accounts in Solids, Ducats, Stables, or whatever the name might be, which it undertakes to redeem on demand with such amounts of the various other currencies as are required to buy on the established commodity exchanges the stated collection of the various raw m aterials by the aggregate price of which th e unit in question is defined? (Hayek 1981: 6-7)

He answers by describing the tasks that he believe such a banking institution would have to accomplish. Basically, a bank in a free banking system faces a tradeoff. On the one hand, it must stand prepared at all times to buy or sell the commodity basket at the announced rate. And it must be ready to buy or sell whatever amount is offered. Its "aim would be to offer in competition with other institutions a clearly distinguishable asset desired by the public as a liquid reserve because it was trusted to preserve its value.(ibid.: 7) On the other hand, such a bank would have to find sufficient opportunities to invest its assets so that it can preserve the assets' value in the face of competition. Hayek adds that the bank might charge an "administration fee for running" customers accounts.(ibid. 7-8) Closer examination reveals that Hayek's defense of his claim that a commodity based money would emerge is at best incomplete. Indeed, he appears to merely assume that

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competition would produce a winner who would offer the basket-based currency he has in mind.10

2. Credit and Fiduciary Currency

In this section, I present a brief statement of Taylor's theory of the credit system and then show two ways in which money can emerge that do not require commodity money to first exist.

Taylor on Credit vs. Commodity-Based Money in the Analysis of Macroeconomic Problems Mises and Hayek assumed that either commodity money or a commodity was the anchor on which all other money and credit must be based, including the money that resulted from free banking. Hayek used the concept of a pyramid for which commodity money would be the base. He further believed that under a system of free banking, banks would not expand fiduciary currencies far beyond the base established by commodity money.11 A radically different approach was taken by an obscure American economist, W.G. Langworthy Taylor (1913).12 Taylor viewed the system of markets and prices as the result, or manifestation, of a deep system of interpersonal relationships built on trust and promises or, broadly speaking, credit. He argued that in general, and in the long term, gold and other commodities play a relatively small role in a modern (1913) economy. If there was no commodity basis for money,

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credit would provide an adequate basis under normal conditions. Conditions as they are, gold and commodities make up part of the guaranty that largely provides the foundation for the trust that is necessary for promises to be made and accepted. But although these goods facilitate the promise-making that is so important in modern production and exchange, they are not necessary and are becoming less significant relative to credit as time passes. Because credit and credit money are so important in a modern society (1913), economists who aim to explain the kinds of changes that make up the subject matter of modern macroeconomics ought to pay far more attention to credit than to commodity money. Taylor would have viewed the Mises-Hayek approach to such macroeconomic changes as just the opposite of that which ought to be taken: [T]he proper wa y is not to explain credit by mon ey, but money by credit . The real thing to be understood, in and of itself, is the exclusively mental process by which exchange may be and is carried on, and the significance of mo ney must be derived from its incid ental association with the more hig hly evolved way of exchanging without it. Money is the alternative, it is, on special occasions [during crises], the substitute for credit; credit is not the substitute for money...(Taylor 1913: 39)

The modern theory is in error: The modern theory o f economics shows "that co nsiderable expansion o f loans may be quite normal. But as a theory it is incomplete, for it fails to account for price fluctuations, because it regards normal credit as incapable of causing them and abnormal credit as unaccountably causing them. [The theory in this book is] that price fluctuation is itself a normal phenomena, depending upon the interacting interests of various orderly groups of producers and financiers, traceable through successive stages, whether nominal pu rchasing power be regarded in light of normal or abnormal credit.( ibid.: vivii)

Taylor saw the development of the credit system (the system of promises, trust, and guaranty) under free banking as a series of stages. At any given time, the system is the survivor of a

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previous crisis and is partly built on the lessons learned during and from that crisis and the crises that proceeded it. Society...in the course of its progress, passes integrally from one 'zone of characterization' into another. Whenever a financial crisis takes place, a contrast between entourages is evoked, which is not merely a contemporaneous setting-over-against-one-another of previously concordant elements, but is also a temporal and historical of crises. The theory rests fundamentally upon the necessity that society, in its progress, pass from crude to relatively complex conditions, signalized by greater perfection in the economies of the cred it system and in the organization of industry. A wider dealing in the securities of corporations is observed. The study of crises teaches that, as in outer nature are found plants and animals endeavoring to survive under the circumstances in which they are placed, a large mass of them perishing, but finally a mode of existence working itself out which is favorable to the survivors and to their successors; in the same way, in industry, enterprisers continually attempt the impossible; the crisis comes and sweeps away the unsuccessful. They are not undeserving, in all cases; their efforts may be for the common weal, even where they appear to be selfish, for failure is the precursor of success. It is, inferentially, necessary that crises take place in order that a better system of industry may be evolv ed."(ibid.: 61-2)

Taylor's hypothesis that, under free banking, credit and fiduciary currencies are more important than money based on commodities was similar to that of contemporary Herbert J. Davenport, who wrote a broader and more widely read book.(Davenport, 1914) In both books, the authors expressed the view that no matter what was happening in the use of commodity money, the credit system would evolve and progress. Therefore, one who aims to discuss macroeconomic problems ought to focus on that system.

Fiduciary Currency Without Commodity Money Taylor supported his thesis about the relative unimportance of commodity money by showing how fiduciary currency could emerge even in the absence of commodity money. To do this helps one to identify the conditions under which individuals might demand and supply existing and new forms of fiduciary currency regardless of the monetary regime. More directly,

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it helps one identify economic incentives to produce fiduciary currency, whether or not commodity money or money substitutes are already in use. These incentives may not be uniform through time and, indeed, may fluctuate substantially due to changes in entrepreneurs' perceptions of economic conditions, changes in the law and change in government regulations. For example, if a government or central bank tries to restrict the amount of credit money produced or if it causes a shortage of the approved and customary money, the incentives to discover and produce new kinds of fiduciary currency that are not covered by restrictions will be higher than otherwise. Entrepreneurs may find ways to circumvent the controls and they may substitute a different kind of money for the approved money.13 This might be done indirectly through transfers of accounting credits or, in modern times, through strongly encrypted electronic transfers of credit. This theme is developed more fully in part four. We present two examples of how fiduciary currency may emerge even in the absence of commodity money. The first is through endorsement. The second is through central planning.

Taylor's Theory of Novation and Endorsement In British law before 1705, the debt represented by a note promising the delivery of goods or services could be collected only by the person to whom the note was issued. Thus, if A issued B a promissory note in exchange for goods, only B could collect it. A change in the law during that year, recognized the right of third parties to collect on promissory notes.(Taylor 1913: 72-3n) Referring William Dunning McLeod's interpretation of Roman Civil law, Taylor called this legal right the principle of novation.(ibid.: 66) Thus British law came to recognize

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the principle of novation. According to this principle, the law honors the right of a holder of a promissory note to collect on it even though it was issued to someone else. In practice, the principle of novation applied not only to the issuer of the promissory note but also to any endorser. By signing the note, the endorser indicates his responsibility to pay the debt indicated on note. When combined with endorsement, the principle of novation gives the current holder of an endorsed note, whoever it might be, the right to collect from the issuer. If the issuer could not pay, then the current holder was permitted to collect from any person who had endorsed the note, including the person who passed it to him. Multiple endorsement means that a number of people would endorse a promissory note and thereby become potentially liable for paying it off. Suppose that the original issuer of a not was unable to pay his debt. With multiple endorsements, the principle of novation meant that, theoretically, a note could be passed back along the chain of endorsers, through a series of court cases, until the first endorser ultimately became liable. To understand how endorsement of a debt could lead the debt to become a medium of exchange, one must realize that so long as any of the endorsers had the wealth to pay off on the note, the current holder of the note would be assured of payment. Thus, if someone offered an endorsed note in payment for a good, the seller would base his decision to accept or reject the note on whether he recognized the names of any of the endorsers and whether he trusted one or more of them enough to give him confidence that the note would be paid in the event he could not himself use it to purchase the goods he wanted. As a result, a strongly endorsed promissory note could acquire exchangeability. Because exchangeable promissory notes could be used to

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buy goods, once the principle of novation was recognized in law and utilized in commerce, it became the basis for the development of a new medium of exchange: the promissory note that was endorsed or issued by a wealthy and reputable endorser. Given the potential acceptance in exchange of an endorsed promissory note, if an issuer of such a note wanted to maximize its value, he could begin by seeking out reputable individuals to endorse his note. Let us call such a reputable individual a prime endorser. A prime endorser, through his endorsement, could make an otherwise non-negotiable promissory note negotiable. Thus he could transform debt into fiduciary currency. Another way to say this is that he could monetize debt.14 He could become a banker without ever having received a deposit of commodity money. So far, we have only considered how a prime endorser could monetize someone else's debt. Brief reflection will indicate that he can also monetize his own debt. If a well known and reputable prime endorser merely issued promissory notes himself and lent them out, the notes may be even more negotiable than notes that he endorses. Indeed, a large and reputable endorser could design his notes to be durable, of high value in relation to bulk, easily recognized, and in convenient denominations. In other words, he could design them especially to be used as media of exchange. It is useful to note the differences between the gold warehouse manager-turned-banker, upon whom Mises based his theory of credit money, and the prime-endorser-turned-banker. The gold warehouse manager is able to issue fiduciary currency because he has a reputation for

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redeeming certificates or checks in gold. The prime endorser can issue fiduciary currency because of his reputation as a guarantor of notes. Why would a prime endorser issue promissory notes? In order to maintain his reputation, he would have to stand ready to pay them off in commodities or other currency according to the terms of the note.15 One possible answer is that he would anticipate that a certain minimum amount of his notes would always and forever be used in exchange. If so, he would be able to enjoy the use of the goods or resources that he could buy with the commodity money value of notes that corresponds to that minimum value. A second answer is that he could operate a credit intermediary business in which he lent either his own notes or the commodity money he acquired in exchange for them at interest. In this event, the prime endorser's reputation would depend partly on entrepreneurs' appraisals of the portfolio of promissory notes he acquires by making loans. Because of the potential for earning interest, even a relatively poor person who was a good judge of investment opportunities could join the ranks of prime endorsers. This is because she could offer interest to individuals who agreed to accept her notes in exchange and/or who agreed to hold them in their portfolios. Imagine that there is competition among a number of prime endorsers and that endorsed promissory notes are the only kind of money. Each issues promissory notes drawn on themselves so that there is product differentiation. And each offers interest on balances in an effort to circulate their notes as media of exchange (as private monies). Over time, moneychangers and speculators would assure that the competitors who were able to maintain

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their reputations and, at the same time, offer users of their notes the highest interest premiums would survive. It might be asked why users of private moneys would accept the notes issued by a prime endorser over commodity money or over Mises's money substitutes. The main reason is that the endorser would pay interest. This would be especially important to users of money who wish to have relatively liquid portfolios. When considering this advantage, one should keep in mind that interest can be paid in more than one form. Instead of paying the holders of his notes, the prime endorser might pay sellers of goods a premium to accept them in payment for their goods. He anticipates that after consumers get accustomed to being able to purchase goods either more conveniently or at lower prices when they use his money, they will want to hold his money instead of some alternative. We shall see that this possibility makes the prime endorser's money similar to the central planner's money, a type to which we now turn.

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Planning a Fiduciary Currency A second way that fiduciary currency can emerge without being based on commodity money is by a deliberate, comprehensive act of coordination and synchronization on the part of a resourceful enterpriser. To see how this can occur, let us look at a case in history. In history, there have been numerous examples of companies that produced their own money. Such money was made of paper or token metal coins.16 Most of these companies were far away from a major economic center. The most prominent examples are mining and timbering companies. Related companies like canneries and farming plantations have also produced their own monies. Finally, there were the company-sponsored colonial settlements whose main task was to produce commodities, usually agricultural, to be sold in the mother country. Such "company money" was ordinarily produced in places or times when it was inconvenient or not customary to use gold or silver, when a bank or government had recently defrauded users of its paper money, or when laws made it difficult or costly for prospective money users to acquire the customary money. Company monies usually did not last long. A more universally accepted form of money would typically replace the company money as the community grew and became more diverse. These monies also operated in an environment of quasi-legality.17 How did the managers of companies persuade people to accept their money? Typically, the companies were operated by trustworthy leaders who had enough wealth at their disposal to finance at least the beginning of a small self-sufficient community. Suppose that a company leader initially instructs each person to perform a particular task that has value to other

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community members. For example, he may instruct individuals to produce different types of food, to produce different types of clothing, and so on. After the goods are produced, they are deposited in the company storehouse. He rewards each of the workers by periodically allowing her to take specified amounts of produce from the storehouse. Once such a community was established, the leader could substitute purchase certificates for what were previously regarded by workers as rights to output in the storehouses. He could pay workers with purchase certificates, which he agrees to redeem at the company store. Having received their "wages" in the form of purchase certificates, the workers or other family members would present them at the company store. Assuming that the company established a reputation for having the goods on hand and for selling them at reasonable prices, community members would tend to use the certificates to buy from and sell to each other also. The same result could be achieved by the company if workers produced some commodity for export and if the goods to sustain workers were all imported. The company could pay its workers in purchase certificates and then offer to exchange the certificates for the imported goods at the company store. The company could pay for the imported goods, in turn, with the minerals that were mined, the plantation surplus, or whatever other commodity(ies) the company specialized in producing. Let us disregard the particular historical examples and look at the problem from the perspective of a resourceful businessperson who lives in a somewhat specialized barter society. Pretend that you are the businessperson. You conceive of the idea of issuing "special purchase certificates" and introducing them as media of exchange. Before you can do this, however, you

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would have to persuade producers of different goods to agree to accept the certificates in exchange. So you proceed to ask them to agree to trade goods on demand to consumers in exchange for the certificates. You ask each producer to draw up a proposal containing a "price list," on which she tells you the amount of certificates she will accept for each good she produces. How could you persuade producers (or owners of retail outlets supplied by producers) to accept such certificates? This question is easiest to answer if we assume that there are a number of producers, each of whom produces a different type of good. Under these circumstances, if each producer knew that the others had agreed to accept the purchase certificates, she might agree to accept them also. She would expect that she could use any certificates she acquired to purchase goods from the other specialized producers. So long as you can obtain an agreement from a number of specialized producers simultaneously, there is a chance that your proposal would be accepted. If your proposal is accepted, the purchase certificates could be used to buy goods from all of the producers. The certificates would then come to act as a medium of exchange, a store of value, a unit of capital accounting, and a standard for making appraisals of resources. Some goods' producers might even borrow them in order to hire resources, agreeing to pay back the certificates (plus a return). If these events take place, the purchase certificates would be fiduciary currency. The introduction of this currency could be accomplished without the presence of gold or other commodity-based money.

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We can easily imagine that once a single fiduciary currency was introduced, other reputable businesspeople would make arrangements with the same producers or with others in order to compete with the initial currency producer. Under competition, individuals would use the currency that was cheapest in terms of time and energy to acquire and which enabled them to buy the goods they wanted at the lowest prices. In addition, a currency producer may increase the attractiveness of his currency by offering interest on balances.

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Implications These two theories inform us that credit may be a source of new money, regardless of the presence of commodity money. It thus breaks the causal sequence and the assumed theoretical link that Austrian economists like Mises have placed between commodity-based money and fiduciary currency. It challenges Mises's view that the theory of money ought, for theoretical purposes, to be built in a foundation of commodity money. It is possible that the logical deductions and policy conclusions reached on the basis of such a theory need revision or amendment. Consider the following possibilities. First, these theories of fiduciary currency emergence suggest that the regulation of banking may not be sufficient to control the quantity of money. Money might profitably be created by anyone who achieves sufficient trustworthiness and who possesses sufficient wealth. To the extent that money creation is regulated and controlled, periodic local shortages of money will provide incentives for entrepreneurs to discover and produce new types of money that have not previously been regulated. Second, for the same reason, the theories raise doubts about whether a free banking system would generate an "equilibrium" quantity of money.18 Third, in light of Taylor's belief that people in a free wheeling credit system could create fiduciary currency on practically any foundation, it seems wise to reconsider the view that either a regulated or unregulated banking system would generate "stability." If Taylor's theory is correct, one might even doubt the wisdom of making "stability" a policy goal on the grounds that the costs associated with retarding the development of the financial system are greater than the benefits. Even if we judge that credit and fiduciary currency production can be controlled,

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such control may seriously retard the functioning of the credit system. Controls on money growth may stifle real economic development and growth because the controls reduce entrepreneurial innovation in the credit system. 19 Besides entrepreneurial innovation, it may reduce legal innovation. Judges will not have opportunities and incentives to make innovations in the law pertaining to property and contracts that facilitate the development of a more productive and diverse system of credit and money services.

3. Toward a General Theory of Fiduciary Currency

John Hicks suggested that "one way of looking at monetary evolution is to regard it as the development of ever more sophisticated ways of reducing transactions costs."(Hicks 1967: 7) In the modern history of professional economics, a succession of writers, beginning with F. H. Hahn and Robert Clower,20 seem to have followed this suggestion. Much of the professional literature has proceeded with the goal of constructing models in which money exists by virtue of the help it gives in carrying out transactions. This literature is neutral concerning the question of whether a commodity money or credit money would best fulfill these transactions services although most writers, following Menger, tell a story about how some goods are less transaction resource-using than others.

Praxeological Phenomena in the Credit System

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Because practically all of the mainstream work is mathematical, we can hardly expect it to add much light to the praxeological view of the credit system (or, what is the same thing, the credit system as part of the "market process"). Contemplate for a moment the basic phenomenon of a deferred receipt or payment from a praxeological point of view by trying to put yourself in the shoes of the individuals involved in a credit exchange in a peaceful society that has a property system. We ignore motives associated with altruism, maliciousness, and moral reservations against gaining the most satisfaction in the cheapest way, since they would complicate the discussion. One party (A) provides a service now in exchange for a service to be provided by a second party (B) in the future. If A does not trust B, no exchange can be made. Thus B has an incentive to build a reputation. But suppose that B builds a reputation. Then, unless he wants to trade again in the future, he has an incentive to renege on his part of the bargain after it is made. But A knows this. Thus he has an incentive to try to understand B's position and to predict his action by putting himself in B's shoes. At the same time, B has an incentive to try to fool A and he can best accomplish this by trying to predict A's action. He does this by trying to understand A's thinking about his trustworthiness. True intersubjective interaction of this type is incapable of being mathematically modeled. We can know intuitively that it exists but it defies modeling. In a many person situation, the incentives change largely due to problems of public goods and collective decision-making. A complex credit system evolves that economists can only understand by setting up the counterfactual of a system that is populated by robots performing routine functions.21 Among the types of incentives that must be considered are the

A Praxeological Theory of Credit and Money

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following. First, individuals have incentives to build reputations for keeping promises of the same type to a number of individuals at the same time. One might say that there are economies of scale in reputation building. These economies are limited partly by the limited scope of intersubjective interaction

i.e., by the limited time, energy and ability of a single actor to deal

with others. A single individual can only have quality interaction with a limited number of people. Second, when a person builds a reputation among many individuals, he may have a much larger incentive to renege on his promises since he may be able to gain from swindling many people at the same time. Knowing this, each promisee has a greater incentive to try to understand the promiser in order to predict his action. However, typical public goods problems arise, since information about the promiser has public goods characteristics. In response, specialist entrepreneurs emerge to help satisfy the joint demands for information about promisers. But some of these entrepreneurs may be manipulated by the promiser. Alternatively, consumers may wish to select someone to represent their collective interests and to delegate the authority to him to act as their agent. Third, a competitor has an incentive to obtain and reveal information about a successful promiser that is damaging to him. However, she may also have an incentive to lie about the promiser if by doing so, she can persuade the promisees to shift away from him to her. Or, if she can join with the promiser, she may blackmail him into paying her not to spread tales that are harmful to his reputation. Finally, specialists may emerge to perform the various functions of supplying information, endorsing promises made by others, and arranging and providing guaranty. Human action of this type is inherently entrepreneurial and, therefore, inherently incapable of being modeled.

A Praxeological Theory of Credit and Money

26

In studying fiduciary currency, one must take account of these basically praxeological phenomena. The reason is that, depending on conditions, the more competent credit entrepreneurs may find it more profitable to produce their own money than: (a) in a free banking system, to borrow money from lenders of existing money; or (b) in a regulated banking system, to borrow the regulated money.

Why Not an Austrian Theory of the Credit System? It is not surprising that mainstream professional economists, for whom mathematization dominates their thinking, have neglected the praxeological foundation of credit and fiduciary money. But why have Austrian economists also neglected it? Surely, modern Austrians are well aware of entrepreneurship in the market process and of the impossibility of modeling it. Indeed, it was Mises himself who crystallized this idea.22 Since Mises also wrote the definitive Austrian treatise on money and credit, one would expect the entrepreneurship involved in credit money creation to play a substantial role in the Austrian theory of money. The trouble is, on the one hand, that Mises did not begin to study methodology and entrepreneurship until after he had long finished his treatise on money and credit. 23 On the other hand, he did not go back and revise the money and credit theory in light of his methodological discoveries. Other Austrian writers appear to have followed Menger and Mises in their deduction or assumption that the basic money must be commodity-based money.24 Beyond this, most of the Austrian writings in recent years have been filtered through the editorial process at the Mises Institute, where deception, fraud, and even the making of contracts that allow depository institutions to

A Praxeological Theory of Credit and Money

27

engage in lending as part of the same operation are ruled out by appeal to alleged universal moral or legal norms. One could hardly expect a praxeological theory of fiduciary money to develop there.25 The work by Austrians that is most widely known in mainstream economics is that of Selgin and White (see references). While these authors view fiduciary currency as a consequence of free banking, they anticipate that free banking will lead to a stable monetary unit. If the conjectures in part two of this paper about the ease with which new money can be created through endorsement and planning are true, it is difficult to see how any particular system (or entourage, as Taylor calls it) would be stable in any significant sense. It is less certain whether, over time and in light of previous experience, entrepreneurship and judges w ill develop methods and institutions to reduce the prospect and severity of economic crisis. Most Austrian writings on the kind of entrepreneurship that would occur under a free banking regime is unimaginative. In addition it assumes that the judicial system is either fixed in time or is constrained to follow a rule that separates the supply of pure deposit services from the supply of credit intermediation services. This needs to change. A truly praxeological theory of money and credit would incorporate (a) all kinds of entrepreneurial interaction in the making of all sorts of contracts for money and lending services and (b) a constraining but also an adaptive property system to reflect the discovery of new goods and new kinds of contracts.

Toward a Praxeological Theory of the Credit System

A Praxeological Theory of Credit and Money

28

What is needed is a theory of alternative money forms that includes an entrepreneurial component. Such a theory, which can only be outlined here, would enable economists to discuss the role of entrepreneurs in producing different money forms under different legal conditions. Perhaps such a theory would go like this. Where law is primitive and contracts largely unenforceable, commodity money is most likely to emerge because of the absence of means to enforce promises. In a more advanced system of law, where promises can be enforced in some measure, there is a basis for establishing a complex network of trusting relationships. Entrepreneurs under such conditions have an incentive to produce such relationships and fiduciary currency based on them. If one aims to develop a monetary theory to apply to such conditions, he would need to begin with an elaborate theory of trusting relationships and of actions that facilitate and hinder the development of such relationships. In such a theory, intersubjective interaction oneself in their shoes

interaction in which trying to predict others' actions by putting

would dominate the credit system.

Where law is highly developed, complex trusting relationships are less important. What develops in the latter society is a complex set of more or less legally enforceable contracts involving promise, reputation, endorsement, guaranty, anticipated promise-breaking, and market appraisement of endorsers and guaranty. Monetary theory for this society would begin with an elaborate theory of contractual relationships, since the use of government coercion to enforce contracts acts as a cost-reducing substitute for acquiring information and bearing uncertainty about a person who makes a promise.

A Praxeological Theory of Credit and Money

29

Viewed historically, the evolution of money and money forms is the consequence of a complex set of "self-interested" entrepreneurial activity under an evolving property system which, in the more advanced countries, has gradually changed from the primitive to more highly developed. At the same time, pressure politics, anti-capitalist ideologies, ignorance of economics and law, and enforcement costs have left loopholes in the property system. If the evolution is left free to continue

as it must be, at least in some measure

there is no reason to

expect that the property system that is most suitable for today's money and credit environment would also be most suitable for tomorrow's environment. Indeed, the presence of entrepreneurship and legal innovation suggests the contrary. To understand the history of money and to make judgments about the form it will take under free banking requires a simultaneous sensitivity to both entrepreneurship and the property system. To demonstrate this sensitivity, Austrian economists should abandon their predisposition to assume a commodity-based money and try to conceive of the entrepreneurial creation of money under alternative property systems. To know which property systems are most relevant, they need to study the systems to which they wish their theory of money to apply. In this, they might be wise to follow the lead of George Grantham, Tom Velk, and Arthur Fraas: The capacity to form unanticipated contractual arrangements means that the monetary authorities can never shut off the supply of new money. Indeed, the attempt to prevent money creation by regulating monetary activity creates new kinds of incentives to invent private means of payment...[T]o the extent that the creation of private money d epends on private prom ises, money econom ies will be subject to crises and fluctuations caused by the invention and diffusion of new and unregulated means of payment. One should also expect to find monetary innovation in areas where the legal jurisdiction of national monetary autho rities is ambiguous, as it is in international bank ing...Because money is essentially a convention, the regulation of the money supply is inextricably tied to a particular set of legal definitions and procedures that envelop and determine the monetary arrangements of a society. By slightly altering the legal description of their liabilities, private persons can create instruments that have

A Praxeological Theory of Credit and Money

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the potential to become means of payment in their own right. These properties seem to flow from the contractual and legal structure of any society that engages in exchange. By omitting the consideration of these subterranean public goods, recent monetary theorists have allowed themselves to ignore the microeconomic found ations of money supp ly...(Grantham, Velk, and Fraas 1 977: 355-6). 26

We are fortunate today to have a technology that allows us to more clearly understand this implication. It is evident that single governments cannot control electronic credit. Without a theory of credit such as that presented by Taylor, it might seem that we have more to worry about from an anticipated financial crisis than we actually do. If Taylor were alive today to see the development, one suspects that he would regard the growth of internet credit and internet money as just another stage, or entourage. One might expect him to make some observations about the likely changes in trust relationships and contract law that would develop to aid the economies of the world in avoiding or minimizing the harmful effects of the next financial crisis. But it is doubtful that he would advocate that governments try to maintain monetary stability through intervention, since it is only by passing through the crisis that a credit system can move to a higher stage.

4. Conclusion An all-comprehensive praxeology would provide a theory referring not only to human action as it is under the conditions and circumstances given in the real in which man lives and acts. It would deal no less with hypothetical acting such as would take place under the unrealizable conditions of imaginary worlds. But the end of science is to know reality. It is not mental gymnastics or a logical pastime. Therefore praxeology restricts its inquiries to the study of acting under those conditions and presuppositions which are given in reality. It studies acting under unrealized and unrealizable conditions only from two points of view. It deals with states of affairs which, although not real in the present and past world, could possibly become real at some future date. And it examines unreal and unrealizable

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conditions if such an inquiry is needed for a satisfactory grasp of what is going on under the conditions present in reality.(Mises 1966: 64-65)

The conditions of free banking are conditions that "could become real at some future date." The problem faced by Austrian economists who want to study action under such conditions is to specify them clearly and to identify the fundamental types of action and interaction that would occur under these conditions. To do this, they will have to study such phenomena as promise, reputation, endorsement, guaranty, anticipated promise-breaking, and market appraisement of endorsers and guaranty. In addition, they will have to consider property not as a fixed system but as a changing system governed by actors who have been assigned the task of maintaining it in light of the continuing changes in credit relationships in a market economy. References

Cowen, Tyler and Randall Croszner (1990). "Mutual Fund Banking: A Market Approach." Cato Journal. 10 (1): 223-237. Davenport, H. (1914) Economics of Enterprise. New York: Macmillan. DeSoto Jesús Huerta (1998) "A Critical Note on Fractional-Reserve Free Banking." The Quarterly Journal of Austrian Economics. 1 (4): 25-49. England, Minnie Throop. (1915) "Promotion as the Cause of Crises. Quarterly Journal of Economics. 29: 748-767. Grantham, George, Tom Velk, and Arthur Fraas (1977). "On the Microeconomics of the Supply of Money." Oxford Economic Papers. (November): 339-356. Greenfield, Robert L. and Yeager, Leland B. (1983). "A Laissez-Faire Approach to Monetary Stability." Journal of Money, Credit, and Banking. 15: 302-315. Gunning, J. Patrick (1998). "H. J. Davenport's Loan Fund Theory of Capital" Journal of the History of Economic Thought. 20: 3 (349-369)

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Hayek, F. A. (1935). Prices and Production. London. Hayek, F. A. (1978). Denationalization of Money (second edition). London: Institute for Economic Affairs. Hayek, F.A. (1981). "The Future Unit of Value." Paper presented to the Visa International annual conference in Athens, Greece. Reprinted in Pascal Salin (ed.) (1984). Currency Competition in Monetary Union. The Hague: MartinusNijoff Publishers. Hayek, F. A. (1984). "The Future Monetary Unit of Value." In Barry Siegel (ed.) Money In Crisis. San Francisco: Pacific Institute for Public Policy Research. Hayek, F. A. (1992) "The economics of the 1920s as seen from Vienna.." In The fortunes of Liberalism, The collected works of Friedrich August Hayek. Vol IV. edited by P.G. Klein. London: Routledge 19-38 . Hicks, John (1967). Critical Essays in Monetary Theory. Oxford: Clarendon Press. Hoppe, Hans-Hermann (1994). "How is Fiat Money Possible? and Credit." Review of Austrian Economics. 7 (2): 49-74.

or The Devolution of Money

Horwitz, Steven (1990). "Competitive Currencies, Legal Restrictions, and the Origins of the Fed: Some Evidence from the Panic of 1907." Southern Economic Journal. (January): 639-49. Horwitz, Steven (1992). Monetary Evolution, Free Banking, and Economic Order. Boulder, CO: Westview Press. Kauder, Emil (1965). A History of Marginal Utility Theory. Princeton, New Jersey: Princeton University Press. Levine, Ross (1997) "Financial Development and Economic Growth: Views and Agenda." Journal of Economic Literature. 35 (2) 688-726. Loasby, B. J. (1991) "The Austrian School." In Douglas Mair and Anne G. Miller (eds.). A Modern Guide to Economic Thought. Brookfield, Vermont: Edward Elgar Publishing Company. Menger, Carl (1981). Principles of Economics. Translated by James Dingwall and Bert Hoselitz. New York: New York University Press. (Originally published in German in 1871) O'Brien, D. P. (ed.) (1997), The Foundations of Business Cycle Theory. Cheltenham, UK: Edward Elgar Publishing Ltd.

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Rothbard, Murray N. (1962). "The Case for a 100 Percent Gold Dollar." In In Search of a Monetary Constitution Leland B. Yeager (ed.) Cambridge, Massachusetts: Harvard University Press: 94-136. Rothbard, Murray N. (1988) Ludwig von Mises: Scholar, Creator, Hero. Auburn, Alabama: Ludwig von Mises Institute. Salerno, Joseph T. (1994) "Ludwig von Mises's Monetary Theory in Light of Modern Monetary Thought." The Review of Austrian Economics. 8 (1): 71-115. Scherman, Harry. (1938) The Promises Men Live By New York: Random House. Smith, Bruce (1985). "American Colonial Monetary Regimes: the Failure of the Quantity Theory and Some Evidence in Favor of an Alternative View." Canadian Journal of Economics. 43: 531-65. Selgin, George A. and Lawrence H. White (1987) "The Evolution of a Free Banking System" Economic Inquiry. 25 (July): 439-457. Reprinted in Stephen Littlechild (ed.) (1990) Austrian Economics. Vol. 2. Brookfield, Vermont: Edward Elgar Publishing Company. Sylla, Richard (1982). "Monetary Innovation in America," Journal of Economic History. 42: 21-30. Schumpeter, J. A. (1954). History of Economic Analysis. New York: Oxford University Press. Taylor, W. G. Langworthy. (1913) The Credit System. New York: Macmillan. Timberlake, Richard M. (1987). "Private Production of Scrip-Money in the Isolated Community." Journal of Money, Credit and Banking. 19 (4): 437-47. Ulph, A.M. and D.T. Ulph (1975) "Transaction Costs in General Equilibrium Theory--A Survey," Economica. (November): 355-72. von Mises, Ludwig. (1961) "Epistemological Relativism in the Sciences of Human Action." In Helmut Schoeck and James W. Wiggins. Relativism and the Study of Man. Princeton, NJ: D. Van Nostrand. Reprinted in Richard Ebeling (ed.). (1990) Money, Method, and the Market Process: Essays by Ludwig von Mises. The Netherlands: Kluwer Academic Publishers. von Mises, Ludwig. (1935) The Theory of Money and Credit. New York: Harcourt Brace. (originally published in German in 1912)

von Mises, Ludwig (1966). Human Action: A Treatise on Economics. Chicago: Henry Regnery Company. West, Robert C. (1978) "Money in the Colonial American Economy." Economic Inquiry (January) 1-15. White, Lawrence H. (1984) "Free Banking as an Alternative Monetary System." In Barry Siegel (ed.) Money In Crisis. San Francisco: Pacific Institute for Public Policy Research. White, Lawrence H.(1998) "Monetary Nationalism Reconsidered." In Kevin Dowd and Richard Timberlake (ed.) Money and the Nation State: the Financial Revolution, Government, and the World Monetary System. Oakland California: The Independent Institute. Yeager, Leland B. (1988). "The Austrian School on Money and Gold." Journal of Economic Studies. 15 (3/4): 92-105.

1.On this issue, it is interesting to note Hayek's comments on the European common market.

ThoughThough I strongly sy mpathise with the desire to Though I strongly sy mpathise with the desire to comp lete the econo EuropeEurope byEurope by completely freeing theEurope by completely freeing the flow of money betw een them, I have grave dou bts ofof doing so by creating a newof doing so by creating a new European currency managed by any sort ofof doing so by creating a n ew apartapart from the extreme unlikelihood that the member countriesapart from the extreme unlikelihoo d that the member countries w inin practice by a common monetarin practice by a common m onetary authin practice by a common monetary authority (and the p worseworse currency than they have now), it seems highly unlikely,worse currency than they h ave now), it seems highly u nlikely, even thatthat it wthat it would that it would be administered better than the present national currencies. Moreover, in many respects a singlesingle international currency is not better but worse than a national currency if it is not bettersingle international currency is not b leaveleave a country with a financially more sophisticated public not even the chancleave a country with a financially more soph consequencesconsequences of the crude prejudices governing the decisions of theconsequences of the crude prejudices gov international authority should be mainlyinternational authority should be mainly to protect a member state from the harmful measure not to force it to join in their follies.

NowNow that theNow that the Euro is a fact and that it must compete with otherNow that the Euro is a fact and tradingtrading system, ittrading system, it seems evident that the central bank of thetrading system, it seems evid be under great pressure to maintain the value of its currency in terms of other currencies.

2.A2.A more recent argument for international free banking2.A more recent argument for international free banki prospect for an international central bank.

3.More recent Austrian writings on3.More recent Austrian writings on the consequences of free banking also p commodity-basedcommodity-based currency. These include Robert Greenfield and Leland Yeager (1983), Wh (1984: 279), White and George Selgin (1987), and Selgin (1988: 32).

4.One4.One might4.One might argue that they are ultimately backed by the willingness of a4.One might argue t fiscalfiscal restraint (i.e., afiscal restraint (i.e., a combinatfiscal restraint (i.e., a combination of increased taxe increase in money.

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35

5.Emil5.Emil Kauder mentions Taylor's defense of Austrian marginal5.Emil Kauder mentions Taylor's defense his work on credit.(Kauderhis work on credit.(Kauder 1965: 109) A theory of credit similar to Taylor's washis byby the more prolific Herbert Davenpoby the more prolific Herbert Davenport, of whoby the more prolific 6.Murray6.Murray Rothb6.Murray Rothbard, for 6.Murray Rothbard, for This example, maintained that the However,However, Davenport cloaked his theory in the rubric of capital. probably discouraged the gove because he defined moneybecause he defined money "a certain useful for other purp Austrians,Austrians, who usually sidedAustrians, whoasusually sidedcommodity, with Bohmpreviously BawerkAustrians, who usually market, chosen over the years byof thatmarket, chosen over theadvance years byon that market chosen over theory the ye Clark.Clark. Davenport's theory capital was a substantial Clark and,asmarket, iClark. Davenport's toto serve Mises. as a medium foronexchanges."(Rothbard 1962:see9to serve as a medium for exchanges."(Roth anticipated For more Davenport's capital theory, Gunning, 1998. commodity.commodity. The various Austrian positions were described by Leland Yeager (1988). More recently,recently, some Austrian writers have claimedrecently, some Austrian writers have claimed that the use o oror violates universal ethics or law.or violates universal ethics or law. Examples ofor violates universal ethi Huerto DeSoto (1998).

7.The7.The 7.The terms "credit money" and "fiduciary currency" mean basically the same thing. I use t7.Th formerformer whenformer when thereformer when there is no reason to emphasize the possibility of competing cu brandbrand names.brand names. A more descriptive term would be "creditbrand names. A more descriptive ter insist on new terminology.

8.The8.The main reason for this theoret8.The main reason for this theoretical di8.The main reason for this t MisesMises to present his theory oMises to present his theory of the Mises to present his theory of the rel explanationexplanation of business fluctuations was based on the idea that, under cexplanation of business flu wouldwould reduce the rate of interest on business loans in order to find users for new credit mwould reduce ThisThis would encourage the misdirection of resources inThis would encourage the misdirection of reso urce ofof whichof which turn out to be unprofitable and get abandoned. Thus an increase in credit money,of which tu isis presumably easy, particularly for a central bank, to cause;is presumably easy, particularly for a central ban inin commodity money could have thein commodity money could have the same effect. However, such increases are due to factors outside the control of governments and banks.

9.This9.This explains9.This explains why "Mises never addresses the momentous9.This explains why "Mises ne andand bonds whoseand bonds whose exchange values in terms of money fluctuateand bonds whose exchange va depositsdeposits are 'exchanged' on adeposits are 'exchanged' on a market in whichdeposits are 'exchanged' on andand guaranteed by the practically inexhaustible resources of the central bank."(Joseph Sand guaranteed b 1994:1994: 80). Sale1994: 80). Salerno regar1994: 80). Salerno regards this failure to address the insti However,However, it would seem more correct to argue that itHowever, it would seem more correct to argue t orientationorientation and with his 1912 book on money and credit. It seems likely that this theoretical orientation blinded Mises to a number of institutional facts. 10.See also his 1984 paper for a repeat of this assumption.

11.M11.Mises11.Mises 11.Mises e11.Mises envisioned a slowly increasing quantity of credit money under free ba 443)

A Praxeological Theory of Credit and Money

36

12.Taylor12.Taylor spent his career as an12.Taylor spent his career as an economics professor at the University of 13.Steven13.Steven Horwitzof(19913.Steven has numerous ways during he made(1990) century, heidentified made several contributions to cent andand the latter part13.Steven of the first decade the 20th century,Horwitz institutionsinstitutions produced fiduciary currency circumvent reguinstitutions produced fiduciary curren economics-orientedeconomics-oriented journals. Thetoearliest were oneconomics-oriented journals. The earliest shortageshortage of the commonly-used money.what Another possibility is financial that a lower level shortage of thehecoc were mainly on financial crises. He developed hewere mainly on crises. Heofdeveloped what wouldwould create money towould money to he circumvent restrictions imposed by awould create money to is discussed in his 1913 book. Aftercreate his retirement, shifted away from economics. colonialcolonial governments in the Americacolonial governments in the America respondedcolonial governmen AlsoAlso see West's report on the widespread useAlso see West's report on the widespread use of bookAlso see W 1978)

14.For14.For a discussion of Davenport's theory of how the14.For a discussion of Davenport's theory of how the d 61.

15.The15.The note may specify that the goods or other money must be paid on demand, on demand after aa certain period of time sincea certain period of time since ita certain period of time since it was issued, or after for payment.

16.Examples16.Examples and references can be found in Richard Timberlake's16.Examples and references ca namename used toname used to refername used to refer to "a localized medium of exchange that is redeemable sold by the issuer."(Timberlake 1987: 440)

11717.Timberlake17.Timberlake notes that in the mid 19th century, the U.S. government passed laws against privateprivate printing or coining ofprivate printing or coining of money. But courts ruledprivate printing or coin notnot intended to circulate as money, eve to circulate as money, even thou to circulate as m jurisdictions.(ibid.: 443)

18.Selgin18.Selgin defines monetary equilibrium as "the state of affairs that prevails when there is neither anan excess demand for money nor an excess supplyan excess demand for money nor an excess supply of it at t HeHe and others argue that a free banking systemHe and others argue that a free banking system in which there is to restrict their note issue and, in so doing, reduce substantially the prospect of a crises.

19.Theories19.Theories of how such growth would occur that were made ear19.Theories of how such gro wth thoughtthought were part of an explanation of crises. Seethought were part of an explanation of crises. Se EnglandEngland (1915), a colleague England (1915), a colleague of Taylor. SeEngland (1915), a colleague book edited bybook edited by D. P. O'brien.(O'brienbook edited by D. P. O'brien.(O'brien 1997) Joseph Schum financed by new credit money is another example. For afinanced by new credit money is another example. For ininterestinginteresting description.(1991: 60-61). Schumpeter, by the way, appears to have been interesting historian of economic thought who paid any attention to Taylor s theory. He wrote:

Davenport sDavenport s contribution [toward a com plete theory of credit] merelyDavenport s contribution [toward a com plete theor outout in hisout in his Value and Distribution (1908) without making (1908) without making much of them: he emphasized, e.g., that correctcorrect to saycorrect to say that banks lend their deposits. W.G. L. Taylor, incorrect to say that banks lend their deposits. W receivedreceived the recognition it deserv received the recognition it deserved,received the recognition it deserved , received the recognitio

A Praxeological Theory of Credit and Money

37

21.Surveying21.Surveying the literature on the relationship between financial de21.Surveying the literature growth,growth, Ross Levine identifies several functions of what he calls the financial system (andgrowth, Ross II have called the credit system): "facilitating the traI have called the credit system): "facilitating the tradiI managers,managers, savings, and easing the history. trmanagers, mobilizing savings, and easing 20.See Ulph and Ulphmobilizing (1975) for an early discussion of this contracts."(Levinecontracts."(Levine 1997: 689) The question ofcontracts."(Levine 1997: 689) The question of w analysis would identify is beyond the scope of this paper. 22.See especially his methodological chapter 14 in Human Action.(1966)

23.See Mises's discussion of his desire to publish his23.See Mises's discussion of his desire to publish his Theo WorldWorld War I.(MisesWorld War I.(Mises 1978: 56) On the other hand, he writesWorld War I.(Mises 1978 theorytheory of money in Human Action.(ibid.: 112) Y.: 112) Yet,.: 112) Yet, in the latter book, with the ex largelylargely unspecified concept of the "entrepreneurial component of intlargely unspecified concept of assumesassumes that a commodityassumes that a commodity money is already in use, he shows little appreciati ofof entrepreneurs to produce fiduciaryof entrepreneurs to produce fiduciary currencyof entrepreneurs to produc InIn other words, he apparently did nIn other words, he apparently did not In other words, he apparently did differentdifferent money forms for hidifferent money forms for his condifferent money forms for his concept considerconsider theconsider the possibility that entrepreneurship could create money either because laws hadcon in an artificial shortage in a particular place, because of changes in lawsin an artificial shortage in a particular p becausebecause entbecause entrepreneurbecause entrepreneurs had invented new ways to solve existi trustworthiness.trustworthiness. His entire discussion otrustworthin ess. His entire discussion of ftrustworth disregardsdisregards the legal framework,disregards the legal framework, or property system.disregards the lega andand relationshipsand relationships among peopleand relationships among people in which rights to benefits actionaction are fully identified and assigned and costlessly enforced. This rules out public goods problems and changes in the property system.

24.24.An24.An except24.An exception is Cowen and Kroszner, 1990, who discuss a system of mutual fund b TheirTheir discussion of the effects of a sharp decline in stock prices on bank depositsTheir discussion of the ef expectationsexpectations of market participantsexpectations of market participants who trade with depositors ise of their thinking on the credit system.(ibid.: 227-8)

25.See25.See especially the articles by DeSoto, Hoppe, and Rothbard25.See especially the articles by DeSoto, H hashas taken on an ethical connotation at the Institute, thereby differentiating it from the praxeology defined by Mises.

26.Horwitz also recognizes26.Horwitz also recognizes this point when26.Horwitz also recognizes this point w ofof the monetary and legal orders."(Horwitz 1992: 142) Lof the monetary and legal orders."(Horwitz 19 however,however, he does nhowever, he does not seem thowever, he does not seem to appreciate the st institutions in a free banking system to produce money based on credit.

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