In the well-known show The Office (US), there are a few scenes in which Dwight attempts to introduce his currency, “Schrute bucks,” to his co-workers in hopes that they will do certain things to earn Schrute bucks. Eventually, when Dwight learns that his colleagues are uninterested in earning Schrute bucks, Stanley offers to give him a billion “Stanley nickels” to stop bothering him. At this point, Dwight asks a funny, but important question for our purposes here: “What’s the ratio of Stanley nickels to Schrute bucks?” To which Stanley responds, “The same as the ratio of unicorns to leprechauns.” Obviously, there can be no meaningful ratio, either between these two imaginary currencies or between these currencies and goods and services because neither currency has a previously-established referent for exchange.
While comedic, this scene illustrates an important point about the nature of money and monetary units, and, although some economists do discuss this scene, they seem to miss this point. Dwight’s question presupposes that there is some determinate exchange-ratio between Stanley nickels and Schrute bucks. But the more fundamental problem is that neither currency has an established purchasing power or exchange-ratios relative to other goods and services. Without such exchange-ratios, there is no meaningful basis for determining the purchasing power of either currency, much less how many units of one should exchange for a unit of the other. The question, “What’s the ratio of Stanley nickels to Schrute bucks?” is therefore not merely asking for a number; it is asking for the underlying exchange relationship that would make the two currencies economically meaningful. Without such a relationship, the numbers attached to the currencies are arbitrary.
The same problem arises when we ask how a monetary unit can meaningfully function as a unit of account. A unit of account allows us to evaluate and compare the exchange-values of heterogeneous goods by expressing those values in a common monetary unit. But for that common denominator to be meaningful, the monetary unit must itself be grounded in determinate exchange-ratios and purchasing power. Otherwise, we are attempting to express the values of other goods in terms of a unit whose own exchange-value is undefined.
These realities bolster the Menger-Mises monetary theory and reveal a profound problem with chartalism, the state theory of money, and Modern Monetary Theory (MMT). This article examines a problem that would arise on the theoretical first day of chartalism: What is the referent of a newly-created fiat monetary unit? Is it market-given or politically-determined? How can a definition-less fiat-token acquire determinate exchange-value and function as a meaningful unit of account in the first place?
A Unit of Account
“If we determine that a Dollar shall be our Unit, we must then say with precision what a Dollar is.” — Thomas Jefferson
Money is able to function as a unit of account. A unit of account allows people to evaluate and compare the exchange values of heterogeneous goods by expressing those values in a common monetary unit. The monetary unit does not itself create these exchange values, however; it provides a common denominator in which they can be expressed. For example, a banana and a can of tennis balls are heterogeneous goods, but, in a monetary economy, we can evaluate both using money prices. If a banana costs $0.25 and a can of tennis balls costs $5, the dollar price allows us to compare their exchange ratios: a can of tennis balls exchanges for the equivalent of twenty bananas. This allows for price comparisons and economic calculation.
Prior to money, non-monetary exchange-ratios (i.e., “prices”) existed in a barter economy. Absent coercion, goods (or fractions of goods) exchanged for one another according to supply and demand. As certain goods—usually measurable weights of gold or silver—began to be exchanged indirectly as media of exchange and became generally accepted, they were thereby enabled to function meaningfully as units of account. Writes Rothbard,
Because gold is a commodity medium for all exchanges, it can serve as a unit of account for present, and expected future, prices. It is important to realize that money cannot be an abstract unit of account or claim, except insofar as it serves as a medium of exchange. (emphasis added)
Note that, according to Mengerian-Misesian monetary theory, the goods that became money, then units of account, were already integrated into a matrix of exchange-ratios determined by supply and demand. This provides the basis for both money’s original purchasing power and, consequently, money’s price relative to other goods and services and usefulness as a unit of account.
Rothbard explains the price of money in terms of an array of all goods and services for which a unit of money will exchange on the market, establishing meaningful exchange-ratios between money and goods,
The inverse of the money price of any good gives us the “goods-price” of money in terms of that particular good. . . . In a money economy, every good except money now has one market price in terms of money [i.e., it can now be a fit unit of account]. Money, on the other hand, still has an almost infinite array of “goods-prices” that establish the “goods-price of money.” The entire array, considered together, yields us the general “good-sprice of money.”. . .
For every good except money, then, the purchasing power of its unit is identical to the money price that it can obtain on the market. What is the purchasing power of the monetary unit? Obviously, the purchasing power of, e.g., an ounce of gold can be considered only in relation to all the goods that the ounce could purchase or help to purchase. The purchasing power of the monetary unit consists of an array of all the particular goods-prices in the society in terms of the unit. (emphasis in original)
Thus, in Austrian theory, the concept of a unit of account is meaningful because it is grounded in a determinate definition (e.g., a specified weight of gold), market exchange-value, and previous purchasing power. To be meaningfully established as a unit of account, a monetary unit must previously possess these things. Otherwise, it would be an attempt to define the exchange-values of all goods and services in terms of a monetary unit that itself has no determinate definition or exchange-value (e.g., Schrute bucks). Attempting to introduce a unit of account, independent of preexisting purchasing power, is nonsensical. According to Rothbard,
Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a “claim on society”; it is not a guarantee of a fixed price level. It is simply a commodity.
He continues,
. . .in contrast to directly used consumers’ or producers’ goods, money must have pre-existing prices on which to ground a demand. But the only way this can happen is by beginning with a useful commodity under barter, and then adding demand for a medium to the previous demand for direct use.
But what happens when the monetary unit is not defined as a quantity of some commodity that already possesses exchange-value on the market?
The Ungrounded Unit of Account and Price Controls
If the chartalist says that the state can simply declare the unit of account by fiat, what gives that unit its determinate exchange-value in the market? In other words, what, how much, and why will people exchange for the definition-less monetary unit?
The claim of chartalism and MMT is that the political state gives the market its unit of account by issuing otherwise worthless fiat-tokens, which acquire purchasing power because the state denominates debts in terms of those tokens and accepts them in payment of taxes. Thus, because of the state, money becomes money. Writes L. Randall Wray,
The [neo-chartalist] approach begins with the recognition that no matter what might have been the case in the long distant past, the nearly universal situation today is one in which the nation state establishes the unit of account to be used within its boundaries.
Wray argues that, from the beginning, “government played an important role in determining what would function as unit of account. . .” It is clear that, according to Wray, the government-decreed unit of account precedes and enables a currency’s use as a medium of exchange,
Certainly the government’s tokens can also be used as a medium of exchange, but this derives from its ability to impose taxes, and indeed is necessitated by imposition of the tax (if one has a tax liability but is not a creditor of the crown, one must offer things for sale to obtain the crown’s tokens).
That process would explain some demand for the fiat-tokens to pay taxes; however, it does not solve the issue that there would still be no preexisting exchange-ratios between the token and any other goods or services. In other words, it remains unclear how many fiat-tokens will be exchanged for full or partial goods or services, that is if people accepted them in exchange at all (except for taxes or because of legal tender laws, etc.). The fiat-token cannot serve as a unit of account because there is no calculus by which either the people or the political elites can establish or calculate an exchange-ratio between a definition-less monetary unit and all other goods and services. The fiat monetary unit cannot account.
Theoretically, the only way that a definition-less fiat-token can be introduced, grounded, and operate meaningfully as a unit of account is if the issuer also provides a corresponding, comprehensive, and compulsory list of exchange-ratios between the token and all other goods and services. This would simply be a comprehensive system of price controls. (This can work in a game like Monopoly because the definition-less fiat-token acts as a unit of account within a preestablished system of exchange-ratios or prices). Under such a regime, with a fiat unit of account plus comprehensive price controls, prices would communicate no genuine information about relative supply and demand and meaningful economic calculation by entrepreneurs would be impossible. Both the fiat money and fiat prices would offer no catallactic information for economic science because they would both be mandated arbitrarily.
It is here that Mises offers a devastating critique, made over a century ago,
Another acatallactic doctrine seeks to explain the value of money by the command of the state. According to this theory the value of money rests on the authority of the highest civil power, not on the estimation of commerce. The law commands, the subject obeys. This doctrine can in no way be fitted into a theory of exchange; for apparently it would have a meaning only if the state fixed the actual level of the money prices of all economic goods and services as by means of general price regulation. Since this cannot be asserted to be the case, the state theory of money is obliged to limit itself to the thesis that the state command establishes only the Geltung [validity, worth] or validity of the money in nominal units, but not the validity of these nominal units in commerce. But this limitation amounts to abandonment of the attempt to explain the problem of money. (emphasis added)
Mises’s point here may be a bit challenging to fully grasp at first due to the fact that his foresight into the problem might see further than we do at first reading. He first calls the state theory of money an “acatallactic” doctrine. By “catallactic” Mises means “the Science of Exchanges,” so chartalism, or the state theory of money, is acatallactic because it does not seek to explain money within an economic theory of supply, demand, and exchange. Therefore, Mises sees the state theory of money—that a fiat-token has value because the state says so—as an “abandonment of the attempt to explain the problem of money.” In other words, there is no economic explanation of why money has its purchasing power or why it exchanges against other goods and services; we are no longer explaining money within a science of exchanges. Ironically, to go further, while Mises considered chartalism an abandonment of the economic issue of money, neo-chartalists attempt to simultaneously use history to establish their theory and attack their opponents only then to abandon monetary history as irrelevant concerning modern money.
Mises then draws the same conclusion as above: if the state were actually to determine the purchasing power of its definition-less monetary unit by political command, it could do so only by fixing “the actual level of the money prices of all economic goods and services” through “general price regulation.” In other words, the state would need a system of corresponding, comprehensive, and compulsory price controls to make the otherwise meaningless fiat-token meaningful in commerce. But that would still not provide an economic explanation of money. It would merely replace market-determined exchange-ratios with politically-imposed ones.
Mises also makes a point about economic history and the comprehensive price controls necessary to salvage chartalism theoretically: “this cannot be asserted to be the case. . .” As simple as this seems, it is devastating to note that, if the logic above is sound and comprehensive price controls of all goods and services would be necessary to ground a fiat-token as a meaningful unit of account, then there is no historical evidence that this ever occurred and the burden of proof would be on the chartalists to provide it. Certainly, there have been price controls throughout history, but it cannot be shown that a comprehensive system of price controls was ever introduced to establish the exchange-ratios between a government’s new fiat-token and all other goods and services. The historical record therefore does not provide the missing mechanism by which a definition-less fiat-token could become a meaningful unit of account.
Conclusion
The state can declare a monetary unit and establish that a certain number of those units are legally owed to the state. But that does not, by itself, establish the purchasing power of those units in commerce. To determine their actual exchange-value by political command, the state would have to fix the money prices of economic goods and services generally. Otherwise, the state has established only a nominal unit, not a determinate unit of account grounded in market exchange-ratios.
Either the exchange-ratios are market-determined or they are state-determined. If market-determined, then the market is supplying the exchange-value of both a commodity money or the fiat-token. Taxation may create demand for a token, but it does not by itself explain the token’s determinate purchasing power or its ability to function as the unit in which those values are calculated. If state-determined, then the state must prescribe a comprehensive system of prices—price controls—to make its definition-less token meaningful as a unit of account.
At this point, the chartalist may object that the state does not need to establish the price of every good. It need only create a tax liability denominated in its currency. The state can force people to trade real resources with it in exchange for the fiat-tokens. People will also acquire the currency because they need it to satisfy their tax obligations, after which market exchange determines the currency’s purchasing power. Notice, the argument has been relocated. Taxation no longer creates the value of money; it creates a reason to demand the money, while market exchange determines what the money is worth. The exchange-value of the fiat-token is therefore being supplied by the market after all.
The question then becomes: How does the market determine the initial purchasing power of a token that has no preexisting exchange-value? We have simply arrived back at the original regression problem. If the answer is that people value and exchange the token according to their subjective valuations, we must still explain how they arrive at those valuations and establish exchange-ratios between the token and other economic goods in the first place. The chartalist explanation has therefore not solved the problem of money’s origin or purchasing power; it has merely pushed the problem one step backward.
