Why Classical Economics Was Mistaken on The Value of Currencies and Its Contemporary Relevance for Cryptocurrencies
In the modern discourse of economics, it is unnecessary to belabor the plausibility that value may be vested in a medium of exchange that may be described as “unbacked”. Though it may be contended by some that the weight of the nation-state “backs” the value of its money via legal tender laws, the contemporary reliance on fiat money as a form of currency distinct from “commodity” money like that of the gold standard systems of history or the bona-fide currencies that may be witnessed in black markets such as contraband in prisons, illustrates the value of money as being separable from the utility of direct use furnished by a material good. With “cryptocurrencies” in the forefront of popular media attention, questions have arisen on whether or not cryptocurrencies may properly be considered “currencies”. Separate from the debate concerning if cryptocurrencies qualify as an account of wealth or are sufficiently popular to be regarded as money, a different conversation has arisen critiquing the Austrian School’s explanation of currency in the context of emerging cryptocurrencies. Critics, hard monetarists among them, have advanced that the regression theorem as an addendum to Carl Menger’s subjective theory of value, which held that the value of currency is the derivation of money’s historical direct use as a commodity, cannot account for the supposed value of the transpiring cryptocurrencies of the last decade, including the popularly traded Bitcoin, Ethereum and Litecoin. Advancing such a position, one economist has written, “Mises’ theory is elegant, and for a long time it has been accepted wisdom among many Austrian economists. The only trouble is that Bitcoin is in the process of proving it wrong (Albright).” If the subjective theory of value is deficient in this regard, perhaps the internal logic of cryptocurrencies lends itself better to David Ricardo’s characterization of value as a product of labor existing in the context of scarcity. But in contrast to both Albright and Ricardo, the following illustrates that the emergence of cryptocurrencies and their rising evaluations do not falsify the Austrian characterization of currency as a derivation of the subjective theory of value represented by Carl Menger and built upon by Ludwig von Mises.
It would be assumed that the value of currency like other goods and services arises from subjective frameworks, however the matter becomes less clear when applying the same concept to emerging monies. Prima facie, it is acceptable that consumer goods derive their value from the subjective evaluation framework of individuals. An individual seeking to trade a widget can reasonably be said to be entering this transaction to increase his individual utility. The other party to the trade of said widget can likewise be understood as conferring his good to increase his utility as well, resulting in a mutually beneficial exchange of valued goods. This value derives from the conclusion that a particular good or service can satisfy a want (Menger 115). This evaluation occurs and is formed within the subjective framework of a homo economicus in the ex ante, that is prior to the economic exchange (Menger 116–117). Thus the subjective theory of value according to Menger’s framework is capable of demonstrating the motivations of the trade. Individuals trade for goods they believe to be of higher marginal utility per each unit relative to their corresponding cost for the pursuit of higher pleasure (Menger 123). However, without a further addendum, Menger’s outlining of the origins of value proves unsatisfactory when applied to the issue of currency and its worth. At most, Menger’s characterization of the subjective theory of value provides a definitional exemption for currency. Viz, the theory would hold true of all other trucked economic goods, but is deficient in explaining the value vested in money by economic actors.
When questioning why a unit of money grants an economic actor the ability to trade using a medium of exchange, it is unclear how the logic of the subjective theory of value is sound, indicating that Menger’s theory is inadequate to describe the value of money. If an individual seeks to purchase a widget from a seller and the seller agrees, the subjective theory of value entails that each party to the transaction seeks to increase their respective utility. The seller values the unit of money more than the departing good and the buyer values the incoming good more than the departing money. An explanation of this trade would follow that people value money because of its purchasing power. It may be then characterized that the reason money has value is due to its ability to generate purchasing power in the marketplace. Individuals value a unit of money because they will be able to purchase goods with the units of money they possess, in doing so they accept money as a form of payment on the pretext that they themselves will be able to use the money as a medium of exchange. This perspective is not wholly different to the classical interpretation. Despite the differences between the marginal and classical schools on the origin of value, the utility of money has, since modern times, featured purchasing power as its telos. A passage from A Treatise on Political Economy reads:
For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you and the very next purchase you make, it will again convey to a third person the value of the product you may have sold to others (Say).
Though the subjective theory of value could explain the individual values placed on particular goods by actors, without the reconciliation of the theory with the exchange of currency as a medium, it would be necessary to rely on the extraneous exchange of goods as having taken place in a barter economy. At most it could have been said that widget¹ , having been traded for widget², were of equivalent value. Given this problem, factors of production which are not frequently bartered for with other factors of production, but whose cost influences the final price to consumers cannot be said to have definite value and the costs of production would have to be accounted for in an epistemological vacuum.
The paradox does not solely lay on Menger’s account of marginal utility. Other non-currency wares could be expressed in terms of marginal utility as evidenced by their respective supply and demand schedules. Yet, the demand schedule of a given economy’s currency would need to be compiled using all other goods being traded. However, the value of goods is reflected in their price as a function of money. If currency as a medium of exchange derives its value from the basket of goods being traded in a given market and money is an evaluation of these goods, there is no evident origin to the value of money. Ergo, a paradox results that seems to indicate a fallacious circular argument. A logically equivalent statement of Menger’s subjective theory of value applied to currency would be that: the reason money can purchase things is because money can purchase things. If cryptocurrencies are indeed a currency, it would appropriate to use the same framework to analyze both mediums.
If the subjective theory of value is inadequate, an explanation must be substituted to account for the exchange of cryptocurrencies. The governing rules of cryptocurrencies, Bitcoin being the most prominent example, correlate with David Ricardo’s theory of value. For Ricardo, value is determined by two variables: “from their scarcity and from the quantity of labor required to obtain [the commodity] (qtd. in Medema 168). First, cryptocurrencies have artificial scarcity built into their systems so that a finite amount of them may possibly exist. Second, there is labor involved in the “mining” of cryptocurrencies. Namely, computing power must be invested so that units of these currencies may be procured. Though “computing power” seems to feature no human labor, it is still a byproduct of human expenditure. The computer must be created by human hands and sustained by human harnessed electricity for it to function as a factor of production. Moreover, the quantity of cryptocurrency yielded by the computer is dependent on the total amount of computational power devoted to the mining process. The faster the computer is capable of processing and thereby solving the complex mathematical algorithms required to unlock a unit of a given cryptocurrency the more currency is acquired. This is compatible with Ricardo’s qualifier that the “intensity” of labor is a variable in accounting for a good’s value (in Medema 270–272).
However, the price of cryptocurrencies as a reflection of their value cannot be explained with the labor theory of value. Over the last few years, there has been tremendous volatility in these markets absent fluctuations in labor or in scarcity. A $6,000 drop in the price of Bitcoin on a single day cannot be attributed to a new flood of Bitcoin — they are released according to a predetermined schedule. Furthermore, it is not the case that computing power suddenly increases exponentially for a short while, only to return to previous levels shortly thereafter. “Real factors” like technology shocks do not account for the patterns of cryptocurrencies. The subjective theory of value alone holds promise of explaining rapid changes in cryptocurrency evaluations.
To amend the deficiencies of Menger’s theory, the regression theorem expressed in the works of Ludwig von Mises illustrates that money is not exempt from the subjective theory of value; cryptocurrencies may be explained via this framework. The fallacy of circularity is avoided by introducing the element of time. Currency is not exchanged within a defined singular time period, rather the value of currency is said to exist because money is transacted for its future utility. The reason that money may be assigned a subjective value in the present is because it is able to be exchanged at a different time t. This evaluation of a unit of currency at a future time t is predicated on an actor’s forecast. Laborers accept a unit of money in time t¹ because there is an expectation that the unit of money will have purchasing power in time t². Thus, money derives its purchasing power in the present because there exists an expectation that it will have purchasing power in the future.
Mises’ explanation of the regression theorem does not contradict the principles of marginal utility. To the contrary, by virtue of extending the logic of the subjective theory of value to money with the element of time included, the demand schedule for money is reminiscent of other wares excluding the behavioral phenomenon of Veblen or Giffen goods, insofar as the demand curve for money is downward sloping. Although the inclusion of the time variable in the regression theorem solves the gap in the subjective theory of value, it simultaneously creates a new problem. Actors formulate their subjective evaluations based on previous market interactions. A wage is only acceptable for a laborer in time t¹ if there is a rational expectation that the wage has value in time t². How do actors know what the value of their wage is in time t¹? Actors must rely on market information gathered prior to time t¹. This period may be defined as time t⁰. In other words, a wage is accepted by a laborer in the present, for the wage’s future purchasing power, based on information from the past. But to explain why a laborer might accept a wage in period time t⁰, it would follow that the actor concluded it was worthwhile based on information gathered in time t-¹ and so forth. By explaining how a unit of currency qualifies as an account of value in the present for future market transaction, the line of reasoning creates a chain of infinite regress.
Mises countered this apparent fallacy by arguing that it is necessary that money as an economic instrument has a historical terminating point. Namely, it is epistemologically justifiable in the a priori to reason there was indeed a genesis to currency. Given the necessity of money’s genesis, the seemingly infinite regressing chain would terminate at currency’s inception. There is no logical contradiction to track money backwards through time until there was a point in human history whereby money as a form did not exist. This recalls the story of the homo economicus as presented in The Principles of Economics, who “creates” money, not through determination or his intent, but through his rationality, finding that commodities could suffice as a medium of exchange instead of relying on the direct exchange of the barter economy (Menger 175–191). This is in direct opposition to Ricardo’s theory that labor was the “first price”. Per Ricardo, the current monetary regime is rooted in the exchange of labor as a medium, explaining, “[Labor was] — the original purchase-money that was paid for all things…the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another (qtd. in Medema 269).” But according to Mises:
The theory of the value of money as such can trace back the objective exchange value of money only to that point where it ceases to be the value of money and becomes merely the value of a commodity…Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility (102).
The history of money was characterized by the medium of exchange having consumer value, i.e. salt flavored meat, beaver pelts made clothes and so forth. Each of the aforementioned goods enjoyed a time as a currency, but were commodities first. But cryptocurrencies have no direct consumer “value in use”. They do not have any evident function beyond the possibility of being used as a medium of exchange, nor is there an apparent aesthetic use for them largely due to its immateriality. Is it then the case that cryptocurrencies violate the regression theorem and in doing so refute the subjective theory of value? No.
It is logically possible that a material good, not one regularly consumed or understood as a commodity, can become a currency without value being subjectively vested into it by an individual. Thus, it is irrelevant to produce an example of a cryptocurrency being transacted as a commodity in a given economy. It would be sufficient for actors to merely expect the currency to be valuable as an intermediary in a trade for it to qualify as a medium of exchange.
But the practical fact remains, Mises argues that “a” currency emerges from a state of barter using a commodity. It is only relevant that the first currency emerges this way to establish a terminating point, halting the infinite regression. Menger and Mises do not contend that all currency is the result of its historical use as a commodity. Rather, an economy that utilizes money as a medium of exchange is the product of rational expectations and the pursuit of increasing one’s relative utility in the state of a direct exchange economy. Thus, the theorem does not need to address all possible future manifestations of currency because each subsequent currency can utilize the price framework of previous currencies.
This is evident with contemporary fiat money. American dollars absent of their value in exchange offers little to no use to actors as a commodity apart from some contrived use a person has for pieces of paper. It is only necessary to establish that the emergence of fiat money has a history rooted in a price framework. Ultimately, these evaluations of currency are psychological. Once an actor believes that he can exchange units of a thing with a suitable economic partner, a currency of that thing can be the result. When evaluating a cryptocurrency in time t¹, actors may look to how dollars are used in exchanges in time t⁰. Thus they can derive a rational expectation of the future based on previous evaluations of other currencies. It need not be the case that each and every currency may be tracked back through history to its use as a commodity.
As such, the makeup of the currency or its historical use as a commodity is an extraneous complexity. As long as there is perceived value in cryptocurrencies, they can be said to have the possibility of being a currency. There are several features that an economizing individual may find valuable. The volatility of Bitcoin and Ethereum has been frequently published in media outlets. The effects of this volatility on the status of cryptocurrencies as a medium of exchange are two-fold. Since there have been several large drops in the evaluation of Bitcoin in particular, it is likely that some have been deterred in investing in it. Given that mediums of exchange derive their value in exchange from historical evaluations of actors, it is plausible that sellers have been skeptical of receiving Bitcoin and other cryptocurrencies as payment for fear that once they have received payment, their account of wealth will depreciate with a sudden drop in the cryptocurrency market price. However, this does nothing to falsify the subjective theory of value. Despite this, the volatility has become attractive to some speculators hoping to purchase at a lower cost and subsequently exchange the more valuable currency when the evaluation rises. Though intraday and weekly evaluations of Bitcoin are sporadic, a regression analysis or trend line shows an upward pattern in its price depending on the scope of time, alluring prospective speculators. Additionally, cryptocurrencies possess several features that make it attractive vis-á-vis the fiat currencies of nation states. Most importantly it is not centralized. That is, its supply is not governed by a central bank or controlled by a firm, largely mitigating the problem of inflation. Given that it is stored and operated over the internet, it is easily exchanged with individuals or firms across the globe. It is then apparent why some individuals may see utility in these cryptocurrencies and make subjective preferences for them relative to some other good. To “start” a cryptocurrency a transaction of the first “genesis block” is needed to start the blockchain protocol that these distributed network cryptocurrencies utilize. At their inception these genesis blocks have no price attached to them. They are not convertible to dollars or another currency as a result of them not having an established price framework. Yet, people still have transacted them. This illustrates that to some individuals there is an expectation they will increase their utility in some fashion. It is something valuable to them.
Since cryptocurrencies are a modern phenomenon, they have emerged within the context of prevailing money programs like the dollar or euro. Though it is improbably that cryptocurrencies have a value as a commodity or where at anytime used as a commodity, it does not nullify their ability to become money, nor does it prove to be an exception to the subjective theory of value. Ergo, cryptocurrencies as an emerging economic trend do not require a “value in use” feature to be a medium of exchange. It is then clear that these new currencies do not violate Menger’s account of the subjective theory of value by proving to be an exemption to the regression theorem. Nor is the behavior of these digital lines of code appropriately explained by the classical accounts of value by the likes of David Ricardo. By virtue of their ability to purchase goods and services they have already demonstrated their capacity to be a medium of exchange. The debate on whether or not these cryptocurrencies constitute “money” shifts to a semantic argument. Since it is generally regarded that money is widely accepted by the general populace, it is conceivable that some would not consider cryptocurrencies to possess the requisite level of liquidity and acceptability needed to be labeled “money”. However, given its features, it satisfies the requirements of being an account of value and as a medium of exchange and considering the large quantity of transactions on the deep web using cryptocurrencies, the characterization of Bitcoin, Ethereum and Litecoin as money, the largest cryptocurrencies by market share, would not be unfitting.