What Makes Good Money? A Misesian Perspective

Why did the market choose gold as an international standard for money? In his classic book The Theory of Money and Credit, Ludwig von Mises developed a beautiful and comprehensive philosophy of what money is and how it comes about, starting from barter and working all the way through the international gold standard. One of the valuable insights from the book is Mises’s concept of what characteristics are vital to the money function. He focused on five aspects in particular, and understanding them is still valuable today, even in a world of pure fiat money.

The first characteristic he described is marketability [1]. This characteristic is most important during the early stages of a monetary system. A marketable good is one which is consistently in demand by a large proportion of people in the market. In the infancy of a monetary system, the most marketable goods are those most likely to be held as media of exchange. However, as the monetary system matures, goods used as media of exchange create their own demand, generating positive feedback. Gold meets many of the criteria very well, but it was not the first money in most places. Rather, the monetary system started from some other, more immediately available good, and moved toward gold over time, especially as influences from foreign trade made using multiple media of exchange inconvenient and as new innovations, like banknotes, simplified moving wealth around. A mature money creates its own marketability, to the point that a state-administrated gold money can be stripped of its backing without necessarily causing a collapse [2].

The second characteristic Mises explores is durability [3]. A durable good allows a person to store wealth, and makes it useful for credit transactions. Later in the book, Mises notes that a valuable characteristic of money is its “resistance to destructive external influences” [4]. One source of these destructive influences is natural–living creatures used as money can die, paper can be shredded, shells can be crushed, and base metals corrode. However, noble metals are particularly resistant to many of these influences.

The third characteristic is fungibility [5]. Fungibility is the degree to which one unit of the money is identical to another. Fungible money allows large sums to be traded without reliance on time-consuming and potentially erroneous measurements of weight or volume. A money that has significant variation is susceptible to division into smaller pieces, each piece then being treated as a full unit. Another aspect of fungibility is anonymity. Gold serves this aspect well. It is malleable and can be shaped or stamped into well-defined weights. Gold pieces can be embossed with hard-to-copy patterns representing famous and trustworthy mints. And even in the absence of agreed-upon weighted coins, gold can be traded by weight, with each unit of mass fungible with any other.

Mises then brings up the trustworthiness of a money [6]. Obviously, it must be possible to distinguish money from non-money. For moneys consisting of a certain weight or volume of some material, the reputations of the issuers affect their trustworthiness. However, once some material or type of object has been accepted as money, an incentive will exist for groups, both state and private, to make counterfeits at lower cost. To this end, materials and objects with unique bulk characteristics, such as high density, make for more trustworthy money. Gold is once again a standout in this aspect, having anomalously high density. However, it is important to remember that an issuing authority can act against trustworthiness. This is another source of “destructive external influences” [4]. Put simply, issuers can clip or sweat coins and use the residue to make new ones, and, if the issuer is a state, enforce the old value of the now lighter coins with legal tender laws.

Fifth and finally, Mises notes that a medium of exchange, to be generally accepted and used, must be convenient for most users [7]. He notes the difference between wholesale and retail use, and that money should serve both. Convenience is more subjective, but it has a significant effect when taken with the regression theorem. What was money yesterday has tremendous influence on what is money today. For instance, a state can remove the gold-backing of notes without completely devaluing them. Convenience to retail means that the money must be divisible into amounts that minimize rounding in the trade of inexpensive goods (remember penny candy?), yet wholesalers and savers demand high density value, to minimize shipping and storage costs.

Here we observe that a pure gold standard is good for wholesalers but presents problems to small retail trade. In a system that uses gold exclusively as money, the amount of gold corresponding to a small purchase is difficult to reliably transfer. Imagine trying to trade a penny’s worth of gold–approximately 171 micrograms as of this writing ($1814/Troy oz.). Various solutions arose, including token coins, purchasing on account, and notes laced with very small quantities of gold. Bimetallic standards, such as gold and silver, were another attempt to solve this problem. Each has advantages and drawbacks, but the net effect is reduced convenience somewhere in the supply chain. Even so, market forces continued to rely on gold as money until the state took over the process.

As the gold system matured, the use of notes and token coins became common for small retail trade. These had both private and state-sanctioned cases, but all were susceptible to bad incentives produced by extremely low-cost production. Specifically, the incentive is to produce more notes than are backed by the gold reserves, resulting in notes which are part money-certificate and part fiduciary media [8], with the users of the notes largely unaware to what degree each note was backed by specie. When the monetary system started to move away from trustworthiness demanded by the market, private issuers of notes and tokens found themselves hit by bank runs. The state then monopolized the administration of the monetary system, resulting eventually in the complete loss of the gold-backing, which was not a market phenomenon [2].

Based on Mises’s work, we have outlined five characteristics that make a good money. Gold served those requirements admirably while the state allowed it to do so. However, as the state-based monetary system falters in the face of furious inflationism, it is an open question where the market will go from here. Will it return to gold, choose some other metal, or go in some other direction entirely? The answer will be decided, not by theorists, but by the market, yet it is still a topic worth considering by serious economists.

References

[1] Ludwig von Mises, The Theory of Money and Credit, 2009 Edition, pp. 31-32

[2] Gary Richardson, “Gold Reserve Act of 1934,” https://www.federalreservehistory.org/essays/gold-reserve-act, Accessed 2022-11-24.

[3] Ludwig von Mises, The Theory of Money and Credit, 2009 Edition, p. 35

[4] ibid., p. 99

[5] ibid., p. 35

[6] ibid., pp. 60-66

[7] ibid., p. 99

[8] ibid., p. 133