The Economics Of Bitcoin – Challenging Mises’ Regression Theorem – Prof. George Selgin Responds

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

 

If you liked this article and my previous works, please consider donating a fraction of a coin to my site.  See the sidebar for the address. Thanks for your support.

Related articles:

The Economics Of Bitcoin – Doug Casey Gets It Wrong

How To Use Bitcoin – The Most Important Creation In The History Of Man

Libertarian Goldbugs Hating On Bitcoin – Free Market Money

The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

The Economics Of Bitcoin – How Bitcoins Act As Money

Against The Gold Standard

The Ridiculousness Of Demanding Government Return To A Gold Standard

The Economics Of Bitcoin – Resource Allocation And Interest Rate Distortion

  • Hugo

    Im glad George Selgin is debating Bitcoin since he is as well one of my favorite economists. And I think I can answer one of his question/concerns. He writes:

    “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.”

    I can answer to this question because I was there and participating in the project when nobody accepted Bitcoin as a means of exchange. I had a low power computer mining bitcoins in early 2010 (if I knew they were going to develop so quickly I would have dedicated more computer power and not a shitty low power computer…). So I guess the question professor Selgin is askin is: Why did I do what I did? Why, if noone was accepting bitcoins and they had no value to almost anyone? Why did I asign value to those pieces of electronic data that noone accepted?

    My motivations, and I believe the motivations of the rest of the early adopters, were two (but they are mixed so maybe they are only one and a half): entrepreneurship and ideology.

    – I was an entrepreneur because I believed in a project and saw the oportunity when very few others did. I was projecting a vision into the future. I believed that Bitcoin could produce a better monetary system and ocupy a part of the currency market.

    – It was ideological because I though they could create a better world by allowing people to scape the monopolly on money imposed by governments.

    So there you go. Bitcoins had an initial value, but its not quite what Mises had expected something could have as initial value. To defend Mises one must say that imagining something like Bitcoin when the idea of Internet was not even imaginable is almost impossible.

    • http://twitter.com/rstybeach Bryan T.

      What most economists are missing in this debate is the fact that no other currency has been developed solely for use over the internet in the means that Bitcoin has. Economists can attempt to pigeonhole Bitcoins into a variety of different economic models only to see that it has no chance in the free-market, but their conclusions would be and are extremely limited.

      Those economic models do not consider the medium of exchange nor the entrepreneurial influence a new currency could pose (as suggested by Hugo). PLUS these economic models do not consider the current state of financial affairs in the world. With the U.S. dollar dropping and OPEC considering to trade oil in Euros and not Dollars, the world’s financial market is very unstable. Such an environment could sway many “iffy” entrepreneurs and consumers to start using Bitcoins because of Bitcoins separation from any world government and the world financial market.

      Something this new and innovative should not be pigeonholed into archaic economic models that attempt to explain physical currency. It is time for an economist to step into the realities of the virtual world to acknowledge and identify the correct parameters in which a currency like Bitcoin exists. Gold does not exist in the virtual world for a reason. Bitcoins do exist in the virtual world for a reason. This reason is completely ignored by the majority of economists who are critical of Bitcoins potential.  

  • Ben Abuya

    Prof. Selgin writes: “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.”

    But in fact cigarettes (if not butts), shells, and even Rai Stones  (which are impractical for any use other than as a means of exchange), have been used throughout history. Most of these things are inferior to gold and silver as MofE for various reasons, and are usually only used when those aren’t available. Bitcoin, otoh, has some distinct advantages over gold and silver, and it’s therefore not unexpected that it would have value for that use case.

  • Pingback: The Economics Of Bitcoin ? Challenging Mises … – Libertarian News | esekytapunyg()

  • Erik Voorhees

    Great post, very interesting to see the discussion.

    I’ve considered that Bitcoin does indeed have value purely apart from its monetary use (whether it needs this value in order to be a “real” money can be debated). This non-monetary value, as it turns out, is quite similar to gold.

    Gold’s “first use” was in fact not industrial, unless I’m mistaken. Its first use was aesthetic or ornamental. It was shiny and pretty and smooth. People liked it for these properties. Gold appealed to their desires. It was a “fascinating” thing.

    Bitcoin, in similar manner, had its original allure as a technological marvel. The Bitcoin protocol is both brilliant and elegant, and these attributes attracted early adopters even before it could be said to be effectively used as money. I would agree that this portion of Bitcoin’s value is very small relative to its monetary value, but nevertheless a Bitcoin was valued by curious onlookers before its monetary use.

    Like gold, Bitcoin was first demanded because it was “fascinating.” Both Bitcoins and gold have this original value as a fascination factor which helped set first prices… and the rest is history.

  • Pingback: The Economics Of Bitcoin ? Challenging Mises … – Libertarian News | ekonitigune()

  • Pingback: The Economics Of Bitcoin ? Challenging Mises … – Libertarian News | unecygilefip()

  • Vector

    I agree with some of your analysis, and your approach is well-reasoned (unlike most others who argue the same).

    I think “the demand for a medium of exchange is the composite of two partial demands” refers to the demand for any particular medium of exchange, not the demand for a facilitator in general.  For a medium of exchange with no commodity value (no use-demand), then the composition of partial demands is 0% for consumption and 100% for use as a medium of exchange.

    The question is whether this situation of 0% commodity demand and 100% currency demand can work.  (Whether bitcoin actually has 0% commodity demand is a separate question.)  I do not believe that fiat money actually belongs in this category, because of the distortion of legal tender laws.

    I think the problem with 100% currency demand is that there is no rational basis for establishing a price level.  Even if people see the value as a medium of exchange, it does not
    address the problem of how to establish a price level.  One bitcoin or
    1000 or 0.01 bitcoins serve equally well in facilitating trade.  Which price is to be used?

    When a commodity is used as currency, those wishing to use it as currency must outbid the industrial users, and as currency demand rises or falls, a greater or lesser fraction of the commodity will be devoted to currency use, and the price levels will change accordingly.  The currency then inherits its price level from the supply and demand of the commodity.

    Now, I would not go so far as to say that there can be no price level for items that have no commodity value.  This is obviously not true.  Price levels are regularly established for things that have no commodity value, whether or not they are used as currency.  What I would argue is that this demand is not rational.  For the sake of argument I will call the non-rational demand numismatic, in contrast with commodity demand.

    The same supply and demand rule applies for numismatics that are found to be valuable as a medium of exchange.  Those wishing to use it as a medium of exchange must outbid those wishing to hold it for numismatic reasons, and the market can settle on a price level as a result.  The difference, and the hazard, is that this value is not rational and I believe not stable.

    A related question is, if we presume the circular cycle has been broken and price levels have been established, can a currency with 100% demand as a medium of exchange be sustained.  In other words, if the numismatic and commodity demand both fall to zero, can a currency survive only on its medium-of-exchange value?

    When there is commodity demand or numismatic demand, those alternative demands provide not only a basis for an initial price level, but also elasticity and price stability over time.  If more or fewer people wish to use it as a medium of exchange, the alternative demands can accept the shortage or surplus without a large change in price.

    The elasticity and stability afforded by the non-currency demands does not mean that the currency cannot have stability without them.  But I think it’s important to understand what mechanisms exist, either necessarily or accidentally, that contribute to its stability.

    I can think of no mechanisms to sustain the value that exist necessarily, yet I can probably name a few that happen to exist today as a matter of fact.  This means the currency can survive as long as these conditions happen to be true, which is entirely different from being praxeologically necessary.

    To summarize, the problem is not that bitcoins cannot or do not have value, but that they need not have value.

  • Pingback: The Economics Of Bitcoin – George Selgin Responds | Bitcoin State()

  • A Country Farmer
    • Erik Voorhees

      Actually, Country Farmer, Bitcoin is as anonymous as the user wishes to make it. The article you cite – the author of that article posted this in his follow-up comments:

      “It is possible to use Bitcoin in a way that is almost certainly
      anonymous, in the same way it is possible to get almost certain
      anonymity on the Internet, by using encryption, onion routing, and never
      associating your identity with your actions.

      Our point is that
      you don’t get this anonymity automatically, and that most casual users
      of Bitcoin may not be anonymous, even though many of them may believe
      they are.”

      • Joe

        Erik, can you link to that comment?

  • Anonymous

    I like this blog so much. As this is mine first visit to this blog i found this blog informative and impressive one. I come to k now good knowledge about $Economics and investment from this blog which in future helps me in earning money by investment and CFD trading.
    forex

  • Pingback: Regresszió – kritika és cáfolat | Magyar Bitcoin Portál()

  • Pingback: Bitcoin Rebuttal Part 2 Pipe Transactions | OTC Capital Group()

  • Kyle J Marsh

    I just finished this response and your previous article and I must say they have been a pleasure to read. Kudos.