The Value of Money
[August 11, 2000]
Although 1870 saw a breakthrough in price theory, the advances of the marginalist revolution had not yet penetrated to monetary theory by the early decades of the 20th century. Most economists were still content to work with the centuries-old quantity theory of money even though it took an aggregated approach while the key insight of the new price theory was the link between a good's price and the valuation of it made by individual consumers.
Benjamin Anderson was among a handful of economists, led by Ludwig von Mises in his pioneering work The Theory of Money and Credit in 1912, who set out to integrate monetary theory into a general theory of value.
Like Mises, Anderson devoted a major portion of his The Value of Money, published in 1917, to a refutation of the "mechanical" quantity theory of money. Many of Anderson's arguments will be familiar to any student of Mises: the causes and effects from which the data of the quantity equation are constructed are disaggregated and complex; whatever the correlation between the aggregate variables of the quantity equation, correlation is not causation; causation cannot be established in the equation because there are no quantitative constants in human action (in particular, velocity is not constant); the quantity theory ignores time; there is no unambiguous way to define the variables in the theory: the money stock, velocity, the quantity of goods, and the price level.
Additionally, Anderson holds that whatever true propositions the quantity theory offers can as well be deduced from a correct theory of value and that many true theories of modern economics (such as the laws of demand and supply, the theory of capitalization, and Gresham's law) are inconsistent with it.
Although some true propositions can be had from the quantity theory, not every conclusion derived from it is true. Anderson expended much effort to demonstrate that many theories constructed upon it are false. For example, he argued that the independence between the stock of money and the quantity of goods, assumed for the purpose of reaching the conclusion that increases in the stock of money lead to proportional increases in the price level, if carried into macroeconomics has pernicious effects.
Specifically, it rules out of bounds any correct theory of the business cycle, which, he argued, was bound up with monetary inflation and credit expansion. Another example: if the price level cannot be defined then there is no such thing as a stable price level and consequently it makes no sense to claim that stable prices are superior for the economy than unstable prices. Anderson had insights that eluded monetarists: that inflation can exist in the economy even though the price index is stable and that money and credit are connected in a modern central-banking system. He chided the monetarist for advocating reflation and deficit spending as a cure for depression.
Anderson argued that macroeconomics in general and business-cycle theory in particular must be based on nonaggregated and nonmathematical thought and give due consideration for speculation, banking, money, credit, and international trade and finance. He devoted two full chapters and several sections of other chapters to issues involving credit in which he explained the critical role of money and credit in economic production and business cycles.
In searching for a general theory of value, Anderson staked out a middle ground between "extreme individualism," which sees prices as the outcome of the subjective and independent valuations of individuals, and "social organicism," which postulates a societal force separate from its members as determining prices and production. He argued that individual valuations, which determine prices, were manifestations of social value. Social value, in turn, was set by the "social mind," which is both the product of the totality of individual interactions and the cause of each individual's action. That is, a person's mind develops within the context of social relationships and thus, becomes part of, or one might say a manifestation of, the social mind itself.
Examples that Anderson gives of the products of the social mind include moral rules, law, and economic valuations. Particular illustrations of the latter would be fashions or investor confidence. Individual demands and supplies then have an objective basis, being determined by the social mind, and prices, which are the outcome of the interplay between demand and supply, are formed on the basis of social valuations. The social mind then has the function of properly allocating factors of production. And, as long as the social mind is relatively stable, prices do not vary greatly and patterns of production have continuity.
Anderson identified H.J. Davenport as a leading proponent of the extreme individualism view and criticized the marginal-utility explanation of price for asserting that marginal utility is a given instead of being determined itself by the social mind. Since it involves circular reasoning when applied generally to explain the prices of goods, Anderson argued, the marginal-utility theory has the same defect when applied to money. But despite his claim that Mises did not solve the circularity problem with his regression theorem, Mises in the English edition of The Theory of Money and Credit, called The Value of Money, Anderson's "excellent work."