Austrian School arguments on the free market origin of money
By Gennady Stolyarov II
web posted October 17, 2005
The Austrian School of Economics offers an innovative and vital perspective on how money came to be, a perspective that firmly establishes money as a free market creation and validates the efficacy of market exchange. According to Carl Menger, the 19th-century founder of the Austrian School, money could not have originated as the invention and imposition of a wise ruler or government. Several difficulties and outright absurdities are inherent in such a scenario:
1) No historical record of any state-imposed origin of money anywhere in the world can be found. Surely, such a critical development -- if it had originated in a state edict -- would have attracted the attention of contemporaries who would have permanently commemorated it in a multitude of ways.
2) The state theory of the origin of money assumes that a single person or committee -- having never been introduced to the concept of a universal medium of exchange that is seldom or never used for direct consumption -- invented such a concept. This would require an almost superhuman degree of creativity, seeing as the king or committee would need to have originated the idea of money in an experiential vacuum.
3) When money emerged, there was already a multitude of differently valued goods in the economy. If money had arisen as a state edict, the state would need to have pre-determined all the initial monetary prices and exchange rates for the myriad commodities already in existence. This would imply that money -- a characteristic of at least a somewhat free market -- would need to have begun in a setting of absolute government price controls -- a contradiction in terms.
Furthermore, absolute price controls have empirically shown to be unenforceable even in the most intrusive totalitarian dictatorships. How could an ancient king, with far less technology and manpower, have managed to impose the new monetary unit and all its accompanying exchange rates on his entire populace? His subjects likely would have been reluctant to immediately alter their lives in so radical a fashion. Their resistance would have rendered even a wise monetary scheme impossible to implement from above.
As an alternative to the state theory, Menger offers a view of money as derived from the spontaneous order of the free market. To Menger, money is a "product of human action, but not of human design."
Menger begins with the commonsense observation that different goods have different degrees of salability or liquidity. That is, some goods are more readily tradable for desired products than others. One might more easily find sellers for a bushel of grain than for a telescope, for example, thus rendering the bushel of grain more saleable. A prime measure of salability is the amount of time required to obtain an economic price for the good in question. One's neighbor might give one a mere loaf of bread for one's telescope, because the neighbor is not an astronomer and does not value telescopes highly. But this will not satisfy any prudent seller of the telescope. To find a fitting market price for the telescope, one would need to search longer and more carefully for professional astronomers who appreciate the telescope sufficiently to fittingly compensate the owner for it.
Some goods are significantly more salable than others -- especially goods which are permanent, durable, divisible, and whose smaller units are still highly valued. The precious metals -- especially gold and silver -- fulfill these criteria. Due to these precious metals' portability and ease of storage, it is much more advantageous to the seller of the telescope to trade it for gold and then to use the gold to purchase goods from sellers who might not themselves have desired the telescope. Gold thereby becomes a medium of exchange which -- though not used in direct consumption by most of its possessors -- is nonetheless desired for the sole purpose of indirectly obtaining consumption and production goods.
The emergence of a medium of exchange is a self-reinforcing process. Once an individual actor in the marketplace learns that others demand gold, he is more likely to demand gold himself in the interest of more readily facilitating trades with them. Subsequent actors are even more likely to use the same reasoning to seek to acquire gold; hence, the salability of gold increases dramatically to far outstrip the salabilities of all other commodities. Gold, then, becomes the natural, free-market choice for the best medium to facilitate complex, indirect economic transactions.
During the late 19th and early 20th centuries -- despite Menger's discovery of the law of marginal utility and his explanation of the origin of money -- mainstream economists did not use a marginal utility approach to account for the value of money. To them, the marginal utility approach seemed circular. To explain the value of money by claiming that an actor subjectively values each individual of unit of money was, in the minds of the mainstream economists, tantamount to asserting that money has value because money has value. While production and consumption goods had some objective qualities which accounted for why people valued them, money -- especially when used solely as a medium of indirect exchange -- did not seem to have any objective properties behind it. This erroneous paradigm was shattered by Ludwig von Mises' 1912 treatise, Theory of Money and Credit.
Austrian economists and Mises especially concentrate on value not in an objective sense, but from the point of view of the economic actor. Mises therefore strives to prove why money is subjectively valuable to its possessors. Mises refutes the circularity accusation leveled at the marginal utility approach by introducing the element of time in explaining the value of money. The economic actor values money now because of the purchasing power he expects it to have later. Why does he expect money to have purchasing power later? Because he has observed that money had purchasing power before -- that is, the actor has lived in a society where money was accepted as a universal medium of exchange, whether it be a paper or a commodity money.
From this insight originates Mises' regression theorem: the actor knows that money is valuable today because of its empirically observed value yesterday. He knew of its value yesterday because of its value the day before. This regress in time can be taken as far back as the origin of money on the free market, for which Menger's prior explanation accounts. Thus, there is no historical or empirical disconnect between the first origins of money as a valuable medium of indirect exchange and its present perceived value by individual economic actors.
Austrian Economics offers an elegant, logical, and thoroughly causal explanation of how money came to be, again demonstrating the power of the free market to spontaneously organize human activity in meaningful and universally beneficial ways. 
G. Stolyarov II is a science fiction novelist, independent philosophical essayist, poet, amateur mathematician, composer, contributor to The Autonomist, Le Quebecois Libre, and The Liberal Institute. He is also Editor-in-Chief of The Rational Argumentator , a magazine championing the Western principles of reason, rights, and progress. Learn about Mr. Stolyarov's newest science fiction novel, Eden against the Colossus, here and his newest non-fiction treatise, A Rational Cosmology, here . Mr. Stolyarov can be contacted at gennadystolyarovii@yahoo.com.
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