The following is commentary from Professor George Selgin in response to my article The Economics Of Bitcoin – Challenging Mises’ Regression Theorem. Professor Selgin is another one of my favorite economists. I love his work on the private supply of money. You can watch a lecture by Prof. Selgin on the private supply of money here. I highly recommend it. It’s packed full of great information.

Prof. Selgin writes:

Dear Michael,

Because I’m preparing to go overseas I haven’t time to give much thought to your remarks about BitCoin and the regression theorem. However, I thin you should be aware that the characterization of the latter you refer to is incorrect. According to it, “…because of Menger’s explanation of the origin of money. We can trace the purchasing power of money back through time, until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained. People valued gold for its own sake before it became a money, and thus a satisfactory theory of the current market value of gold must trace back its development until the point when gold was not a medium of exchange.

First of all, you offer this remark in a manner that makes it appear to come from Mises; in any event you supply no other source for it. Yet I’m quite certain that Mises never wrote any such thing, not only because the laanguage isn’t his, but because the quoted passage get’s the regression theorem utterly backwards. The theorem isn’t aimed at explaining the “current market value of gold”! It is aimed at explaining the value of fiat money.

Nor do I think that your arguments address the real challenge facing issuers of a new fiat money, which is that, because such money necessarily has no non-monetary value, it cannot readily be assigned a purchasing power by those who might otherwise dare to be the first to accept it in exchange for goods. Your theory seems, like Patinkin’s, to simply take for granted that some traders assume that BitCoin will be regarded by others, to some definite extent, as a medium of exchange, so that they can assign imagine the relevant MofE demand and supply schedules and proceed from there. But this apprach begs the question: on what is the assumption in question based? It must have some basis, or else traders might as well assign a positive MofE value to anything and everything–spent matches; cigarette buts; pebbles–on the ground that it, too, might conceivably become an exchange medium.

Kirzner has an excellent, unpublished paper on the problem with the Patinkin critique of Keynes, which I cite in my 1994 piece (I think). If Pete cannot secure one for you, I will try to find mine. But you must be patient as I’m leaving the country for a week tomorrow.

Best,

George Selgin

My rebuttal:

Dear Prof. Selgin,

The quote that defines Mises’ Regression Theorem is a Bob Murphy paraphrase of the regression theorem taken from this Mises Daily article. I suppose I should include Mises actual remarks on the theory for those who are unfamiliar with it. The entire theory can be found in Human Action, Chapter 17 Section 4.

You write:

The theorem isn’t aimed at explaining the “current market value of gold”! It is aimed at explaining the value of fiat money.

I disagree that Mises is strictly limiting his theory to explaining how the value of fiat money comes about. He’s clearly discussing how money itself comes into existence.

Mises writes:

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its “price” as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange. If people stop using the good in question as a medium of exchange, this additional specific demand disappears and the “price” drops concomitantly.

Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange. With regard to modern metallic money one speaks of the industrial demand and of the monetary demand. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.

Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble so that they abstained from following farther along this line of reasoning. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power.

The difficulty is, however, merely apparent. The purchasing power which we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle.

Clearly Mises is discussing the market value of metallic commodities as money. Perhaps its just Mises’ phraseology that I have a problem with, but I think the demand for a medium of exchange is not a composite of industrial use and as a medium of exchange. The two things are entirely distinct and separate issues, thus it would makes sense if Mises said “the demand for gold is the composite of…” but not “the demand for a medium of exchange is a composite of…”

You write:

Nor do I think that your arguments address the real challenge facing issuers of a new fiat money, which is that, because such money necessarily has no non-monetary value, it cannot readily be assigned a purchasing power by those who might otherwise dare to be the first to accept it in exchange for goods.

I actually think my theory does solve this problem. If we consider that to the extent that people believe the supply of fiat money is limited, a State could issue fiat money and people could ascribe it a value in the market all on its own without the money having any prior use. We can clearly see with Bitcoins that people were able to ascribe Bitcoins a value in the open market without Bitcoins having prior demand for use in some other application.

Mises is stating that because demand previously existed for gold due to consumption or production of gold fabricated goods, people were able to readily ascribe it a value for its use as a medium of exchange. Since all they would need to do is horde some gold products for use in trade at a later date, and as more people engaged in this behavior, gold’s use as a money would come into existence.

While I agree with Mises that this is most likely how gold’s use as a money came to be, I disagree specifically with his statement that:

…the regression does not go back endlessly. It reaches a point at which the explanation is completed and no further question remains unanswered. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday’s exchange value is exclusively determined by the nonmonetary –industrial–demand which is displayed only by those who want to use this good for other employments than that of a medium of exchange.

Mises is conflating all monies with metallic commodities. While Mises theorem makes sense for gold it does not make sense for Bitcoins. Consider that Mises openly states:

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it.

Since this is indeed the case, we can say that there is a pre-existing market need for a medium of exchange. Since the market is able to recognize a need for a medium of exchange, we can say that anything that can fulfill this need will have inherent value in and of itself to market participants.

Thus, if something is viewed by the market as having inherent value, prices for it can be established by market participants through normal market action. People can look at a Bitcoin and see that it has value as a medium of exchange, even if Bitcoin has no value for any other purpose. Since they can see inherent value in the coins, they will be willing to trade some products for it until a pricing for the coins is established.

You go on to write:

Your theory seems, like Patinkin’s, to simply take for granted that some traders assume that BitCoin will be regarded by others, to some definite extent, as a medium of exchange, so that they can assign imagine the relevant MofE demand and supply schedules and proceed from there.

correct.

But this apprach begs the question: on what is the assumption in question based? It must have some basis, or else traders might as well assign a positive MofE value to anything and everything–spent matches; cigarette buts; pebbles–on the ground that it, too, might conceivably become an exchange medium.

I don’t think it begs the question, since as Mises notes, “a new employment has emerged…and creates an additional demand for it”. Mises is stating that people were able to see the benefits of having a money, so they actively sought out a product that could fulfill this need.

Thanks so much for your response Prof. Selgin. I hope to hear more from you on this subject in the future. My article has garnered a lot of attention from the Bitcoin community and many people are eager to hear more about the economics of the Bitcoin currency system from someone who is as competent in Austrian monetary theory as yourself.

Sincerely,

Michael Suede

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