Mises’s Regression Theorem: A Critique

Ludwig von Mises held that money can only have an indirect utility: money has indirect utility by its ability to purchase goods and services. That is to say, the indirect utility of money is derived from the utility of any commodity or set of possible commodities you can purchase with it. Mises stated this in the following way:

“In the case of money, subjective use-value and subjective exchange value coincide. Both are derived from objective exchange-value, for money has no utility other than that arising from the possibility of obtaining other economic goods in exchange for it. It is impossible to conceive of any function of money, qua money, that can be separated from the fact of its objective exchange-value. As far as the use value of a commodity is concerned, it is immaterial whether the commodity also has exchange-value or not; but for money to have use-value, the existence of exchange-value is essential. This peculiarity of the value of money can also be expressed by saying that, as far as the individual is concerned, money has no use-value at all, but only subjective exchange-value.” (Mises 2009 [1953]: 97–98).

“The price of money, like other prices, is determined in the last resort by the subjective valuations of buyers and sellers. But, as has been said already, the subjective use-value of money, which coincides with its subjective exchange-value, is nothing but the anticipated use-value of the things that are to be bought with it. The subjective value of money must be measured by the marginal utility of the goods for which the money can be exchanged. It follows that a valuation of money is possible only on the assumption that the money has a certain objective exchange-value.” (Mises 2009 [1953]: 108–109).

To clarify, according to Mises, the objective exchange-value of money is “popularly called its purchasing power” (Mises 2009 [1953]: 97). The problem, then, for Mises was to account for the “origin of the objective exchange-value of money” (Mises 2009 [1953]: 123). Money is held by people in cash balances, but not to be consumed: money (supposedly) has no use in itself, but is held because of its past exchange value, so that it may be exchanged for goods (Rothbard 2011: 692). What is the cause of the immediate future purchasing power of money? Mises held that the solution is to look at the purchasing power of money in the immediate past (Mises 1998 [1949]: 405).

However, there is a problem with this: it appears that the indirect utility of money (by means of its purchasing power) depends on its utility (see Graziani 2003: 7–9; Schumpeter 1954: 1086–1091).

The Regression Theorem was intended to break this circularity (Mises 2009 [1953]: 97–123; Mises 1998 [1949]: 405–413; Rothbard 2009: 60–61; Rothbard 2011: 692–695). Mises states:

“The objective exchange-value of money which rules in the market to-day is derived from yesterday’s under the influence of the subjective valuations of the individuals frequenting the market, just as yesterday’s in its turn was derived under the influence of subjective valuations from the objective exchange-value possessed by the money the day before yesterday. If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange-value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as money. But this point is not merely an instrumental concept of theory; it is an actual phenomenon of economic history, making its appearance at the moment when indirect exchange begins.

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. It was not until it became customary to acquire certain goods merely in order to use them as media of exchange that people began to esteem them more highly than before, on account of this possibility of using them in indirect exchange. The individual valued them in the first place because they were useful in the ordinary sense, and then additionally because they could be used as media of exchange.” (Mises 2009 [1953]: 121).

Money’s purchasing power today is derived from its purchasing power yesterday and so on back to a time when money originally had direct utility as a commodity. The Regression Theorem was also used to explain why fiduciary media or fiat money have and maintain value:

“If the objective exchange-value of money must always be linked with a pre-existing market exchange-ratio between money and other economic goods (since otherwise individuals would not be in a position to estimate the value of the money), it follows that an object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange-value based on some other use. This provides both a refutation of those theories which derive the origin of money from a general agreement to impute fictitious value to things intrinsically valueless and a confirmation of Menger’s hypothesis concerning the origin of the use of money.

This link with a pre-existing exchange-value is necessary not only for commodity money, but equally for credit money and fiat money. No fiat money could ever come into existence if it did not satisfy this condition. Let us suppose that, among those ancient and modern kinds of money about which it may be doubtful whether they should be reckoned as credit money or fiat money, there have actually been representatives of pure fiat money. Such money must have come into existence in one of two ways. It may have come into existence because money-substitutes already in circulation, i.e., claims payable in money on demand, were deprived of their character as claims, and yet still used in commerce as media of exchange. In this case, the starting-point for their valuation lay in the objective exchange-value that they had at the moment when they were deprived of their character as claims. The other possible case is that in which coins that once circulated as commodity-money are transformed into fiat money by cessation of free coinage (either because there was no further minting at all, or because minting was continued only on behalf of the Treasury), no obligation of conversion being de jure or de facto assumed by anybody, and nobody having any grounds for hoping that such an obligation ever would be assumed by anybody. Here the starting-point for the valuation lies in the objective exchange-value of the coins at the time of the cessation of free coinage. Before an economic good begins to function as money it must already possess exchange-value based on some other cause than its monetary function. But money that already functions as such may remain valuable even when the original source of its exchange-value has ceased to exist. Its value then is based entirely on its function as common medium of exchange.” (Mises 2009 [1953]: 110–111).

Thus a “money thing” must emerge from its original exchange value in direct exchanges, but then it comes to be used as a medium of exchange in indirect exchanges. The process Mises imagines is as follows:

commodity with objective exchange-value traded in direct barter exchange > commodity used as a medium of exchange for indirect exchanges > emergence of money.

The essence of Mises’s theory was summed up by Sir John Hicks as the idea that “money is a ghost of gold – because, so it appeared, money as such has no marginal utility” (Hicks 1935: 2).

But there is a severe flaw underlying Mises’s whole intellectual program in producing his Regression Theorem: the truth of the assumption that money only has indirect utility.

The view that money only has utility through its exchange value is also held by neoclassicals. As the American neoclassical F. W. Taussig argued,

“[t]he phrase “marginal utility of money” must … be used with caution. Money has utility in a different way from other things. It is valued not because it serves in itself to satisfy wants, but as a medium of exchange, having purchasing power over other things. Gold jewelry is subject to the law of diminishing utility precisely as other things are. But gold coin—money—is subject to it only in the sense that an individual buys first the things he prizes most, and then other things in the order of their less utility” (Taussig 1911: 124).

This idea held by Austrians and neoclassicals should be rejected. To begin with, the neoclassical idea that money is neutral is false: the economy cannot be modelled as a mere barter system, as if money is only a numeraire.

Subjective value (or “economic value”) consists in the utility (satisfaction or pleasure) derived by an economic agent from a good. Fiat money may not be a good in the sense of a producible commodity, but money and even financial assets do have utility in themselves, because they have a store of value function in an uncertain world: holding or possessing them allows security against uncertainty, which gives one the ability to meet future uncertain obligations and needs.

Money can even be hoarded directly by some people for the pleasure they might derive from holding large amounts, such social prestige associated with the status of being rich. The existence of the practice of hoarding of money, particularly in times before the widespread use of fractional reserve banking, cannot be doubted either. In a world where we face pure uncertainty in the Knightian sense, cash balances have direct utility (for the history of the idea of preference for liquidity in an uncertain world, see Ritzmann 1999).

But money as the most liquid asset has greater utility than most financial assets, except perhaps the debt instruments we call fractional reserve demand deposits or transactions accounts. Possession of money gives direct satisfaction in providing protection against uncertainty, and allows one to discharge expected and unexpected future liabilities or obligations. Hence money provides a liquid balance that provides the satisfaction of protection against uncertainty. The economist Karl Schlesinger (1914) was an early proponent of this view, and he argued that money held as cash balances can have direct utility, in addition to the indirect utility money can have from its purchasing power (Graziani 2003: 10). John Hicks (1980 [1933]: 528) also appears to have come close to the same view in a 1933 paper.⁽¹⁾ (see Leijonhufvud 2000: 97–98 for an analysis of the wider issues Hicks raised relating to general equilibrium theory).

Money, then, can yield direct utility (Graziani 2003: 11). Post Keynesian economics also takes the view that money (even fiat money) has utility:

“In an uncertain world, the possession of money and other nonproducible liquid assets provides utility by protecting the holder from fear of being unable to meet future liabilities” (Davidson 2003: 236).

Where does this leave Mises’s Regression theorem? The conclusions to be drawn are as follows:

(1) The search for a solution to the alleged circularity of the indirect utility of money depends on rejecting the view that money has direct utility. But money has direct utility, and the whole problem of the alleged circularity that Mises tried to solve is an illusion. It follows that the Regression Theorem is essentially pointless and worthless.

The whole assumption underlying the Regression Theorem is flawed in that the expected future value of money or liquid financial assets can provide direct utility to the holder of money or that asset (for other critiques of Mises’s Regression Theorem, see Patinkin 1965, whose critique already raised the possibility that Mises’s assumption of only an indirect utility for money was wrong; Zazzaro 2003: 237, n. 18; Timberlake 1987).

(2) The regression theorem also commits a non sequitur in ignoring the role that money can have in discharging future obligations such as taxes, and the theoretical possibility and empirical reality that money could arise by governments imposing tax obligations on a community, by taking goods in kind, paying wages for labour, or issuing debt, and giving in return a token or money thing, and demanding that taxes be discharged in that particular money thing (e.g., a hazelwood tallystick, paper money, etc.). Money can then acquire purchasing power through people’s need to acquire it to pay taxes: the purchasing power of money would then develop as related to the value of goods that can also be used to extinguish taxes. The direct utility that money provides would be the ability to meet future tax obligations.

I suspect that real world examples of the introduction of paper money or fiat money provide empirical evidence that refutes the Regression Theorem, including the following:

(1) The introduction of paper money under some dynasties in medieval China (although it is possible that these paper monies were originally convertible into specie; see Glahn 1996 for a starting point in the research literature).

(2) Some of the fiat monies of the British North American colonies in the 18th century.

(3) The issue and use of hazelwood tally sticks by European medieval states as debt money issued to state creditors, which could be used as a medium of exchange and to discharge tax obligations.

A further investigation of these historical examples is clearly in order, though I will not do it here.

In ancient Mesopotamia, money appears to arise first as a unit of account developed from weight units of silver and barley by temple and palace institutions, which was used to calculate the value of taxes, rents and debt, in real goods. Payment could be made not just in silver or barley, but in goods through administered prices denominated in the temple/state unit of account. The use of the unit of account and the medium of exchange was then imposed on the community.

Footnotes

(1) Strictly speaking, Hicks did not appear to regard his demand for cash balances owing to future uncertainty as providing “direct” utility: “ … people always demand money as money – not because it has direct utility to them, but because it is to be used in the making of future payments. In addition to the demand for money as a commodity, there is a demand that arises directly out of ignorance of the future” (Hicks 1980 [1933]: 528).


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