A Priori Theory and Sound Money - Thorsten Polleit

In 1953, Ludwig von Mises wrote,

The sound-money principle has two aspects. It is affirmative in approving the market's choice of a commonly used medium of exchange. It is negative in obstructing the government's propensity to meddle with the currency system.[1]

And further,

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of right.[2]

To Mises, the sound-money principle thus meant

1. free choice of currency, meaning that money is chosen and produced by the free demand for and free supply of money in the market place, and
2. a line of defense against government violations of individual property rights.

In what follows I will try to show that it can be logically concluded that if money does not comply with the sound-money principle, that is if it is unsound money, it will erode and eventually destroy civil liberties by (and here I may add, ever greater) despotic inroads on the part of government.

Such a statement can be shown to be irrefutably true, as it is derived from the sound-money principle, and the sound-money principle can be traced back to the irrefutably true axiom of human action, which is at the heart of praxeology: the logic of human action, as Mises termed it.

II.

One of Mises's pathbreaking achievements is that he reconstructed the science of economics along the lines of praxeology.[3] At the heart of praxeology is the axiom of human action.
The axiom of human action is of a rather special quality: it meets the requirements of an a priori synthetic judgment, as the German-Prussian philosopher Immanuel Kant (1724–1804) called it.[4]

To explain, a priori here means knowledge that comes to us before, or irrespective of, sensory experience. A priori knowledge is within our minds, so to speak. It is knowledge about the real world (reality), and for obtaining it one does not have to take recourse to observation.

Consider the following two examples:

1. If this thing is one meter long, it is not, and cannot be, two meters long.
2. If A is taller than B, and B is taller than C, then A is taller than C.

These statements strike one as necessarily a priori true; one wouldn't have to test them for proving their validity.

Synthetic means that one adds to a concept (say, body) a predicate (say, heavy) that is not thought in the concept before. The example is this:

All bodies are heavy.

One would have to learn from experience that bodies are heavy; one wouldn't know this a priori. Synthetic judgments are a posteriori.

Kant maintained that there is the possibility of so-called a priori synthetic judgments: judgments that neither repeat the meaning of concepts tautologically nor express new information about the subject term on the basis of experience.

According to Kant, a priori synthetic judgments must meet two requirements.

1. They must not be derived from experience but from reflection.
2. They must be self-evident, that is, their truth value cannot be denied without running into an intellectual contradiction.

Mises's axiom of human action meets both of these requirements.[5] The axiom of human action is not derived from sensory observation. To understand that humans act stems from a reflective understanding, not from observation.

And, it is self-evident. The truth value of the axiom of human action cannot be denied, as such a denial would be a form of action and thus contradict the very statement that there cannot be such a thing as human action.

Praxeology, therefore, provides us with true knowledge about the outer world, and the truth of knowledge derived from praxeology is valid independent of sensory experience. It is in this sense that we can speak of praxeology as a priori theory.

III.

An a priori economic proposition informs us about the relationships between observable events and the counterfactual alternatives to these events; it does not concern relationships between various observable events.[6]

An aprioristic proposition allows us to name the outcome of a certain action with certainty. For instance, if the stock of money is increased, we know for sure that it will lower the exchange value of a money unit.

We know that the law of diminishing marginal utility is implied in the axiom of human action. This law says that the marginal utility of a unit (that is the utility of an additional unit of the good) declines if the supply of the good increases (other things equal).

An additional money unit in one's possession can only be employed as a means for removing an uneasiness that is deemed less urgent than the least urgent one that has so far been satisfied by the unchanged size of money units in one's possession.

We can therefore say with certainty that a rise in the money stock necessarily reduces the exchange value of a money unit (when compared to a situation in which the money stock had remained unchanged).

This, of course, is not to say that aprioristic propositions allow us to make exact forecasts in a quantitative sense. For instance, we do not know when and by how much the exchange value of a money unit declines if and when the money stock rises.

However, a priori theory tells us in advance (that is, without having to run a social experiment) whether or not a given action — or policy measure, for that matter — can or cannot bring about the promised effects.

For instance, we know with certainty that a rise in the money stock will never be "neutral" in the sense of leaving market agents' income and wealth positions unaffected. A rise in the money stock will always benefit some at the expense of others. It is impossible to think otherwise.

As action requires time — with time being a category of human action — a rise in the money supply benefits the early receivers of the newly created money at the expense of the later receivers of the new money or those who don't receive any of the new money (known as the "Cantillon effect").

IV.

In what follows it will be shown that the sound-money principle can be traced back to the axiom of human action. To do so, one has to start with stating some true propositions that can be logically derived from this axiom.

From the irrefutably true axiom of human action we know that human action is purposeful action: means are employed to achieve certain ends.

We also know that means are scarce with regard to the services for which man wants to use them. Where man is not restrained by the insufficient quantity of things available, there is no need for any action — and this is impossible to think.

And because of the scarcity of means, we also know that man prefers more goods over fewer goods.

Assuming that people realize that the division of labor yields a higher productivity than self-sufficient production (which is, it should be stressed, an assumption), they will engage in specialization and trade.

Trading becomes most efficient if people make use of an indirect means of exchange. Exchanging goods against a good that has a higher marketability expands actors' markets, allowing them to take full advantage of the productivity gains provided by the division of labor.

The commodity with the highest marketability will be chosen as money. Mises described the process as follows:

There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.[7]

Why, however, is money chosen by the unhampered market necessarily commodity money, as Mises maintains (as did Carl Menger before him)? Already in 1912, Mises had shown with his regression theorem that money must have emerged, for aprioristic considerations, from a commodity.

People demand money because there is uncertainty (which, in turn, is a category of human action), and money helps to deal with uncertainty: It can be exchanged against other vendible items most conveniently, as it has purchasing power.

The purchasing power of money is determined by the supply of and the demand for money. But isn't such an explanation circular? If the purchasing power of money is determined by the supply of and demand for money, how can this explain the demand for money, which is, in turn, determined by the purchasing power of money?

Mises with his regression theorem found the answer to this question. He explained that the demand for money in the present is explained by money's purchasing power experienced in the (immediate) past.

He saw that the purchasing power of money can be regressively traced back to the point in time when a commodity, which had previously been used only for nonmonetary purposes, is used for monetary purposes for the first time.

From a praxeological viewpoint we can therefore conclude that in a free market — where people are assumed to be governed by self-interest and have the ability to appreciate the higher productivity resulting from a division of labor — money must emerge in the form of commodity money, and that free-market money means sound money.

V.

Against this backdrop the following questions arise: How can it be that today's moneys — the US dollar, the euro, the Chinese renminbi, the British pound or the Swiss franc — are no longer commodity moneys? How can it be that they are not produced freely (in the sense of complying with free-market principles)?

Today's moneys are so-called fiat moneys: moneys that represent intrinsically valueless paper tickets or "bits and bytes" on computer hard disks; they are not redeemable into anything. These fiat moneys are produced by government-sponsored central banks, which hold the money production monopoly.

We know from history that the gold standard was, in an admittedly prolonged process, replaced by fiat money. Mainstream economists typically maintain that this happened because the gold standard failed — as it didn't allow for a flexible, or politically motivated, increase in the money supply.

However, a priori theory offers a rather different explanation of why the gold standard (sound money) was replaced by a fiat-money standard (unsound money). The central element in this a priori theoretical explanation is the concept of the state.
Murray N. Rothbard developed a new Austrian theory of the state, defining it as follows:

The State is that organization in society which attempts to maintain a monopoly of the use of force and violence in a given territorial area; in particular, it is the only organization in society that obtains its revenue not by voluntary contribution or payment for services rendered but by coercion.[8]

Rothbard not only explained that the state is incompatible with the free-market society; he also outlined in What Has Government Done to Our Money? how and why commodity money was replaced by fiat money — namely, because of the continual expansion of the state... read more at source>>