On the Money Yield and the Monetary Equilibrium Theory

The recent nasty attack of Robert Wenzel on a fellow Austrian Steve Horwitz (I won’t link to it), while being unfortunate and almost childish, nonetheless raised the question of the soundness of the monetary equilibrium approach to monetary economics of which Steve Horwitz is one of the most prominent defenders.

I think the biggest flaw of this approach is the underlying notion that it is possible for a person to decide to hold money without even a vague idea about what she is planning to spend it on in the future.

This theory is superficially plausible but in fact mistaken. It is not possible to choose between spending a certain amount of money on some determinate good now and holding it to spend on something completely indeterminate in the future. What looks like the second alternative is just not an alternative at all. It’s like a “choice” between going to the cinema now and doing something completely indeterminate tomorrow. It is impossible to make.

Now this doesn’t mean that the plans for spending money in the future must be completely fixed. A person choosing to hold money for a period of time to spend at some future point probably bears in mind the possibility of a future choice to spend it on something different from what she originally envisaged. But this is a far cry from saying that it is possible to choose to hold money just for the sake of holding it.

A qualification is required that a strange preference may be imagined under which a person would accumulate the objects serving as money for the sake of it. But such a person will not be treating such objects as money.

But doesn’t what I’m saying negate what some monetary economists call “the money yield”? For instance in this paper Steve Horwitz, drawing on William Hutt, defines the money yield as “being a subjectively valued service of availability”. I hope I’ve already shown above that money at least can’t be valued for this reason alone.

The special character of money comes from the fact that it can be relied on to exchange it for goods in the future. For money to perform its function of being a means of exchange, it doesn’t need to be valued for uncertain purchases only. But it can be partly valued for this reason.

The above analysis allows us to address the idea that, if it were possible to supply money precisely to those who choose to hoard it so as to offset their hoarding, such increases in money supply would not be distortionary. Even if it were possible to achieve this goal, this would mean that over a certain period of time the purchasing power (and ultimately the power to consume) would be arbitrarily increased not in accordance with their prior or expected contribution to production. This is distortionary by default.

In addition to this, a decision by a consumer to hoard some money for a period of time is necessarily a choice expressing her lower subjective valuation of certain current goods vis-a-vis certain future goods. The declines in prices of certain goods resulting from such choices are important signals for market coordination that must not be suppressed. Thus, there is no need to offset the changes in money balances and the monetary equilibrium approach is to be discarded.


There is no aggregate roundaboutness and this is why market socialism is untenable

The title of this post might seem somewhat strange because on the surface the concepts of roundaboutness and market socialism are not directly related. However, bear with me until the end of this post and I hope that I will be able to demonstrate that these things are tightly connected.

I explain why the notion of aggregate roundaboutness of the economy is probably meaningless in this latest short paper of mine:

It is not even clear that the notion of the economy’s total roundaboutness may be ascribed a determinate meaning. Consider the fact that even the decision about what to consider the beginning of production of a certain good is necessarily going to be arbitrary. Even the moment of extraction of the relevant raw materials used in its production is probably not the right starting point because the extraction of those raw materials requires investments of other resources and so on ad infinitum.

The realization that there is no point where the production of a unit of a certain good is started ex nihilo has an important corollary which is relevant to the subject of this post. The corollary is that the production of any input requires obtaining other inputs. This is what is needed to demonstrate that market socialism is untenable.

Recall that market socialism a la Oscar Lange is a system under which price mechanism exists for consumer goods but all the factors of production are owned or hired (in the case of labor) by the state. The traditional argument against this set-up has been that there is no competition in this system. But the response of a market socialist may be that nothing theoretically prevents the government from instructing the appointed managers to compete with one another for producing better consumer goods. Of course, opponents of market socialism may respond that, without being owners of their enterprises, the appointed managers will have weaker incentives to innovate. But this argument is merely psychological and vulnerable to counter-arguments appealing to the fact that in many modern corporations the key entrepreneurial decisions are made by appointed top-managers who rarely own a large enough stake in their companies.

But the observation that I made above about the necessity of other inputs for production of any inputs provides the basis for a praxeological argument against market socialism. Since it is the state and not the managers who will own the money from the sale of consumer goods, the state may not allow the managers to freely decide how to spend the money on inputs because in such case there is no socialism here. The state must thus decide according to some principle where inputs are going to be used and in what quantities and combinations. And the state may not replace input markets by auctioning the inputs exactly because the state does not itself produce and sell some output. Thus, market socialism is untenable.

UPD: What I wrote in the last paragraph probably requires some clarification. The idea is that due to the Hayekian critique market socialism can only succeed if it can combine the advantages of the capitalist system with the absence of property rights in the inputs and the money received for them. Thus, the state cannot just assign some specialized managers to run different enterprises producing inputs as they wish. It must dispose of the inputs or at least the profits itself. More precisely, if the state auctions the inputs as they are produced to retain the prices for them, it may not merely transfer the money to the managers running the enterprises producing the auctioned inputs because such an arrangement will just be capitalism made less efficient by artificially forcing everyone to buy inputs at institutionalized exchanges. Thus, the state must itself decide how to invest either the whole amounts of money it gets for the inputs  or at least the difference the input producers make between the price at which the inputs are auctioned and the prices at which they buy the inputs they need at other auctions.

In the first case, the state will quickly find itself displacing all the appointed specialized managers in deciding about the allocation of the inputs. But even in the second case the Hayekian critique still applies in full force because it is not the specialized managers with the relevant knowledge who will have to decide how the profits will be invested but some central bureaucrats.

Methodological non-individualism is inherently metaphorical

Recently, I started to realize that the disagreement with methodological individualism is one of the most important reasons for many people not to get behind Austrian economics and the libertarian paradigm in political philosophy.

Here I will try to shortly demonstrate that methodological non-individualism is an inherently metaphorical position which for that reason is not about trying to correctly describe the world, but is instead essentially some kind of poetry.

There are various versions of methodological non-individualism but all of them claim that at least some social phenomena exist separately from their constituent elements.

To start with, something can only be said to independently exist if it can enter into relations with other things not through its constituent elements.

As an example, let us look at a human hand. It consists of cells at the micro level but can cells be said to grab something in the mechanical sense? To my knowledge, the answer is no. The purported counter-cases actually involve non-mechanical interactions. Thus, the grabbing action of a hand is not reducible to the actions of its cells on pain of a category error.

However, the same is not true for social phenomena. All social phenomena are completely realized by their constituent individual actions and thoughts (I include feelings into thoughts because I do not think they are separable). Thus, social phenomena do not exist in the same sense as individuals and their thoughts and actions.

The social phenomena are not ‘stumbled upon’

The recent success-story of Bitcoin is a fascinating example showing that there is a big problem with any evolutionary accounts of social phenomena, like the Hayekian one. To quote Hayek from The Use of Knowledge in Society, 

“The price system is just one of those formations which man has learned to use (though he is still very far from having learned to make the best use of it) after he had stumbled upon it without understanding it.”

Although of course no one ever designed even a fraction of the interactions that have involved bitcoins, that doesn’t mean that people just ‘stumbled upon the Bitcoin scheme. Well, at least not the people who invented it and decided to give it a try. They realized from the start that they were trying to launch a new medium of exchange.

It may be countered here that Bitcoin might have emerged as a normal entrepreneurial innovation but when means of exchange initially emerged their emergence could not follow the same trajectory. However, this criticism is unpersuasive. The first persons who have deliberately exchanged something for what would become a means of exchange in the future, or decided to forgo its consumption in the hope to exchange it into something else in the future obviously realized what they were doing, even though they might not have had the praxeological term ‘means of exchange’ in their minds.

So no one just stumbled upon means of exchange and ultimately money, either. The same holds true of other social phenomena, such as the price system mentioned in Hayek’s quote above. At some point some of those who have been involved in exchanging their stuff into the future means of exchange noticed that other people are doing a similar thing. And they decided to regularize their exchanges, i.e. to quote prices for their stuff in terms of the relevant liquid good. They were followed by others, and the process snowballed. Thus, the price system was born.

However, another interesting question is what got Hayek confused. I think that it was the ambiguity of the word ‘understanding’. We rarely understand any phenomenon completely. Even modern economists have and probably can have only a very general understanding of how the price system works. But they understand about it somewhat more than, say, ancient Romans two thousand years ago. However, can we say that the latter had no understanding of the price system whatsoever? Of course not. Otherwise, entrepreneurship would have been impossible which actually existed in the Roman Empire, too. As Israel Kirzner showed in his works, entrepreneurship involves reallocating inputs for uses that produce more valuable things than are currently produced with them. But the only way this can systematically be done is by reliance on the prices of inputs and consumer goods. And in that reliance, entrepreneurs must understand what prices mean for their particular situations.

The intellectual work of an economist is actually not entirely different from that of an entrepreneur, it only is done at a significantly higher level of abstraction. Whereas an entrepreneur needs understanding of only some relative prices and some preferences and other facts that influence their formation, an economic theorist starts from preferences and other relevant facts in general. But the essence remains the same. The latter observation is especially evident when as an economist one has to study particular business models and try to explain why they work. The entrepreneurs, however, usually make poor economic theorists because, as the vast majority of people, they can only think abstractly in the context of their familiar activity.

Marginalism is not needed for economics: the case of the water-diamond paradox

I have already raised strong doubts about the soundness of marginalist analysis in economics even in the version presented by Murray Rothbard in Man, Economy, State.

Since then, my opinion that economists should abandon marginalism has grown even stronger. Most of our actual choices do not involve deciding whether to add an infinitesimal amount of good A to the stock of good A or an intitesimal amount of good B to the stock of good B, and this alone should give pause to any proponent of marginalism.

But I am sure that I will be asked at this point how we should deal with the famous water-diamond paradox which classical economists could not resolve. Does its resolution require marginalism, though?

The seeming paradox briefly goes like this. Water in general is obviously more important for humans than diamonds because it is indispensable for supplying many basic needs. Whereas diamonds are a mere luxury. Yet a minuscule diamond costs more than a liter of water.

The marginalist response to this was that humans are not choosing between all water and all diamonds, they are choosing rather among infinitesimal amounts of them. My point is that the first part of their response is correct but the second part should be changed.

Humans do not choose goods for their own sake, they pursue them for satisfaction of certain goals. Thus, what matters for a particular choice are not the volumes over which the choice is being made but the goals among which the trade-off is indirectly made by means of the trade-off among certain amounts of certain goods.

In other words, it is not impossible to imagine that humans will have to make a choice between large amounts of water or diamonds, for example if they in the future face a choice whether to colonize a planet rich in water or in diamonds. But nothing in the underlying basic structure of choice will change. Therefore, the notion of marginalism is not basic to economics, if it is a properly economic notion at all.

Huemer on the dualism between the world and mind

In one of yesterday’s discussions this criticism of Ayn Rand’s theory of concepts and propositions from the position of modern dualist (in the sense of dualism between the world and concepts) philosophy by Michael Huemer went up. However, what I want to do here is not to defend Rand’s theory but to show that Huemer fails to prove two very important points.

He starts with defening the necessity of distinction between sense and reference:

The need for distinguishing the ‘sense’ of a word from its ‘reference’ is shown by examples like this:
Oedipus, famously, wanted to marry Jocaste, and as he did so, he both believed and knew that he was marrying Jocaste. The following sentence, in other words, describes what Oedipus both wanted and believed to be the case:
(J) Oedipus marries Jocaste.

However, Oedipus certainly did not want to marry his mother, and as he did so, he neither knew nor believed that he was marrying his mother. The following sentence, then, describes what Oedipus did not want or believe to be the case:

(M) Oedipus marries Oedipus’ mother.

But yet Jocaste just was Oedipus’ mother. That is, the word “Jocaste” and the phrase “Oedipus’ mother” both refer to the same person. Therefore, if the meaning of a word is simply what it refers to, then “Jocaste” and “Oedipus’ mother” mean the same thing.

It does follow from this example that the Randian theory of meaning is mistaken but it does not follow that distinguishing sense from reference is the only alternative. The alternative that I have in mind is the idea that it is possible for someone to have only a limited grasp of a certain concept and thus to refer to the referent of such a concept only in a limited sense. After seeing a tiger, a child may, while still not knowing that a tiger is a carnivorous mammal with a certain areal of existence, etc., realize that tiger has big teeth and a lot of strength. The same is true of Oedipus and Jocaste.

Another important point by Huemer concerns the existence of Kantian a priori.

By an item of “empirical knowledge” I mean something that is known that either is an observation or else is justified by observations. A priori knowledge is that which is not empirical – i.e., an item of knowledge which is not an observation and which is not justified by observations.

Note the word “justified”. I do not say that a priori knowledge does not depend causally on observations. I do not say that the concepts required to understand it are innate or formed without the aid of experience. I only maintain that a priori knowledge is not logically based on observations. In other words, if x is an item of a priori knowledge, then there is no observation that is evidence for the truth of x – but we still know x to be true.

He provides an example with addition:

How about this, then: I see one orange, over here. Then I see another orange, over there. I put the two oranges together. I count them, and get the result “2”. I therefore conclude that 1 orange plus 1 orange = 2 oranges. Perhaps by doing this experiment with a lot of different kinds of objects, I eventually conclude (inductively) that 1 + 1 = 2, regardless of what type of objects are being counted. Thus, observation has confirmed (B). Perhaps by also confirming a lot of other equations, I might also be able to inductively support the axioms of arithmetic.

This idea, of course, involves a confusion about the nature of addition. Addition is not a physical operation. It is not the operation of physically or spatially bringing groups together, and the equation (B) does not assert that when you physically unite two distinct objects, you will wind up with two distinct objects at the end.

Addition is not any and not only physical grouping of distinct objects. But it does not mean that it is not instantiated in some such groupings (from observing which everyone of us has learned the meaning of addition). Thus, there is no problem in saying that 1+1=2 is evidenced by putting two oranges together. And thus the knowledge that 1+1=2 is not a priori. In fact, there is probably no such thing as Kantian a priori knowledge.

2+2=4 is not an instance of Kantian a priori knowledge

contra what most philosophers believe.

Even if you define 2 as (1+1) and 4 as (1+1+1+1), it does not follow from these definitions that 2+2=4 because (1+1)+(1+1) is not the same thing as (1+1+1+1). This is because nothing allows you here to open the brackets.*

If even this is not an instance of a Kantian a priori, then probably Kantian a priori does not exist. But neither does it mean that the knowledge that 2+2=4 is empirical in the narrow sense of being testable by experiment. It is empirical in the broader, Aristotelian sense.

*This beautiful short explanation I owe to Roger Penrose’s great book “The Emperor’s New Mind”.