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• Two kinds of marketability
• Space-time duality
• The subjective theory of value
• Marketability in the large or salability
• The subjective theory of interest
• Marketability in the small or hoardability
• The paper boy and his silver dime
• The Fullarton-effect
• The chimaera of hoardability
Two Kinds of Marketability
It should not come as a surprise that the concept of
marketability plays a central role in explaining both the origin of money and
the origin of interest. The starting point of Carl Menger
in studying the origin of money was the observation that the economizing
individual who wants to exchange his surplus of X for Y may
nevertheless exchange X for Z first, provided that Z is
more easily exchangeable for Y than X, especially in large
quantities. Never mind that he has no need, or he has satisfied all his
needs, for Z. He will be closer to his ultimate end because Z
is more saleable than X. When the usefulness of a commodity for
the purpose of facilitating exchange is widely recognized, more and more
economizing individuals will proceed along the same lines and, finally, the
commodity that is most saleable (or, as we shall also say, most marketable in
the large) becomes money. The connection between salability
and marketability in the large becomes clear if we think of the great medieval
fairs. Producers from far-away places brought their accumulated surpluses to
the fair city. It was natural for them to quote their prices in terms of the
commodity that was most marketable in the large, because they were hoping to
buy and sell in bulk.
Following in Menger's
footsteps, we choose our starting point in studying the origin of interest
with a similar observation. The economizing individual who is producing
surpluses of x and wants to create a store of y may
nevertheless decide to create a store of z first, provided that z
is easier to exchange for y than x, especially in small
quantities. Never mind that he has no direct need for z now or in the
foreseeable future. He will be closer to his ultimate end because z is
more hoardable than x. When the
usefulness of one commodity for the purposes of hoarding and dishoarding is widely recognized, more and more
economizing individuals will proceed along the same lines and, finally, the
commodity that is most hoardable (or, as we shall
also say, most marketable in the small) becomes money. The connection between
hoardability and marketability in the small becomes
clear if we think of the local craftsman who wants to save for his old age. It
was natural for him to quote his prices in terms of the most marketable
commodity in the small. He was adding small bits at a time to his retirement
fund. And, after he started drawing on his fund, he would need to exchange
small bits of it for food and other daily necessities.
Notice that the most hoardable
commodity is generally not the most saleable one. This is the reason
why throughout the ages, up to 1870, there existed two different kinds of
money circulating side-by-side. In antiquity cattle became the most saleable
commodity, and salt the most hoardable one. Later
on these roles were taken over by others till, ultimately, the market has
settled on gold as the most saleable, and silver as the most hoardable commodity.
Space-Time Duality
This discussion reveals that money has a dual
nature. We can also derive the duality of money from philosophical
principles, notably from the duality of space and time. In every treatise on
money, in one form or another, the proposition is advanced that money
(whatever else it may be) is a transmitter of value through space and
time. The concept of money is therefore directly linked to these two
absolute categories of human thought. The dichotomy of space/time explains
the dualistic nature of money, explicitly observable throughout the ages --
right up to the demise of bimetallism scarcely over six scores of years ago. In
its first capacity money transmits value in space, that is, over great
distances with the smallest possible losses. In antiquity cattle were
particularly well-suited for this purpose and have become money.
However, cattle-money was not particularly suitable
for transmitting value over time with the smallest possible losses. This
explains the emergence of another kind of money, more suitable for hoarding
and dishoarding, that is, to facilitate the
transmission of value over time. This other kind of money was salt. Not only
was it less perishable than other marketable goods; salt was also the most
important agent of food preservation. In antiquity the threat of periodic
food shortages loomed large, and the chief agent of food preservation was
destined to assume a monetary role.
To people of the antique world it must have appeared
natural that two vastly different commodities answered their money-needs, and
they took the coexistence of cattle-money and salt-money for granted. Our
linguistic heritage clearly reflects this fact. The English adjective pecuniary
and noun salary were derived from the Latin words pecus
(meaning cattle) and sal (meaning salt). Even
though gold and silver which have later replaced cattle and salt were far
more similar to one another, the dual nature of money persisted throughout
the ages. The main reason for that was the fact that the specific value of
gold was high, and parceling it out in molar
quantities added substantially to the cost of production. Only towards the
end of the 19th century did advances in metallurgy make it possible that one
single monetary metal, gold, could answer both monetary needs of man better
than any other commodity. I refer to the development that has made it
possible to produce or to recover gold in molar quantities at a cost
competitive to the cost of producing the same value represented by silver
(for which molar processes were not needed, thanks to the lower specific
value of the silky metal). The practical outcome of this development was the
recognition that the best monetary system was gold monometallism.
As Bruno Moll put it in his book La
Moneda, "gold is that
form of possession which is of the highest elevation above time and
space".
The Subjective Theory of Value
The dualism of the monetary system is the starting
point of my investigations as I explore the two sources of man's need for
money. The first, man's need to transfer value over space, was put by Carl Menger in the center of his
subjective theory of value. The second, man's need to transfer value over
time (or, as I shall more specifically describe it, man's need to convert
income into wealth and wealth into income) is at the center
of my 'subjective theory of interest'. This is the preferred name we shall
apply to the new theory of interest to be developed in this course here at Gold Standard
University. In
developing his subjective theory of value Menger
described the origin of money in terms of the evolution of the marketability
of goods. The unit of value could be chosen only after the most saleable
commodity, gold, had been established as the monetary metal. Out of this
monetary metal the unit of value, the standard gold coin, could be made.
But marketability, like the ancient Italian god
Janus (in whose honor the first month of the year
has been named) has two faces: marketability in the large (salability), and marketability in the small (hoardability). The former is synonymous with Menger's term Absatzfahigkeit
which he has made the corner stone of the subjective theory of value. Hoardability has not been isolated before as a scientific
concept. Ours is the first attempt to analyze its role in the conversion of
income into wealth and wealth into income, so that it may become the corner
stone of the subjective theory of interest.
Marketability in the Large or Salability
Menger observed that
the market quotes not one but two prices: a higher ask price and a lower bid
price (understood as unit prices). He placed the bid/asked spread, the
difference between the two, right in the center of his analysis. We follow his insight and observe
that as ever larger quantities of a commodity are offered for sale, the
bid/asked spread widens. The market-maker takes a greater risk in buying or
selling unusually large amounts. To work off a greatly expanded inventory, or
to replenish a greatly reduced one, is time-consuming. In the meantime the
price could change unfavorably for him. The
market-maker compensates for his risks by quoting a wider spread. The behavior of the bid/asked spread is fundamental for the
determination of salability.
A commodity X is said to be more
marketable in the large, or more saleable than another Y if
the bid/asked spread for X increases more slowly than that for Y,
as ever larger quantities of X and Y are offered for sale
in the market. For example, perishable or seasonal goods have a lower, while durable goods or goods for all seasons a
higher, degree of salability. It is easy to see how
cattle have become the most saleable good in antiquity. People had superb
confidence that there could never develop a glut in the cattle market. Long
before such a turn of events owners would drive their herds of cattle to
regions where a shortage prevailed or, at least, there was no glut. The cost
of transporting a given value represented in the form of cattle was lower
than the cost of transporting the same value represented by anything else,
due to the mobility of cattle. This fact is also preserved in our linguistic
heritage. A herd is also known as a drove of cattle and the herdsman
as the drover (both are derived from the verb to drive). Thus
mobility or, better still, portability is an important aspect of salability. The more portable a commodity, the more
easily it can seek out havens where it is in the greatest demand.
The term salability refers
to the quality whereby a good is capable of being bought or sold in the
largest quantities with the smallest possible losses -- explaining how this
quality earns its name. Among the most saleable goods we find the precious
stones and metals. A long historical process has promoted gold to become the
most saleable of all goods. For gold, the bid/asked spread is virtually
independent of the quantity for which it is quoted. As we have seen, for
non-monetary commodities different spreads are quoted for different quantities, and the larger the quantity the larger is the
spread. For gold the spread only depends on the cost of shipping it to the
nearest gold center. Under a gold standard the
bid/asked spread is actually constant and is equal to the difference between
the higher and lower gold points. (The lower gold point is that price at
which it becomes profitable to melt down domestic gold coins in order to
export the bullion; the higher gold point is that price at which it becomes
profitable to import the bullion in order to have it coined at the domestic
Mint.)
The gold standard is seen as the result of a market
process in search of the most saleable commodity. Some authors deliberately
confuse the issue insisting that the constant spread for gold is due to
institutional factors such as the statutory requirement that the central bank
stand ready to buy or sell unlimited quantities of the metal, namely, buy at
the lower and sell at the upper gold point. But this argument is putting the
cart before the horse. Institutional constraints would sooner or later break
down if another metal with less than perfect salability
were substituted for gold as the monetary metal -- as indeed happened to
silver in the 19th century, to copper in medieval times, and to iron in
antiquity.
The Subjective Theory of Interest
We have studied the first source of man's need for
money: his need to transfer value over space. The second source, man's need
to transfer value over time or, as we have more specifically described it,
his need to convert income into wealth and wealth into income, is at the center of the subjective theory of interest. The duality
between the subjective theory of value and the subjective theory of interest
is remarkable. The two are related through monetary duality that has
prevailed through millennia.
It is common knowledge that, although precious
stones have a high degree of marketability in the large, their marketability
in the small is poor. The process of cutting up a large stone into a number
of smaller pieces often results in a permanent loss of value. This is an
example of the paradox that the value of a parcel may actually be greater
than the value of its component parts. Even for precious metals, whose
subdivision into smaller parts is fully reversible, marketability in the
small cannot be taken for granted. A penetrating example due to a 19th
century traveler is cited by Menger.
When a person goes to the market in Burma, he
must take along a piece of silver, a hammer, a chisel, a balance, and the
necessary weights. 'How much are those pots?' he asks. 'Show me your money',
answers the merchant and, after inspecting it, he quotes a price at this or
that weight. The buyer then asks the merchant for a small anvil and belabors his piece of silver with his hammer until he
thinks he has found the correct weight. Then he weighs it on his own balance,
since that of the merchant is not to be trusted, and adds or takes away
silver until the weight is right. Of course, a good deal of silver is lost in
the process as chips fall to the ground. Therefore the buyer prefers not to
buy the exact quantity he desires, but one equivalent to the piece of silver
he has just broken off." (Op.cit.,
p 281.)
I have in my possession the remnants of a heavy gold
chain that had once held the pocket-watch of my grandfather. The watch itself
was bartered away for food by my mother during hard times before I was born. But
I remember very vividly the delicate hands of the dentist as he was clipping
off an agreed weight from the chain with his fine pair of clippers in the
year 1945. He would not take paper currency in exchange for doing dental work.
Instead, his clippers went a long way to help my mother to discharge our
debt. Examples such as these justify the isolation of the concept of hoardability as the corner stone of the subjective theory
of interest. The buyer of pots in Burma, and my mother in Hungary, were
converting wealth into income. They must have been painfully aware of losses
due to chips of the precious metal falling to the ground.
Marketability in the Small or Hoardability
The precious metals are more hoardable
than precious stones, as the losses involved in parceling
them out into ever smaller pieces are smaller. It is this common-sense
experience that we want to generalize. Our first observation is that, as ever
smaller quantities of a commodity are offered for sale, the bid/asked spread
widens. A wider spread compensates the market-maker for the lack of
incentives to deal in unusually small quantities. The bid/asked spread is of
fundamental importance for the determination of hoardability
as well.
A commodity x is more marketable in the
small, or more hoardable than another y
if the bid/asked spread for x increases more slowly than that for y,
as ever smaller quantities of x and y are offered for sale in
the market. For example, non-perishable foodstuff such as
grains are more hoardable than perishable
ones. Horse meat is more hoardable than live
horses. It is easy to see how salt has become the most hoardable
commodity in antiquity. People were confident that disturbing surpluses of
non-perishable foodstuff would not develop. Everybody who could afford it
would be happy to hoard them. They realized that seven lean years would soon
follow the seven fat ones. For the stronger reason, people were superbly
confident that their hoard of salt, this foremost agent of
food-preservation before the age of refrigeration would not lose its value,
come rain or shine. Value could not be transferred over time with
smaller losses than through the stratagem of hoarding salt. Other examples of
highly hoardable commodities are: grain, tobacco,
sugar, spirits, silver. It is interesting to note the heavy government
involvement, at one time or another, with the production or trade of all
these.
The term hoardability
refers to the quality whereby a good is allowed to be bought or sold in the
smallest quantity with the smallest possible losses -- explaining how this
quality earns its name. It is this property that matters most when the
economizing individual is trying to convert income into wealth or wealth into
income. It is this property that is most crucial for him in solving the
problem of transferring value over time most efficiently. He will succeed
best if he employs the most hoardable commodity.
The Rise and Fall
of Bimetallism
An historical process similar to the one making gold
the most saleable has promoted silver to become the most hoardable
commodity. Gold was the money used to pay princely ransoms and to buy vast
territories such as Louisiana and Alaska. Silver, by
contrast, was the money used by people of small means to buy food, or to accumulate
capital (cf. the silver penny and Maundy money of England). As
long as the necessary technology was lacking, gold could not challenge
silver's position as the most hoardable commodity. The
cost of producing or verifying a small fraction of the unit of value as
represented by gold could involve expensive molar processes. As I have
already observed, the same small fraction of the unit of value represented by
silver incurred no such extra cost: the amounts involved were no longer
molar, due to the lower specific weight of silver.
This explains the rise of bimetallism under which
the dual monetary system that has prevailed since time immemorial assumed a
highly symmetric form. The most saleable commodity, gold, and the most hoardable, silver, have become monetary metals
spontaneously through the market process. Gold and silver coins continued to
circulate side-by-side for millennia. As long as governments adhered to a
"hands off" policy, the dual monetary system was highly successful.
In the end it was government meddling, in trying to enforce a rigid exchange
ratio for the monetary metals, that brought the
system down. For thousands of years the bimetallic ratio has been remarkably
stable, in fact, more stable than any other economic indicator. It was not
constant, however. There was a secular trend making gold relatively more
valuable with the passing of time, as the bimetallic ratio was slowly rising
from 10 in
antiquity to about 15 at the beginning of the Modern Age. Paradoxically, the
reason for the secular rise in the bimetallic ratio was the fact that gold
has become more widely available for monetary uses, partly through the
violent dispersal of ancient hoards (e.g., the rape of Persian gold by
Alexander the Great, and the rape of the gold of the Inca by Pizzaro), and partly through increasing output from the
gold mines. However, it is important to note that the volatility of the
bimetallic ratio has been so small that it has never provided speculators
with an opportunity to make a profit. The wild orgy of speculation in
precious metals, making windfall profits available, first started with the
fixing of the bimetallic ratio which has destabilized the dual monetary
system.
In fixing the official bimetallic ratio governments
were led by greed. They thought that they could make their vast hoards of
silver more valuable by stopping the slide in the relative value of the silky
metal. It is not in the power of earthly governments, however powerful
economically and militarily, to create value at will. Unfortunately, this
simple lesson has not been learned even today, as governments are engaged in
a mad race to flood the world with their own irredeemable currency before
others could do it with theirs.
The measure to fix the official bimetallic ratio
backfired. It signaled to people that time has come
to switch from silver-hoarding to gold-hoarding. In response, people started
dumping silver at the door of the Treasury while depleting its gold hoards. Governments
solemnly declared that they would defend their official bimetallic ratio
through thick and thin. However, eventually, they had to eat their words.
Once more, the market proved to be stronger than governments. They were
forced to replace bimetallism with gold monometallism.
As the history of bimetallism is widely misunderstood and even
misrepresented, I plan to return to it in a later Lecture to set the record
straight.
The Paper Boy and His Silver Dime
The mechanism of direct conversion of income into
wealth worked as follows. A wage earner aspiring to become his own boss
would, on every payday, put aside a silver dime or two not just for a rainy
day but, more importantly, for the day when he would quit the labor force and become a businessman. Silver dimes were
the agent of capital accumulation. Financial annals tell us about success
stories such as that of the shoeshine boy setting up shop at the main
entrance of the department store that he would eventually buy out. His secret
was the silver dime which he could hoard with confidence. Some countries,
especially poor ones, had even smaller silver coins in circulation, e.g.,
the half-dime of Newfoundland.
Mr. Warren Buffett started his own fortune,
reportedly among the greatest in the world today, as a paper boy in the
streets of Washington, D.C.
where his father the Hon. Howard Buffett served as
a member of the U.S. House of Representatives from Nebraska. It is an interesting question to
ask why paper boys are no longer on track to become multi-billionaires. Could
it have something to do with the government's denying the silver dime to
people? Ask Mr. Buffett whether he thinks that
paper boys still had a chance of ending up as the owner of the newspaper
empire whose papers they used to sell on the streets, by hoarding the 'clad'
dimes of today?
The Fullarton
Effect
By far the most important example of gold hoarding
in the modern world is furnished by the so-called Fullarton
effect. This important topic I shall study in full details in a future
course, Monetary Economics 202: The Advanced Theory of Interest -- The
Bond Market and the Formation of the Rate of Interest. John Fullarton of England published a book in 1844
entitled On the Regulation of Currencies in which he described the
reaction of bondholders to a falling interest-rate structure. They would
certainly not let the rate of interest fall through the floor. They would
take profits in selling their overpriced bonds, and put the proceeds into
gold, until bond prices have come back to earth once more. I shall refer to
this market action as the gold/bond arbitrage of the marginal bondholder. He
is guided by time preference. (Together with the productivity of capital,
time preference is one of the regulators of the rate of interest, as we shall
see in full details later.) It is important to understand that the sale of
the bond is not in itself sufficient to bring about the desired effect: a
reversal of the fall in the market rate of interest. For that it is necessary
that the proceeds of the sale be held in the form of gold. The Fullarton effect depicts gold hoarding as a protest vote
against interest rates being pushed down to unreasonably low levels through
institutional means by the banks or by the government. Holding gold as
opposed to holding a promise to pay gold is absolutely essential, to make the
protest effective.
Mises on Gold Hoarding
Ludwig von Mises ridiculed
gold hoarding calling it "the regular deus
ex machina" in Fullarton's
work (see Theory of Money and Credit, p 169). Mises
maintained that secure and mature claims to gold money are complete
substitutes for it and, as such, are able to fulfil all the functions
of money in those markets in which their maturity and security are
recognized. Mises has committed a great error in
refusing to accept the fact that the gold coin, but no claims to it, is the
indispensable agent of the marginal bondholder to validate his time
preference. We may assume that the maturity and security of circulating
claims to gold coins are fully recognized in the bond market. Even so, felt uneasiness
on the part of the marginal bondholder caused by the abnormally low rate of
interest (the flip-side of which is the abnormally high bond price) will not
be assuaged if he exchanges the bond for another piece of paper. However
mature and secure a claim may be, he wants to hold the metal (a present
good), and not a mere claim to it (a future good). His ultimate end is to
raise the rate of interest to the level of his time preference. It would be
counter-productive (not to say foolish) to exchange the bond for bank notes. Such
an exchange would mean extending credit at zero interest while forgoing the
positive interest on the bond he had sold. By contrast, holding the gold coin
does not involve extending credit -- in fact it is the only way of denying
it! The gold coin must be seen as the indispensable agent of the marginal
bondholder in asserting his marginal time preference. No fiduciary media can
ever be a substitute for the gold coin in this capacity. Time preference
would be little more than a pious wish if it was not for the cutting edge of
the gold coin which alone could validate it. In fact, time preference lacks
any concrete meaning outside of the arbitrage-nexus between the bond and gold
markets.
Mises categorically
states that the bank note is just as much a present good as the gold coin. "A
person who accepts and holds bank notes grants no credit -- he exchanges no
present good for a future good... A bank note is a present good just as much as gold money." (Op.cit., p 304-305.) I must part company
with Mises over this point. The issue whether a
bank note is a present or a future good goes right to the heart of the theory
of interest. My view is that holders of bank notes or gold certificates
are (voluntary or involuntary) grantors of credit, furthermore, their greater
or lesser willingness to continue to hold the paper is an important component
of the force determining the rate of interest. The only way for the
individual to deny credit to the banking system is to divest himself of his
holdings of bank notes and deposits in excess of his indebtedness. If we
admitted that a bank note were a present good, then we would also have to
admit that Keynes was right after all in suggesting that governments have the
power to create wealth out of nothing, simply by sprinkling some ink on
little scraps of paper. Gold hoards are far from being a deus
ex machina. They are, rather, a sharp tool of
human action by means of which the marginal bondholder can validate his time
preference under a gold standard. They are the very mechanism through which
savers exercise their franchise to regulate the rate of interest. It was
precisely for this reason that governments first sabotaged and, finally,
destroyed the gold standard. They wanted to disenfranchise the savers.
The culmination of these courses here at Gold Standard
University will be a
demonstration of my thesis that the apparent success of governments to
disenfranchise savers and to usurp their prerogative to regulate the rate of
interest will ultimately turn out to be a failure, and may even be the cause
of an unprecedented economic catastrophe. Savers, frustrated, turn en
masse from gold hoarding to marginal hoarding, that is, the hoarding of
other highly hoardable commodities, with disastrous
consequences. The Brave New World of synthetic credit, manufactured out of
inextinguishable debt, is unworkable. While gold hoarding is self-limiting,
marginal hoarding is not. It destabilizes the system of production and
distribution and generates a long-wave cycle, also known as the Kondratyeff cycle, complete with ruinous deflations and
depressions alternating with ruinous inflations, ultimately self-destructing
in a crack-up boom.
* * *
A Forgotten Anniversary
Other economists have also condemned gold hoarding. John
Maynard Keynes said that he was prepared to pass the pathology of gold
hoarding along to the psychiatrist for examination "with a
shudder". Politicians were jubilant in welcoming this verdict. Seventy
years ago, in 1933 during one of his fire-side chats F. D. Roosevelt declared
that he wanted to put an end to the "senseless practice" of
shuttling gold back and forth between the banks and individual depositors. What
he did not say was that he was going to rob both. He appealed to the
people to yield control over gold temporarily to the government so
that it may restore confidence in the monetary system. People responded, and
surrendered their gold out of patriotic zeal. No sooner had Roosevelt
plundered the gold belonging to the banks and their depositors than he wrote
up the value of the loot. There was no more talk about the temporary nature
of the measure. Today, 70 years after the event, there is still no talk about
guilt or reparation. The bad faith in this particular chicanery cries to
heaven for justice.
References
Carl Menger, Principles
of Economics, New York:
N.Y.U Press, 1981 (originally published in German in 1871 under the title Grundsatze der Volkswirtschaftlehre).
John Fullarton, On the
Regulation of Currencies, New York: A.
M. Kelley, 1969 (originally published in London, 1844).
March 1, 2003
Antal E. Fekete
Professor Emeritus
Memorial University
of Newfoundland
St.John's, CANADA A1C5S7
e-mail: aefekete@hotmail.com
GOLD UNIVERSITY
SUMMER SEMESTER, 2002
Monetary
Economics 101: The Real Bills Doctrine of Adam Smith
Lecture
1: Ayn Rand's Hymn to Money
Lecture 2: Don't
Fix the Dollar Price of Gold
Lecture 3: Credit
Unions
Lecture 4: The
Two Sources of Credit
Lecture 5: The
Second Greatest Story Ever Told (Chapters 1 - 3)
Lecture 6: The
Invention of Discounting (Chapters 4 - 6)
Lecture 7: The
Mystery of the Discount Rate (Chapters 7 - 8)
Lecture 8: Bills
Drawn on the Goldsmith (Chapter 9)
Lecture 9: Legal
Tender. Bank Notes of Small Denomination
Lecture 10: Revolution
of Quality (Chapter 10)
Lecture 11: Acceptance
House (Chapter 11)
Lecture 12: Borrowing
Short to Lend Long (Chapter 12)
Lecture 13: The
Unadulterated Gold Standard
FALL SEMESTER, 2002
Monetary
Economics 201: Gold and Interest
Lecture
1: The
Nature and Sources of Interest
Lecture 2: The
Dichotomy of Income versus Wealth
Lecture 3: The Janus-Face of Marketability
Lecture 4: The Principle of Capitalizing Incomes
Lecture 5: The Pentagonal Structure of the Capital Market
Lecture 6: The Definition of the Rate of Interest
Lecture 7: The Gold Bond
Lecture 8: The Bond Equation
Lecture 9: The Hexagonal Structure of the Capital Market
Lecture 10: Lessons of Bimetallism
Lecture 11: Aristotle and Check-Kiting
Lecture 12: Bond Speculation
Lecture 13: The Blackhole of Zero
Interest
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