Austrian Economics Puzzle

Hammering the Pieces Into Place

In a previous post, The World's Hardest Austrian Economics Puzzle , based on the pdf paper entitled: On The Optimum Quantity of Money by William Barnett II and Walter Block, the question was posed as to whether a gold standard society would benefit more, or at all, from an exclusive infusion of an increase in monetary gold or non-monetary gold.

As the paper notes, it has been an accepted belief of Austrian Economics that Society does not realize a benefit from a larger money supply, nor does it suffer from a smaller one. While the issues involved in this question often seem to be almost endless in both their quantity and complexity, this puzzle only attempts to deal with the specific benefit(s) that the paper proposes as benefits to society from an increase in monetary gold.

From the paper :

"...Whence, then, the source of the value as money, if any there be, of the newly mined gold? (Its value in jewelry or contacts is obvious.) The value of the new money would arise out of the additional transactions that would be made possible by its existence. That is, there would be transactions, previously impossible to undertake because the cost of using valuable gold to mediate such was excessive, which would now be made possible because the new monetary gold reduced the value of money at the margin. There are, at any time, a variety of potential exchanges. Some of these would create a great deal of value; others only a minute amount. The value that would be created by some potential exchanges is so small that the utility of gold in facilitating such exchanges would be less than its utility in nonmonetary uses. In such cases the potential exchanges would not occur...."

It literally took me months before I began to understand what is being suggested here, and there remain either gaps in my imagination or redundencies in the paper itself.

What I do understand is this :

If I decide not to buy a candy bar for $1 it will be because the marginal utility of the $1 to me will be greater than the subjective marginal utility or use-value of the candy bar in providing me with the satisfaction of consumption.

If the supply of money is increased and the marginal utility of money is thereby decreased, it may well now be that my decision will be to purchase the candy bar for $1. This would be a benefit to society in the sense that new consumption has been enabled.

Where my imagination fails is that I can think of no way in which 'facilitating new exchanges' by reducing the marginal utility of money is other than identical to the candy bar buying process described above.

However, even this benefit is overstated. If the marginal utility of money is decreased as a result of an increase in the supply of money, there will be a general tendency for all money prices in the economy to adjust to the new marginal utility by rising. Although I may be able to buy a candy bar for a $1 for a while, it is only a matter of time until its price is raised to $1.25, for example. This means that this benefit to society of the increased money supply is only temporary, at best.

The only real benefit is for goods that use gold as a factor of production. In general, it is likely that the demand for a given gold containing good at a given nominal price will rise, but that the gold factor itself will not rise in price. This means that these goods will be more profitable and some will actually be produced that were previously unprofitable.

Given this benefit of an increased production of gold-containing products that would have otherwise not been produced, which is more beneficial, an addition of 100% monetary gold or 100% non-monetary gold?

The answer is neither.

Under the initial conditions of the problem, with all gold profits having been already realized, and no sterile gold setting in the gold manufacturers' vaults, an increase in monetary gold does reduce the marginal utility and the exchange value of gold, and would allow for additional profitable gold-containing products, but there is no gold available to make those products without some conversion of monetary gold.

Conversely, an increase in non-monetary gold can be stored in the gold manufacturers' vaults, but since there has been no reduction in the marginal utility of gold because of no increase in monetary gold, it can not be profitably used in production unless some gold is converted to monetary gold.

Thus it would appear, under the limited type of benefit that is considered here, that additional gold must be allocated to both monetary and non-monetary uses. This could happen directly, or conversions between monetary and non-monetary gold could be allowed after the fact. While it is possible that the same allocation could result from any of the possible initial allocations, the non-neutrality of money makes this unlikely in fact. In any case, there will be no way in general to chose between the final market-driven allocations if they turn out be different.

With this in mind, consider the Mises Human Action quote from the paper :

"...The fact that things which could render some other useful services are employed as money [emphasis added] and thus withheld from these other employments appears as a superfluous curtailment of limited opportunities for want-satisfaction. (Mises 1996, pp. 421–22)..."

In a technical sense, the fact that additional gold money seems to be necessary to utilize additional non-monetary gold seems to be in conflict with this.

Share this

If the objective exchange

If the objective exchange value of a dollar falls, causing you to make a transaction that would not otherwise occurred at a fixed price, "society" is not better off. You just get a candy bar at the price you would have paid anyway, and the seller gets less objective exchange value in the transaction. Block and Barnett are claiming that increasing the money stock reduces transactions costs due to certain physical properties of gold. This is not a very convincing argument.

The proper insight as to why adding to the money stock is "socially beneficial" is this. Anyone wishing to convert their use gold to money gold can be made better off by doing this. The value of gold for use gold and money gold cannot deviate on the free market. If there is any such deviation there will be a correction. If there is an intervention to prevent this, the problems of fiat money creep in. Thus, all new gold must be allocated to both money and use gold. When more gold is produced gold prices fall, and this is good for those who demand use gold.

Gold coins don't drop from

Gold coins don't drop from the sky. Gold has to be mined, refined, & then converted into coins. That is why, during the 19th century, there were gold rushes: returns to gold-mining rose. This happened when prices generally were falling - or when people wished to convert more of their resources into cash balances, ie, increase the supply of monetary services relative to other goods & services. That is the whole point of a commodity money: resources are required to produce it. This means its relative supply is integrated into the supply of all goods & services.

The governments of the

The governments of the western world have continuously attempted to put a 'penny in the fusebox' by denigrating or outright fixing/manipulating the price of gold for decades. The problem with that is that this always leads to unbelievable speculation and market corruption, as golds function in price regulation is temporarily shut off, until the smoke is so thick no one can ignore it. gold is the monetary control agent, par excellance, and everyone knows it, but like alchoholics, choose to ignore it and think its ok to 'have just one'. Rothbard was a genius because not only did he see this was self evident, but he could explain it with such clarity. Power mad human beings, especially the sociopathic types, like Greenspan or Gordon Brown or ?, can never be counted on to make the correct choices and this monkey-ing with the freemarket gold price is the untimate root of social breakdowns and one of the driving forces of Kondratief waves.IMO.

If the supply of money is

If the supply of money is increased and the marginal utility of money is thereby decreased, it may well now be that my decision will be to purchase the candy bar for $1. This would be a benefit to society in the sense that new consumption has been enabled.

That's not at all what they meant, and this is precisely why inflation is harmful. The scenario above is possible only if you're ahead of the curve in getting the new money, and, although it benefits you, it's a net loss to society.

Here's what Barnett and Block meant: Suppose that there's only one kilogram of gold in the whole world. With a very small population, this might be sufficient. But as the economy grows, the transaction costs of transferring this money around become so high that many transactions simply are not economically feasible. For example, you may be willing to pay an atom of gold for a candy bar, but are you willing to pay the transaciton costs of transferring an atom of gold to the merchant? Under such circumstances, the sale of candy bars would be impossible.

As long as we have commodity money, there is such a thing as too little money. There's also such a thing as too much money--one wouldn't want to have to lug around several pounds of gold to buy a candy bar, either. Bank notes suffer from neither of these problems, but they do allow for the possibility of fraud.

I do think that they reach too far in claiming that the free market will always produce the optimal amount of money, as I suspect that it creates more money than is necessary to alleviate the problems above. Unfortunately, this is just a price we have to pay to keep the money supply safe from government meddling.

I feel stupid for not

I feel stupid for not thinking about this type of sh*t. Should I? :dunce: