Carl Menger on Endogenous Money and Organic Institutions

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Menger wasn’t really an endogenous money theorist. If you were to ask the typical Post Keynesian or MMTer about endogenous money, they would talk about the causation of money creation. Changes in input prices lead to more demand for credit money which in turn leads to money creation and price changes. In simpler terms, the money supply is credit driven, not the other way around as the money multiplier would suggest. But I’m not going to talk about that. Instead, I thought I would take a look at different models on money endogeneity, the first of which concern the selection of money as a uniform medium of exchange. With that in mind, where better to start than Carl Menger’s endogenous model on the origin of money?

In his famous article, On the Origin of Money, Menger created a model in which money is chosen by the agents within the model*. He first imagines a world without money, where economic agents exchange for goods in spot transactions:

In considering the goods he will acquire in trade, each man takes account only of their use value to himself. Hence the exchange transactions that are actually performed are restricted naturally to situations in which economizing individuals have goods in their possession that have a smaller use value to them than goods in the possession of other economizing individuals who value the same goods in reverse fashion. A has a sword that has a smaller use value to him than B’s plough, while to B the same plough has a smaller use value than A’s sword—at the beginning of human trade, all exchange transactions actually performed are restricted to cases of this sort. (Menger 1871: 258)

Commodities have different degrees of saleability and goods are more or less saleable based on a number of criteria, e.g how easily they can exchanged at any given market, their ability to be exchanged at any convenient time, and their ability to be exchanged at current purchasing prices. Because different commodities hold different degrees of saleability, many commodities once bought can only be re-sold at a loss. As Menger notes; “the truth is, that even in the best organized markets, while we may be able to purchase when and what we like at a definite price, viz.: the purchasing price, we can only dispose of it again when and as we like at a loss, viz. : at the selling price.” (Menger 1892: 243-244)

When a person brings his goods to the market place, it would make sense to acquire certain goods with a high degree of saleableness. That way, when a person wishes to obtain specific goods in exchange for his own, he/she is in a more favorable position. Soon individuals recognize the commercial advantages of highly saleable goods, they begin to barter their less saleable goods for those “special” commodities which have highly saleable characteristics:

These wares would be qualified by their costliness, easy trans circumstance of their corresponding to a steady and widely , to ensure to the possessor a power, not only ‘here’ and ‘now,’ but as nearly as possible unlimited in space and time generally, over all other market-goods at economic prices. (Menger 1982: 248)

As this knowledge slowly spreads throughout a nation, mechanisms such as tradition, custom, and habits solidify this process and a uniform medium of exchange is eventuality decided upon by all. “In this way practice and habit have certainly contributed not a little to cause goods, which were most saleable at any time, to be accepted not only by many, but finally by all.” (Menger 1892: 249)

The paper concludes that precious metals (gold, silver, etc) became an accepted medium of exchange because their saleableness is superior to that of other commodities.

One thing to note is that this entire process that Menger laid out is completely endogenous. Agents within this system determine the medium of exchange and there is no outside variable that imposes its influence on the model. This method is in obvious contrast with the idea that money is exogenously determined by some outside body such as the state.

Some might take issue with this a priori theorizing and to some extent these complaints are valid, as recent evidence suggests that this theory is completely ahistorical and outdated. Others might dislike that some “vulgar” Austrians invoke this theory to rabidly support a commodity (gold) backed currency. But this ignores the more nuanced views that Menger held later in his life. He clearly mentioned the importance of pragmatic institutions, i.e institutions created by human will and deliberation, and even stated that money could be a pragmatic institution in his original essay:

It is not impossible for media of exchange, serving as they do the commonwealth in the most emphatic sense of the word, to be instituted also by way of legislation, like other social institutions. But this is neither the only, nor the primary mode in which money has taken its origin. This is much more to be traced in the process depicted above, notwithstanding the nature of that process would be but very incompletely explained if we were to call it ‘organic,’ or denote money as something ‘primordial,’ of ‘primaeval growth,’ and so forth. Putting aside assumptions which are historically unsound, we can only come fully to understand the origin of money by learning to view the establishment of the social procedure, with which we are dealing, as the spontaneous outcome, the unpremeditated resultant, of particular, individual efforts of the members of a society, who have little by little worked their way to a discrimination of the different degrees of saleableness in commodities. (Menger 1892: 250)

However, the broader point here is that Menger not only constructed an endogenous model on the origins of money, but he also laid the foundations for an endogenous theory on the origins of institutions. Individuals, through social interaction, are led to do things which produce unintended results, in this case a uniform medium of exchange. This can also be applied to other things such as language and markets. Menger called these organic institutions, i.e institutions that are the result of a natural process rather that the product of human deliberation. Others who are familiar with the Austrian tradition might call this process spontaneous order.

So when we put Menger’s theory into the context of the marginal revolution and the history of economic thought, Menger not only enriched Austrian economic theory, but he contributed heavily to the analysis of institutions. To those who scoff at Austrian economics, I highly recommend you give Menger a chance. Even if you don’t value the economic analysis of Mises and Rothbard, I think the founder of Austrian economics is of a different cloth and definitely worth a look.


Notes:

1. I will also be using some passages from Chapter VII of Menger’s Principle of Economics, where he also talks about the origins of money. There are also other articles that Menger wrote on this topic, but to my knowledge they haven’t been translated.

References:

1. Barry, Norman. 1982. “The Tradition of Spontaneous Order.” Literature of Liberty 5: 7–52.

2. Menger, Carl, 2007. Principles of Economics (trans. Grundsätze der Volkwirthschaftslehre [1st edn. 1871] by J. Dingwall and B. F. Hoselitz), Ludwig von Mises Institute, Auburn, Alabama.

3. Menger, C. 1892. “On the Origin of Money,” Economic Journal 2: 238–255.

4. Palley, Thomas I. “Endogenous Money: What It Is and Why It Matters.” Metroeconomica 53.2 (2002): 152-80. Print.

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2 Comments

Filed under Economics, History, Home

2 responses to “Carl Menger on Endogenous Money and Organic Institutions

  1. Blue Aurora

    Interesting post, Rousseau1214. That stated, have you seen Robert Murphy’s exchanges with David Graeber on the intellectual views of Carl Menger on this matter? I saw part of the exchanges, but only briefly and in passing, and I’ve largely forgotten the details of it.

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