 Welcome back everyone to Mises weekends. I'm your host Jeff Deist and this weekend our show features a recent talk By our good friend and an associated scholar at the Mises Institute, Dr. Malavika Nair. Malavika was kind enough to teach our bootcamp course on money and she really does a great job of explaining money From an Austrian perspective, how it emerges, how it evolves, how it works, how it has value and Basically, its role in a free society as opposed to the one we've got. The bootcamp concept is really very simple We take the entire world of economics and distill it down to six basic classes So that any intelligent lay person who attends could walk out after half a day Knowing more economics than 99% of the population and they could know more without reading a 900 page book Without attending classes in high school or college or community college or what have you. So Malavika does a great job here and I think you'll really enjoy it Even if it's basic for you or rudimentary, don't hesitate to send it around to your friends and family who may not have as good an Understanding of money and its origins that you do. So stay tuned for a great talk from Dr. Malavika Nair Hello everybody. My name is Malavika Nair and it's a pleasure to be here today Let me just tell you a little bit about myself before we start. I am a Assistant professor of economics at Troy University, which is kind of down the road. It's about 90 miles south from here Anybody interested in getting a masters in economics, you know, come come study with us We have a great free market center called the Johnson Center at Troy University And that's where I teach and I have several colleagues who are also interested in these very same ideas and we all teach and research And these ideas so we are very receptive to these ideas Anybody interested in getting a degree with us come and study with us What I'm talking about today is money the concept of money and just very basic Issues of money kind of all the basic theoretical concepts that are kind of key in Australian economics that relate to money that is what we'll go over today And this is something that I find extremely interesting. It is my Area of research. It is what I teach as well at Troy University. So I'm very excited to come and talk to you about this today Okay, so let's talk about money. What is money? First of all, what is money? Money is unique when we want to start explaining what money is from the point of view of economics. It's actually unique because When we think about it money is not something that you consume directly. It's not something that you eat It's not something that you know gets used up. It's not something that we use in any kind of production process It is something that we only Hold or it's something that we only have in our pockets because we plan to give it away again at some point and so when we try to Apply the subjective theory of value, which is what you've been hearing about today, which is The basic we understand where all of value comes from It's the subjective theory of value and we try to apply that to money. It becomes difficult There are certain issues that we have to deal with now. What is money? Of course, we all know from our daily experience. We know what money is We use it every day we we buy stuff with it. It's something that most of us think a lot about, right? It's something very important to us But when we try to explain it from the point of view of economics, it becomes a little unique now When we think of money today, we know it as paper bills. We know it as coins, right? Through history money has been many different things. It's been gold. It's been silver It's been all kinds of commodities salt cattle shells Iron so if we try to define money by the actual thing that it is we will fail So think of when we think of what is an apple or what is an orange or what is a car? We think of the thing that it is right, but if we try to do that with money It's not possible because money has been so many different things money is no one specific thing Money is defined. However by its function Money is what money does so from an economic point of view when you think of what is money? Money first and foremost is a medium of exchange What is a medium of exchange a medium of exchange is something that you hold on to or you exchange for? Only in order to exchange again in order to buy something that you do want to consume So it's kind of like an intermediary. It's a medium, right? All the money that you have in your pocket you intend to use in some way to exchange with somebody else Now that's the first and foremost function of money the next Function of money that kind of follows from the first one is that it is a unit of account Which means that it allows us to express prices in terms of money That means that when you go to a store you have one price you have one dollar price for everything You don't have to have Border prices you don't have to have an apple price or an orange price or a banana price for each and everything You can have one price and that is a unit of account So money is something that allows you to trade and it makes trade a lot easier because it allows for one price and The third function of money is that it is typically also a good store of value meaning that It is something that typically holds its value or we hope will hold its value over time now This is something that is not as True with fiat money, but when we look at gold which used to be money for most of history It was definitely true money used to be a very good store of value Okay, now this brings us to the question of why use money at all and this was a question that Mengar was trying to answer Why do we use money at all money or indirect exchange? Right, so think about it. You work you have a job, right? Why because it pays you money What do you do with that money? You go and buy groceries you go pay your rent you pay your car bill Right, so their money is something that is being used as an intermediate step. Why do that? Why not just go work at the grocery store and border with them for your weekly groceries? Wouldn't that be more convenient that that's direct exchange, right? Where you just bother everybody borders with everybody else trades with everybody else for the things that they do Really want to consume. Why do we introduce this extra step of trade? Why does everybody trade for money and then go buy the things that they want? It seems to be Unnecessary it seems to be an extra step Well, we do this because if we were all to just go back to a barter economy Or we were all to even look at any kind of rudimentary barter economy There is a huge problem of the double coincidence of wants. So if you think about it so I have this simple example here think of a mr. Smith and he is a wheat farmer and he grows wheat now he would like to buy some candles and He knows there's a mr. Jones out there who has candles, but he doesn't really care for wheat now What is mr. Smith to do? He would like to trade he really wants to trade he Wants to buy some candles, but he's having a hard time finding anybody who will directly trade with him Who will barter with him? This is called the problem of the double coincidence of wants and it is something that Increases if you think of the term transactions costs It is something that increases our transaction costs in the economy It would make it very hard for the economy to work for the economy to run for any trade to take place if we were all To go back to barter now. This is where money comes in or a medium of exchange comes in now If mr. Smith is a smart guy, what would he do? He will try and think about okay Mr. Jones doesn't want my wheat, but there's got to be something that he does want There's got to be something that he does want to trade with if he's a smart guy He'll figure this out. He'll figure out maybe okay, mr. Jones needs some salt Why don't I go trade my wheat with somebody who will give me salt for it? And then I'm gonna take that salt and then go trade with mr. Jones and get those candles now What role is that salt playing in this example? It's playing the role of a medium of exchange at a very very basic form It's playing the role of a money and that is basically what money does it allows trades to take place Which would not have taken place because it's too costly. It's too hard to find People that who want to trade with you directly now Manger was thinking about these problems and he Asked this question. Why do we use money? Why do we have this extra step in trade? Where does money even come from and his answer was that this very process so if we again We stick with this example of mr. Jones and mr. Spitt with the salt this very process of people trying to figure out How to trade and figuring out that there are actually a few items maybe salt maybe Iron maybe cattle. There are some things that are more Sailable or more Marketable than other things that most people would like to have some of right we can all think of these things So even if we lived in a barter economy all of us would probably have some goods that we would all like to have some of at all Times at home right now It would make sense for people who want to trade with us Who want to buy the things that we are able to sell to them to come to us to offer these things? Which are saleable which are marketable rather than offering something that is obscure now Manger describes this process and he says that this is how money actually emerges in the market just through this It's very simple people trying to trade with each other and finding out that if they use a medium Instead of directly trying to trade with each other that that medium actually gets them what they want now slowly There's going to be just a few media of exchange. There's going to be a few more saleable goods that are going to emerge as a medium of exchange in an economy because Once somebody or a few people catch on to the fact that most people actually would like to have salt at home If people are smart and they want to trade easily, they're all going to carry some salt What is that going to do to the demand for salt? It's going to increase it, right? It's going to raise it now That is going to lead spontaneously to the emergence of salt as a medium of exchange Once that is established as if salt has been established as a medium of exchange Other people coming into this economy Let's imagine new people coming into this economy never heard about salt don't know what it is But if they see oh look people are trading with each other and everything has a salt price They're going to want to go get some salt themselves even though they have no use for it This is the point where we say a pure monetary demand for that good has kicked in a great Example of this is a paper by Ari Radford where he describes money emerging in prisoner of war camps in World War two so in prisoner of war camps each prisoner would be given a fixed amount of rations and They could do what they wanted with those rations right and everybody was given a fixed amount of rations now He studied how cigarettes became a medium of exchange cigarettes because people realize that even if they don't Have what the other person wants if they go get their hands on some cigarettes It'll be easy to trade with somebody else because most people smoke most prisoners smoke and he describes how it's quite fascinating How there were cigarette prices for everything every good in the prisoner of war camp actually had a cigarette price and new Prisoners coming in even if they did not smoke They actually have an incentive to go get some cigarettes and this is what is meant by a pure monetary demand Even if you do not smoke yourself You actually have an incentive to go get some some of that thing because it's going to allow you to trade with other people Okay. Now what are some implications of this theory of manger? Well, it's he's explaining the emergence of money spontaneously through what we call the market process and What it implies is that government does not create money. It does not legislate money into existence It can try but money is what money does money is something that is being used as a medium of exchange You still need people to accept it to hold it to give it away in return for goods That is what a money is if I was today to print some notes and put my name on them and call it money Does that make it money? No, I would need people here to actually accept it use it hold it Sell it for goods exchange it for real goods. That's what makes money a money It has to be acting as a medium of exchange now It also allows us to explain the emergence of money purely through individual actions now This is something it may seem simple, but it's actually extremely powerful because Think about if you think about like an alien invasion coming and looking at our economy and looking at oh Look at this really smart way They do trade you know They have this thing where all prices are denominated in this one thing and they all hold this thing and they all Trade with it and it seems really smart It seems like a really smart way to do trade right but and you would think that somebody must have created it one person Some really smart guys to figure this out created and put it in place, but mangers theory tells us no it's actually it's much more Elegant than that. It's just comes about through the rational actions of marginal Actors trying to maximize their utility. It comes about as an unintended effect. It's it's a very Hayekian process So it's actually something which is simple yet powerful Okay, so like I said through history you have all kinds of things that have been money So it's very hard to define money as a thing It's the best defined as a function in primitive economies and this you can see this even today You if you go to Africa a lot of tribes you can see that they use cattle as money It exists even today all kinds of things have been used as money But at some point most places have made the move to metallic money Typically to gold and to silver and there are some advantages to that it's because if you have a money You want it to be a good store of value. It's probably a good idea that it's non perishable. It's not gonna die So something like a cow, you know, it's probably a good idea if it's easily divisible, right? It's very hard to cut up a cow and you know, just have it still keep its value Right if you were to cut up a cow, it would it would have no value at the end of it But something like gold it's very easy to melt it down to divide it up and have it still keep its value It's very easy to move it around. Okay, and another advantage with gold and silver is that their supply tends to be not not open to Extreme inflation. It's because they're expensive to mine. It's expensive to find gold and that actually helps keep its value stable and Then we have the move towards paper money banknotes and digital money, which is something that we have today Okay, the value of money. I missed a slide there. Okay. Now. So I've spoken about where money comes from. What is money? Where does it come from? How do we explain the value of money? So today you've been hearing about the subjective theory of value and how it applies to all goods So when you exchange when we know that when you people are exchanging goods for goods apples for oranges Where does the price when you see a price emerging between apples and oranges? We know that it signifies the subjective value to each of those people for apples and oranges, right? When you see people exchange goods for money This is difficult because the only reason that anybody holds on to money is to be able to buy those goods So where is that value of money coming from? How do we explain the subjective? subjective value of money now this was a criticism This is when Mises was writing and this was a big criticism of the marginal utility theory Applied to money people said that this cannot be done because there's a problem of Circularity when you try to apply it to money because if you say the subjective value of money depends on what money will buy Right what you can buy for it, which means it depends on the money prices of goods But then on the other hand when you look at a price a money price for good and you say oh You know it comes from the subjective value of money, right? How much people value money for it? This is looks like it is a circular problem, right now Mises Provides a solution to this problem and it's called the regression theorem and he said well It looks like it's a circular problem, but it's not it's actually a temporal problem and we can actually break it up We can go back in history we can say the subjective value to me today of how much my money is worth to me right now the money in my pocket right now how much I value it depends on the prices what I can get for it of The immediate past when we think of prices we think of okay, how much do I need to buy groceries this week? How much do I need to go get lunch, right? I think of the prices I think okay it costs ten bucks to get lunch it costs whatever eighty bucks to get groceries But those prices are technically actually prices of the immediate past the prices that I saw last week at the grocery store The prices that I saw last week at the restaurant, right? So the value subjective value of money to me today depends on prices of the immediate past now How did those prices of the immediate past come about well? They came about from people's subjective valuation of money at a time right before that at a time t-minus two So this is actually not a circular problem, but we're able to break it up and go back in time Now of course if we go back in time we have to push this problem all the way back It goes all the way back logically to a time of butter, right? Which is now we're back kind of in Mengor's problem. Where does the value of money come from? How does it emerge? How does money emerge in butter and this is Mises this is where Mises says that This is why we know that money must emerge Out of some sort of use value the initial emergence of money It must have some sort of use value Outside of any use of media of exchange so it must be some kind of commodity It must have some kind of value in use to people then it allows for it to emerge as a medium of exchange So it's actually a neat way where these two theories tie back together Mengor and Mises Okay, now kind of switching gears a little bit and talking about banking because When we talk about money we have to talk about banks because banks actually have play a big role in money creation Before that we have to understand the concept of the money substitute now the money substitute is any kind of claim to money a claim which is Redeemable meaning you can go and redeem it for money at any point in time at the bank So it could be your checking account. So when you have your checking account balance on your phone, right? These are the money substitutes of today, you know, you can take money out at any point in time You can write a check on it. You can swipe your debit card. It's a money substitute It used to be bank notes. It used to be paper money bank notes used to be the money substitutes now Why is this important? Why does this creation of money substitutes by banks give? Banks the ability to create money themselves. Well, it's because and Mises talks about this It's because money is unique when you think about a claim to money a redeemable claim to money It is actually able to do technically is technically able to do the same work that money does Why is this because money is a medium of exchange? We only hold it to give it away again We never consume it ourselves. So if you think about a claim to a house or a claim to a car There's only so much work that the claim to a car can do you can it can you can sell your car? By giving handing over the claim to it to somebody, but there's only so long that that's going to work There's only so long that they're going to be happy with that claim They're going to want that car pretty soon. Why because the only way to consume a car is to Drive it because the only way to use a car is to drive it but if you were to give somebody a claim to money and Let them and tell them, you know, you can use this instead There's a good chance they might actually start to use it in place of that money Why because money is used only to be given away again in exchange It's never consumed itself the use of money is in its exchange So technically it is possible that claims to money are capable of doing the same work that money itself does now This very property actually gives banks an ability to create money How do they do this? So before we get into what is fractional reserve banking? Let me just talk briefly about what is not fractional reserve banking So you can have one type of banking which is called warehouse banking Where if you want to keep your goods or your money safe and you don't want the bank or the warehouse doing anything with them You can do that where it's basically like a storage house and they print receipts and they give you those receipts Now those receipts can technically circulate in place of the money that's been deposited Another type of banking or credit is loan banking where you put your money in Into a bank and the bank tells you we're going to loan this out to you loan this out to somebody else And we're going to pay you a rate of interest We're going to pay you a rate of return on this But you cannot redeem your money at any point in time You can only redeem it after a certain point of time So you are that money is not available to you so the difference here is in warehouse banking the money is available at all times and Loan banking the money is not available for a certain amount of time now Fractional reserve banking stands somewhere in between these two Okay, it allows for money to be available to you at all times But also the bank to be using that money and lending it out at the same time So here what is the bank doing? It's actually creating money through the issuing of money substitutes It's issuing its own money substitutes So it could do it in the form of warehouse receipts if it's a warehouse a bank or warehouse Sorry could over issue receipts let them circulate at the same time the original Depositor has his receipt and there is these new receipts circulating in effect. You've created a fractional reserve There's not there's only so much of the actual good to go around another way to create fractional reserve banking is to lend Balances to lend the actual money out to create new checking account balances or to issue new bank notes on Accounts that are redeemable at the same time. So checking accounts today, right? This is today. We have fractional reserve banking the money that it says you have in your balance The actual money isn't there at the bank. There's a balance an electronic balance Which is serving as your money substitute which you're using right and you're swiping your debit card You're writing your checks for the actual base money. The cash isn't actually there The bank has issued a bunch of new loans and you created new checking accounts Thus they're meeting on top of that and thus actually creating new money through fractional reserve banking now This is what Mises calls fiduciary media Claims to money that are unbacked by actual base or commodity money So today the base money in the system is cash just the paper cash but it used to be gold it used to be actual gold and This is something that plays a role fiduciary media is something that will become important in the next lecture when you Hear about business cycle theory and this is Mises is big Contribution to business cycle theory now when we talk about this Involvement of the state in money, you know when we think of money today and we we see paper dollars and we see Electronic bank notes, so we just take it for granted that money's probably been paper Currency for for very long time, but that's actually not true. If you look at history Money has actually been gold or silver or in some way linked to gold or silver until fairly recently It was only in 1971 when we actually Have since we actually have a pure fiat currency meaning there is no link at all to any kind of gold or silver Any kind of commodity standard? So if you think of the money we have today It's it's actually a very new phenomenon and governments in central banks don't really completely Know what they're doing necessarily because there are the rules that apply under commodity standards are very different from the rules That apply with pure fiat money commodity standards place much more stronger limits on the amount that governments have discretion to manipulate the money supply while pure fiat money in Hand in hand with central banks have a lot more discretion now some would argue that that's a good thing Many economists argue that it's a good thing. We want money to be flexible We want economists and the government to have control over money that that's actually a good thing It's a social end that we want we don't want it to be tied to something so inflexible as gold But another way to look at it is if it is actually tied to a certain commodity standard We're putting a certain limit on the government, which some would argue is a good thing so way before there were central banks Kings and monarchs typically would take over the the printing of coins But that does not mean that there was not a free market in the gold itself so you would typically take Gold to the mint and you would have coins created and the government and the king would put his seal on it now Kings quickly realized that if we were to clip coins and to kind of make them lighter and keep some of the gold for ourselves In addition to the tax that we levy on the creation of the coins This is a great way to get rich, right? It's it's a hidden tax basically you can keep metal for yourself and keep the face value of the coin the same So if it's a dollar coin call it a dollar coin, but let it have 50% of the metal in it, right? That's great. It's it's I have 50% of the metal to do whatever I want with it But now because it's a gold standard and because there is a free market for the metal out there still There are still full-bodied coins which have a hundred percent value of the metal out there What's going to happen to them people are going to realize that actually if I were to just melt this thing Its value is much higher than the face value that these new coins have So what would happen would be the full-bodied coins would actually just disappear from circulation because they would be so undervalued Now this is actually it's it's a it's a limit. It's a limit on the king's power to manipulate the money It's because there is a free market in the metal and we are tied to this Commodity standard and this is what is called Gresham's law So you hear this phrase pretty often that bad money drives out good money, but only when it has been Officially devalued what about the gold standard? How would that work? So this is again very brief But the dollar under the classical gold standard was just defined as a certain weight of gold So it was just a certain weight of gold. There was still a free market in that metal now That's that mean people used gold in their day-to-day transactions now They they typically used bank notes paper in place of that gold But those paper notes were redeemable at any time for that goal. They were money substitutes Now what happens if the world is on a gold standard and even if we have central banks? Well, there's still a strict limit placed on the ability of those central banks to inflate if the central bank starts to create Money and put paper notes out there. What's going to happen? They're going to go abroad right their own money is going to get inflated the value is going to get inflated People are going to start demanding redemption. They're going to want their gold back Gold reserves are going to flow out of the country that is inflating its bank notes They're going to flow out of the country into a country which is not where prices are more stable What's going to happen to the country with that was inflating its bank as well It's not going to want to lose gold reserves and but it has to redeem them It's going to place a natural check on the amount you can inflate on the amount You can print bank notes and this is this is known as the price PC flow mechanism but again, it's it's a way that limits the ability of Countries and banks to create money under a commodity standard now This is not the system that we have today at all We have a pure fiat money where central banks are in charge of printing notes and there is no limit to the supply and in fact Central bankers today are much closer. I would argue are the new central planners because they are charged with many Functions and they're charged with many things that gives them a lot of power over the economy that gives them a lot of Discretion they have they're allowed to check inflation. They're required to maintain moderate interest rates as well as Maintain full employment now how you do that and how you do that through the money supply There's many ways to do that, but you can see that it gives central banks today a lot more power But it's only possible because we have a fiat money it's because they have the power to create that money if you were on a gold standard you would not be able to just print money and you know have everybody accept it and very quickly if we think about this was pure fiat money in 1971 But where it's come to today. We're in a completely unprecedented place So the Fed with what it has done recently with the crisis I mean now we have this whole new philosophy that certain banks are just too big to fail and Certain industries so like the banking sector or the finance sector is going to get propped up and We've seen the Fed do things that it has never done before bailing out not just commercial banks investment banks insurance companies You know, it's it's it's balance sheet is completely Ballooned if you look at their asset side and they're holding all these toxic assets now. We're in a in a completely New place and it would not be possible without fiat money central banking by itself could not achieve this