Max Weber and the State Theory of Moneyby Fiona Maclachlan* I hope for the approval of those
who take the monetary system as a branch of political science. --G.F. Knapp (1924, p. viii) Max Weber has left us with a rich legacy of suggestive insight into many issues in sociology, economics, and political science. Of this legacy his reflections on issues in monetary theory are among his least well known. The reason is not far to seek: Weber himself did not devote much space to these reflections. In his two volume magnum opus, Economy and Society, for example, Weber’s discussion of monetary theory is contained in fewer than forty pages. Furthermore, his remarks in the sections devoted to monetary matters are somewhat cryptic, relating to issues current at the time of his writing, and thus not easily accessible to the modern reader. Most of the discussion in Economy and Society revolves around Georg Friedrich Knapp’s famous book The State Theory of Money. Published originally in 1905, it created a stir among academics and policy makers, with proponents and critics both arguing forcefully about it. It was written at a time when monetary matters were in a great flux. Throughout the world, countries debated the optimal metallic standard for their monetary systems. Should it be silver, gold, both in a fixed relation (bimetallism), a combination of the two (symmetalism), or should the selection of the standard be left to the market? Knapp put the debate on new ground by suggesting that there need not be a metallic standard at all. Ideas about the desirability of unbacked paper money had been presented before but were never able to command academic respectability. At one end of the
spectrum of opinion at the time were the members of the By chartal money , Knapp was referring to any money whose exchange value exeeds its intrinsic value. He traces it back to a time at which an early sovereign monetary authority would have its subjects hand in their metal coins and then issue back coins of lesser weight. Knapp expresses his approval of the evolution to chartal money when he writes: ““How strange that chartality of money, this achievement of exalted wisdom, this precious flower of State-ruled life, should have sprung from so base a root!” (Knapp 1924, p. 88) What Knapp took to be his major thesis in The State Theory of Money, however, was that in the modern age, the only consideration important in a state’s administration of a metallic standard is the maintenance of its foreign exchange rate. Knapp looked forward to a time when a metallic standard would be obsolete even in international payment systems—which, of course, came about in the post-Bretton Woods era. John Maynard Keynes was an important proponent of Knapp's ideas about the desirability of chartal money. From his remark in The Tract on Monetary Reform (1923) that gold is a barbarous relic through his discussion of chartalism in his Treatise on Money (1976 [1930], pp. 3-11) to his contribution to the Bretton Woods conference where he argued for an international exchange rate regime in which gold is replaced with the chartal bancor, Keynes’ views were in line with those of Knapp. Weber’s assessment of Knapp’s contribution was mixed. On the one hand, he criticizes Knapp for downplaying the danger of inflation and notes that the treatment of monetary theory that he finds “most acceptable” (Weber 1978, p. 78) is that of Ludwig von Mises, referring to his Theory of Money and Credit. But, on the other hand, Weber gives Knapp’s book lavish praise. He says that in spite of its limitations, it is "otherwise absolutely correct and brilliantly executed, hence of permanently fundamental importance" (1978, p. 169), adding that it is "one of the greatest masterpieces of German literary style and scientific acumen" (ibid., p. 179). Weber’s effusive praise is somewhat puzzling given his high opinion of Mises’ Theory of Money and Credit. Mises devotes an entire chapter in that work in criticism of Knapp’s State Theory of Money. In this paper I explore Weber’s reaction to Knapp’s book and attempt to unravel the puzzle. I begin by reviewing the aspects of Knapp’s book about which Mises and Weber were in agreement and note that they relate mostly to judgments about the potential of monetary authorities to behave in the public interest. I then examine the reasons why, unlike Mises, Weber maintained a highly favorable opinion of Knapp’s work. I argue that Weber stood closer to Knapp than Mises in the Methodenstreit and that from this position he could appreciate aspects of Knapp’s contribution that Mises neglected. Further, I argue that Mises’ neglect of the fundamental insights of The State Theory of Money has led to an ambiguity in his own monetary theory. This is turn has led to a division among his followers as they attempt to extend his theory. Weber’s Critique of Knapp’s State Theory of MoneyIn his
critical commentary of Knapp, Weber indicates that he was writing in
1920. Besides being the last year of his
abbreviated life (he died at the age of 56), it was a time leading up
to Weber was skeptical of Knapp's view that the state would carry out its monetary policy with the maintenance of its foreign exchange rate as its primary consideration. If this were true, states would not allow inflations to occur since they lead to a depreciation of the currency. But Weber points out that the state might allow a depreciation of the domestic currency if it has large debts to pay. Entrepreneurs, insofar as they may see their product prices rising without an equivalent rise in input prices, might welcome an inflation, as well. Finally, Weber notes that in the interest of stimulating the economy, the state has still another reason to allow an inflation to go forward. Weber understood well
the complexity of the relationship between changes in the money supply
and the changes in money prices, labelling
older forms of the quantity theory "incredibly primitive" (Weber 1978,
p. 172). After enumerating the reasons
that an accurate forecasting of the effect of a monetary expansion is
impossible, he makes the perhaps overly generous remark that "it is
thus understandable that, all things considered, Knapp should have
entirely neglected the possibility of
inflationary price policies being used in the modern market economy as
a deliberate rational policy comparable to maintenance of foreign
exchange stability" (Weber 1978, p. 89). But
Weber goes on to note that inflationary policies on the part of
governments are a historical fact. In
confessing that "the formulation of monetary theory, which has been
most acceptable to the author, is that of von Mises"
(1978, p.78), Weber suggests a sympathy with the Weber identifies what he believes a serious error in Knapp's justification for downplaying the danger of inflation in Knapp's insistence that everyone is equally a debtor and a creditor. Knapp makes use of the accounting truism that for every transaction the debits must equal the credits. His argument is that the real effect of a rise in prices should be minimal, since nominally both sides of the balance sheet are affected equally. About this line of argument, Weber (1978, p.193) correctly notes that "we now all know now from personal experience" that it is erroneous. In his fundamental assumptions about the behavior of the state, Weber was closer to Mises than Knapp. Like Mises he was skeptical that monetary authorities could be safely entrusted with the management of the money supply. Knapp, more like Keynes, had faith in the potential wisdom and integrity of the monetary authorities. His thesis that monetary authorities would concern themselves mainly with the maintenance of the foreign exchange rate was based on the assumption that they would behave in the national interest. Weber was unwilling to make that assumption going as far as to say that the money interest and public interest are rarely in unison (1978, p. xx). Money as a Creature of the State Weber's enthusiasm for Knapp’s book was most likely directed at the doctrine for which Knapp is usually remembered: the doctrine that money is a creature of the state, or alternatively put that money is a creature of the law. His ideas about monetary authorities formulating monetary policy only with a view to stability in foreign exchange rates are often neglected in summaries of his major contributions, although it is clear that he, himself, took these ideas to be central to The State Theory of Money. The
notion of money as a creature of the state was sharply criticized by Mises (1980, ch. 4;
1963, pp. 405-408). Mises
regarded money, rather, as a creature of the market.
Carl Menger (1892), the
father of the Austrian School of Economics with which Mises is identified, had expounded a theory
about the origin of money in which he shows that it is the unintended
consequence of the pursuit of self-interest within the context of a
free market. It is an example of a
"spontaneous order", the elucidation of which is one of the key
features of the work of the Mises labels his economic theory praxeology maintaining that within a praxeologic approach, it is possible to formulate exact laws. The spontaneous emergence of money in an exchange economy is one of those laws: The praxeological method traces all phenomena back to the actions of individuals. If conditions of interpersonal exchange are such that indirect exchange facilitates the transactions, and if and as far as people realize these advantages, indirect exchange and money come into being ... The historical question concerning the origin of indirect exchange and money is afterall of no concern to praxeology. The only relevant thing is that indirect exchange and money exist because the conditions for their existence were and are present. If this is so, praxeology does not need to resort to the hypothesis that authoritarian decree or a covenant invented these modes of exchanging. The étatists may if they like continue to ascribe the "invention" of money to the state, however unlikely this may be (Mises 1963, pp. 406-407). In Mises' complaints about a state theory of money, hints of the Methodenstreit are evident. Knapp was part of the German Historical School and at the time there was a major clash between the Historical School who believed that economic truth could only be ascertained through studying the pecularities of history and real world institutions, and the Austrian School, of which Menger and Mises were part, who argued that exact laws comparable to those in the physical sciences could be formulated. Oversimplifying a bit, one might say it was a struggle over whether economics was to be an empirical or theoretical discipline. That Mises and Knapp were on different sides of the Methodenstreit may explain the unsympathetic reading that Mises gave The State Theory of Money. A more careful reading would have shown that there is nothing in Knapp's exposition that is inconsistent with the account of the evolution of commodity money given by Menger (1892). Knapp admits that commodity money to which state money is historically linked arises from the free play of economic interests, as economic agents seek a better means of exchange than barter. The only difference would be that Knapp might claim that Menger's story is properly regarded as an historical account.[1] The regression theorem is an important contribution to Austrian monetary economics made by Mises. Again, something very similar can be found in Knapp, the difference being that he would not label his account as anything as grandiose as a theorem. Mises attempts to resolve the puzzle of why money has exchange value so much greater than its intrinsic value. Why can a piece of paper that may cost a few cents to produce command a hundred dollars in purchasing power? Mises says that one needs to consider that paper money is historically linked to a commodity and that if one regresses far back enough to the beginnings of indirect exchange, one will find a commodity used as money whose exchange value and instrinsic value were the same. In Human Action, Mises addresses the issue of whether his "theorem" is really more of an historical observation. He says that "to explain an event historically means to show how it was produced by forces and factors operating at a definite date and a definite place. . .. To explain a phenomenon theoretically means to trace back its appearance to the operation of general rules which are already comprised in the theoretical system" (1963, p. 410). Menger's theory of the origin of money and Mises's regression theory provide evidence that the two sides in the Methodenstreit may not have been that far apart on substantive issues in economic theory. In doing economics they reached the same conclusions; it was just in their account of what they were doing when doing economics that they clashed. Weber cannot be easily
classified within the Methodenstreit. His first attempted work in methodology was a critque of two members of the older German
Historical School, Roscher and Knies (Max Weber 1975). But
in his inaugural lecture as Professor of Economics and Finance at the Weber believed in the possibility of economic theory but saw it emerging in the form of a causal explanatory model in which human motives were the causal determinants. About these motives a social scientist has a unique type of knowledge which Weber called Verstehen: "We can accomplish something which is never attainable in the natural sciences, namely the subjective understanding of the action of the component individuals" (Weber 1978, p. 15). In place of the exact laws of the Austrian school, Weber proposed that we need a special type of theoretical construct. Following Georg Jellinek (Marianne Weber 1975, p. 314), he called these constructs ideal types. These abstractions may never occur perfectly in the real world but allow the analyst to structure his observations. The ideal type is not a presentation of reality, but it aims at providing the presentation with clear means of expression … It is not a hypothesis, but it aims at directing the formation of hypotheses. It is not historical reality or a scheme into which it is to be integrated, but a border concept by which reality is measured to elucidate certain significant components of its substance and with which it is compared. (ibid.) Weber could be seen as
transcending both sides of the Methodenstreit and this would explain why
he could accept Mises’ Knapp summarizes his delineation of money as follows: "What forms part of the monetary system of the State and what does not? The criterion cannot be that the money is issued by the State, for that would exclude kinds of money which are of the highest importance; I refer to bank-notes: they are not issued by the State, but they form a part of its monetary system. Nor can legal tender be taken as the test, for in monetary systems there are very frequently kind of money which are not legal tender ... We keep most closely to the facts if we take as our test, that the money is accepted in payments made to the State's offices. ... On this basis it is not the issue, but the acceptation, as we call it, which is decisive" (1924, p. 95). Knapp's thesis has a rare quality in economics of being both not obvious and not obviously incorrect. The Misesian view of money as a purely market phenomenon misses out on a role for the state. In his aversion to making statements that could be construed as non-theoretical, Mises may have neglected an important part of the truth. Knapp's historicism helps one understand how money evolves in interaction with the state. Modern accounts of Knapp’s chartalism (e.g., Wray 1999) emphasize Knapp’s conclusion that money is that which is used to pay taxes, but without putting it in the context of the historicist analysis that leads to this conclusion. Knapp puts significance on the historical fact that banks and states will collaborate in times of war. Banks will make loans to the state which may violate the principles of prudent lending: “certainly in doing so the bank has overstepped the limits prescribed for its business, but its guardian, the State, has compelled it” (Knapp 1924, p. 142). The bank’s credit money is used by the state to make payments in its war efforts which leads to an important juncture in the evolution of money: Since the courts cannot compel my subjects to pay in other ways than those in which I, the State, make payment, these notes are legal tender for all payments among private persons (ibid., p. 142). Knapp notes a “great change” (ibid., p. xx) has occurred. At one point the state would accept only specie money for the payment of taxes and would enforce contracts in specie money. But because of its financial exigencies relating to military expenditures, bank money, based on fractional reserves, gains a legitimacy within the economy that it did not have previously. Knapp’s ideal type allows us to easily resolve the conundrum of when credit is money. Economists have long observed that exchanges are often made with promises to pay. In business to business transactions paying on credit is the norm. Furthermore, these promises to pay can sometimes take the form of a note which can be transferred to a third party, who could transfer it to a forth party, and so on. It is natural to wonder if these notes should not be included as money. Knapp would say simply, no--not unless the government starts accepting them for payment of taxes. Thus bank deposits are money and commercial paper is not. Construed as an ideal type, Knapp’s concept of money “is not a presentation of reality, but it aims at providing the presentation with clear means of expression” (Marianne Weber, 1975, p. 314). Contrary to Mises’ interpretation of Knapp’s theory implicit in his critique (1966, pp. 405-408), it is not the legal tender laws which are essential to what is or is not money: the laws “merely express a pious hope” (Knapp 1924, p. 111). Knapp recognizes that money cannot be determined by decree. Rather it arises out of an interaction of the economic agents and the state as a payor and payee of money. Later in his discussion, Mises presents an explanation of the transition from a commodity money to bank money that echoes Knapp’s treatment in important ways. He agrees with Knapp that the motive for the state using bank money is to increase its resources. He makes the additional point that it is not the intention of the state to move from a commodity money to unbacked credit money. It is an unintended consequence: “This result has always come to pass against the will of the state, not in accordance with it” (1980, p. xx). In the modern literature based on Mises’ monetary economics, there are two distinct groups that have formed, both clashing to claim the Misesian mantle (see Hoppe 1994 vs. Selgin & White 1996; also Hülsmann 2003 vs. White 2003). The side of Hoppe and Hülsmann, which we could call an extreme libertarian position, insists that, in the absence of government intervention, money would be a commodity (most likely gold) and fully backed claims to that commodity. Credit money, such as bank deposits based on fractional reserves, they claim, is a fraud and that without government protections, would be rightly exposed to be so. This line of reasoning was argued forcefully by Mises student, Murray Rothbard (e.g., Rothbard 1990). Selgin and White take a more moderate libertarian position. They maintain that a monetary system based on fractional reserve banking is consistent with the absence of government involvement in the monetary system. They envision the possibility, at least in theory, of a libertarian state in which there exists a commodity standard with banks providing money to the system on a fractional reserve basis. Ironically given Knapp’s advocacy of unconstrained state intervention in the monetary system, his state theory of money leads one to accept the argument behind the more extreme libertarian position. Knapp’s hypothesis is that fractional reserve bank money comes into general use only because the state needs it to finance its activities. In a libertarian world with no state activities to finance, fractional reserve bank money would never come into existence. So we find the Rothbardians and Knapp in agreement about the issue of why bank money is included in the money supply. Both agree that, fundamentally, bank money is a creature of the state, and not as the free banking theorists would have it, a creature of the market. Conclusion In praising The State Theory of Money, Weber (1978, p. 78) notes that Knapp “solves the formal problem brilliantly.” But it is not clear from his discussion exactly what that formal problem is. We might speculate that it was the same problem that has plagued economists ever since they began to formalize their thoughts about money. How do we draw the line between various means of indirect exchange to clearly specify what is and what is not money? Conflicting definitions of money have led to many pointless debates in economics and progress would move forward more easily if a single definition could be established. Knapp’s contribution could be seen as the construction of a kind of “ideal type.” Money is that which is accepted at government pay offices. Knapp is abstracting from all other means of exchange to isolate this one type. Within his theoretical construction of money, unlike those often assumed by economists, the state plays a crucial role. But it is important to remember Knapp’s historicist analysis and understand the state does not select the thing in which it wants to be paid in total disregard for market usage. Knapp’s analysis is entirely consistent with the account of the origin of money presented by Menger (1892, 1981). In his discussion of Knapp, Schumpeter (1954, p. 1090) draws an analogy between the statement that money is a creature of the law with the statement that marriage is a creature of the law. Marriage customs existed long before the state began to play a role but in understanding what it means to be married today, one cannot abstract from the state—similarily with money. As Keynes (1976, p. 5) notes in his Treatise of Money, in addition to enforcing contracts that specify payment of the thing officially named money, the state “claims the right to determine and declare what things correspond to the name, and to vary its declaration from time to time—when that is to say, it claims the right to re-edit the dictionary.” As an “ideal type” Knapp’s construction serves to clarify thinking about monetary matters. Purely economic concepts of money such as the one proposed by Mises can lead the analyst into difficulties when tackling policy oriented questions. An example is the question of what type of monetary system is consistent with a libertarian state. Followers of Mises are divided on this issue. One group believes the absence of government intervention in the monetary system would lead to the use of a commodity money (most likely gold) and fully backed claims to it. While another group claims that it is consistent in a libertarian state to have a system of fractional reserve banking in which banks are able to create money through the money multiplier process. I argue above that an appreciation of Knapp’s analysis leads one to side with the former group.
Weber recognized as the major limitation of The State
Theory of Money its optimistic assumption that the state could be
trusted to properly manage a fiat money system. Writing
in References
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|
* Associate Professor,
Economics
and Finance,
[1]
Recently, Max Alter (Alter
& White 1990) made precisely this claim saying that Menger's
theory of the origin of money is a "truly historicist analysis." His statement provoked a reply from Lawrence
H. White (ibid.), a prominent modern
Austrian economist, denying any affinities between Menger
and historicists (or institutionalists as
they are
known today).