Rothbard Chapter 3: Indirect Exchange

Although direct exchange plays an important role in Rothbard's move from human action to a modern economy, it plays a small role in modern economies. If I want a car and have corn to trade, it is unlikely that I find someone who wants that much corn and looking to sell a car. In jargon, we lack a double coincidence of wants. It would be quite the coincidence if a trade is acceptable for both parties. Anything more complicated than a banana for the rest of a snack-pack is nearly impossible. Even that trade is hard.

Emergence of Money

Suppose Ava has corn and would like to buy Bob's wheel-barrow. Unfortunately, Bob wants tobacco and not corn. However, after some searching, Ava finds a third person, Carl, who will buy corn for tobacco. Ava makes this trade, not for tobacco's use-value, but for its exchange-value. She want to sell the tobacco for a wheel barrow. This is indirect exchange. For Ava, the tobacco is just a medium of exchange.

More generally, for what goods will Ava sell her corn?  She wants something that she can trade easily in the future, since she does not actually want to use the medium of exchange, something with high marketability.

The level of marketability is a self-enforcing mechanism.  If Ava sells her corn for a highly marketable good, Carl is more likely to buy the marketable good (and therefore sell his wheel-barrow), because he can use it as a medium of exchange too. Over time, a few goods develop as common media of exchange. We call this money. It is a tricky term and there is no black/white definition of what is money and what is not.

Rothbard highlights a few characteristics that make a good marketable and increase its exchange-value as money-

  1. Desirability by others
  2. Divisibility
  3. Durability
  4. Transportability

The exact good used as money cannot be determined by praxeology or economics. However, through history, gold and silver have been very common, though not the only form. Keep this in mind when evaluating possible monies, such as Bitcoin.

Money and Specialization

Money allows for more specialization. This is key. In a direct exchange economy, nothing but the lowest production goods and consumption goods can exist. Ava could never buy a house with corn, but she can with money. Now, more complex arrangements are possible.

Producers can specialize in production, sell their goods for money, and buy other producers' goods with that money. "Nearly all exchanges are made against money, and money impresses its stamp upon the economic system" (pg 195.)

Balance of Payments

On top of the specialization, money allows for an accounting system of transactions, which Rothbard calls "a balance of payments." Ava sells her labor as a programmer and some old clothes and purchases money. This is an odd terminology for modern readers, but it is exactly what she is doing. The total amount of purchased money is Ava's income.

Similarly, Ava sells some money and buys food, new clothes, and a lawnmower. These make up Ava's expenses for that period. Any difference between income and expenses results in a change in cash balance at the end of the period. If Ava purchased $1,000 of money and sold $800, she has a cash balance of $200.

Simple accounting shows that this $200 change in cash balance must come from someone else. For the economy, the amount of money bought and sold must equal zero. Since both decisions to add to the cash balance (save) or subtract from it (dissave) are made by actors pursuing their goals, both are making the best choice. In fact, net savers is impossible. There is no need to worry about a balance of payments. When all accounts are included, it is zero.

Production and Money

Above, Ava sold money for consumers' goods. However, people also sell money and buy inputs in the production process. Unlike sellers of labor, sellers of producers' goods need to buy inputs before they are able to sell anything. They need to buy invest in factors of productions. Rothbard calls these actors capitalists. They spend money on producers' goods and can also be called producers.

It is important to note that producers must buy goods in anticipation of selling. Investors are always engaged in entrepreneurship, because they are looking to the future. If entrepreneurs can forecast accurately, the production process can be quite complex. Money is a vital signal in forecasting. Already, we can see the roots of Austrian business cycle theory.

However, to obtain the money for investing, the producer (or someone connected with him) has to save money. This necessarily involves a restriction in consumption. Readers of chapter one will start to notice the parallels. For an actor alone, investment requires a reduction in his consumption. This lengthens the production process. It is the same with a monetary economy, except now the reduction can be further removed from the actual investment. The reduction in consumption reveals itself in the form of an increase in cash balance. Producers can also borrow, but that is for later chapters.

Producers as Maximizer

Just like everyone in direct exchange, producers want to sell for the highest price, the most money. They want to buy at the lowest price, the least money. If they are successful, the cash-balance of the "producer-side" of an actor will have a positive cash balance, which is often called an accounting profit. 

This profit system simplifies thinking. Information is a scarce resource and money allows for a simplification in thinking. Instead of comparing the ranking of all the consumers' goods bought from the revenue and the inputs, the entrepreneur can now simply look at his profit. It is a shorthand signal for his efficiency. The producer tries to maximize this profit from production, which allows for more goods to be consumed by the "consumer-side" of an actor. Remember, consumption what we call the means to ends and are always the goals of action.

This maximization requires a key ceteris paribus qualifier. The producer wants to maximize profit, everything else being equal. If the production process requires work he does not enjoy the profit is not his only consideration. He might rank the higher (expect) profit and the worse work lower than the lower profit work. In that case, he will undertake the latter. He maximizes his psychic revenue.

Conclusion

For Rothbard, money is vital to an economy. It expands trade, the division of labor, and the production process. Yet, there is nothing magical about it. Money is just a special type of commodity. Actors buy and sell it, based on preferences for money.

This is different from money in other textbooks, which treat money as neutral afterthought. Rothbard considers money vital in expanding trade and the ability to calculate in production. Both of these aspects are different from Samuelsonian textbooks and come from differences in their understanding of knowledge.

With perfect knowledge and friction-less exchanges assumed in other texts, money is meaningless. I know I can sell my car for 1,000 bananas, because I know other people will buy 400 for a iPad, 300 for a TV, 100 for a Netflix membership, and 100 more for suit.

When economists assume perfect knowledge and market clearing, money does not help. Money is simply added to mimic the real world. Once we add frictions, then finally, money impacts the economy.

Leave a Reply

Your email address will not be published. Required fields are marked *